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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM__________ TO__________ .
COMMISSION FILE NUMBER: 0-1100
HAWTHORNE FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 95-2085671
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER IDENTIFICATION NO.)
ORGANIZATION)
2381 ROSECRANS AVENUE, 2ND FLOOR
EL SEGUNDO, CALIFORNIA 90245
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 725-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(TITLE OF CLASS)
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [X]
As of February 25, 2000, the aggregate market value of voting stock held by
nonaffiliates of the registrant was approximately $38,637,556 (based upon the
last reported sales price of the Common Stock as reported by the Nasdaq National
Market). Shares of Common Stock held by each executive officer, director, and
shareholders with beneficial ownership of greater than 10% of the outstanding
Common Stock of the registrant and persons or entities known to the registrant
to be affiliates of the foregoing have been excluded in that such persons may be
deemed to be affiliates. This assumption regarding affiliate status is not
necessarily a conclusive determination for other purposes.
The number of shares of Common Stock, par value $0.01 per share, of the
Registrant outstanding as of February 25, 2000 was 5,544,301 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report incorporates by reference portions of the
Proxy Statement to be filed with the Securities and Exchange Commission in
connection with the Registrant's 2000 Annual Meeting of Stockholders.
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HAWTHORNE FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10-K
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 21
Item 3. Legal Proceedings........................................... 22
Item 4. Submission of Matters to a Vote of Security Holders......... 23
Item 4A. Executive Officers.......................................... 24
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 25
Item 6. Selected Financial Data..................................... 26
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 28
Item 7A. Quantitative and Qualitative Disclosure about Market
Risks....................................................... 39
Item 8. Financial Statements and Supplementary Data................. 40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 40
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 41
Item 11. Executive Compensation...................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 41
Item 13. Certain Relationships and Related Transactions.............. 41
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 41
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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
When used in this Form 10-K or future filings by Hawthorne Financial
Corporation ("Company") with the Securities and Exchange Commission ("SEC"), 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. Also, the Company wishes to advise readers that various
risks and uncertainties could affect the Company's financial performance and
cause actual results for future periods to differ materially from those
anticipated or projected. Specifically, the Company cautions readers that the
following important factors could affect the Company's business and cause actual
results to differ materially from those expressed in any forward-looking
statement made by, or on behalf of, the Company:
- Economic Conditions. The Company's results are strongly influenced by
general economic conditions in its market area. Accordingly,
deterioration in these conditions could have a material adverse impact on
the quality of the Company's loan portfolio and the demand for its
products and services. In particular, changes in economic conditions in
the real estate industry may affect its performance.
- Interest Rate Risk. The Company realizes income principally from the
differential or spread between the interest earned on loans, investments,
and other interest-earning assets, and the interest paid on deposits and
borrowings. The volumes and yields on loans, deposits, and borrowings are
affected by market interest rates. As of December 31, 1999, 87.5% of the
Company's net loan portfolio was tied to adjustable-rate indices such as
Prime Rate, 11th district cost of funds (COFI), MTA, CMT and LIBOR. The
majority of the Company's deposits are time deposits with a stated
maturity (generally one year or less) and a fixed rate of interest. The
borrowings from the FHLB also carry a fixed interest rate for a term of
up to 10 years, although the weighted average maturity of the borrowings
as of December 31, 1999, was four years and six months.
Changes in the market level of interest rates directly and immediately
affect the Company's interest spread, and therefore profitability. Sharp
and significant changes to market rates can cause the interest spread to
shrink or expand significantly in the near term, principally because of
the timing differences between the adjustable-rate loans and the
maturities (and therefore repricing) of the deposits and borrowings.
Rising interest rates can also adversely affect the Company's ability to
earn money by (1) causing an increasing number of borrowers to cease
making payments on their loans (because the required payments, which
adjust with changes to the market interest rates, may have risen beyond
their financial resources), and (2) reducing the volume of financing
opportunities and new loan commitments (because higher interest rates
tend to make the refinancing of real estate less attractive to owners, or
because the availability of mortgage credit and equity funds is reduced,
thereby dampening the liquidity of the region's property markets).
- Government Regulation and Monetary Policy. All forward-looking statements
presume a continuation of the existing regulatory environment and United
States' government monetary policies. The banking industry is subject to
extensive federal and state regulations, and significant new laws or
changes in, or repeals of, existing laws may cause results to differ
materially. Further, federal monetary policy, particularly as implemented
through the Federal Reserve System, significantly affects credit
conditions for the Company, primarily through open market operations in
United States government securities, the discount rate for member bank
borrowings and bank reserve requirements, and a material change in these
conditions would be likely to have a material impact on the Company's
results.
- Competition. The Company competes with numerous other domestic and
foreign financial institutions and non-depository financial
intermediaries. The Company's results may differ if circumstances
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affecting the nature or level of competition change, such as the merger
of competing financial institutions or the acquisition of California
institutions by out-of-state companies.
- Credit Quality. A significant source of risk arises from the possibility
that losses will be sustained because borrowers, guarantors and related
parties may fail to perform in accordance with the terms of their loans.
The Company has adopted underwriting and credit monitoring procedures and
credit policies, including the establishment and review of the allowance
for credit losses, that management believes are appropriate to minimize
this risk by assessing the likelihood of nonperformance, tracking loan
performance and diversifying its credit portfolio, but such policies and
procedures may not prevent unexpected losses that could materially
adversely affect the Company's results.
- Other Risks. From time to time, the Company details other risks with
respect to its business and/or financial results in press releases and
filings with the SEC. Stockholders are urged to review the risks
described in such releases and filings.
The risks highlighted herein should not be assumed 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 that 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.
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PART I
ITEM 1. BUSINESS
GENERAL
ORGANIZATION
Hawthorne Financial Corporation ("Hawthorne Financial" or "Company"), a
Delaware corporation organized in 1959, is a savings and loan holding company
that owns 100% of the stock of Hawthorne Savings, F.S.B. ("Hawthorne Savings" or
"Bank"). Hawthorne Savings was incorporated in 1950 and commenced operations on
May 11, 1951. The Bank's seven full-service retail offices are located in
Southern California.
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").
HAWTHORNE SAVINGS
Hawthorne Savings is a federally chartered stock savings bank (referred to
in applicable statutes and regulations as a "savings association") incorporated
and licensed under the laws of the United States. The Bank is a member of the
Federal Home Loan Bank of San Francisco ("FHLB"), which is a member bank of the
Federal Home Loan Bank System. The Savings Association Insurance Fund ("SAIF"),
which is a separate insurance fund administered by the Federal Deposit Insurance
Corporation ("FDIC"), insures the Bank's deposit accounts up to the $100,000
maximum amount currently allowable under federal laws. The Bank is subject to
examination and regulation by the Office of Thrift Supervision ("OTS") and the
FDIC. Hawthorne Savings is further subject to regulations of the Board of
Governors of the Federal Reserve System ("Federal Reserve Board") concerning
reserves required to be maintained against deposits and certain other matters.
GENERAL
The Company's only operating segment is the Bank. The Bank offers a variety
of consumer banking products through its network of seven retail branches, which
includes the traditional range of checking and savings accounts, money market
accounts and certificates of deposit. The Bank's primary target market is the
South Bay region of Southern California, where it currently ranks fifth in terms
of deposit market share based on branch information provided to the FDIC as of
June 30, 1999. The Bank also has branches in the San Fernando Valley and
Westlake Village areas of Los Angles County.
In connection with its principal business activities, the Company generates
revenues from the interest and fees charged to customers and, to a much lesser
extent, the interest earned on its portfolio of liquid investments. The
Company's costs include primarily interest paid to depositors and to other
providers of borrowed funds, and general and administrative expenses.
The Company's lending activities include single-family residential,
multi-family residential, commercial real estate loans for the construction of
single family residential homes, and the acquisition and development of land for
the construction of such homes. See "Item 1 -- Business -- Statistical Financial
Data -- Loan Portfolio." The Company funds its loans predominately with its
retail deposits and, to a lesser extent, with advances from the FHLB. See "Item
1 -- Business -- Statistical Financial Data -- Sources of Funds."
The Company's current loan origination activities are governed by
established policies and procedures appropriate to the risks inherent to the
types of collateral and borrowers financed by the Company. The Company's primary
competitive advantages, which include (1) a willingness and competence to tailor
the terms and conditions of individual transactions to accommodate both the
borrower's and the Company's transaction-specific objectives, (2) a strategy of
holding in portfolio virtually all new loan originations, and
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(3) highly effective, efficient and responsive transaction execution, are
consistent with the Company's relatively flat organizational structure and its
reliance upon relatively few, highly-skilled lending professionals (including
loan officers, loan underwriters, processors and funders, in-house appraisers,
and in-house legal staff). Management believes that this combination of
competitive, organizational and strategic distinctions contribute to the
Company's success in attracting new business and in its ability to receive a
return believed by management to be commensurate with the inherent and
transaction-specific risks assumed and value added to customers.
MARKET AREA AND COMPETITION
The Company concentrates on marketing its services throughout Southern
California. The Company's operating results and its growth prospects are most
directly and materially influenced by (1) the health and vibrancy of the
Southern California real estate markets and the underlying economic forces which
affect such markets, (2) the overall complexion of the interest rate
environment, including the absolute level of market interest rates and the
volatility of such interest rates, (3) the prominence of competitive forces
which provide customers of the Company with alternative sources of mortgage
funds or investments which compete with the Company's products and services, and
(4) regulations promulgated by authorities, including those of the OTS, the FDIC
and the FRB. The Company's success in identifying trends in each of these
factors, and implementing strategies to exploit such trends, significantly
influence the Company's long-term results and growth prospects.
The Bank faces significant competition in California for new loans from
commercial banks, savings and loan associations, credit unions, credit
companies, Wall Street lending conduits, mortgage bankers, life insurance
companies and pension funds. Some of the largest savings and loans and banks in
the United States operate in California, and have extensive branch systems and
advertising programs, which the Bank does not have. Large banks and savings and
loans frequently also enjoy a lower cost of funds than the Bank and can
therefore charge less than the Bank for loans. The Bank attempts to compensate
for competitive disadvantages that may exist by providing a higher level of
personal service to borrowers and "hands-on" involvement by senior officers to
meet borrower's needs. Intense competition within the lending area has
contributed to the Company has experienced a decline in the yield within the
Company's commercial real estate lending portfolio over the last several years.
See "Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Net Interest Income."
Generally, the Company competes for deposit funds with other Southern
California-based financial companies, including banks, savings associations and
thrift and loans. These companies generally compete with one another based upon
price, convenience and service. Many of the Bank's competitors offer a greater
array of products to customers than the Bank. For example, the Bank does not
currently offer debit cards or internet banking, and thus has a competitive
disadvantage to other commercial banks and savings associations in attracting
depositors. The Bank attempts to compensate for the lack of a full array of
services in its branches by providing superior personal service and will be
focusing on enhancing products offered during 2000.
Because the Company does not have a critical mass of retail banking
facilities, and because its smaller size does not afford it the economies of
scale to advertise its basic products to the extent of its principal
competitors, the Company generally competes on price and, to a lesser extent, on
service and convenience. The average tenure of all households with the Bank is
approximately five years, which includes individuals over 55 years of age. The
Company solicits deposits from the public throughout its service area and
attained a cross-sell ratio (products per household) of 1.3 at December 31,
1999.
SUPERVISION AND REGULATION
GENERAL
Savings and loan holding companies and savings associations are extensively
regulated under both federal and state law. This regulation is intended
primarily for the protection of depositors and the SAIF and not for the benefit
of stockholders of the Company. The following information describes certain
aspects of that
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regulation applicable to the Company and the Bank, and does not purport to be
complete. The discussion is qualified in its entirety by reference to all
particular statutory or regulatory provisions.
REGULATION OF THE COMPANY
General. The Company is a unitary savings and loan holding company subject
to regulatory oversight by the OTS. As such, the Company is required to register
and file reports with the OTS and is subject to regulation and examination by
the OTS. In addition, the OTS has enforcement authority over the Company and its
subsidiaries, which also permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the subsidiary savings association.
Qualified Thrift Lender Test. As a unitary savings and loan holding
company, the Company generally is not subject to activity restrictions, provided
the Bank satisfies the Qualified Thrift Lender ("QTL") test or meets the
definition of domestic building and loan association pursuant to section 7701 of
the Internal Revenue Code of 1986, as amended (the "Code"). If the Company
acquires control of another savings association as a separate subsidiary, it
would become a multiple savings and loan holding company, and the activities of
the Company and any of its subsidiaries (other than the Bank or any other
SAIF-insured savings association) would become subject to restrictions
applicable to bank holding companies unless such other associations each also
qualify as a QTL or domestic building and loan association and were acquired in
a supervisory acquisition. See "-- Regulation of the Bank -- Qualified Thrift
Lender Test."
Restrictions on Acquisitions. The Company must obtain approval from the OTS
before acquiring control of any other SAIF-insured association. Such
acquisitions are generally prohibited if they result in a multiple savings and
loan holding company controlling savings associations in more than one state.
However, such interstate acquisitions are permitted based on specific state
authorization or in a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or
indirectly or through or in concert with one or more other persons, may acquire
"control," as that term is defined in OTS regulations, of a federally insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS. For additional restrictions on the acquisition of a unitary thrift holding
company, see "-- Financial Services Modernization Legislation."
Financial Services Modernization Legislation. On November 12, 1999,
President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 (the
"Financial Services Modernization Act"). The Financial Services Modernization
Act repeals the two affiliation provisions of the Glass-Steagall Act: Section
20, which restricted the affiliation of Federal Reserve Member Banks with firms
"engaged principally" in specified securities activities; and Section 32, which
restricts officer, director, or employee interlocks between a member bank and
any company or person "primarily engaged" in specified securities activities. In
addition, the Financial Services Modernization Act also contains provisions that
expressly preempt any state law restricting the establishment of financial
affiliations, primarily related to insurance. The general effect of the law is
to establish a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the Bank Holding Company Act framework to
permit a holding company system to engage in a full range of financial
activities through a new entity known as a "Financial Holding Company."
"Financial activities" is broadly defined to include not only banking,
insurance, and securities activities, but also merchant banking and additional
activities that the Federal Reserve Board, in consultation with the Secretary of
the Treasury, determines to be financial in nature, incidental to such financial
activities, or complementary activities that do not pose a substantial risk to
the safety and soundness of depository institutions or the financial system
generally.
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The Financial Services Modernization Act provides that no company may
acquire control of an insured savings association after May 4, 1999, unless that
company engages, and continues to engage, only in the financial activities
permissible for a Financial Holding Company, unless grandfathered as a unitary
savings and loan holding company. The Financial Institution Modernization Act
grandfathers any company that was a unitary savings and loan holding company on
May 4, 1999 (or becomes a unitary savings and loan holding company pursuant to
an application pending on that date). Such a company may continue to operate
under present law as long as the company continues to meet the two tests: it can
control only one savings institution, excluding supervisory acquisitions, and
each such institution must meet the QTL test. It further requires that a
grandfathered unitary savings and loan holding company must continue to control
at least one savings association, or a successor institution, that it controlled
on May 4, 1999.
The Financial Services Modernization Act also permits national banks to
engage in expanded activities through the formation of financial subsidiaries. A
national bank may have a subsidiary engaged in any activity authorized for
national banks directly or any financial activity, except for insurance
underwriting, insurance investments, real estate investment or development, or
merchant banking, which may only be conducted through a subsidiary of a
Financial Holding Company. Financial activities include all activities permitted
under new sections of the Bank Holding Company Act of 1956 ("BHCA") or permitted
by regulation.
The Company and the Bank do not believe that the Financial Services
Modernization Act will have a material adverse effect on the operations of the
Company and the Bank in the near-term. However, to the extent that the act
permits banks, securities firms, and insurance companies to affiliate, the
financial services industry may experience further consolidation. The Financial
Services Modernization Act is intended to grant to community banks certain
powers as a matter of right that larger institutions have accumulated on an ad
hoc basis and which unitary savings and loan holding companies already possess.
Nevertheless, this act may have the result of increasing the amount of
competition that the Company and the Bank face from larger institutions and
other types of companies offering financial products, many of which may have
substantially more financial resources than the Company and the Bank. In
addition, because the Company may only be acquired by other unitary savings and
loan holding companies or Financial Holding Companies, the legislation may have
an anti-takeover effect by limiting the number of potential acquirors or by
increasing the costs of an acquisition transaction by a bank holding company
that has not made the election to be a Financial Holding Company under the new
legislation.
REGULATION OF THE BANK
As a federally chartered, SAIF-insured savings association, the Bank is
subject to extensive regulation by the OTS and the FDIC. Lending activities and
other investments of the Bank must comply with various statutory and regulatory
requirements. The Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board.
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the consideration of the Bank's Board of Directors on any
deficiencies found in the operations of the Bank. The relationship between the
Bank and depositors and borrowers is also regulated by federal and state laws,
especially in such matters as the ownership of savings accounts and the form and
content of mortgage documents utilized by the Bank.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other financial institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the SAIF and depositors.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such regulations, whether by the OTS, the FDIC, or the
Congress could have a material adverse impact on the Company, the Bank, and
their operations.
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Insurance of Deposit Accounts. The Bank's deposit accounts are insured by
the SAIF, as administered by the FDIC, up to the maximum amount permitted by
law. Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order, or condition imposed by the FDIC or the institution's
primary regulator.
The FDIC charges an annual assessment for the insurance of deposits based
on the risk a particular institution poses to its deposit insurance fund. Under
this system as of December 31, 1999, SAIF members paid within a range of 0 cents
to 27 cents per $100 of domestic deposits, depending upon the institution's risk
classification. This risk classification is based on an institution's capital
group and supervisory subgroup assignment. In addition, pursuant to the Economic
Growth and Paperwork Reduction Act of 1996 (the "Paperwork Reduction Act"), the
Bank pays, in addition to its normal deposit insurance premium as a member of
the SAIF, an amount equal to approximately 2.12 basis points toward the
retirement of the Financing Corporation bonds ("Fico Bonds") issued in the 1980s
to assist in the recovery of the savings and loan industry. Under the Paperwork
Reduction Act, the FDIC is not permitted to establish SAIF assessment rates that
are lower than comparable BIF assessment rates. The Paperwork Reduction Act also
provided for the merging of the BIF and the SAIF by January 1, 1999 provided
there were no financial institutions still chartered as savings associations at
that time. Although legislation to eliminate the savings association charter had
been proposed, at January 1, 1999, financial institutions such as the Bank were
still chartered as savings associations.
Regulatory Capital Requirements. OTS capital regulations require savings
associations to meet three capital standards: (1) tangible capital equal to 1.5%
of total adjusted assets, (2) leverage capital (core capital) equal to 4% of
total adjusted assets for all but the most highly rated institutions, and (3)
risk-based capital equal to 8.0% of total risk-based assets. The Bank must meet
each of these standards in order to be deemed in compliance with OTS capital
requirements. In addition, the OTS may require a savings association to maintain
capital above the minimum capital levels.
Under OTS regulations, a savings association with a greater than "normal"
level of interest rate exposure must deduct an interest rate risk ("IRR")
component in calculating its total capital for purposes of determining whether
it meets its risk-based capital requirement. Interest rate exposure is measured,
generally, as the decline in an institution's net portfolio value that would
result from a 200 basis point increase or decrease in market interest rates
(whichever would result in lower net portfolio value), divided by the estimated
economic value of the savings association's assets. The interest rate risk
component to be deducted from total capital is equal to one-half of the
difference between an institution's measured exposure and "normal" IRR exposure
(which is defined as 2%), multiplied by the estimated economic value of the
institution's assets. In August 1995, the OTS indefinitely delayed
implementation of its IRR regulation. Based on information voluntarily supplied
to the OTS, at December 31, 1999, the Bank would not have been required to
deduct an IRR component in calculating total risk-based capital had the IRR
component of the capital regulations been in effect.
These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk; (2) a savings association is growing, either internally
or through acquisitions, at such a rate that certain supervisory concerns may be
presented that OTS regulations do not address; and (3) a savings association may
be adversely affected by activities or condition of its holding company,
affiliates, subsidiaries, or other persons, or savings associations with which
it has significant business relationships. The Bank is not subject to any such
individual minimum regulatory capital requirement.
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As shown below, the Bank's regulatory capital exceeded all minimum
regulatory capital requirements applicable to it as of December 31, 1999.
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TANGIBLE CAPITAL CORE CAPITAL RISK BASED CAPITAL
------------------ ------------------ -------------------
BALANCE % BALANCE % BALANCE %
(DOLLARS IN THOUSANDS) ---------- ---- ---------- ---- ---------- -----
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Stockholders' equity........... $ 127,160 -- $ 127,160 -- $ 127,160 --
Adjustments:
General reserves............. -- -- -- -- 14,115 --
Other(1)..................... -- -- -- -- (1,460) --
---------- ---- ---------- ---- ---------- -----
Regulatory capital............. 127,160 8.05% 127,160 8.05% 139,815 12.50%
Regulatory capital
requirement.................. 23,690 1.50 63,174 4.00 89,468 8.00
---------- ---- ---------- ---- ---------- -----
Excess capital................. $ 103,470 6.55% $ 63,986 4.05% $ 50,347 4.50%
========== ==== ========== ==== ========== =====
Adjusted assets(2)............. $1,579,348 $1,579,348 $1,118,348
========== ========== ==========
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(1) Includes the portion of non-residential construction loans that exceed a
loan-to-value of 80%.
(2) The term "adjusted assets" refers to (i) 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 (ii) the term "risk-weighted assets" as defined in
12 C.F.R. Section 567.5 (d) for purposes of the risk-based capital
requirements.
The Home Owners' Loan Act ("HOLA") permits savings associations not in
compliance with the OTS capital standards to seek an exemption from certain
penalties or sanctions for noncompliance. Such an exemption will be granted only
if certain strict requirements are met, and must be denied under certain
circumstances. If the OTS grants an exemption, the savings association still may
be subject to enforcement actions for other violations of law or unsafe or
unsound practices or conditions.
Prompt Corrective Action. The prompt corrective action regulation of the
OTS, requires certain mandatory actions and authorizes certain other
discretionary actions to be taken by the OTS against a savings association that
falls within certain undercapitalized capital categories specified in the
regulation.
The regulation establishes five categories of capital classification: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." Under the regulation, the
risk-based capital, leverage capital, and tangible capital ratios are used to
determine an institution's capital classification. At December 31, 1999, the
Bank met the capital requirements of a "well capitalized" institution under
applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured
depository institution from declaring any dividends, making any other capital
distribution, or paying a management fee to a controlling person if, following
the distribution or payment, the institution would be within any of the three
undercapitalized categories. In addition, adequately capitalized institutions
may accept Brokered Deposits only with a waiver from the FDIC and are subject to
restrictions on the interest rates that can be paid on such deposits.
Undercapitalized institutions may not accept, renew, or roll-over Brokered
Deposits.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
6
<PAGE> 11
The Bank's actual capital amounts and ratios and the capital amounts and
ratios required in order for an association to be well capitalized and
adequately capitalized are presented in the table below.
<TABLE>
<CAPTION>
TO BE WELL
FOR CAPITAL CAPITALIZED
ADEQUACY UNDER PCA
ACTUAL PURPOSES PROVISIONS
----------------- ---------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(DOLLARS IN THOUSANDS) -------- ----- ------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
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%
As of December 31, 1998:
Total capital to risk weighted assets...... $119,400 11.10% $86,090 8.00% $107,612 10.00%
Core capital to adjusted tangible assets... 108,673 7.65% 56,804 4.00% 71,005 5.00%
Tangible capital to adjusted tangible
assets................................... 108,673 7.65% 21,302 1.50% n/a n/a
Tier 1 capital to risk weighted assets..... 108,673 10.10% n/a n/a 64,567 6.00%
</TABLE>
Loans-to-One Borrower. Savings associations generally are subject to the
lending limits applicable to national banks. With certain limited exceptions,
the maximum amount that a savings association or a national bank may lend to any
borrower (including certain related entities of the borrower) at one time may
not exceed 15% of the unimpaired capital and surplus of the institution, plus an
additional 10% of unimpaired capital and surplus for loans fully secured by
readily marketable collateral. Savings associations are additionally authorized
to make loans to one borrower, for any purpose, in an amount not to exceed
$500,000 or, by order of the Director of OTS, in an amount not to exceed the
lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided: (i) the purchase price of each single-family
dwelling in the development does not exceed $500,000; (ii) the savings
association is in compliance with its fully phased-in capital requirements;
(iii) the loans comply with applicable loan-to-value requirements, and (iv) the
aggregate amount of loans made under this authority does not exceed 150% of
unimpaired capital and surplus. At December 31, 1999, the Bank's
loans-to-one-borrower limit was $22.5 million based upon the 15% of unimpaired
capital and surplus measurement. At December 31, 1999, the Bank's largest
relationships consisted of two borrowers with outstanding commitments greater
than $20.0 million, which consisted of approximately five loans each, and were
secured by commercial real estate in the Bank's lending area. All of these loans
were performing in accordance with their terms.
Qualified Thrift Lender Test. Savings associations must meet a QTL test,
which test may be met either by maintaining a specified level of assets in
qualified thrift investments as specified in HOLA or by meeting the definition
of a "domestic building and loan association" in section 7701 of the Code. If
the Bank maintains an appropriate level of certain specified investments
(primarily residential mortgages and related investments, including certain
mortgage-related securities) and otherwise qualifies as a QTL or a domestic
building and loan association, it will continue to enjoy full borrowing
privileges from the Federal Home Loan Bank ("FHLB"). The required percentage of
investments under HOLA is 65% of assets while the Code requires investments of
60% of assets. An association must be in compliance with the QTL test or the
definition of domestic building and loan association on a monthly basis in nine
out of every 12 months. Associations that fail to meet the QTL test will
generally be prohibited from engaging in any activity not permitted for both a
national bank and a savings association. As of December 31, 1999, the Bank was
in compliance with its QTL requirement and met the definition of a domestic
building and loan association.
Affiliate Transactions. Transactions between a savings association and its
"affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.
In general, Sections 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings association or its subsidiaries
may engage in certain "covered transactions" with affiliates to an
7
<PAGE> 12
amount equal to 10% of the association's capital and surplus, in the case of
covered transactions with any one affiliate, and to an amount equal to 20% of
such capital and surplus, in the case of covered transactions with all
affiliates. In addition, a savings association and its subsidiaries may engage
in covered transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance, or letter of credit on behalf of an
affiliate.
In addition, under the OTS regulations, a savings association may not make
a loan or extension of credit to an affiliate unless the affiliate is engaged
only in activities permissible for bank holding companies; a savings association
may not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate; and covered transactions and certain other
transactions between a savings association or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each loan or extension of credit by a
savings association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130% (depending on the type of collateral) of the
amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations upon
all capital distributions by savings associations, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The OTS recently adopted an amendment to these capital
distribution limitations. Under the new rule, a savings association in certain
circumstances may be required to file an application and await approval from the
OTS prior to making a capital distribution, may be required to file a notice 30
days prior to the capital distribution, or may be permitted to make the capital
distribution without notice or application to the OTS.
An application is required (1) if the savings association is not eligible
for expedited treatment of its other applications under OTS regulations; (2) the
total amount of all of capital distributions (including the proposed capital
distribution) for the applicable calendar year exceeds net income for that year
to date plus retained net income for the preceding two years; (3) the savings
association would not be at least adequately capitalized, under the prompt
corrective action regulations of the OTS following the distribution; or (4) the
savings association's proposed capital distribution would violate a prohibition
contained in any applicable statute, regulation, or agreement between the
savings association and the OTS (or the FDIC), or violate a condition imposed on
the savings association in an OTS-approved application or notice.
A notice of a capital distribution is required if a savings association is
not required to file an application, but: (1) would not be well capitalized
under the prompt corrective action regulations of the OTS following the
distribution; (2) the proposed capital distribution would reduce the amount of
or retire any part of your common or preferred stock or retire any part of debt
instruments such as notes or debentures included in capital (other than regular
payments required under a debt instrument approved by the OTS); or (3) the
savings association is a subsidiary of a savings and loan holding company.
If neither the savings association nor the proposed capital distribution
meet any of the above listed criteria, no application or notice is required for
the savings association to make a capital distribution. The OTS may prohibit the
proposed capital distribution that would otherwise be permitted if the OTS
determines that the distribution would constitute an unsafe or unsound practice.
8
<PAGE> 13
Activities of Subsidiaries. Federally chartered savings associations, such
as the Bank, are permitted to invest up to 2% of their assets in the capital
stock of, or secured or unsecured loans to, subsidiary service corporations,
with an additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. Under the 2% limitation,
the Bank was permitted to invest up to approximately $31.6 million at December
31, 1999. A savings association seeking to establish a new subsidiary, acquire
control of an existing company or conduct a new activity through a subsidiary
must provide 30 days prior notice to the FDIC and the OTS and conduct any
activities of the subsidiary in accordance with regulations and orders of the
OTS. The OTS has the power to require a savings association to divest any
subsidiary or terminate any activity conducted by a subsidiary that the OTS
determines to pose a serious threat to the financial safety, soundness or
stability of the savings association or to be otherwise inconsistent with sound
banking practices.
Recent Legislation. Congress has been considering legislation in various
forms that would require federal thrifts, such as the Bank, to convert their
charters to national or state bank charters. The Treasury Department has been
studying the development of a common charter for federal savings associations
and commercial banks. Pursuant to the Paperwork Reduction Act, if the thrift
charter is eliminated after January 1, 1999, the Paperwork Reduction Act would
require the merger of the BIF and the SAIF into a single Deposit Insurance Fund
on that date. In the absence of appropriate "grandfather" provisions,
legislation eliminating the thrift charter could have a material adverse effect
on the Bank and the Company because, among other things, the regulatory,
capital, and accounting treatment for national and state banks and savings
associations differs in certain significant respects. The Bank cannot determine
whether, or in what form, such legislation may eventually be enacted and there
can be no assurance that any legislation that is enacted would contain adequate
grandfather rights for the Bank and the Company.
Community Reinvestment Act and the Fair Lending Laws. Savings associations
have a responsibility under the Community Reinvestment Act ("CRA") and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act (together, the "Fair Lending Laws")
prohibit lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. An institution's failure to comply
with the provisions of CRA could, at a minimum, result in regulatory
restrictions on its activities and the denial of certain applications, and
failure to comply with the Fair Lending Laws could result in enforcement actions
by the OTS, as well as other federal regulatory agencies and the Department of
Justice.
Federal Home Loan Bank System. The Bank is a member of the FHLB system.
Among other benefits, each FHLB serves as a reserve or central bank for its
members within its assigned region. Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system. Each FHLB makes available
to members loans (i.e., advances) in accordance with the policies and procedures
established by the Board of Directors of the individual FHLB.
As a member, the Bank is required to own capital stock in an FHLB in an
amount equal to the greater of: (i) 1% of its aggregate outstanding principal
amount of its residential mortgage loans, home purchase contracts and similar
obligations at the beginning of each calendar year, (ii) 0.3% of total assets,
or (iii) 5% of its FHLB advances (borrowings). At December 31, 1999, the Bank
had $22.2 million in FHLB stock, which was in compliance with this requirement.
Liquidity Requirements. Under OTS regulations, a savings association is
required to maintain an average daily balance of liquid assets (including cash,
certain time deposits and savings accounts, bankers' acceptances, certain
government obligations, and certain other investments) in each calendar quarter
of not less than 4% of either (1) its liquidity base (consisting of certain net
withdrawable accounts plus short-term borrowings) as of the end of the preceding
calendar quarter, or (2) the average daily balance of its liquidity base during
the preceding quarter. This liquidity requirement may be changed from time to
time by the OTS to any amount between 4.0% to 10.0%, depending upon certain
factors, including economic conditions and savings flows of all savings
associations. The Bank maintains liquid assets in compliance with these
regulations. Monetary penalties may be imposed upon an institution for
violations of liquidity requirements.
9
<PAGE> 14
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain noninterest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW, and Super NOW
checking accounts) and non-personal time deposits. The balances maintained to
meet the reserve requirements imposed by the Federal Reserve Board may be used
to satisfy the liquidity requirements that are imposed by the OTS. At December
31, 1999, the Bank was in compliance with these requirements.
OTHER REAL ESTATE LENDING STANDARDS
The OTS and the other federal banking agencies have jointly adopted uniform
rules on real estate lending and related Interagency Guidelines for Real Estate
Lending Policies. The uniform rules require that associations adopt and maintain
comprehensive written policies for real estate lending. The policies must
reflect consideration of the Interagency Guidelines and must address relevant
lending procedures, such as loan-to-value limitations, loan administration
procedures, portfolio diversification standards and documentation, approval and
reporting requirements. Although the final rule did not impose specific maximum
loan-to-value ratios, the related Interagency Guidelines state that such ratio
limits established by an individual association's board of directors should not
exceed levels set forth in the Guidelines, which range from a maximum of 65% for
loans secured by raw land to 85% for improved property. No limit is set for
single family residence loans, but the guideline states that such loans
exceeding a 95% loan-to-value ratio should have private mortgage insurance or
some other form of credit enhancement. The Guidelines further permit a limited
amount of loans that do not conform to these criteria.
EMPLOYEES
The Company employed 274 full time equivalent persons at December 31, 1999.
A union or collective bargaining group does not represent employees and the
Company considers its employee relations to be satisfactory.
STATISTICAL FINANCIAL DATA
LOAN PORTFOLIO
Loans Receivable
The Company's loan portfolio is almost exclusively secured by real estate,
concentrated in Southern California. The Bank's principal lending activities
consist of single family residential, single family construction and income
property lending. The composition of the net growth in loans, from $1.3 billion
at December 31, 1998 to $1.4 billion at December 31, 1999, includes increases in
single family residential loans of $107.2 million and income property loans of
$27.7 million.
10
<PAGE> 15
The table below sets forth the composition of the Company's loan portfolio
as of the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------------ ------------------ ------------------ ---------------- ----------------
BALANCE % BALANCE % BALANCE % BALANCE % BALANCE %
(DOLLARS IN THOUSANDS) ---------- ----- ---------- ----- --------- ------ -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Single family
residential............ $ 683,250 41.0% $ 576,032 35.9% $ 396,629 41.0% $337,784 45.7% $367,626 56.2%
Income property:
Multi-family(1)........ 222,616 13.4 250,876 15.6 225,738 23.3 220,707 29.9 219,015 33.5
Commercial(1).......... 208,859 12.5 222,558 13.9 111,893 11.6 60,388 8.2 31,258 4.8
Development(2)......... 148,092 8.9 78,425 4.8 7,310 0.8
Land(3).................. 59,095 3.5 69,581 4.3 39,475 4.1 14,513 2.0 5,579 0.9
Single family
construction:
Single residence(4).... 274,697 16.5 275,888 17.2 107,989 11.2 56,306 7.6 21,987 3.4
Tract.................. 24,056 1.4 85,942 5.4 68,653 7.1 33,791 4.6 6,800 1.0
Other.................... 46,132 2.8 46,615 2.9 9,698 1.0 15,684 2.1 1,459 0.2
---------- ----- ---------- ----- --------- ------ -------- ----- -------- -----
Loans receivable,
total(5)............... 1,666,797 100.0% 1,605,917 100.0% 967,385 100.0% 739,173 100.0% 653,724 100.0%
===== ===== ====== ===== =====
Less:
Undisbursed loan
funds................ (196,249) (256,096) (108,683) (46,646) (15,208)
Deferred loan fees and
credits, net......... (1,295) (5,919) (7,177) (6,611) (5,996)
Allowance for credit
losses............... (24,285) (17,111) (13,274) (13,515) (15,192)
---------- ---------- --------- -------- --------
Loans receivable, net.... $1,444,968 $1,326,791 $ 838,251 $672,401 $617,328
========== ========== ========= ======== ========
</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) Gross loans receivable includes the principal balance of loans outstanding,
plus outstanding but unfunded loan commitments, predominantly in connection
with construction loans.
11
<PAGE> 16
The table below reflects the diversification of individual transactions on
loans in excess of $10.0 million, between $5.0 and $10.0 million and less than
$5.0 million:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1999 1998
------------------------------- -------------------------------
NO. OF GROSS AVERAGE NO. OF GROSS AVERAGE
LOANS COMMITMENT LTV LOANS COMMITMENT LTV
(DOLLARS IN THOUSANDS) ------ ---------- ------- ------ ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Loans in excess of $10.0 million:
Single family residential.......... 1 $ 13,000 46.4% 1 $ 13,000 46.4%
Income property:
Multi-family..................... -- -- -- -- -- --
Commercial....................... 3 32,622 69.9 3 36,801 68.5
Development...................... 3 33,900 76.4 -- -- --
Land............................... -- -- -- 1 11,500 31.6
Other.............................. 1 16,000 n/a 2 28,000 n/a
-- ---------- -- ----------
8 $ 95,522 69.3% 7 $ 89,301 56.7%
== ========== == ==========
Percentage of total gross loans.... 5.7% 5.6%
Loans between $5.0 and $10.0 million:
Single family residential.......... 7 $ 39,364 68.9% 10 $ 63,487 63.4%
Income property:
Multi-family..................... 1 6,655 74.8 2 11,775 70.9
Commercial....................... 9 65,998 71.1 9 61,980 71.2
Development...................... 11 71,049 68.9 1 5,259 56.0
Land............................... 1 6,501 59.4 -- -- --
Single family construction:
Single family residence.......... 4 24,812 68.4 -- -- --
Tract............................ 2 11,040 70.2 2 14,091 67.0
Other.............................. 3 27,466 n/a 2 18,852 n/a
-- ---------- -- ----------
38 $ 252,885 69.4% 26 $ 175,444 64.2%
== ========== == ==========
Percentage of total gross loans.... 15.2% 10.9%
Loans less than $5.0 million......... $1,318,390 $1,341,172
---------- ----------
Total....................... $1,666,797 $1,605,917
========== ==========
</TABLE>
Single Family Residential Loans
The Bank offers first mortgage loans secured by single family (one-to-four
unit) residential properties located in the Bank's primary lending area of
Southern California. At December 31, 1999, $683.3 million, or 41.0% of the total
loan portfolio was secured by single family residential properties with an
average loan size of $0.4 million, compared to $576.0 million, or 35.9% of the
total portfolio at December 31, 1998.
The Company originates single family residential loans principally through
contact with, and submissions by, independent mortgage brokers. The Company pays
a fee, generally ranging from 0.5% to 2.0% of the loan amount, to mortgage
brokers in connection with its funding of certain loans. The practice and
pricing are common for single family-secured loans originated throughout the
Company's market area.
Single Family Construction
The Company provides individual home construction financing, primarily to
local builders and, to a much lesser extent, homeowners. Generally, the Company
finances the construction of luxury custom homes throughout the coastal region
of Southern California and elsewhere within the Company's market area. A
majority of the Company's Single Family Construction -- Single Residence Loans
are sourced through standing relationships between the Company's loan officers
and local builders and, therefore, do not typically involve mortgage brokers.
12
<PAGE> 17
The Company's loan commitment generally includes provision for a portion of
the cost of the acquired land and all of the costs of construction (including
financing costs). Generally, the Company's loan commitment covers between 70.0%
and 75.0% of the total costs of construction (including the cost of land
acquisition, the cost to construct the planned improvements and financing
costs), with the borrower providing the remainder of the funds required at the
date the Company records its financing commitment.
The Company's Single Family Construction -- Single Residence Loans have
initial terms of 12 to 24 months, with an option for the borrower to extend the
loan for up to six months, subject to the Company's then current evaluation of
the status of construction, costs to and at completion, the as-completed
valuation of the property, and other factors. Single Family
Construction -- Single Residence homes accounted for $274.7 million, or 16.5% of
the total loan portfolio at December 31, 1999, with an average loan size of $1.3
million, compared to $275.9 million, or 17.2% of the total loan portfolio at
December 31, 1998.
Income Property Multi-family and Commercial Loans
The Company originates loans secured by multi-family properties and
commercial properties, such as office buildings, retail properties, industrial
properties and various special purpose properties. The Company generates a
majority of its new income property loan opportunities through contact with, and
submissions by, independent mortgage loan brokers. However, a growing proportion
of the Company's new business is derived from existing customer relationships or
through referrals from existing customers. The Company competes for such loans
by providing highly responsive transaction execution, specialized market
knowledge and expertise and a high customer service orientation. Multi-family
and commercial real estate loans accounted for $222.6 million or 13.4% and
$208.9 million or 12.5%, respectively, of the Bank's loan portfolio at December
31, 1999. The average loan size of the income producing properties portfolio was
$1.2 million during 1999. At December 31, 1998, multi-family and commercial real
estate loans consisted of $250.9 million, or 15.6% and $222.6 million, or 13.9%,
respectively, of the Bank's total loan portfolio.
Income Property -- Development Loans
Commencing in 1998, the Company has pursued financing opportunities
involving (1) the acquisition of land and the construction of income-producing
improvements thereon or (2) the acquisition and substantial renovation of
existing, income-producing properties. To date, the Company has focused on loans
for apartment building construction (primarily located in the West Los Angeles
area) and the renovation of existing commercial real estate improvements located
throughout Los Angeles County. At December 31, 1999, Income Property Development
loans accounted for $148.1 million, or 8.9% of the Bank's total loan portfolio
compared to $78.4 million, or 4.8% of the Bank's total loan portfolio at
December 31, 1998.
Single Family Construction -- Tract Loans
In the past, the Company provided financing to small-to-medium-sized
developers of residential subdivisions located throughout Southern California.
Generally, the Company's tract loans finance land acquisition, site development
and home construction.
Except for very small subdivisions (i.e., generally developments involving
10 or fewer homes), the Company generally structured its tract loans such that
it will separately finance land acquisition and site development, and the
individual phased construction of homes. In connection with these multi-phase
developments, the Company does not commit to finance more than one phase of the
development at a time, and fully underwrites future phases at such time as the
borrower makes their financing request. Generally, the Company's tract loans
carry a loan term of 12 months, with built-in options to extend the loan for up
to an additional six months. As finished homes are sold, the Company generally
receives substantially all of the proceeds from sales until its loan is fully
repaid.
At December 31, 1999, tract loans accounted for $24.1 million, or 1.4% of
the Bank's total loan portfolio compared to $85.9 million, or 5.4% of the Bank's
total loan portfolio at December 31, 1998. The decrease in Tract loans reflects
the Bank's decision to cease the origination of such loans for its portfolio,
which was announced during the fourth quarter of 1998.
13
<PAGE> 18
NEW BUSINESS GENERATION
The Company extends credit pursuant to its lending policies covering loan
applications, borrower financial information and legal and corollary agreements
which support the vesting of title to the Company's collateral, title policies,
fire and extended liability coverage casualty insurance, credit reports, and
other documents necessary to support each extension of credit. The real property
collateral that secures the Company's loans is appraised either by an
independent fee appraiser or by one of the Company's staff appraisers. The
Company's staff appraisers and the Company's Chief Appraiser generally review
independent fee appraisals. With few exceptions, all of the principal legal
documents that support each extension of credit are prepared or reviewed by the
Company's in house legal staff or outside attorneys.
The following table sets forth the approximate composition of the Company's
gross new loan commitments, net of internal refinances, for the periods
indicated, in dollars and as a percentage of total loans originated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1999 1998 1997
----------------- ----------------- -----------------
AMOUNT % AMOUNT % AMOUNT %
(DOLLARS IN THOUSANDS) -------- ----- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Single family residential(1)...... $293,600 42.0% $302,600 31.4% $126,100 25.5%
Income property:
Multi-family(2)................. 21,800 3.1 64,800 6.7 51,700 10.4
Commercial(3)................... 61,400 8.8 125,900 13.1 105,100 21.2
Development(4).................. 86,400 12.4 81,200 8.4 -- --
Land(5)........................... 51,500 7.4 98,500 10.2 35,700 7.2
Single family construction:
Single family(6)................ 164,100 23.5 220,400 22.8 104,900 21.2
Tract(7)........................ 12,100 1.7 57,100 5.9 61,800 12.5
Other(8).......................... 7,700 1.1 14,100 1.5 9,700 2.0
-------- ----- -------- ----- -------- -----
Total loans originated............ $698,600 100.0% $964,600 100.0% $495,000 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
- ---------------
(1) This amount includes unfunded commitments under lines of credit of $0.4
million, $5.3 million and $7.4 million at December 31, 1999, 1998 and 1997,
respectively.
(2) There were no unfunded commitments at December 31, 1999. Includes $1.7
million and $5.0 million of financings provided in connection with sales of
previously foreclosed properties for 1998 and 1997, respectively.
(3) Includes unfunded commitments of $10.8 million, $16.4 million and $15.9
million at December 31, 1999, 1998 and 1997, respectively.
(4) Includes unfunded commitments of $40.2 million and $17.5 million at December
31, 1999 and 1998 respectively. There were no unfunded commitments at
December 31, 1997.
(5) Includes unfunded commitments of $4.0 million, $12.9 million and $14.1
million at December 31, 1998 and 1997, respectively.
(6) Includes unfunded commitments of $72.3 million, $109.8 million and $50.8
million at December 31, 1999, 1998 and 1997, respectively.
(7) Includes unfunded commitments of $2.5 million, $34.7 million and $33.6
million at December 31, 1999, 1998 and 1997, respectively.
(8) Includes unfunded commitments of $9.8 million, $1.2 million and $4.0 million
at December 31, 1999, 1998 and 1997, respectively.
14
<PAGE> 19
The table below sets forth, by contractual maturity, the Company's loan
portfolio at December 31, 1999. The table below is based on contractual loan
maturities and does not consider amortization and prepayments of loan principal.
<TABLE>
<CAPTION>
MATURING IN:
----------------------------------------------------------------
OVER OVER
ONE YEAR FIVE YEARS TOTAL
LESS THAN THROUGH THROUGH OVER LOANS
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS RECEIVABLE
(DOLLARS IN THOUSANDS) --------- ---------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Single family...................... $ 28,596 $ 54,327 $331,591 $268,736 $ 683,250
Income property:
Multi-family..................... 1,015 35,522 99,996 86,083 222,616
Commercial....................... 24,184 75,004 107,353 2,318 208,859
Development...................... 83,747 64,345 -- -- 148,092
Land............................... 47,630 7,857 3,374 234 59,095
Single family construction:
Single residence................. 251,324 23,373 -- -- 274,697
Tract............................ 24,056 -- -- -- 24,056
Other.............................. 23,273 15,850 7,000 9 46,132
-------- -------- -------- -------- ----------
Loans receivable, total(1)......... $483,825 $276,278 $549,314 $357,380 1,666,797
======== ======== ======== ========
Less:
Undisbursed funds................ (196,249)
Deferred loan fees and credits,
net........................... (1,295)
Allowance for credit losses...... (24,285)
----------
Loans receivable, net.............. $1,444,968
==========
</TABLE>
- ---------------
(1) Gross loans receivable includes the principal balance of loans outstanding
plus outstanding but unfunded loan commitments, predominantly in connection
with construction loans.
ASSET QUALITY
The Company has an asset review and classification system to establish
specific and general reserves and to classify assets and groups of assets. The
Company's problem asset classifications are discussed below.
NONACCRUAL LOANS
As a matter of policy, the Company generally ceases to accrue interest on
any loan with respect to which the loan's contractual payments are more than 90
days past due, as well as loans classified substandard for which interest
payment reserves were established from loan funds rather than borrower funds. In
addition, interest is not recognized on any loan to which management has
determined that collection of the Company's investment in the loan is not
reasonably assured.
CLASSIFIED ASSETS
OTS regulations require insured institutions to classify their assets in
accordance with established policies and procedures. A classified asset is an
asset classified substandard, doubtful or loss. Loans that are not classified
are categorized as pass or special mention. The severity of an asset's
classification is dependent upon, among other things, the institution's risk of
loss, the borrower's performance, the characteristics of the institution's
security, and the local market conditions, among other factors.
The Company automatically classifies as substandard (1) REO, (2) loans
delinquent 90 or more days, and (3) other loans that have been adversely
classified pursuant to OTS regulations and guidelines ("performing/classified").
Performing loans are classified consistent with the Company's classification
policies.
15
<PAGE> 20
The table below sets forth information concerning the Company's classified
assets as of the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------
1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS) ---------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Risk elements:
Total nonaccrual loans................. $ 44,031 $ 47,688 $ 15,396 $ 28,624 $ 21,709
Real estate owned, net................. 5,587 4,070 9,859 20,140 37,905
---------- ---------- -------- -------- --------
49,618 51,758 25,255 48,764 59,614
Performing loans classified substandard
or lower(1)............................ 25,646 45,397 35,845 45,088 57,049
---------- ---------- -------- -------- --------
Total classified assets........ $ 75,264 $ 97,155 $ 61,100 $ 93,852 $116,663
========== ========== ======== ======== ========
Total classified loans......... $ 69,677 $ 93,085 $ 51,241 $ 73,712 $ 78,758
========== ========== ======== ======== ========
Loans restructured and paying in
accordance with modified terms(2)...... $ 15,394 $ 27,334 $ 25,631 $ 22,446 $ 16,729
========== ========== ======== ======== ========
Loans receivable, net of specific
reserves and deferred fees............. $1,468,445 $1,338,718 $847,647 $683,731 $629,094
========== ========== ======== ======== ========
Core capital............................. $ 127,160 $ 108,673 $ 69,906 $ 52,803 $ 43,360
========== ========== ======== ======== ========
Risk-based capital....................... $ 139,815 $ 119,400 $ 78,454 $ 59,560 $ 49,448
========== ========== ======== ======== ========
Ratio of classified assets to:
Loans receivable, net of specific
reserves and deferred fees.......... 5.1% 7.3% 7.2% 13.7% 18.5%
========== ========== ======== ======== ========
Core Capital........................... 59.2% 89.4% 87.4% 177.7% 269.1%
========== ========== ======== ======== ========
Risk-based capital..................... 53.8% 81.4% 77.9% 157.6% 235.9%
========== ========== ======== ======== ========
</TABLE>
- ---------------
(1) Excludes nonaccrual.
(2) TDRs not classified and not on nonaccrual.
The table below sets forth information concerning the Company's gross
classified loans, by category, as of December 31, 1999.
<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............. $12,905 $6,621 $ 3,497 $11,399 $34,422
Income property:
Multi-family........................ -- -- -- 195 195
Commercial.......................... -- -- 10,498 11,265 21,763
Land.................................. 44 20 2,075 2,339 4,478
Single family construction:
Single residence.................... -- -- 6,847 -- 6,847
Tract............................... 1,945 -- -- -- 1,945
Other................................. 22 -- -- 5 27
------- ------ ------- ------- -------
Classified loans, gross............... $14,916 $6,641 $22,917 $25,203 $69,677
======= ====== ======= ======= =======
</TABLE>
- ---------------
(1) Includes $0.4 million in loans 30 - 89 days past due and still accruing
interest.
(2) Loans that have been restructured and are paying as agreed.
16
<PAGE> 21
ALLOWANCE FOR ESTIMATED CREDIT LOSSES
Management establishes specific allowances for estimated losses on
individual loans when it has determined that recovery of the Company's gross
investment is not probable and when the amount of loss can be reasonably
determined. In making this determination, management considers, among other
things, (1) the status of the asset, (2) the probable future status of the
asset, (3) the value of the asset or underlying collateral and (4) management's
intent with respect to the asset. In quantifying the loss, if any, associated
with individual loans, management primarily utilizes external sources of
information (i.e., appraisals, price opinions from real estate professionals,
comparable sales data and internal estimates). In establishing specific
allowances, management estimates the revenues expected to be generated from
disposal of the Company's collateral or owned property, less construction and
renovation costs (if any), holding costs and transaction costs. For tract
construction and land development, the resulting projected cash flows are
discounted utilizing a market rate of return to determine their value.
The Company maintains an allowance for estimated credit losses, which is
not tied to individual loans or properties ("general reserves"). General
reserves are maintained for each of the company's principal loan segments, and
supplemented by periodic additions through provisions for estimated credit
losses. In measuring the adequacy of the Company's general reserves, management
considers (1) the Company's historical loss experience for each loan portfolio
segment and in total, (2) the historical migration of loans within each
portfolio segment and in total (i.e., from performing to nonperforming, from
nonperforming to REO), (3) observable trends in the performance of each loan
portfolio segment, (4) observable trends in the region's economy and in its real
property markets and (5) guidelines published by the OTS for maintaining General
Reserves.
The allowance formula is calculated by applying loss factors to outstanding
loans and unused commitments, in each case based on the internal risk grade of
such loans, pools of loans, or commitments. Changes in risk grades of both
performing and nonperforming loans affect the amount of the formula allowance.
Loss factors are based on our historical loss experience and may be adjusted for
significant factors that, in management's judgment, affect the collectibility of
the portfolio as of the evaluation date. The following outlines the derivation
of the loss factors for problem graded loans, pass graded loans, and pooled
loans: (1) problem graded loan loss factors are derived from a migration model
that tracks three years of historical loss experience. Management is exploring
changes to the migration model to track historical loss experience over a
three-year period, which management believes approximates a business cycle, (2)
pass graded loan loss factors are based on the average annual net charge-off
rate over a three-year period and (3) pooled loan loss factors (not individually
graded loans) are based on expected net charge-offs for three years. Pooled
loans are loans that are homogeneous in nature, such as consumer installment and
residential mortgage loans.
In addition to the amount of reserves determined by applying individual
loss factors to the portfolio, the general reserve may also include an
unallocated amount. The unallocated allowance recognizes the model and
estimation risk associated with the 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), (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.
17
<PAGE> 22
Executive management reviews these conditions quarterly in discussion with
senior credit officers. To the extent that any of these conditions is evidenced
by a specifically identifiable problem credit or portfolio segment as of the
evaluation date, management's estimate of the effect of such condition may be
reflected as a specific allowance applicable to such credit or portfolio
segment. Where a specifically identifiable problem credit or portfolio segment
as of the evaluation date does not evidence any of these conditions,
management's evaluation of the probable loss related to such condition is
reflected in the unallocated allowance.
The table below summarizes the Company's allowance for estimated credit
losses by category for the periods indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS) ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Dollars:
Single family residential.............. $ 7,095 $ 7,836 $ 6,671 $ 6,476 $ 6,652
Income property:
Multi-family........................ 646 1,063 2,000 4,786 7815
Commercial.......................... 6,738 4,334 2,252 1,150 259
Development......................... 2,067 354 -- -- --
Land................................... 1,470 293 162 167 361
Single family construction:
Single residence.................... 3,946 789 503 168 83
Tract............................... 855 1,092 817 338 9
Other loans............................ 480 1,082 226 -- --
Unallocated............................ 988 268 643 430 13
------- ------- ------- ------- -------
Total.......................... $24,285 $17,111 $13,274 $13,515 $15,192
======= ======= ======= ======= =======
Percentage of year end allowance:
Single family residential.............. 29.22% 45.80% 50.26% 47.92% 43.79%
Income property:
Multi-family........................ 2.66 6.21 15.07 35.41 51.44
Commercial.......................... 27.75 25.33 16.97 8.51 1.70
Development......................... 8.51 2.07 -- -- --
Land................................... 6.05 1.71 1.22 1.24 2.38
Single family construction:
Single residence.................... 16.25 4.61 3.79 1.24 0.55
Tract............................... 3.52 6.38 6.15 2.50 0.06
Other loans............................ 1.98 6.32 1.70 -- --
Unallocated............................ 4.07 1.57 4.84 3.18 0.09
------- ------- ------- ------- -------
Total.......................... 100.00% 100.00% 100.00% 100.00% 100.00%
======= ======= ======= ======= =======
</TABLE>
18
<PAGE> 23
The table below summarizes the activity of the Company's allowance for
estimated credit losses for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS) ---------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Average loans outstanding........ $1,411,697 $1,081,382 $745,197 $671,365 $578,766
========== ========== ======== ======== ========
Allowance for estimated credit
losses, beginning of period.... $ 17,111 $ 13,274 $ 13,515 $ 15,192 $ 21,461
Provision for estimated losses... 12,000 7,135 5,137 6,067 472
Charge offs:
Single family residential...... (1,910) (1,178) (3,472) (3,103) (2,894)
Income property:
Multi-family................ (186) (1,038) (1,745) (4,641) (3,595)
Commercial.................. (512) (815) -- -- (70)
Land........................... (1,140) -- (150) -- (48)
Single family construction:
Single residence............ -- (267) -- -- --
Tract....................... -- -- -- -- (134)
Other.......................... (1,124) -- (11) -- --
Recoveries:
Single family residential...... -- -- -- -- --
Income property:
Multi-family................ -- -- -- -- --
Commercial.................. -- -- -- -- --
Land
Single family construction:
Single residence............ -- -- -- -- --
Tract....................... -- -- -- -- --
Other.......................... 46 -- -- -- --
---------- ---------- -------- -------- --------
Net charge offs.................. (4,826) (3,298) (5,378) (7,744) (6,741)
---------- ---------- -------- -------- --------
Allowance for estimated credit
losses, end of period.......... $ 24,285 $ 17,111 $ 13,274 $ 13,515 $ 15,192
========== ========== ======== ======== ========
Ratio of net charge offs to
average loans outstanding
during the period.............. 0.34% 0.30% 0.72% 1.15% 1.16%
Ratio of allowance to average
loans outstanding.............. 1.72% 1.58% 1.78% 2.01% 2.62%
</TABLE>
REAL ESTATE OWNED
Real estate acquired in satisfaction of loans is transferred to REO at
estimated fair values, less any estimated disposal costs. The difference between
the fair value of the real estate collateral and the loan balance at the time of
transfer is recorded as a loan charge-off if fair value is lower. Any subsequent
declines in the fair value of the REO after the date of transfer are recorded
through a write-down of the asset or through the establishment of, or additions
to specific reserves. The Company's investment in REO increased from $4.1
million to $5.6 million, or 36.6%, from year-end 1998 to year-end 1999.
19
<PAGE> 24
The table below summarizes the composition of the Company's portfolio of
real estate owned properties as of the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------ ------ ------
<S> <C> <C> <C>
Single family residential................................ $1,218 $2,509 $7,695
Income property:
Multi-family........................................... -- 213 2,362
Commercial............................................. -- 1,393 --
Land..................................................... 4,398(1) -- 2,365
Investment, total........................................ 5,616 4,115 12,422
Reserves................................................. (29) (45) (2,563)
------ ------ ------
Investment, net.......................................... $5,587 $4,070 $9,859
====== ====== ======
</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.
In the preceding table, the Company's gross investment in REO equals loan
principal at foreclosure, plus post-foreclosure capitalized costs, less
cumulative charge-offs.
The table below summarizes the changes in valuation of the REO portfolio
for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS) ---- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
Real estate owned
Reserve balance at beginning of period.... $ 45 $ 2,563 $ 11,871 $15,725 $ 32,609
Provision for estimated losses............ 80 60 913 4,933 18,973
Charge offs............................... (96) (2,578) (10,221) (8,787) (35,857)
Recoveries................................ -- -- -- -- --
---- ------- -------- ------- --------
Balance, end of period.................... $ 29 $ 45 $ 2,563 $11,871 $ 15,725
==== ======= ======== ======= ========
</TABLE>
INVESTMENT SECURITIES
The Company has authority to invest in a variety of investment securities,
including U.S. Government and agency securities, mortgage-backed securities and
corporate securities. However, in recent years the Company's strategy has been
to deploy its assets through loan originations, rather than purchases of
investment securities. As a result, the investment activity has been steadily
decreasing over the last six years, and during 1999 there was no investment
activity. During the first quarter of 1997, the Company purchased $40 million of
U.S. Government agency callable bonds, which was partially offset by sales of
$12.5 million of U.S. Government securities during the second and third quarters
of 1997. These bonds were ultimately called or sold during the fourth quarter of
1997. Subsequent to the Company's stock offering in the third quarter of 1998,
the Company utilized the $27.6 million of proceeds to purchase $27.9 million in
FNMA discount notes, $5 million of which matured in September 1998 and $22.9
million of which matured in December 1998. During 1998, the Company sold $596
thousand in mutual funds. The Company classifies all securities acquired as
available-for-sale under generally accepted accounting principles, and thus the
securities are carried at fair value, with unrealized gains and losses excluded
from income and reported as a separate component of stockholders' equity, net of
taxes.
SOURCES OF FUNDS
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 far lesser
extent, advances from the FHLB and securities sold under agreements to
repurchase ("REPO"). In addition, funds have been obtained from maturities and
repayments of loans and securities, and sales of loans, securities and other
assets, including REO.
20
<PAGE> 25
DEPOSITS
At December 31, 1999, the Company operated seven retail-banking locations
(the seventh one opened in December 1999) with three primary product lines; (1)
checking and savings accounts, (2) money market accounts, and (3) certificates
of deposit. Five of these branches are located in the South Bay area of Los
Angeles County, one is located in the San Fernando Valley area of Los Angeles
County and the other is located near the border of Los Angeles and Ventura
Counties. For the year ended December 31, 1999, the Company's retail branches,
excluding the new Redondo Beach branch, carried average deposit balances of
$175.7 million, which is substantially higher than most local banking companies.
The Company does not operate a money desk or otherwise solicit brokered
deposits.
The Company has several types of deposit accounts principally designed to
attract short-term deposits. The table below summarizes average deposits and the
weighted-average interest rates paid thereon during the periods indicated. See
Note 7 of the Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- --------------------------- ---------------------------
PERCENT PERCENT PERCENT
AMOUNT(1) WAIR OF TOTAL AMOUNT(1) WAIR OF TOTAL AMOUNT(2) WAIR OF TOTAL
(DOLLARS IN THOUSANDS) ---------- ---- -------- --------- ---- -------- --------- ---- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Checking/NOW.................. $ 63,597 1.3% 6.0% $ 45,904 1.7% 5.1% $ 30,786 1.2% 4.1%
Passbook...................... 27,666 1.4% 2.6 17,003 3.7% 1.9 22,084 1.8% 3.0
Money market.................. 152,515 4.5% 14.8 73,190 4.0% 8.0 31,465 3.2% 4.3
Certificates of Deposit....... 810,392 5.3% 76.6 771,618 5.6% 85.0 659,830 5.6% 88.6
---------- ----- -------- ----- -------- -----
Total................. $1,054,170 4.9% 100.0% $907,715 5.3% 100.0% $744,165 5.2% 100.0%
========== ===== ======== ===== ======== =====
</TABLE>
- ---------------
(1) Amounts represent daily averages.
(2) Amounts represent monthly averages.
BORROWINGS
In recent years, the Company has funded loan growth, in part, through
borrowings from the FHLB. The Company may apply for advances from the FHLB
secured by the capital stock of the FHLB owned by the Company and certain of the
Company's loans and other assets. Advances can be requested for any business
purpose in which the Company is authorized to engage. In granting advances, the
FHLB considers a member's creditworthiness and other relevant factors. At
December 31, 1999, the Company had an approved line of credit with the FHLB for
a maximum advance of up to 35% of total assets ($553.3 million as of December
31, 1999). At December 31, 1999, the Company had nine FHLB advances outstanding
totaling $349.0 million which had a weighted averaged interest rate of 5.16% and
a weighted average remaining maturity of 4 years and 6 months.
SENIOR NOTES
On December 31, 1997, the Company sold $40.0 million of 12.5% Senior Notes
due 2004 ("1997 Senior Notes") in a private placement (the "1997 Offering").
Concurrent with the completion of the 1997 Offering, the Company prepaid all of
its 1995 Senior Notes and redeemed all of its Series A Preferred Stock. Interest
on the 1997 Senior Notes is payable semiannually. On or after December 31, 2002,
the 1997 Senior Notes will be redeemable at any time at the option of the
Company, in whole or in part, at the redemption price of 106.25% for the
twelve-month period beginning December 31, 2002, and 103.125% beginning December
31, 2003 and thereafter until maturity.
ITEM 2. PROPERTIES
As of December 31, 1999, the Company had eight leased and two wholly owned
properties. The leased properties included its corporate headquarters, five
branch offices (two of which were ground leases for sites on which the Company
has built branch offices), one warehouse, and one office location. All of the
properties owned or leased by the Company are in Southern California.
21
<PAGE> 26
The following table summarizes the Company's owned and leased properties at
December 31, 1999 and, with respect to leased properties, highlights the
principal terms and net book values of the owned properties and leasehold
improvements. None of the leases contain any unusual terms and are all "net" or
"triple net" leases.
<TABLE>
<CAPTION>
EXPIRATION RENEWAL MONTHLY SQUARE NET
OF TERM OPTIONS RENTAL FEET BOOK VALUE
---------- ----------- -------- ------- ----------
<S> <C> <C> <C> <C> <C>
Leased:
El Segundo Corporate................... 11/30/05 One 5-year $ 74,468 57,817 $ 734,732
Torrance Branch........................ 12/31/01 One 5-year 18,578 7,343 119,925
Irvine, offices only(1)................ 09/30/03 One 5-year 14,000 8,000 30,792
Westlake Branch........................ 06/30/10 Two 5-year 14,245 7,700 42,794
Manhattan Beach Branch(2).............. 10/30/10 Four 5-year 4,590 4,590
Warehouse.............................. 06/30/01 Two 3-year 4,000 10,000 63,522
Tarzana Branch(2)...................... 01/31/05 Five 5-year 3,283 3,352
Redondo Beach Branch................... 04/30/04 Two 5-year 3,857 1,403 192,926
-------- ------- ----------
Total.......................... $137,021 100,205 $1,184,691
======== ======= ==========
</TABLE>
<TABLE>
<S> <C> <C>
Owned:
Hawthorne Branch.......................................... 9,500 $200,199
Westchester Branch........................................ 8,800 412,676
Manhattan Beach Branch (building only).................... 4,590 45,003
Tarzana Branch (building only)............................ 3,352 30,186
------ --------
Total............................................. 26,242 $688,064
====== ========
</TABLE>
- ---------------
(1) Closed February 2000; lease paid through March 2000.
(2) Ground lease only; building and improvements are owned by the Company but
revert to the landlord upon termination of the lease.
The Bank utilizes a client-server computer system with use of various
third-party vendors' software for retail deposit operations, loan servicing,
accounting and loan origination functions. The net book value of the Bank's
electronic data processing equipment, including personal computers and software,
was $1.9 million at December 31, 1999.
At December 31, 1999, the net book values of the Company's office property,
and furniture, fixtures and equipment, excluding data processing equipment, were
$4.0 million. See note 6 of the Notes to Consolidated Financial Statements. The
Company believes that all of the above facilities are in good condition and are
adequate for the Company's present operations.
ITEM 3. LEGAL PROCEEDINGS
LITIGATION
The Bank is a defendant in an action entitled Takaki vs. Hawthorne Savings
and Loan Association, filed in the Superior Court of the State of California,
Los Angeles. The plaintiffs were owners of real property that they sold in early
1992 to a third party. The Bank provided escrow services in connection with the
transaction. A substantial portion of the consideration paid to the plaintiffs
took the form of a deed of trust secured by another property then owned by an
affiliate of the purchaser. The value of the collateral securing this deed of
trust ultimately proved to be inadequate. The plaintiffs alleged that the Bank
knew, or should have known, that the security that the plaintiffs received as
sellers was inadequate and should have so advised them. In June 1997, a jury
found for the plaintiffs and awarded compensatory and punitive damages totaling
$9.1 million. In July 1997, the trial judge reduced the combined award to $3.3
million. The Bank filed an appeal and in July, 1998, the Appellate Court
remanded the case to the Superior Court with directions to dismiss the
fraudulent concealment, misrepresentation and punitive damages claims and to
conduct a new trial pertaining solely to damages arising from negligence, in
particular to determine whether any negligence of the Bank contributed to
22
<PAGE> 27
the plaintiffs' injury and, if so, to apportion liability for negligence between
the Bank and the plaintiffs. On March 30, 1999, the jury returned a verdict in
favor of the plaintiffs in the amount of $2.4 million. In May 1999, the Bank
filed a notice of appeal from the judgment and posted an Appeal Bond with the
court to stay plaintiffs' enforcement of the judgment pending the Appellate
Court's decision. Briefs on appeal were filed in December 1999. The Bank
believes that there is a reasonable likelihood that its position will ultimately
be upheld on appeal. There can be no assurances that this will be the case,
however.
The Bank is a defendant in an action entitled Mells v. Hawthorne, filed in
the Superior Court of the State of California, San Diego. Plaintiffs alleged
that the Bank concealed and misrepresented the severity of defects in a house
that the Bank sold to them. On September 20, 1999, a second amended judgment was
entered on behalf of the plaintiffs for $767 thousand that includes attorney's
fees and costs. In October, the Bank filed a notice of appeal from the judgment
and posted an appeal bond to stay plaintiffs' enforcement of the judgment
pending the Appellate Court's decision. A briefing schedule on the appeal has
not yet been set. The Bank believes that there is a reasonable likelihood that
its position will ultimately be upheld on appeal. There can be no assurances
that this will be the case, however.
The Bank is a defendant in two construction defect cases entitled Marine
Village Townhomes Homeowners' Association v. Hawthorne Savings and Loan
Association and Stone Water Terrace HOA v. Hawthorne Savings and Loan
Association. Both cases were filed in the Superior Court of the State of
California, County of Los Angeles. In each of these actions, Plaintiffs allege,
under several theories of recovery, that the Bank was responsible for
construction defects in multi-unit condominium complexes. The Bank initially
provided construction loans to the developer, but took over the completion of a
portion of the projects after the developer defaulted. Plaintiffs in the Marine
Village Townhomes case are seeking damages of approximately $3.3 million.
Plaintiffs in the Stone Water Terrace matter are seeking damages in an
unspecified amount, plus punitive damages. The Bank has denied the Marine
Village Townhomes claims that it is responsible for all of the defects
Plaintiffs are alleging, and has made claims for indemnification against the
contractor and subcontractors. The Bank has denied the allegations in the Stone
Water Terrace complaint and intends to seek indemnification against the
responsible parties. No assurances can be given that the responsible parties in
either case will ultimately indemnify the Bank. Although the Bank intends to
vigorously defend its position in these actions and to pursue indemnification,
there can be no assurances that the Bank will prevail. In addition, it is
probable that the Bank will incur substantial legal fees defending these cases.
In addition, the inherent uncertainty of jury or judicial verdicts makes it
impossible to determine with certainty the Company's maximum exposure in these
actions.
The Bank is involved in a variety of other litigation matters in the
ordinary course of its business, and anticipates that it will become involved in
new litigation matters from time to time in the future. Based on the current
assessment of these other matters, management does not presently believe that
any one of these existing other matters is likely to have material adverse
impact on the Company's financial condition or result of operations. However,
the Company will incur legal and related costs concerning the litigation and may
from time to time determine to settle some or all of the cases, regardless of
management's assessment of the Company's legal position. The amount of legal
defense costs and settlements in any period will depend on many factors,
including the status of cases (and the number of cases that are in trial or
about to be brought to trial) and the opposing parties' aggressiveness in
pursuing their cases and their perception of their legal position. Further, the
inherent uncertainty of jury or judicial verdicts makes it impossible to
determine with certainty the Company's maximum cost in any pending litigation.
Accordingly, the Company's litigation costs and expenses may vary materially
from period to period, and no assurance can be given that these costs will not
be material in any particular period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the 4th quarter
of 1999.
23
<PAGE> 28
ITEM 4A. EXECUTIVE OFFICERS
The following table sets forth, as of February 25, 2000, the names and ages
of all executive officers of the Company, indicating their positions and
principal occupation during the past five years.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY AND PRIOR EXPERIENCE
---- --- ----------------------------------------------
<S> <C> <C>
Simone Lagomarsino................... 38 President and Chief Executive Officer of Hawthorne
Financial and Hawthorne Savings since December 1999.
Executive Vice President and Chief Financial Officer
of Hawthorne Financial and Hawthorne Savings from
February 1999 through December 1999. Executive Vice
President and Chief Financial Officer of First Plus
Bank from March 1998 to February 1999. Senior Vice
President, Finance of Imperial Financial Group from
March 1997 to March 1998. Senior Vice President and
Chief Financial Officer of Ventura County National
Bank from March 1995 to March 1997. (Ventura County
National Bank was sold to City National Bank in
January 1997.) Financial advisor Prudential Securities
September 1993 to March 1995.
David Hardin......................... 46 Executive Vice President of Hawthorne Savings since
August 1993. Executive Vice President and Chief Retail
Officer of Valley Federal Savings from November 1990
to February 1992.
Charles Stoneburg.................... 57 Executive Vice President of Hawthorne Savings since
August 1983. President of Semper Enterprises Inc. from
August 1981 to July 1982. Executive Vice President of
FiServ Corporation from September 1972 to August 1981.
Eileen Lyon.......................... 42 Senior Vice President, General Counsel, and Corporate
Secretary of Hawthorne Financial and Hawthorne Savings
since February 2000. Partner with Manatt, Phelps &
Phillips, LLP from 1993 to February 2000.
Daniel Ruvalcaba..................... 48 Executive Vice President and Chief Lending Officer of
Hawthorne Savings since February 2000. Executive Vice
President and Chief Credit Officer of California
National Bank from 1997 to January 2000. Senior Vice
President of California Federal Bank from 1994 to
1997. Executive Vice President and Senior Credit
Officer of Travelers Insurance Corporation from 1987
to 1994.
William R. Brown..................... 43 Senior Vice President of Hawthorne Savings since
August 1993. Group manager of single family
residential construction lending since January 2000.
Manager of the Bank's construction servicing group
from January 1998 through December 1999. Manager of
the Bank's single family and tract construction
lending operations from 1995 through 1998. Manager of
Bank's Special Assets division from 1993 through 1995.
Vice President, City National Bank, Real Estate
Special Assets group, from January 1993 to August
1993. Senior Vice President, Valley Federal Savings,
from 1983 to 1992.
</TABLE>
24
<PAGE> 29
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET PRICES OF COMMON STOCK
The common stock of the Company ("Common Stock") is traded on the Nasdaq
National Market under the symbol "HTHR." ChaseMellon Shareholder Services is the
Company's transfer agent and registrar, and is able to respond to inquiries from
shareholders on their website: www.chasemellon.com. The following table sets
forth the high and low sales prices of the Common Stock as reported by Nasdaq
for the periods indicated below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 HIGH LOW
---------------------------- ---- ---
<S> <C> <C>
First quarter............................................... 17 14 3/4
Second quarter.............................................. 16 1/2 13 5/16
Third quarter............................................... 16 3/4 13 1/4
Fourth quarter.............................................. 14 3/4 11 1/16
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 HIGH LOW
---------------------------- ---- ---
<S> <C> <C>
First quarter............................................... 21 1/2 19 1/8
Second quarter.............................................. 21 3/4 16 3/4
Third quarter............................................... 20 13 3/4
Fourth quarter.............................................. 16 7/8 12
</TABLE>
Management is aware of six securities dealers who currently make a market
in the Common Stock: Sandler O'Neill & Partners; Mayer & Schweitzer Inc.;
Neuberger & Berman; Spear Leeds Kellogg; MacAllister Pitfield Mackay; and Knight
Securities, L.P.
STOCKHOLDERS
As of February 25, 2000, there were approximately 443 holders of record.
DIVIDENDS
It is the present policy of the Company to retain earnings to provide funds
for use in its business. The Company has not paid cash dividends on the Common
Stock during the past several years and does not anticipate doing so in the
foreseeable future.
As a holding company whose only significant asset is the common stock of
the Bank, the Company's ability to pay dividends on its common stock and to
conduct business activities directly or in non-banking subsidiaries depends
significantly on the receipt of dividends or other distributions from the Bank.
Federal banking laws and regulations, including the regulations of the OTS,
limit the Bank's ability to pay dividends to the Company. The Bank generally may
not declare dividends or make any other capital distribution to the Company if,
after the payment of such dividends or other distribution, the Bank would fall
within any of the three undercapitalized categories under the prompt corrective
action standards established by the OTS and the other federal banking agencies.
Another regulation of the OTS also limits the Company's ability to pay dividends
and make other capital distributions in a manner that depends upon the extent to
which it meets regulatory capital requirements. In addition, HOLA requires every
savings association subsidiary of a savings and loan holding company to give the
OTS at least 30 days' advance notice of any proposed dividends to be made on its
guarantee, permanent or other non-withdrawable stock or else the dividend will
be invalid. Further, the OTS may prohibit any dividend or other capital
distribution that it determines would constitute an unsafe or unsound practice.
In addition to the regulation of dividends and other capital distributions,
there are various statutory and regulatory limitations on the extent to which
the Bank can finance or otherwise transfer funds to the Company or any of its
non-banking subsidiaries, whether in the form of loans, extensions of credit,
investments or asset purchases. The director of the OTS may further restrict
these transactions in the interest of safety and soundness.
25
<PAGE> 30
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below is derived from the audited
consolidated financial statements of the Company and should be read in
conjunction with the Consolidated Financial Statements presented elsewhere
herein.
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Interest Revenues...................... $ 132,747 $ 106,992 $ 75,616 $ 65,354 $ 50,994
Interest Costs......................... (73,626) (61,874) (43,825) (39,960) (34,486)
---------- ---------- -------- -------- --------
Net interest income.................... 59,121 45,118 31,791 25,394 16,508
Provision for credit losses............ (12,000) (7,135) (5,137) (6,067) (472)
---------- ---------- -------- -------- --------
Net interest income after provision for
credit losses........................ 47,121 37,983 26,654 19,327 16,036
Noninterest revenues, net.............. 7,820 4,653 3,588 8,588 4,148
Income (loss) from real estate operations,
net.................................. 324 1,909 229 (2,378) (14,309)
General and administrative costs....... (32,363) (28,802) (22,009) (21,046) (20,339)
Other non-operating (expense) income... (4,672) (31) 112 (3,366)(1) 864
---------- ---------- -------- -------- --------
Total noninterest expense....... (37,035) (28,833) (21,897) (24,412) (19,475)
Income (loss) before income tax (expense)
benefit and extraordinary item....... 18,230 15,712 8,574 1,125 (13,600)
Income tax (expense) benefit........... (8,030) (4,674) 2,577 6,382 (617)
---------- ---------- -------- -------- --------
Income (loss) before extraordinary item.. 10,200 11,038 11,151 7,507 (14,217)
Extraordinary item..................... -- -- (1,534)(2) -- --
---------- ---------- -------- -------- --------
Net income (loss)...................... $ 10,200 $ 11,038 $ 9,617 $ 7,507 $(14,217)
========== ========== ======== ======== ========
Net income (loss) available for common
stock................................ $ 10,200 $ 11,038 $ 5,254 $ 5,070 $(14,334)
========== ========== ======== ======== ========
Per Share Amounts:
Basic earnings (loss) per share before
extraordinary item................... $ 1.93 $ 2.64 $ 2.35 $ 1.95 $ (5.52)
Basic earnings (loss) per share before
extraordinary item................... 1.93 2.64 1.82 1.95 (5.52)
Diluted earnings (loss) per share before
extraordinary item................... 1.33 1.65 1.30 1.17 (5.52)
Diluted earnings (loss) per share before
extraordinary item................... 1.33 1.65 1.00 1.17 (5.52)
Diluted book value per share........... 12.10 10.43 7.67 7.14 10.53
Balance Sheet Data at Period End:
Total Assets........................... $1,581,153 $1,412,434 $928,197 $847,195 $753,583
Cash and cash equivalents.............. 86,722 45,449 51,620 93,978 14,015
Investment securities.................. -- -- 578 38,371 62,793
Loans receivable, net.................. 1,444,968 1,326,791 838,251 672,401 617,328
Real estate owned, net................. 5,587 4,070 9,859 20,140 37,905
Deposits............................... 1,086,635 1,019,450 799,501 717,809 698,008
Senior notes due 2004.................. 40,000 40,000 40,000 -- --
Senior notes due 2000.................. -- -- -- 12,307 12,006
Other borrowings....................... 349,000 264,000 40,000 50,000 --
Stockholders' equity................... 92,304 81,424 42,319 43,922 38,966
Allowance for credit losses............ 24,285 17,111 13,274 13,515 15,192
</TABLE>
26
<PAGE> 31
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1999 1998 1997 1996 1995
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Asset Quality at Period End:
Nonaccrual loans....................... $ 44,031 $ 47,688 $ 15,396 $ 28,624 $ 21,709
REO, net............................... 5,587 4,070 9,859 20,140 37,905
---------- ---------- -------- -------- --------
$ 49,618 $ 51,758 $ 25,255 $ 48,764 $ 59,614
========== ========== ======== ======== ========
Net charge-offs.......................... $ 4,826 $ 3,298 $ 5,378 $ 7,744 $ 6,741
Yields and Costs (for the period):
Interest-earnings assets............... 8.68% 9.06% 9.00% 8.43% 7.62%
Interest-bearing liabilities........... 5.21% 5.54% 5.44% 5.29% 5.01%
Interest rate spread(3)................ 3.47% 3.52% 3.56% 3.14% 2.61%
Net interest margin(4)................. 3.87% 3.82% 3.78% 3.28% 2.47%
Performance Ratios(5):
Return on average assets............... 0.66% 0.93% 1.11% 0.93% (1.96)%
Return on average common stockholders'
equity............................... 11.66% 18.22% 19.83% 17.75% (47.57)%
Average stockholders' equity to average
assets............................... 5.68% 5.09% 5.60% 5.24% 4.11%
Efficiency ratio(6).................... 48.35% 57.88% 62.19% 77.03% 114.14%
Bank Capital ratios at period end:
Tangible............................... 8.05% 7.65% 7.55% 6.27% 5.80%
Core................................... 8.05% 7.65% 7.55% 6.27% 5.80%
Tier 1................................. 11.37% 10.10% 10.23% 9.85% 9.01%
Risk-based............................. 12.50% 11.10% 11.48% 11.11% 10.27%
Asset Quality Data at Period End:
Total nonaccrual loans to total assets... 2.78% 3.38% 1.66% 3.38% 2.88%
Nonaccrual loans to total gross loans... 3.00% 3.55% 1.81% 4.17% 3.43%
Allowance for credit losses to gross
loans................................ 1.65% 1.27% 1.56% 1.97% 2.40%
Allowance for credit losses to nonaccrual
loans................................ 55.15% 35.88% 86.22% 47.22% 69.98%
Net charge-offs to average loans....... 0.34% 0.30% 0.72% 1.15% 1.16%
</TABLE>
- ---------------
(1) Includes a one-time charge on all deposits insured by the SAIF as of March
31, 1996 to recapitalize the SAIF.
(2) Relates to the accelerated write off of unamortized issue costs and original
issue discount associated with Senior Notes due 2000, which were issued by
the Company in December 1995 and repaid in full in December 1997, with a
portion of the proceeds from the offering of Senior Notes due 2004.
(3) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(4) Net interest income divided by average interest-earning assets.
(5) With the exception of period-end ratios, all ratios are based on average
monthly balances.
(6) Represents general and administrative costs divided by net interest income
before provision for credit losses and noninterest revenues.
27
<PAGE> 32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion provides information about the results of
operations, financial condition, liquidity, and asset quality of the Company.
This information is intended to facilitate the understanding and assessment of
significant changes and trends related to the financial condition of the Company
and the results of its operations. This discussion and analysis should be read
in conjunction with the Company's Consolidated Financial Statements and the
accompanying notes presented herein. See "Cautionary Statement Regarding Forward
Looking Statements."
RESULTS OF OPERATIONS
GENERAL
For the year ended December 31, 1999, the Company earned $10.2 million, or
$1.33 per diluted share, reflecting a return on average assets ("ROA") of 0.7%
and a return on average equity ("ROE") of 11.7%. The Company earned $11.0
million, or $1.65 per diluted share, with a ROA of 0.9% and a ROE of 18.2% for
the year ended December 31, 1998, and $9.6 million, or $1.30 per diluted share
before extraordinary item, for the year ended December 31, 1997. The Company's
consolidated capital structure has changed significantly since 1995, initially
as a result of its recapitalization in December 1995, and then again in December
1997, due to its refinancing of the securities issued in the 1995
recapitalization, through the sale of Senior Notes ("Senior Notes"). The results
for 1997 included an extraordinary item of $1.5 million incurred in connection
with the early repayment, and the accelerated write-off of unamortized issue
costs and discounts, of the Senior Notes due 2000, and Series A Preferred Stock.
In July 1998, the Company completed a public offering of approximately 2.0
million shares of its Common Stock, which raised approximately $27.6 million of
net proceeds. In addition, the Company returned to taxable status during 1998,
following several years in which it realized substantial income tax benefits
from utilization of accumulated operating loss carry-forwards.
The table below identifies the principal components of the Company's pretax
income and the Company's net income for the three years ended December 31, 1999,
1998 and 1997, respectively.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) -------- -------- --------
<S> <C> <C> <C>
Net interest income................................ $ 64,121 $ 50,118 $ 33,770
Provision for credit losses........................ (12,000) (7,135) (5,137)
-------- -------- --------
Net interest income after provision for credit
losses........................................ 52,121 42,983 28,633
Noninterest revenues, net:
Noninterest revenues............................. 7,820 4,646 3,599
Gain (loss) on sales of investment securities.... -- 7 (11)
Income from real estate operations, net.......... 324 1,909 229
Noninterest expenses:
General and administrative....................... (32,363) (28,802) (22,009)
Other non-operating expense (income)............. 4,672 31 (112)
Interest on senior notes........................... (5,000) (5,000) (1,979)
-------- -------- --------
Income before income taxes and extraordinary
item.......................................... 18,230 15,712 8,574
Income tax (provision) benefit..................... (8,030) (4,674) 2,577
-------- -------- --------
Net income before extraordinary item............... 10,200 11,038 11,151
Extraordinary item................................. -- -- (1,534)
-------- -------- --------
Net income......................................... $ 10,200 $ 11,038 $ 9,617
======== ======== ========
</TABLE>
The Company's net interest income achieved pretax income of $18.2 million
for the year ended December 31, 1999, representing a 15.9% increase from the
$15.7 million earned in 1998, which was 82.6%
28
<PAGE> 33
higher than 1997 pretax income of $8.6 million. The increase in net interest
income reflects the growth in the Company's loans and deposits during 1999. The
growth in net interest income resulted from a 29.5% increase in average earning
assets from 1998 and a decrease in the average cost of funds to 5.2% during 1999
from 5.6% and 5.5% during 1998 and 1997, respectively. The Company's resulting
net interest margin from 1999 was 3.9% compared to 3.8% during 1998 and 1997,
respectively.
The Bank recorded a provision for estimated credit losses of $12.0 million
during 1999, compared to $7.1 million and $5.1 million during 1998 and 1997,
respectively. This growth in the provision for credit losses was the result of
management's previously announced commitment to increase the Bank's allowance
for estimated credit losses by the end of 1999. This commitment acknowledges (1)
the significant growth in net loans, (2) the introduction during 1998 and 1999
of new loan products, and (3) the resulting lack of seasoning of many of the
Bank's loans. At December 31, 1999, the ratio of the total allowance for
estimated credit losses to total loans, net of specific reserves, reached 1.65%
compared to 1.27% and 1.56% at December 31, 1998 and 1997, respectively.
Noninterest revenues were $7.8 million for the twelve months ended December
31, 1999, compared to noninterest revenues of $4.6 million and $3.6 million
earned during 1998 and 1997, respectively. The increase in noninterest revenues
resulted primarily from a greater amount of exit and release fees, and
prepayment penalties in connection with loans repaid during the period, which
offset reductions in income from real estate operations.
Nonaccrual loans were $44.0 million at December 31, 1999, or 2.8% of total
assets, compared to $47.7 million, or 3.4% of total assets, at December 31,
1998. Included in nonaccrual loans at December 31, 1999, were five single family
residential loans with balances greater than $1.0 million representing $18.0
million, or 41% of total nonaccrual loans, and one commercial loan with a $10.5
million balance, or 23.8% of total nonaccrual loans, at December 31, 1999. See
"Asset Quality" section for further discussion of nonaccrual loans. The average
loan to value (LTV) for these five loans was 74%. Other classified loans were
$25.6 million at December 31, 1999 compared to $45.4 million and $35.8 million
for 1998 and 1997, respectively.
The Company incurred $4.7 million in other non-operating expenses during
1999, of which $4.3 million related to amounts paid, or reserved for payment, in
connection with ongoing litigation and/or satisfaction of judgments against the
Company, and for severance for the former CEO. During 1998, the Company incurred
minimal non-operating expenses primarily related to losses on the sale of
certain fixed assets.
The Company's effective tax rate was 44.1% and 29.7% during 1999 and 1998,
respectively, reflecting utilization of accumulated Federal income tax benefits,
principally tax loss carry-forwards, during 1998. By comparison, the Company
recorded income tax benefits of $2.6 million in 1997, which reflected the
Company's utilization of income tax benefits. These income tax benefits, which
consisted principally of tax loss carryforwards, accumulated during the early
1990's, a period during which the Company incurred substantial losses.
29
<PAGE> 34
The following table shows average interest-earning assets and
interest-bearing liabilities, related revenues and costs, and effective
weighted-average yields and costs for each of the three years ended December 31,
1999. The interest costs associated with the Company's issues of Senior Notes
are included in the table.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------
1999 1998 1997
------------------------------- ------------------------------- -----------------------------
AVERAGE REVENUES/ YIELD/ AVERAGE REVENUES/ YIELD/ AVERAGE REVENUES/ YIELD/
BALANCE COST COST BALANCE COST COST BALANCE COST COST
(DOLLARS IN THOUSANDS) ---------- --------- ------ ---------- --------- ------ -------- --------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loan receivable(1)....... $1,411,697 $126,854 8.99% $1,081,382 $102,213 9.45% $745,197 $70,012 9.40%
Cash and cash
equivalents............ 99,179 4,911 4.95 81,188 3,698 4.55 33,747 1,776 5.26
Investment securities.... -- -- -- 8,801 510 5.79 54,420 3,403 6.25
Investment in capital
stock of Federal Home
Loan Bank.............. 18,344 982 5.35 9,862 571 5.79 6,980 425 6.09
---------- -------- ---------- -------- -------- -------
Total interest
earning assets..... 1,529,220 132,747 8.68 1,181,233 106,992 9.06 840,344 75,616 9.00
-------- -------- -------
Noninterest-earning
assets................... 11,005 8,839 25,403
---------- ---------- --------
Total assets......... $1,540,225 $1,190,072 $865,747
========== ========== ========
Liabilities and Stockholders' Equity:
Interest-bearing
liabilities:
Deposits (net of
non-interest
checking).............. $1,029,701 $ 50,831 4.94 $ 894,337 $ 47,642 5.33 $737,587 $38,920 5.28
FHLB advances............ 343,205 17,795 5.18 170,060 9,232 5.43 48,621 2,926 6.02
Senior notes............. 40,000 5,000 12.50 40,000 5,000 12.50 12,473 1,979 15.87
---------- -------- ---------- -------- -------- -------
Total interest
bearing
liabilities........ 1,412,906 73,626 5.21 1,104,397 61,874 5.60 798,681 43,825 5.49
-------- -------- -------
Noninterest-bearing
checking................. 24,469 13,378 6,578
Noninterest-bearing
liabilities.............. 15,337 11,703 11,997
---------- ---------- --------
Stockholders' equity....... 87,513 60,594 48,491
---------- ---------- --------
Total liabilities and
Stockholders
equity............. $1,540,225 $1,190,072 $865,747
========== ========== ========
Net interest income.......... $ 59,121 $ 45,118 $31,791
======== ======== =======
Interest rate spread......... 3.47% 3.46% 3.51%
===== ===== =====
Net interest margin.......... 3.87% 3.82% 3.78%
===== ===== =====
</TABLE>
- ---------------
(1) Includes the interest on non-performing loans only to the extent that it was
paid and recognized as interest income.
NET INTEREST INCOME
The operations of the Company are substantially dependent on its net
interest income, which is the difference between the interest income received
from its interest-earning assets and the interest expense paid on its
interest-bearing liabilities. The Company's net interest margin is its net
interest income divided by its average interest-earning assets. Net interest
income and net interest margin are affected by several factors, including (1)
the level of, and the relationship between, the dollar amount of
interest-earning assets and interest-bearing liabilities, (2) the relationship
between the repricing or maturity of the Company's adjustable-rate and
fixed-rate loans and short-term investment securities and its deposits and
borrowings, and (3) the magnitude of the Company's noninterest-earning assets,
including nonaccrual loans and real estate owned ("REO") properties.
The Company recorded net interest income of $59.1 million, $45.1 million
and $31.8 million in 1999, 1998, and 1997 respectively, representing increases
of 31.0% and 41.8% in 1999 and 1998. The resulting net interest margin increased
during the three years to 3.9% in 1999 from 3.8% in 1998 and 1997.
The increase in net interest income was primarily due to significant growth
in earning assets, which was a direct result of the Bank's continuing successful
pursuit of the real estate secured financing business. For the twelve months
ended December 31, 1999, average earning assets were $1.5 billion, an increase
of 25.0% over
30
<PAGE> 35
average earning assets of $1.2 billion during 1998. Average total loans, net of
deferred fees, grew to $1.4 billion in 1999, an increase of 27.3% over $1.1
billion in average total loans, net of deferred fees in 1998. Total assets
reached $1.6 billion at December 31, 1999, reflecting a growth rate of 14.3%
above total assets of $1.4 billion at December 31, 1998.
For the twelve months ended December 31, 1998, average earning assets were
$1.2 billion, an increase of 50.0% over average earning assets of $0.8 billion
during 1997. Average total loans, net of deferred fees, grew to $1.1 billion in
1998, an increase of 57.1% over $0.7 billion in average total loans, net of
deferred fees in 1997. Total assets reached $1.4 billion at December 31, 1998,
reflecting a growth rate of 55.6 % above total assets of $0.9 billion at
December 31, 1997.
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>
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
1999 AND 1998 1998 AND 1997
INCREASE (DECREASE) DUE TO CHANGE IN INCREASE (DECREASE) DUE TO CHANGE IN
---------------------------------------- --------------------------------------
VOLUME AND NET VOLUME AND NET
VOLUME RATE RATE(1) CHANGE VOLUME RATE RATE(1) CHANGE
(DOLLARS IN THOUSANDS) ------- ------- ---------- ------- ------- ----- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(2)................... $31,222 $(5,041) $(1,540) $24,641 $31,579 $ 428 $ 194 $32,201
Cash and cash equivalents............. 819 322 72 1,213 2,497 (239) (336) 1,922
Investment securities................. (510) (510) 510 (510) (2,853) (249) 209 (2,893)
Investment in Federal Home Loan Bank
stock, at cost...................... 491 (43) (37) 411 175 (21) (8) 146
------- ------- ------- ------- ------- ----- ------- -------
32,022 (5,272) (995) 25,755 31,398 (81) 59 31,376
------- ------- ------- ------- ------- ----- ------- -------
Interest-bearing liabilities:
Deposits.............................. 7,211 (3,493) (529) 3,189 8,510 173 38 8,721
Short term borrowings................. 9,399 (414) (422) 8,563 7,306 (286) (714) 6,306
Senior notes.......................... -- -- -- -- 4,387 (424) (941) 3,022
------- ------- ------- ------- ------- ----- ------- -------
16,610 (3,907) (951) 11,752 20,203 (537) (1,617) 18,049
------- ------- ------- ------- ------- ----- ------- -------
Change in net interest income........... $15,412 $(1,365) $ (44) $14,003 $11,195 $ 456 $ 1,676 $13,327
======= ======= ======= ======= ======= ===== ======= =======
</TABLE>
- ---------------
(1) Calculated by multiplying change in rate by change in volume.
(2) Includes the interest on non-performing loans only to the extent that it was
paid and recognized as interest income.
The Company's interest revenues increased by $25.8 million, or 24.1%,
during the twelve months ended December 31, 1999 compared to the same period in
1998. This increase was primarily attributable to a 30.5% increase in the
average balance of loans outstanding, which was partially offset by a decrease
in the weighted average yield on earning assets, which averaged 8.7% during 1999
compared to 9.1% during 1998 and 9.0% during 1997.
The primary reason for the decline in the yield in the loan portfolio is
due to lower yielding loans being added to the loan portfolio during 1997, 1998
and 1999, reflecting the increased competitive rate pressure in the marketplace
and a change in the portfolio mix. In addition, higher yielding loans have been
paying off during 1998 and 1999, adding to the overall yield decline.
Interest costs increased by $11.8 million, or 19.0%, during the twelve
months ended December 31, 1999 compared to the same period during 1998,
primarily due to a 27.9% increase in the average balance of the Company's
interest bearing liabilities. This increase was partially offset by a decrease
in the weighted average rates paid on the Company's deposits and FHLB advances,
which together averaged 5.0% for the twelve months ended December 31, 1999
compared to 5.3% during the same period of 1998 and 1997. At December 31, 1999,
certificates of deposit totaled $838.1 million, or 77.1% of total deposits, down
from
31
<PAGE> 36
$833.7 million, or 81.8% of total deposits at December 31, 1998. This reduced
reliance on certificates of deposit had a positive impact on the Company's cost
of funds and was achieved by capitalizing on the Bank's strong community
involvement.
PROVISION FOR ESTIMATED CREDIT LOSSES
Provisions for estimated credit losses were $12.0 million, $7.1 million,
and $5.1 million for 1999, 1998 and 1997, respectively. The company's ratio of
charge-offs to average loans has improved from 0.7% in 1997 to 0.3% in 1998, and
has remained at a consistent level of 0.3% in 1999. Additionally, total
classified assets to Bank core capital and general allowance for estimated
credit losses have decreased from 77.1% in 1997 to 50.0% in 1999. Average loans
outstanding during 1999 increased by $330.3 million, or 30.5%, while loan
provisions grew by $4.9 million, or 69.0%, over 1998 provisions.
The increase in the level of provision for estimated credit losses reflects
management's intention to increase the ratio of the Company's general valuation
reserves to approximately 1.5% of net loans by the end of 1999, a level deemed
by management to be prudent in view of the significant growth in the Company's
loan portfolio since 1997, the relative lack of seasoning of many of the
Company's loans, and the significant amount of construction loans in the
Company's loan portfolio directed at financing real estate development. The
Company achieved a ratio of the general allowance for estimated credit losses to
loans receivable, net of specific reserves, of 1.6% as of December 31, 1999
compared to 0.9% and 1.1% as of December 31, 1998 and 1997, respectively. See
"Asset Quality" for a more complete discussion of the Company's allowance for
estimated credit losses.
Although the Company maintains its allowance for credit losses at a level
which it considers to be adequate to provide for potential losses, based on
conditions known at present, there can be no assurance that such losses will not
exceed the estimated amounts, thereby adversely affecting future results of
operations. The calculation of the adequacy of the allowance for credit losses,
and therefore the requisite amount of provision for credit losses, is based on
several factors, including underlying loan collateral values, delinquency trends
and historical loan loss experience, all of which can change without notice
based on market and economic conditions and other factors.
NONINTEREST REVENUES
Noninterest income totaled $7.8 million in 1999, an increase of $3.2
million, or 69.6% from 1998, which increased $1.0 million, or 27.8%, from 1997.
Detail and discussion of noninterest revenues by category is reflected below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------ ------ ------
<S> <C> <C> <C>
Noninterest Revenues:
Loan-related fees...................................... $6,639 $3,842 $2,718
Gain (loss) on sales of investment securities.......... -- 7 (11)
Other.................................................. 1,181 811 892
------ ------ ------
Total.......................................... $7,820 $4,660 $3,599
====== ====== ======
</TABLE>
Loan-related fees primarily consist of fees collected from borrowers (1)
for the early repayment of their loans, (2) for the extension of the maturity of
loans (predominantly short-term construction loans, with respect to which
extension options are often included in the original term of the Company's loan)
and (3) in connection with certain loans which contain exit or release fees
payable to the Company upon the maturity or repayment of the Company's loan. The
prepayment of a large number of loans to which prepayment penalties were
attached, and the repayment of a small number of loans requiring exit fees,
created an increase in prepayments in 1999. During the last half of 1998, the
sharp drop in market interest rates increased the volume of prepayments and
refinancings during the first half of 1999.
32
<PAGE> 37
NONINTEREST EXPENSES
General and Administrative Costs
General and administrative expenses totaled $32.4 million in 1999, an
increase of $3.6 million, or 12.5% from 1998, which increased $6.8 million, or
30.9%, from 1997. Detail and discussion of noninterest expenses by category is
reflected below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
Employee.............................................. $14,822 $14,414 $10,606
Operating............................................. 6,393 6,177 4,470
Occupancy............................................. 3,889 3,404 2,921
Technology............................................ 1,988 2,117 816
Professional.......................................... 4,035 1,738 1,907
SAIF insurance premium and OTS assessment............. 1,236 952 1,289
------- ------- -------
Total....................................... $32,363 $28,802 $22,009
======= ======= =======
</TABLE>
As the Company's business activities have grown and expanded, additional
personnel had been hired into the Company's various business and staff support
groups. During 1999, 1998 and 1997, the Company employed an average of 272, 251
and 206 full-time equivalent individuals, respectively. The corresponding growth
in employee-related expenses, which consist primarily of base salaries,
incentive compensation and the Company's share of benefit expenses, was
substantially less than the growth in the dollar amount of the Company's net
interest income. Other operating expenses include advertising, telephone and
postage, stationery and supplies, bank and item processing charges and
insurance. The $1.7 million, or 37.8%, increase in operating expenses from 1997
to 1998 was primarily due to increased advertising and marketing activities to
support the overall growth of the Company. Increases in occupancy expenses were
attributed to leasehold improvements at the corporate headquarters.
Technology costs increased from $0.8 million in 1997 to $2.1 million in
1998, and decreased to $2.0 million in 1999, a decrease of 4.8% over 1998 costs.
Technology costs during 1999 were principally costs associated with (1) computer
hardware and software maintenance costs, (2) depreciation for computer hardware,
and (3) amortization of costs related to software. In addition to the costs
identified during 1999, technology costs during 1998 included costs associated
with (1) systems conversions, from an outsourced third party vendor, to an
internal system, and (2) data processing charges from an outside vendor during
the first half of 1998. Technology costs during 1997 were primarily related to
maintenance and depreciation for computer hardware and data processing service
charges from an outside vendor.
Professional fees increased $2.3 million during the twelve months ended
December 31, 1999 when compared to the same period of 1998. Professional fees
included expenses of $1.6 million related to outside lawyers, who represent the
Company in a variety of legal matters due to additional litigation and trials.
The remaining professional fees consisted of the Company's independent
accountants, various other vendors that provide employee search and other
professional fees related to operational projects. During 1997, the Company
implemented a core technology platform conversion from an outsourced mainframe
provider to a client server platform. The platform conversion, including Year
2000 compliance initiatives, were substantially completed in 1998. Accordingly,
other professional and consulting fees decreased to $1.7 million in 1998 from
$1.9 million in 1997, a decrease of 10.5% over 1997 costs.
SAIF insurance premium and OTS assessment increased from $1.0 million in
1998 to $1.2 million in 1999. The Company pays premiums to the SAIF based upon
the dollar amount of deposits it holds and the assessment rate charged by the
FDIC, which is based upon the Company's financial condition, its capital ratios
and the rating it receives in connection with annual regulatory examinations by
the OTS.
33
<PAGE> 38
The Company's efficiency ratio (defined as general and administrative
expenses divided by noninterest revenues and net interest income before
provision) for 1999 improved to 48.4% compared to 57.9% and 62.2% in 1998 and
1997, respectively.
Other Non-Operating (Income) Expense
The Company incurred $4.7 million in other non-operating expenses during
1999, primarily during the fourth quarter of 1999, of which $4.3 million related
to amounts paid, or reserved for payment, in connection with ongoing litigation
and/or satisfaction of judgments against the Company, and for severance for the
former CEO. During 1998, the Company incurred minimal non-operating expenses
primarily related to losses on sale of certain fixed assets. Other non-operating
income (expense) is reflected below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------ ---- -----
<S> <C> <C> <C>
Other Non-Operating (Income) Expense:
Legal settlement expenses................................. $3,539 $-- $ --
Other..................................................... 1,133 31 (112)
------ --- -----
Total............................................. $4,672 $31 $(112)
====== === =====
</TABLE>
Real Estate Operations
The table below 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>
YEAR ENDED DECEMBER 31,
---------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ----- ------- -------
<S> <C> <C> <C>
Expenses associated with real estate owned:
Property taxes........................................ $ (3) $ 7 $ 119
Repairs, maintenance and renovation................... 219 277 222
Insurance............................................. 135 116 188
----- ------- -------
351 400 529
Net gains from sale of properties....................... (754) (2,278) (1,282)
Property operations, net................................ (1) (91) (389)
Provision for estimated losses on real estate owned..... 80 60 913
----- ------- -------
Income from real estate operations, net................. $ 324 $ 1,909 $ 229
===== ======= =======
</TABLE>
Net gains from REO sales represent the difference between the proceeds
received from property disposal and the carrying value of such properties upon
disposal. Improved market conditions and the sale of large land parcels resulted
in increased gains during 1998. 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 of
similar funds held by receivers during the period the original loan was in
default.
During the year ended December 31, 1999, the Company sold 22 properties
generating net cash proceeds of $10.4 million and a net gain of $0.8 million, as
compared to sales of 102 properties generating net cash proceeds of $15.2
million and a net gain of $2.3 million during the year ended December 31, 1998
and a net gain of $1.3 million during the same period of 1997.
During 1997 the Company recorded additional provisions for estimated losses
on REO of $0.9 million, principally in connection with the completion and
liquidation of certain tract developments. At December 31, 1997, the Company had
liquidated all of its investments in these tract developments.
34
<PAGE> 39
INCOME TAXES
The Company recorded an income tax provision of $8.0 million during 1999
compared to $4.7 million during 1998 and compared to an income tax benefit of
$2.6 million during 1997. The Company's effective tax rate was 44.1% and 29.7%
during 1999 and 1998, respectively. The Company returned to taxable status
during 1998, following several years in which it realized substantial income tax
benefits from utilization of accumulated operating loss carry-forwards. The $2.6
million of income tax benefit recognized during the year ended December 31,
1997, was due to a $5.9 million increase in the Company's deferred tax asset as
a result of the reduction in the valuation allowance against deferred tax
assets. Partially reducing this benefit was an expected liability of $3.3
million attributable to the Company's profitable operations.
YEAR 2000 READINESS
In 1997, the Company adopted a Year 2000 plan and created a Year 2000
committee. The main objectives of this process were to detect and resolve any
problems that could occur on January 1, 2000, and ensure that the Company was
ready to conduct business as usual on January 3, 2000. Rollover testing occurred
from December 31, 1999 to January 5, 2000. No significant issues were
identified. The last phase of the Company's year 2000 plan entailed leap year
testing. No significant issues were identified.
The expense incurred by the Company to ensure Year 2000 compliance was
substantially integrated and was included with the expense associated with the
planned conversion of its computer-based systems. The Company incurred
approximately $3.8 million in costs related to its data processing conversion
and implementation of the Year 2000 plan. Approximately $1.2 million of these
costs were expensed during 1998. The Company capitalized $2.1 million of the
total costs, which are amortized over a three year period, and expensed the
remaining $0.5 million of the total costs during 1999. The costs were in line
with the original projections and the Company does not anticipate any additional
expenses in fiscal year 2000 related to the Year 2000 project.
BALANCE SHEET ANALYSIS
The Company's total assets at December 31, 1999 were $1.6 billion, an
increase of $168.7 million, or 11.9%, over December 31, 1998. As of December 31,
1999, asset growth was reflected in all categories of interest-earning assets,
with the exception of investment securities. Loan receivables and FHLB stock
reflected the largest growth, increasing by $118.2 million and $8.7 million,
respectively, over 1998. The steady growth in loans was funded through core
deposit growth and borrowings from the FHLB. The increased FHLB borrowings
necessitated an additional investment in FHLB stock. Deposits increased by 10.0%
year-over-year to $1.1 billion from $1.0 billion, with transaction accounts
increasing $62.8 million, or 33.8%, to $248.5 million at December 31, 1999 from
$185.7 million at December 31, 1998. At December 31, 1999, certificates of
deposit totaled $838.1 million, or 77.1% of total deposits, down from 81.8% of
total deposits, or $833.7 million at December 31, 1998. This reduced reliance on
certificates of deposit has had a positive impact on the Company's cost of
funds.
STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL
The Company's capital consists of common stockholders' equity, which
amounted to $92.3 million, or 5.8% of total assets at December 31, 1999 compared
to $81.4 million, or 5.8% of total assets at December 31, 1998.
Management is committed to maintaining capital at a level sufficient to
assure shareholders, customers, and regulators that the Company and its Bank
subsidiary are financially sound. The Company and the Bank are subject to
risk-based capital regulations adopted by the federal banking regulators in
January 1990. These guidelines are used to evaluate capital adequacy and are
based on an institution's asset risk profile and off-balance sheet exposures.
According to the regulations, institutions whose Tier 1 and total capital ratios
meet or exceed 6% and 10%, respectively, are deemed "well-capitalized."
35
<PAGE> 40
The table below compares the Company's actual capital ratios to those
required by regulatory agencies for capital adequacy and well-capitalized
classification purposes for the periods indicated:
<TABLE>
<CAPTION>
TO BE WELL
FOR CAPITAL CAPITALIZED
ADEQUACY UNDER PCA
ACTUAL PURPOSES PROVISIONS
---------------- --------------- ----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(DOLLARS IN THOUSANDS) -------- ----- ------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
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%
As of December 31, 1998:
Total capital to risk weighted
assets.............................. $119,400 11.10% $86,090 8.00% $107,612 10.00%
Core capital to adjusted tangible
assets.............................. 108,673 7.65% 56,804 4.00% 71,005 5.00%
Tangible capital to adjusted tangible
assets.............................. 108,673 7.65% 21,302 1.50% n/a n/a
Tier 1 capital to risk weighted
assets.............................. 108,673 10.10% n/a n/a 64,567 6.00%
</TABLE>
The following table summarizes the regulatory capital requirements under
the Home Owners' Loan Act ("HOLA") for the Bank as of December 31, 1999. As
indicated in the table below, the Bank's capital levels exceed all three of the
currently applicable minimum HOLA 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................. $ 127,160 -- $ 127,160 -- $ 127,160 --
Adjustments:
General reserves................... -- -- -- -- 14,115 --
Other.............................. -- -- -- -- (1,460) --
---------- ---- ---------- ---- ---------- -----
Regulatory capital................... 127,160 8.05% 127,160 8.05% 139,815 12.50%
Regulatory capital requirement....... 23,690 1.50 63,174 4.00 89,468 8.00
---------- ---- ---------- ---- ---------- -----
Excess capital....................... $ 103,470 6.55% $ 63,986 4.05% $ 50,347 4.50%
========== ==== ========== ==== ========== =====
Adjusted assets...................... $1,579,348 $1,579,348 $1,118,348
========== ========== ==========
</TABLE>
CAPITAL RESOURCES AND LIQUIDITY
The Company had $1.3 million cash on hand at December 31, 1999. The Company
is a holding company with no significant business operations outside of the
Bank. Its requisite obligations, which pertain to its debt and operations, are
dependent upon its sole source of funds, which is dividends from the Bank.
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 savings associations to
maintain a monthly average daily balance of liquid assets equal to 4% of the
average daily balance of its net withdrawable accounts and short-term borrowings
during the preceding calendar quarter. The Bank has liquidity ratios of 8.76%
and 12.60% for December 1999 and 1998, respectively.
The Company's current primary funding resources are deposit accounts,
principal payments on loans, proceeds from sales of REO, advances from the FHLB
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, operating
costs and expenses, and holding and refurbishment costs on REO.
36
<PAGE> 41
In March 2000, the Company's board of directors authorized the repurchase
of up to 277,000 shares of the Common Stock or approximately 5% of the Shares
outstanding in open market transactions or privately negotiated purchases. To
date, the Company has repurchased 20,000 shares.
LIQUIDITY
OTS regulations require a savings institution to maintain an average daily
balance of liquid assets (including cash and cash equivalents, and certain
marketable securities that are not committed) equal to at least 4% of either (1)
the average daily balance of its net withdrawable accounts and short-term
borrowings during the preceding calendar quarter, or (2) the amount of its net
withdrawable accounts and short-term borrowings at the end of its preceding
calendar quarter. Under FIRREA, this liquidity requirement may be changed from
time to time by the OTS to any amount within the range of 4% to 10% of such
accounts and borrowings depending upon economic conditions and the deposit flows
of the member associations. Monetary penalties may be imposed for failure to
meet this liquidity ratio requirement. The Company's average liquidity for the
quarter ending December 31, 1999, was 8.59%, which exceeds the applicable
requirements.
INTEREST RATE RISK MANAGEMENT
Interest rate risk (IRR) and credit risk constitute the two greatest
sources of financial exposure for insured financial institutions. Please refer
to Item 1 -- Business, Lending Activities, for a thorough discussion of the
Company's lending activities. IRR represents the impact that changes in absolute
and relative levels of market interest rates may have upon the Company's net
interest income (NII) and theoretical liquidation value, also referred to as net
portfolio value (NPV). NPV is defined as the present value of expected net cash
flows from existing assets minus the present value of expected net cash flows
from existing liabilities. Changes in the NII (the net interest spread between
interest-earning assets and interest-bearing liabilities) are influenced to a
significant degree by the repricing characteristics of assets and liabilities
(timing risk), the relationship between various rates (basis risk), and changes
in the shape of the yield curve.
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 volumes and yields on
loans, deposits and borrowings are affected by market interest rates. As of
December 31, 1999, 87.5% of the Company's loan portfolio was tied to
adjustable-rate indices, such as COFI, Prime, CMT, MTA and LIBOR. The majority
of the Company's deposits are time deposits with a stated maturity (generally
one year or less) and a fixed rate of interest. The borrowings from the FHLB
also carry a fixed interest rate for a term of up to 10 years, although the
weighted-average maturity of the borrowings as of December 31, 1999, was four
years and six months.
Changes in the market level of interest rates directly and immediately
affect the Company's interest spread, and therefore profitability. Sharp and
significant changes to market rates can cause the interest spread to shrink or
expense significantly in the near term, principally because of the timing
differences between the adjustable-rate loans and the maturities (and therefore
repricing) of the deposits and borrowings.
The Company's Asset/Liability Committee ("ALCO") is responsible for
managing the Company's assets and liabilities in a manner that balances
profitability, IRR and various other risks including liquidity. ALCO operates
under policies and within risk limits prescribed by, reviewed and approved by
the Board of Directors.
ALCO seeks to stabilize the Company's NII and NPV by matching its
rate-sensitive assets and liabilities through 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 time periods, the NII generally will be
negatively impacted by increasing rates and positively impacted by decreasing
rates. Conversely, when the amount of rate-sensitive assets exceeds the amount
of rate-sensitive liabilities within specified time periods, net interest income
will generally be positively impacted by increasing rates and negatively
impacted by decreasing rates. The speed and velocity of the repricing of assets
and liabilities will also contribute to the effects on the Company's NII and
NPV, as will the presence or absence of periodic and lifetime interest rate caps
and floors.
37
<PAGE> 42
The Company utilizes two methods for measuring interest rate risk, gap
analysis and interest rate simulations. Gap analysis focuses on measuring
absolute dollar amounts subject to repricing within certain periods of time,
particularly the one-year maturity horizon. SEE ITEM 7A, QUANTITATIVE AND
QUALITATIVE DISCLOSURE ABOUT MARKET RISKS. Interest rate simulations are
produced using a software model that is based on actual cash flows and repricing
characteristics for all of the Company's financial instruments and incorporates
market-based assumptions regarding the impact of changing interest rates on
current volumes of applicable financial instruments. These assumptions are
inherently uncertain, and, consequently, the model cannot precisely measure net
interest income or precisely predict the impact of changes in interest rates on
net interest income. Actual results will differ from simulated results due to
timing, magnitude and frequency of interest rate changes, as well as changes in
market conditions and management strategies.
Interest rate simulations provide the Company with an estimate of both the
dollar amount and percentage change in NII under various rate scenarios. All
assets and liabilities are subjected to tests of up to 300 basis points in
increases and decreases in interest rates. Under each interest rate scenario,
the Company projects its net interest income and the NPV of its current balance
sheet. From these results, the Company can then develop alternatives in dealing
with the tolerance thresholds.
Since 1995, the Company has been utilizing interest rate floors to mitigate
the risk of interest margin compression on its new loans in a decreasing rate
environment. Additionally, on most new income property loans, the Company
utilizes interest rate caps. These are life caps and are usually five points
above the rate at underwriting or at an amount that would still allow for
one-to-one debt service coverage at the maximum rate, thereby reducing the
likelihood of borrower default in a rising rate environment. The risk to the
Company associated with the interest rate floors is that interest rates may
decline, and the borrower may choose to refinance the loan, either with the
Company or with another financial institution, resulting in the Company having
to replace the higher-yielding asset at a lower rate. The risk to the Company
associated with interest rate caps is that interest rates will exceed the
maximum rates on such loans, and while the Company's cost of funds continues to
rise, the interest income derived from these loans will be fixed, resulting in
an overall compression on net interest income.
A traditional, although analytically limited measure of a financial
institution's IRR is the "static gap." Static gap is the difference between the
amount of assets and liabilities (adjusted for any off-balance positions) which
are expected to mature or reprice within a specific period. Generally, a
positive gap benefits an institution during periods of rising interest rates,
and a negative gap benefits an institution during periods of declining interest
rates. However, because the indices that the Company's loan products are priced
to may lag changes in market interest rates by three months or more, the
Company's net interest income may not reflect changes in interest rates
immediately.
The table below sets forth information concerning repricing opportunities
for the Company's interest-earning assets and interest-bearing liabilities as of
December 31, 1999. The amount of assets and liabilities shown within a
particular period were determined in accordance with their contractual
maturities, except that adjustable-rate products are included in the period in
which they are first scheduled to adjust and not in the
38
<PAGE> 43
period in which they mature. Such assets and liabilities are classified by the
earlier of their maturity or repricing date.
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------------------------------------------------------------
OVER THREE OVER SIX OVER ONE
THREE THROUGH THROUGH YEAR OVER
MONTHS SIX TWELVE THROUGH FIVE
OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL
(DOLLARS IN THOUSANDS) -------- ---------- ---------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Cash and cash equivalents..... $ 62 $ -- $ -- $ -- $ -- $ 62
Investments and FHLB Stock.... 22,236 -- -- -- -- 22,236
Loans(1)...................... 971,430 305,678 36,045 37,090 120,305 1,470,548
-------- -------- --------- --------- -------- ----------
Total interest-earning
assets.............. $993,728 $305,678 $ 36,045 $ 37,090 $120,305 $1,492,846
======== ======== ========= ========= ======== ==========
Interest-bearing liabilities:
Deposits
Non-certificates of
deposit(2)............... $207,976 $ -- $ -- $ -- $ -- $ 207,976
Certificates of deposit.... 263,661 186,067 286,390 102,011 -- 838,129
FHLB advances................. -- -- -- 300,000 49,000 349,000
Senior notes.................. -- -- -- -- 40,000 40,000
-------- -------- --------- --------- -------- ----------
Total interest-bearing
liabilities......... $471,637 $186,067 $ 286,390 $ 402,011 $ 89,000 $1,435,105
======== ======== ========= ========= ======== ==========
Interest rate sensitivity gap... $522,091 $119,611 $(250,345) $(364,921) $ 31,305 $ 57,741
Cumulative interest rate
sensitivity gap............... 522,091 641,702 391,357 26,436 57,741 57,741
Cumulative interest rate
sensitivity gap as a
percentage of total interest
earning assets................ 35.0% 43.0% 26.2% 1.8% 3.9% 3.9%
</TABLE>
- ---------------
(1) Balances include nonaccrual loans of $44.0 million at December 31, 1999.
(2) Includes checking/NOW, passbook and money market accounts.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
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 to the degree that its
interest-earning assets reprice differently than its interest-bearing
liabilities. The Company's primary objective in managing interest rate risk is
to minimize the adverse impact of changes in interest rates on the Company's net
interest income and capital, while structuring the Company's asset-liability mix
to obtain the maximum yield-cost spread on that structure.
A sudden and substantial increase in interest rates may adversely impact
the Company's income to the extent that the interest rates borne by the assets
and liabilities do not change at the same speed, to the same extent, or on the
same basis. The Company has adopted formal policies and practices to monitor its
interest rate risk exposure. As a part of this effort, the Company uses the Net
Portfolio Value (NPV) methodology to gauge interest rate risk exposure.
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 is considered its
39
<PAGE> 44
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 December 31, 1999, based on the Company's internally generated model, it
was estimated that the Company's NPV would decrease 7.7% in the event of a 200
basis point increase in rates, and increase by 1.9% if rates were to decrease by
200 basis points.
Presented below, as of December 31, 1999, is an analysis of the Company's
IRR as measured in the NPV for instantaneous and sustained parallel shifts of
100, 200, and 300 basis point increments in market interest rates.
<TABLE>
<CAPTION>
NET PORTFOLIO VALUE
------------------------ CHANGE
CHANGE $ CHANGE FROM FROM
IN RATES $ AMOUNT BASECASE RATIO BASECASE
- ---------- -------- ------------- ----- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
+300 bp $130,328 $(27,910) 8.35% -152 bp
+200 bp 146,026 (12,212) 9.24% -63 bp
+100 bp 154,449 (3,789) 9.69% -18 bp
0 bp 158,238 9.87%
-100 bp 166,614 8,376 10.33% +46 bp
-200 bp 161,272 3,034 9.93% +6 bp
-300 bp 155,669 (2,569) 9.52% -35 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.
Through the inclusion of more specific information regarding the Company's
unique loan portfolio, the internal model reflects less sensitivity in an
increasing rate environment, and greater sensitivity in a declining rate
environment.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information regarding Financial Statements and Supplementary Data appears
on pages A-1 through A-39 under the captions "Consolidated Statements of
Financial Condition," Consolidated Statements of Operations," "Consolidated
Statements of Stockholders' Equity," "Consolidated Statements of Cash Flows" and
"Notes to Consolidated Financial Statements" and is incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
40
<PAGE> 45
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except as hereinafter noted, the information concerning directors and
executive officers of the Company is incorporated by reference from the section
entitled "Election of Directors" of the Company's Proxy Statement, which is
filed as Exhibit No. 99 to this Annual Report on Form 10-K. For information
concerning executive officers of the Company, see "ITEM 4(A). EXECUTIVE OFFICERS
OF THE REGISTRANT."
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference
from the section entitled "Compensation of Directors and Executive Officers" in
the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual
Report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
Management is incorporated by reference from the sections entitled "Principal
Shareholders," and "Election of Directors" of the Company's Proxy Statement,
which is filed as Exhibit No. 99 to this Annual Report on Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is
incorporated by reference from the section entitled "Certain Transactions" of
the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual
Report on Form 10-K.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:
(1) FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report
Consolidated Financial Statements
Consolidated Statements of Financial Condition as of
December 31, 1998 and 1997.
Consolidated Statements of Income for the years ended
December 31, 1999, 1998 and 1997.
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1999, 1998 and 1997.
Consolidated Statements of Cash Flows for the years
ended December 31, 1999, 1998 and 1997.
Notes to Consolidated Financial Statements for the
years ended December 31, 1999, 1998 and 1997.
</TABLE>
(2) FINANCIAL STATEMENT SCHEDULES
Schedules are omitted because they are not applicable or
because the required information is provided in the Consolidated
Financial Statements, including the Notes thereto.
(B) REPORTS ON FORM 8-K
The Company filed a Report on Form 8-K on November 22, 1999 reporting
under Items 5 and 7.
41
<PAGE> 46
(C) EXHIBITS
Exhibits are listed by number corresponding to the Exhibit Table of Item
601 of Regulation S-K.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF DOCUMENT
- ----------- -----------------------
<C> <S>
3.1 Certificate of Incorporation of the Company and Amendment of
Certificate of Incorporation of the Company(1)
3.2 Bylaws of the Company(1)
4.1 Specimen certificate of the Company's Common Stock
4.2 Indenture, dated as of December 31, 1997, between the
Company and United States Trust Company of New York, as
Trustee, relating to the Company's 12 1/2% Notes due 2004(2)
4.3 Form of the Company's 12 1/2% Notes due 2004 (included in
Section 2.02 of the Indenture included as Exhibit 4.2)(2)
4.4 Form of Warrants to purchase an aggregate of 2,512,188
shares of Common Stock(3)
4.5 Registration Rights Agreement among the Company and certain
investors(3)
4.6 Unit Purchase Agreement among the Company and the investors
named therein (3)
10.1 Hawthorne Financial Corporation 1994 Stock Option Plan(4)*
10.2 Hawthorne Financial Corporation 1995 Stock Option Plan(5)
10.3 Lease of corporate headquarters(6)
10.4 Summary of Change in Control Agreement for executive
officers*
11.1 Statement on computation of per share earnings(7)
21.1 Subsidiaries of Registrant, Hawthorn Savings, F.S.B.
23.1 Consent of Deloitte & Touche LLP
27.1 Financial Data Schedule
99 Proxy Statement for Annual Meeting of Shareholders to be
held May 24, 2000(8)
</TABLE>
- ---------------
* Designates management contract, compensatory plan or arrangement.
(1) Incorporated by reference from the Company's Registration Statement on Form
S-8 (No. 33-74800) filed on February 3, 1994.
(2) Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, as amended on May 11, 1998 and November 3,
1998.
(3) Incorporated by reference from the Company's Current Report on Form 8-K
filed on February 7, 1996.
(4) Incorporated by reference from the Company's Registration Statement on Form
S-8 (No. 333-59879) filed on July 24, 1998.
(5) Incorporated by reference from of the Company's Registration Statement on
Form S-8 (No. 333-59875) filed on July 24, 1998.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1996.
(7) See Note 1 to the Notes from Consolidated Financial Statements included in
Item 8 and listed in Item 14 (a) of this Annual Report on Form 10-K.
(8) To be filed within 120 days after the end of the fiscal year ended December
31, 1999.
42
<PAGE> 47
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) 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.
DATED: March 30, 2000
HAWTHORNE FINANCIAL CORPORATION
By: /s/ SIMONE LAGOMARSINO
------------------------------------
Simone Lagomarsino
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE DATE
--------- ----
<C> <S>
/s/ SIMONE LAGOMARSINO March 30, 2000
---------------------------------------------------------
Simone Lagomarsino
Director, President, and Chief Executive Officer
(Principal Executive, Financial and Accounting Officer)
/s/ MARILYN G. AMATO March 30, 2000
---------------------------------------------------------
Marilyn G. Amato, Director
/s/ TIMOTHY R. CHRISMAN March 30, 2000
---------------------------------------------------------
Timothy R. Chrisman, Chairman of the Board
/s/ ANTHONY W. LIBERATI March 30, 2000
---------------------------------------------------------
Anthony W. Liberati, Director
/s/ HARRY F. RADCLIFFE March 30, 2000
---------------------------------------------------------
Harry F. Radcliffe, Director
/s/ HOWARD E. RITT March 30, 2000
---------------------------------------------------------
Howard E. Ritt, Director
/s/ GARY BRUMMETT March 30, 2000
---------------------------------------------------------
Gary Brummett, Director
</TABLE>
43
<PAGE> 48
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS, INDEPENDENT AUDITORS' REPORT
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ A-2
Consolidated Financial Statements
Consolidated Statements of Financial Condition............ A-3
Consolidated Statements of Income......................... A-4
Consolidated Statements of Stockholders' Equity........... A-5
Consolidated Statements of Cash Flows..................... A-6
Notes to Consolidated Financial Statements................ A-8
</TABLE>
A-1
<PAGE> 49
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Hawthorne Financial Corporation
El Segundo, California:
We have audited the accompanying consolidated statements of financial
condition of Hawthorne Financial Corporation and Subsidiary (the "Company") as
of December 31, 1999 and 1998 and the related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based upon our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial condition of Hawthorne Financial
Corporation and Subsidiary as of December 31, 1999 and 1998, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States of America.
DELOITTE & TOUCHE LLP
Los Angeles, California
March 20, 2000
A-2
<PAGE> 50
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1999 1998
(DOLLARS IN THOUSANDS) ---------- ----------
<S> <C> <C>
Assets:
Cash and cash equivalents................................. $ 86,722 $ 45,449
Loans receivable (net of allowance for estimated credit
losses of $24,285 in 1999 and $17,111 in 1998)......... 1,444,968 1,326,791
Real estate owned (net of allowance for estimated losses
of $29 in 1999 and $45 in 1998)........................ 5,587 4,070
Accrued interest receivable............................... 9,250 8,424
Investment in capital stock of Federal Home Loan Bank, at
cost................................................... 22,236 13,554
Office property and equipment at cost, net................ 5,939 6,513
Deferred tax asset, net................................... 2,203 2,822
Other assets.............................................. 4,248 4,811
---------- ----------
Total Assets...................................... $1,581,153 $1,412,434
========== ==========
Liabilities and Stockholders' Equity:
Liabilities
Deposits............................................... $1,086,635 $1,019,450
FHLB advances.......................................... 349,000 264,000
Accounts payable and other liabilities................. 13,214 7,560
Senior notes........................................... 40,000 40,000
---------- ----------
Total Liabilities................................. 1,488,849 1,331,010
Commitments and contingencies (note 13)
Stockholders' equity:
Preferred Stock -- $.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, 5,331,301 shares (1999)
and 5,194,996 shares (1998)............................ 53 52
Capital in excess of par value -- common stock............ 40,981 40,349
Retained earnings......................................... 51,318 41,150
Less:
Treasury stock, at cost -- 5,400 shares................ (48) (48)
Loan to Bank ESOP...................................... -- (79)
---------- ----------
Total Stockholders' Equity........................ 92,304 81,424
---------- ----------
Total Liabilities and Stockholders' Equity........ $1,581,153 $1,412,434
========== ==========
</TABLE>
See Accompanying Notes to Consolidated Financial Statements
A-3
<PAGE> 51
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1999 1998 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA) -------- -------- -------
<S> <C> <C> <C>
Interest revenues:
Loans..................................................... $126,854 $102,213 $70,012
Investments............................................... 5,893 4,779 5,604
-------- -------- -------
Total interest revenues........................... 132,747 106,992 75,616
-------- -------- -------
Interest costs:
Deposits.................................................. 50,831 47,642 38,920
FHLB advances............................................. 17,795 9,232 2,926
Senior notes.............................................. 5,000 5,000 1,979
-------- -------- -------
Total interest costs.............................. 73,626 61,874 43,825
-------- -------- -------
Net interest income......................................... 59,121 45,118 31,791
Provision for credit losses................................. 12,000 7,135 5,137
-------- -------- -------
Net interest income after provision for credit losses..... 47,121 37,983 26,654
Noninterest revenues:
Loan related fees......................................... 7,820 4,646 3,599
Income from real estate operations, net................... 324 1,909 229
Gain (loss) on sales of investment securities............. -- 7 (11)
-------- -------- -------
Total noninterest revenues, net................... 8,144 6,562 3,817
Noninterest expenses:
General and administrative expenses:
Employee............................................... 14,822 14,414 10,606
Operating.............................................. 6,393 6,177 4,470
Occupancy.............................................. 3,889 3,404 2,921
Technology............................................. 1,988 2,117 816
Professional........................................... 4,035 1,738 1,907
SAIF premium and OTS assessment........................ 1,236 952 1,289
-------- -------- -------
Total general and administrative expenses......... 32,363 28,802 22,009
Other non-operating (income)/expense:
Legal settlement expenses.............................. 3,539 -- --
Other.................................................. 1,133 31 (112)
-------- -------- -------
Total noninterest expenses........................ 37,035 28,833 21,897
-------- -------- -------
Income before income taxes and extraordinary item........... 18,230 15,712 8,574
Income tax (provision) benefit.............................. (8,030) (4,674) 2,577
-------- -------- -------
Income before extraordinary item............................ 10,200 11,038 11,151
Extraordinary item.......................................... -- -- (1,534)
-------- -------- -------
Net income.................................................. $ 10,200 $ 11,038 $ 9,617
======== ======== =======
Net income available for common............................. $ 10,200 $ 11,038 $ 5,254
======== ======== =======
Basic earnings per share before extraordinary item.......... $ 1.93 $ 2.64 $ 2.35
======== ======== =======
Basic earnings per share.................................... $ 1.93 $ 2.64 $ 1.82
======== ======== =======
Diluted earnings per share before extraordinary item........ $ 1.33 $ 1.65 $ 1.30
======== ======== =======
Diluted earnings per share.................................. $ 1.33 $ 1.65 $ 1.00
======== ======== =======
Weighted average basic shares outstanding................... 5,288 4,176 2,883
======== ======== =======
Weighted average diluted shares outstanding................. 7,697 6,692 5,235
======== ======== =======
</TABLE>
See Accompanying Notes to Consolidated Financial Statements
A-4
<PAGE> 52
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CAPITAL IN
EXCESS OF CAPITAL IN UNREALIZED
PAR VALUE -- EXCESS OF ACCUMULATED
NUMBER OF PREFERRED PAR VALUE -- OTHER
COMMON COMMON STOCK COMMON COMPREHENSIVE
SHARES STOCK SERIES A STOCK INCOME/(LOSS)
(IN THOUSANDS) --------- ------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996...... 2,605 $26 $ 11,592 $ 7,745 $(132)
Exercised stock options........... 60 1 -- 295 --
Other comprehensive income, net of
tax, net of change in unrealized
gain (loss) on securities....... -- -- -- 138
Net income (loss)................. -- -- -- --
Dividends paid on preferred
stock........................... 431 4 -- 4,270 --
Accrued dividends on preferred
stock........................... -- -- -- --
Redemption of preferred stock..... -- (11,592) -- --
Repayments........................ -- -- -- --
Comprehensive Income..............
----- --- -------- ------- -----
Balance at December 31, 1997...... 3,096 31 -- 12,310 6
Exercised stock options........... 86 1 -- 436 --
Stock offering proceeds, net...... 2,013 20 -- 27,603 --
Other comprehensive income, net of
tax, net change in unrealized
gain (loss) on securities....... -- -- -- (6)
Net income (loss)................. -- -- -- --
Repayments........................ -- -- --
Comprehensive Income.............. -- -- -- --
----- --- -------- ------- -----
Balance at December 31, 1998...... 5,195 52 -- 40,349 --
Exercised stock options........... 110 1 -- 576 --
Exercised warrants................ 26 -- -- 56 --
Net income (loss)................. -- -- -- --
Other............................. -- -- -- --
Repayments........................ -- -- -- --
Comprehensive Income..............
----- --- -------- ------- -----
Balance at December 31, 1999...... 5,331 $53 $ -- $40,981 $ --
===== === ======== ======= =====
<CAPTION>
LOAN TO
EMPLOYEE
STOCK TOTAL
RETAINED TREASURY OWNERSHIP STOCKHOLDERS' COMPREHENSIVE
EARNINGS STOCK PLAN EQUITY INCOME
(IN THOUSANDS) -------- -------- --------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996...... $24,858 $(48) $(119) $ 43,922
Exercised stock options........... -- -- -- 296
Other comprehensive income, net of
tax, net of change in unrealized
gain (loss) on securities....... -- -- -- 138 $ 138
Net income (loss)................. 9,617 -- -- 9,617 9,617
Dividends paid on preferred
stock........................... -- -- -- 4,274
Accrued dividends on preferred
stock........................... (2,455) -- -- (2,455)
Redemption of preferred stock..... (1,908) -- -- (13,500)
Repayments........................ -- -- 27 27
-------------
Comprehensive Income.............. $ 9,755
------- ---- ----- -------- -------
Balance at December 31, 1997...... 30,112 (48) (92) 42,319
Exercised stock options........... -- -- -- 437
Stock offering proceeds, net...... -- -- -- 27,623
Other comprehensive income, net of
tax, net change in unrealized
gain (loss) on securities....... -- -- -- (6) $ (6)
Net income (loss)................. 11,038 -- -- 11,038 11,038
Repayments........................ -- -- 13 13
-------------
Comprehensive Income.............. -- -- -- -- $11,032
------- ---- ----- -------- -------
Balance at December 31, 1998...... 41,150 (48) (79) 81,424
Exercised stock options........... -- -- -- 577
Exercised warrants................ -- -- -- 56
Net income (loss)................. 10,200 -- -- 10,200 $10,200
Other............................. (32) -- -- (32)
Repayments........................ -- -- 79 79
-------------
Comprehensive Income.............. $10,200
------- ---- ----- -------- =======
Balance at December 31, 1999...... $51,318 $(48) $ -- $ 92,304
======= ==== ===== ========
</TABLE>
See Accompanying Notes to Consolidated Financial Statements
A-5
<PAGE> 53
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) --------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................ $ 10,200 $ 11,038 $ 9,617
Adjustments:
Deferred income tax provision (benefit)............ 619 3,999 (2,577)
Provision for estimated credit losses on loans..... 12,000 7,135 5,137
Provision for estimated losses on real estate
owned............................................ 80 60 913
Net (gain) loss on sale of investment securities... -- (7) 11
Net gains from sale of real estate owned........... (754) (2,278) (1,282)
Net loss from disposal of other assets............. 7 34 7
Extraordinary item................................. -- -- 1,534
Loan fee and discount accretion.................... (5,108) (6,396) (3,987)
Depreciation and amortization...................... 2,389 1,551 1,023
FHLB dividends..................................... (961) (571) (425)
(Increase) in accrued interest receivable.......... (826) (3,126) (517)
Increase (decrease) in accounts payable and other
liabilities...................................... 5,654 1,183 (14,447)
Decrease (increase) in other assets................ 563 (453) (2,594)
--------- --------- ---------
Net cash provided by (used in) operating
activities.................................. 23,863 12,169 (7,587)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment securities:
Purchases.......................................... -- (27,919) (40,571)
Maturities......................................... -- 27,900 40,795
Sales proceeds..................................... -- 596 37,570
Loans:
New loans funded................................... (377,267) (487,097) (229,433)
Construction disbursements......................... (336,806) (354,326) (140,783)
Payoffs............................................ 544,156 345,044 202,999
Sales proceeds..................................... 3,000 -- 1,370
Purchases.......................................... (1,155) -- --
Principal payments................................. 24,806 121,940 30,134
Other, net......................................... 7,092 (118,823) (44,523)
Real estate owned, net:
Sales proceeds..................................... 10,385 15,184 32,791
Capitalized costs.................................. (149) (1,058) (8,842)
Other, net......................................... (30) (2,134) 166
Purchase of FHLB stock................................ (7,721) (5,770) --
Office property & equipment:
Sales proceeds..................................... 233 5 9
Additions.......................................... (2,031) (3,904) (726)
--------- --------- ---------
Net cash used in investing activities............ (135,487) (490,362) (119,044)
--------- --------- ---------
</TABLE>
A-6
<PAGE> 54
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) --------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Deposit activity, net................................. $ 67,185 $ 219,949 $ 81,692
Net increase (decrease) in FHLB advances.............. 85,000 224,000 (10,000)
Net proceeds from exercise of stock options and
warrants........................................... 633 437 296
Collection of ESOP loan............................... 79 13 27
Net proceeds from issuance of senior notes............ -- -- 40,000
Redemption of senior notes............................ -- -- (13,500)
Proceeds from stock offering.......................... -- 27,623 --
Redemption of preferred stock......................... -- -- (13,500)
Cash dividends paid on preferred stock................ -- -- (742)
--------- --------- ---------
Net cash provided by financing activities..... 152,897 472,022 84,273
--------- --------- ---------
Increase (decrease) in cash and cash equivalents........ 41,273 (6,171) (42,358)
Cash and cash equivalents, beginning of year............ 45,449 51,620 93,978
--------- --------- ---------
Cash and cash equivalents, end of year.................. $ 86,722 $ 45,449 $ 51,620
========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest........................................... $ 73,214 $ 61,272 $ 43,937
Income taxes, net.................................. 4,233 3,017 --
Non-cash investing and financing activities:
Real estate acquired in settlement of loans........ 13,649 6,387 21,360
Loans originated to finance sales of real estate
owned............................................ 1,500 2,402 5,157
Net change in unrealized gains/(losses) on
available-for-sale securities.................... -- (6) 138
Accrued dividends on preferred stock............... -- -- 2,455
Disposal of other assets........................... -- 39 --
</TABLE>
See Accompanying Notes to Consolidated Financial Statements
A-7
<PAGE> 55
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles and general practices within the
banking industry. The following is a summary of significant principles used in
the preparation of the accompanying financial statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary, Hawthorne Savings FSB. All significant
intercompany transactions and accounts have been eliminated in consolidation.
NATURE OF OPERATIONS
The Company is principally engaged in the business of attracting deposits
from the general public and using those deposits, together with borrowings and
other funds, to originate residential and income property real estate loans. The
Company's principal sources of revenue are interest earned on mortgage loans and
fees received concerning various deposit account services and miscellaneous loan
processing activities. The Company's principal expenses are interest paid on
deposit accounts and the costs necessary to operate the Company.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the period.
Actual results could differ from those estimates. Significant estimates include
the allowance for estimated credit losses, valuation of real estate owned, fair
value of stock options and fair values of financial instruments.
CASH AND CASH EQUIVALENTS
The Bank, in accordance with regulations, must maintain qualifying liquid
assets at an average monthly balance of not less than 4% of the average of all
deposits and other borrowings due in less than one year. Liquid assets consist
primarily of cash, certificates of deposit and overnight investments. In
addition, bankers' acceptances and certain U.S. Government securities, corporate
notes and mortgage-backed securities qualify as liquid assets for regulatory
purposes. In the consolidated statements of financial condition and cash flows,
cash and cash equivalents include cash, amounts due from banks and overnight
investments.
INVESTMENT SECURITIES
The Company has authority to invest in a variety of investment securities,
including U.S. Government and agency securities, mortgage-backed securities and
corporate securities. However, in recent years the Company's strategy has been
to deploy its assets through loan originations, rather than purchases of
investment securities. As a result, the investment activity has been steadily
decreasing over the last six years, and during 1999 there was no investment
activity. The Company classifies all securities acquired as available-for-sale
under generally accepted accounting principles, and thus the securities are
carried at fair value, with unrealized gains and losses excluded from income and
reported as a separate component of stockholders' equity, net of taxes.
A-8
<PAGE> 56
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LOANS RECEIVABLE
Loans are generally carried at principal amounts, less net deferred loan
fees. Net deferred loan fees include deferred unamortized fees, less direct
incremental loan origination costs. The Company defers all loan fees, net of
certain direct costs associated with originating loans, and recognizes these net
deferred fees into interest revenue as a yield adjustment over the term of the
loans using the interest method for permanent loans and the straight-line method
for construction loans. When a loan is paid off, any unamortized net deferred
fees are recognized in interest income.
Interest on loans, including impaired loans, is recognized in revenue as
earned and is accrued only if deemed collectible. Loans 90 days or more
delinquent, or when collection of interest or principal becomes uncertain, are
placed on nonaccrual status, meaning that the Company stops accruing interest on
such loans and reverses any interest previously accrued but not collected. A
nonaccrual loan may be restored to accrual status when delinquent principal and
interest payments are brought current and future monthly principal and interest
payments are expected to be collected.
The Company considers a loan to be impaired when it is probable that it
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. Once a loan is determined to be impaired, the impairment is
measured based on the present value of the expected future cash flows discounted
at the loan's effective interest rate, except that as a practical expedient, the
impairment is measured by using the loan's observable market price or the fair
value of the collateral if the loan is collateral dependent.
When the measurement of the impaired loan is less than the recorded amount
of the loan, an impairment is recognized by creating a valuation allowance with
a corresponding charge to the allowance for credit losses or by adjusting an
existing valuation allowance for the impaired loan with a corresponding charge
or credit to the allowance for credit losses.
All loans are classified as held-to-maturity as the Company has the current
intent and ability to hold these loans in their portfolio until maturity.
ALLOWANCE FOR ESTIMATED CREDIT LOSSES
Management establishes specific allowances for estimated losses on
individual loans and REO when it has determined that recovery of the Company's
gross investment is not probable and when the amount of loss can be reasonably
determined. In making this determination, management considers (1) the status of
the asset, (2) the probable future status of the asset, (3) the value of the
asset or underlying collateral and (4) management's intent with respect to the
asset. In quantifying the loss, if any, associated with individual loans and
REO, management utilizes external sources of information (i.e., appraisals,
price opinions from real estate professionals, comparable sales data and
internal estimates). In establishing specific allowances, management estimates
the revenues expected to be generated from disposal of the Company's collateral
or owned property, less construction and renovation costs (if any), holding
costs and transaction costs. For tract construction and land development, the
resulting projected cash flows are discounted utilizing a market rate of return
to determine their value.
The Company maintains an allowance for estimated credit losses, which is
not tied to individual loans or properties ("General Reserves"). General
Reserves are maintained for each of the Company's principal loan segments and
supplemented by periodic additions through provisions for estimated credit
losses. In measuring the adequacy of the Company's General Reserves, management
considers (1) the Company's historical loss experience for each loan portfolio
segment and in total, (2) the historical migration of loans within each
portfolio segment and in total (i.e., from performing to nonperforming, from
nonperforming to REO), (3) observable trends in the performance of each loan
portfolio segment, (4) observable trends in the region's economy and in its real
property markets and (5) guidelines published by the OTS for maintaining General
Reserves.
A-9
<PAGE> 57
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
REAL ESTATE OWNED
Properties acquired through foreclosure, or deed in lieu of foreclosure
("real estate owned"), are transferred to REO and carried at the lower of cost
or estimated fair value less the estimated costs to sell the property. The fair
value of the property is based upon a current appraisal. Subsequent to
foreclosure, management periodically performs valuations and the REO property is
carried at the lower of carrying value or fair value, less costs to sell. The
determination of a property's estimated fair value incorporates (1) revenues
projected to be realized from disposal of the property, (2) construction and
renovation costs, (3) marketing and transaction costs and (4) holding costs
(e.g., property taxes, insurance and homeowners' association dues). For
multiple-unit residential construction and land developments, these projected
cash flows are discounted utilizing a market rate of return to determine their
fair value. In many instances following foreclosure, these properties require
significant time for the completion of construction and their marketing and
eventual sale. Revenue recognition upon disposition of the property is dependent
upon the sale having met certain criteria relating to the buyer's initial
investment in the property sold.
OFFICE PROPERTY AND EQUIPMENT
Company property and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are computed on a
straight-line basis over the estimated useful lives of the various classes of
assets. The ranges of useful lives for the principal classes of assets are as
follows:
<TABLE>
<S> <C>
Buildings................................... 20 - 30 years
Computers and related software.............. 3 - 5 years
Facsimiles, copiers and printers............ 3 - 7 years
Furniture and fixtures...................... 7 years
Leasehold improvements...................... Shorter of 5 years or term of lease
Automobiles................................. 3 years
</TABLE>
In connection with the issuance of its 1997 Senior Notes, the Company
capitalized $2.5 million of issuance costs. In 1999 and 1998, the Company
amortized $361,000 of its 1997 Senior Notes issuance costs which are being
amortized over the life of the debt, which is seven years.
INCOME TAXES
The Company and its subsidiary have historically filed a consolidated
federal income tax return and a combined state franchise tax return on a fiscal
year ending September 30. The Company has adopted a December 31 tax year-end for
its consolidated federal income tax return and its combined state franchise tax
returns beginning with a stub period ending December 31, 1998 and continuing
each year thereafter.
Deferred tax assets and liabilities represent the tax effects, calculated
at currently effective tax rates, of future deductible or taxable amounts
attributable to events that have been recognized on a cumulative basis in the
financial statements. If it is more likely than not that any of a deferred tax
asset will not be realized, a valuation allowance is recorded.
STOCK BASED COMPENSATION PLANS
The Company has elected to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure requirements of SFAS No. 123 in the footnotes
to its consolidated financial statements. SFAS No. 123 requires pro forma
disclosure of net income and, if presented, earnings per share, as if the
fair-value based method of accounting defined in this statement had been
applied. APB Opinion No. 25 and related
A-10
<PAGE> 58
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
interpretations requires accounting for stock compensation awards based on their
intrinsic value as of the grant date.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangibles related to those
assets to be held and used are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. SFAS No. 121, requires that certain long-lived assets and
identifiable intangibles to be disposed of be reported at the lower of
historical cost or fair value, less cost to sell.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which, as amended by SFAS No. 137, is
effective for financial statements for periods beginning after June 15, 2000.
This statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. Adoption of this statement is not expected to have a material
impact on the Bank's consolidated financial statements.
RECLASSIFICATIONS
Certain amounts in the 1997 and 1998 consolidated financial statements have
been reclassified to conform to the 1999 presentation.
EARNINGS PER SHARE CALCULATION
The table below sets forth the Company's earnings per share calculations
for the years ended December 31, 1999, 1998 and 1997. In the table below, (1)
"Warrants" refers to the Warrants issued by the Company in December 1995, which
are currently exercisable, and which expire December 11, 2005, (2) "Options"
refer to stock options previously granted to employees of the Company and which
were outstanding at each measurement date (see note 10) and (3) "Preferred
Stock" refers to the Cumulative Perpetual Preferred Stock issued by the Company
in December 1995, and redeemed in December 1997, which carried an annual
dividend equal to 18% of the face amount of the Preferred Stock and permitted
dividends thereon to be paid, under certain circumstances, in equivalent value
of the Company's common stock.
In July 1998, the Company completed an offering of 2,012,500 of its common
stock (including 262,500 shares issued upon exercise by the underwriters of
their overallotment option) at a price of $15.00 per share, realizing net
proceeds (after offering costs) of approximately $27.6 million. As an additional
result of this
A-11
<PAGE> 59
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
offering, the exercise price of the Warrants was reduced to $2.128 per share and
the number of shares of common stock purchasable upon the exercise of the
Warrants was increased to 2,512,188.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA) ------- ------- -------
<S> <C> <C> <C>
Average Shares Outstanding:
Basic..................................................... 5,288 4,176 2,883
Warrants.................................................. 2,496 2,444 2,376
Options(1)................................................ 445 587 657
Less: Treasury shares(2).................................. (532) (515) (681)
------- ------- -------
Diluted................................................... 7,697 6,692 5,235
======= ======= =======
Net Income
Income before extraordinary item.......................... $10,200 $11,038 $11,151
Preferred stock dividends................................. -- -- (2,455)
Premium on redemption of Preferred Stock.................. -- -- (1,908)
------- ------- -------
Income available for Common Stock before extraordinary
item................................................... 10,200 11,038 6,788
Extraordinary item........................................ -- -- (1,534)
------- ------- -------
Net income available for Common............................. $10,200 $11,038 $ 5,254
======= ======= =======
Basic earnings per share before extraordinary item.......... $ 1.93 $ 2.64 $ 2.35
======= ======= =======
Basic earnings per share.................................... $ 1.93 $ 2.64 $ 1.82
======= ======= =======
Diluted earnings per share before extraordinary item........ $ 1.33 $ 1.65 $ 1.30
======= ======= =======
Diluted earnings per share.................................. $ 1.33 $ 1.65 $ 1.00
======= ======= =======
Year end shares outstanding:
Basic..................................................... 5,326 5,190 3,091
Warrants.................................................. 2,486 2,512 2,376
Options(3)................................................ 403 527 722
Less: Treasury shares(2).................................. (584) (510) (490)
------- ------- -------
Diluted................................................... 7,631 7,719 5,699
======= ======= =======
Stockholders' Equity:
Basic..................................................... $92,304 $81,424 $42,319
Warrants.................................................. 5,290 5,346 5,346
Options................................................... 2,121 2,792 5,073
Less: Treasury shares(2).................................. (7,411) (9,088) (9,012)
------- ------- -------
Diluted................................................... $92,304 $80,474 $43,726
======= ======= =======
Basic book value per share.................................. $ 17.33 $ 15.69 $ 13.69
======= ======= =======
Diluted book value per share................................ $ 12.10 $ 10.43 $ 7.67
======= ======= =======
</TABLE>
- ---------------
(1) Excludes 385,000 options outstanding for the year ended December 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 pro forma exercise of the Warrants and Options to acquire actual
shares currently outstanding, thus increasing Treasury shares. In this
calculation, Treasury shares were assumed repurchased at the average closing
stock price for the respective period.
A-12
<PAGE> 60
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) Excludes 330,000 options outstanding at December 31, 1999 for which the
exercise price exceeded the average market price of the Company's Common
Stock during the period.
NOTE 2 -- CASH AND CASH EQUIVALENTS
The table below reflects cash and cash equivalents for the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1999 1998
(DOLLARS IN THOUSANDS) ------- -------
<S> <C> <C>
Cash and due from banks.................................. $86,722 $45,449
Federal funds sold....................................... -- --
------- -------
Total.......................................... $86,722 $45,449
======= =======
</TABLE>
NOTE 3 -- INVESTMENT SECURITIES AVAILABLE-FOR-SALE
As of December 31, 1999, the Company did not have any investment securities
available-for-sale. The Company has authority to invest in a variety of
investment securities, including U.S. Government and agency securities,
mortgage-backed securities and corporate securities. However, in recent years
the Company's strategy has been to deploy its assets through loan originations,
rather than purchases of investment securities. As a result, the investment
activity has been steadily decreasing over the last six years, and in 1999 there
was no investment activity. Subsequent to the company's stock offering in the
third quarter of 1998, the Company utilized the $27.6 million of proceeds to
purchase $27.9 million in FNMA discount notes, $5 million of which matured in
September 1998 and $22.9 million of which matured in December 1998. In addition,
during 1998 the Company sold $596 thousand in mutual funds. The Company
classifies all securities acquired as available-for-sale under generally
accepted accounting principles, and thus the securities are carried at fair
value, with unrealized gains and losses excluded from income and reported as a
separate component of stockholders' equity, net of taxes.
The table below reflects comprehensive income, comprised of unrealized
gains arising during the period, net of tax, and reclassification adjustments
for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------ ----- -----
<S> <C> <C> <C>
Unrealized holding gains arising during period, net of tax
expense of $0 in 1999, $2 in 1998 and $0 in 1997(1)....... $ -- $ 1 $127
Less: Reclassification adjustment for gains included in
net income, net of tax expense of $0 in 1999, $4 in
1998 and $0 in 1997(1)................................. -- 7 (11)
----- --- ----
Net change in unrealized loss on securities, net of tax
(expense) or benefit...................................... $ -- $(6) $138
===== === ====
</TABLE>
- ---------------
(1) Due to loss carry forward, there was no tax liability in 1997.
A-13
<PAGE> 61
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 -- LOANS RECEIVABLE
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>
DECEMBER 31,
------------------------
1999 1998
(DOLLARS IN THOUSANDS) ---------- ----------
<S> <C> <C>
Single family residential(1)........................ $ 683,250 $ 576,032
Income property:
Multi-family...................................... 222,616 250,876
Commercial........................................ 208,859 222,558
Development....................................... 148,092 78,425
Land................................................ 59,095 69,581
Single family construction:
Single residence(2)............................... 274,697 275,888
Tract............................................. 24,056 85,942
Other............................................... 46,132 46,615
---------- ----------
Total gross loans receivable(3)........... 1,666,797 1,605,917
Less:
Undisbursed funds................................. (196,249) (256,096)
Deferred loan fees and costs, net................. (1,295) (5,919)
Allowance for credit losses....................... (24,285) (17,111)
---------- ----------
Loans receivable, net............................... $1,444,968 $1,326,791
========== ==========
</TABLE>
- ---------------
(1) Permanent loans secured by single family residential properties
(2) Loans for the construction of individual custom homes, and the acquisition
of land for the construction of such homes
(3) Gross loans receivable includes outstanding balance plus undisbursed
commitments
The table below summarizes the maturities for fixed-rate loans and the
repricing intervals for adjustable-rate loans as of December 31, 1999:
<TABLE>
<CAPTION>
PRINCIPAL BALANCE
-------------------------------------------
FIXED RATE ADJUSTABLE RATE TOTAL
(DOLLARS IN THOUSANDS) ---------- --------------- ----------
<S> <C> <C> <C>
Interval:
1 to 3 months....................... $ 6,539 $1,149,922 $1,156,461
>3 to 6 months...................... 12,399 295,315 307,714
>6 to 12 months..................... 8,644 27,601 36,245
>1 to 2 years....................... 33,192 33,192
>2 to 5 years....................... 12,879 12,879
>5 to 10 years...................... 7,920 7,920
>10 to 20 years..................... 12,707 12,707
More than 20 years.................. 99,679 99,679
-------- ---------- ----------
Total gross loans
receivable................ $193,959 $1,472,838 $1,666,797
======== ========== ==========
</TABLE>
A-14
<PAGE> 62
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The contractual weighted-average interest rates on loans at December 31,
1999 and 1998 were 8.64% and 8.84%, respectively. The table below summarizes
nonaccrual loans for the dates indicated.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1999 1998
(DOLLARS IN THOUSANDS) ------- -------
<S> <C> <C>
Single family residential................................ $22,579 $41,001
Income property:
Commercial............................................. 10,498 3,611
Land..................................................... 2,140 --
Single family construction:
Single family.......................................... 6,847 --
Tract.................................................. 1,945 3,076
Other.................................................... 22 --
------- -------
Total(1)....................................... $44,031 $47,688(2)
======= =======
</TABLE>
- ---------------
(1) Includes $18.7 million and $2.7 million of troubled debt restructured loans
("TDRs") at December 31, 1999 and December 31, 1998, respectively. Excludes
$16.2 million and $3.6 million of TDRs which were paying in accordance with
their modified terms at December 31, 1999 and December 31, 1998,
respectively.
(2) Excludes $790 in loans past due 90 days or more for maturity and still
accruing interest, which were in process of renewal at December 31, 1998.
The interest income recognized on nonaccrual loans for 1999, 1998 and 1997
was $2.3 million, $3.3 million and $0.9 million, respectively. If these loans
had been performing for the entire year, the income recognized would have been
$4.5 million, $4.9 million and $1.4 million for 1999, 1998 and 1997,
respectively.
The table below summarizes the amounts of interest income that would have
been recognized on troubled debt restructurings ("TDRs") had borrowers paid at
the original loan interest rate throughout each of the years below, the interest
income that would have been recognized based upon the modified interest rate,
and the interest income that was included in the consolidated statements of
operations for the periods indicated. For this purpose, a TDR is a loan with
respect to which (1) the original interest rate was changed for a defined period
of time, (2) the loan's maturity was extended due to borrowers financial
difficulty, and/or (3) the Company agreed to suspend principal or interest
payments for a defined period of time.
<TABLE>
<CAPTION>
PRINCIPAL ORIGINAL MODIFIED RECOGNIZED
BALANCE INTEREST INTEREST INTEREST
(DOLLARS IN THOUSANDS) --------- -------- -------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1999:
Construction loans................ $ 5,072 $ 684 $ 681 $ 392
Permanent loans................... 29,766 3,319 2,842 1,636
------- ------ ------ ------
$34,838 $4,003 $3,523 $2,028
======= ====== ====== ======
Year ended December 31, 1998:
Permanent loans................... $34,276 $2,873 $2,695 $2,484
======= ====== ====== ======
Year ended December 31, 1997:
Permanent loans................... $29,562 $2,908 $2,665 $2,505
======= ====== ====== ======
</TABLE>
A-15
<PAGE> 63
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The table below summarizes the activity within the allowance for estimated
credit losses on loans for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
Balance, beginning of year............................ $17,111 $13,274 $13,515
Provision for credit losses......................... 12,000 7,135 5,137
Charge-offs......................................... (4,872) (3,298) (5,378)
Recoveries.......................................... 46 -- --
------- ------- -------
Balance, end of year.................................. $24,285 $17,111 $13,274
======= ======= =======
</TABLE>
Management believes the level of allowance for estimated credit losses on
loans is adequate to absorb losses inherent in the loan portfolio; however,
circumstances might change which could adversely affect the performance of the
loan portfolio resulting in increasing loan losses which cannot be reasonably
predicted at December 31, 1999.
The recorded investment in loans considered to be impaired under SFAS No.
114 as amended by SFAS No. 118, at December 31 was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
Impaired loans with specific loss reserves............ $ 3,991 $41,124 $24,476
Impaired loans without specific loss reserves......... 49,615 28,770 27,970
Specific loss reserves allocated to impaired loans.... (659) (5,177) (2,815)
------- ------- -------
Total impaired loans, net of specific
reserves.................................. $52,947 $64,717 $49,631
======= ======= =======
Average investment in impaired loans.................. $65,500 $60,000 $50,400
Interest income recognized on impaired loans.......... $ 3,417 $ 4,879 $ 4,202
</TABLE>
The table below reconciles the principal balance of impaired loans and TDRs
for the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
(DOLLARS IN THOUSANDS) -------- --------
<S> <C> <C>
Total impaired loans........................................ $ 53,606 $ 69,894
Impaired loans 90 days or more days delinquent.............. (11,853) (13,832)
-------- --------
Performing impaired loans................................. 41,753 56,062
Impaired loans which are not TDRs........................... (14,445) (21,956)
-------- --------
Performing TDRs........................................... 27,308 34,106
TDRs which are 90 days or more delinquent................... 7,530 170
-------- --------
Total TDRs........................................ $ 34,838 $ 34,276
======== ========
</TABLE>
LOANS TO EXECUTIVE OFFICERS AND DIRECTORS
In the ordinary course of business, the Bank has granted loans to certain
executive officers and directors and the companies with which they are
associated. In management's opinion, such loans and commitments to lend were
made under terms that are consistent with the Bank's normal lending policies.
During the year ended December 31, 1998, the Bank granted $155,000 in loans
to executive officers and directors and received repayments of $1,000. During
1999, all loans to executive officers and directors were paid in full. During
1997, there were no loans to executive officers and directors.
A-16
<PAGE> 64
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5 -- REAL ESTATE OWNED
The table below summarizes real estate owned properties for the dates
indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1999 1998
(DOLLARS IN THOUSANDS) ------ ------
<S> <C> <C>
Single family residential.................................. $1,218 $2,509
Income property:
Multi-family............................................. -- 213
Commercial............................................... -- 1,393
Land....................................................... 4,398 --
------ ------
Gross investment........................................... 5,616 4,115
Allowance for estimated losses........................... (29) (45)
------ ------
Net investment............................................. $5,587 $4,070
====== ======
</TABLE>
The table below summarizes activity in the allowance for estimated losses
on real estate owned for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ---- ------- --------
<S> <C> <C> <C>
Balance, beginning of year.............................. $ 45 $ 2,563 $ 11,871
Provision for estimated losses........................ 80 60 913
Charge-offs........................................... (96) (2,578) (10,221)
---- ------- --------
Balance, end of year.................................... $ 29 $ 45 $ 2,563
==== ======= ========
</TABLE>
The table below summarizes the real estate operations for the periods
indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ----- ------- -------
<S> <C> <C> <C>
Expenses associated with real estate owned:
Property taxes............................................ $ (3) $ 7 $ 119
Repairs, maintenance and renovation....................... 219 277 222
Insurance................................................. 135 116 188
---- ------ ------
351 400 529
Net gains from sales of properties.......................... 754 2,278 1,282
Rental income, net.......................................... 1 91 389
Provision for estimated losses on real estate owned......... (80) (60) (913)
---- ------ ------
Income from real estate operations, net..................... $324 $1,909 $ 229
==== ====== ======
</TABLE>
A-17
<PAGE> 65
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 -- OFFICE PROPERTY AND EQUIPMENT -- AT COST
The following is a summary of data for the major categories of property and
equipment for the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1999 1998
(DOLLARS IN THOUSANDS) ------- -------
<S> <C> <C>
Office buildings......................................... $ 1,421 $ 1,228
Furniture and equipment.................................. 9,127 7,994
Leasehold improvements................................... 3,054 2,700
------- -------
Total.......................................... 13,602 11,922
Less:
Accumulated depreciation and amortization.............. (7,853) (5,599)
------- -------
5,749 6,323
Land..................................................... 190 190
------- -------
Net............................................ $ 5,939 $ 6,513
======= =======
</TABLE>
The Company recognized $2.3 million, $1.6 million and $1.2 million of
depreciation expense for the years 1999, 1998 and 1997, respectively.
NOTE 7 -- DEPOSITS
The table below summarizes the balances by original term, weighted average
interest rates ("WAIR") and weighted average remaining maturities in months
("WARM") for the Company's deposits for the dates indicated:
<TABLE>
<CAPTION>
1999 1998
------------------------ ------------------------
BALANCE WAIR WARM BALANCE WAIR WARM
(DOLLARS IN THOUSANDS) ---------- ---- ---- ---------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Noninterest bearing checking.............. $ 28,838 -- -- $ 20,292 -- --
Checking -- NOW........................... 40,563 2.17% -- 35,579 2.36% --
Passbook.................................. 23,568 1.41% -- 17,587 3.72% --
Money Market.............................. 155,537 4.45% -- 112,274 4.04% --
Certificates of deposit:
7 day maturities........................ 30,631 4.08% -- 36,091 4.08% --
Less than 6 months...................... 42,082 4.78% 2 5,688 4.60% 2
6 months to 1 year...................... 147,407 5.24% 3 207,964 5.25% 3
1 year to 2 years....................... 584,488 5.46% 8 537,815 5.51% 7
Greater than 2 years.................... 33,521 5.31% 12 46,160 5.40% 16
---------- ----------
Total........................... $1,086,635 4.86% 5 $1,019,450 5.25% 5
========== ==========
</TABLE>
The table below summarizes interest expense on deposits, by type of
account, for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
Checking/NOW.......................................... $ 801 $ 765 $ 381
Passbook.............................................. 918 632 403
Money Market.......................................... 6,803 2,957 1,018
Certificates of Deposit............................... 42,309 43,288 37,118
------- ------- -------
Total....................................... $50,831 $47,642 $38,920
======= ======= =======
</TABLE>
A-18
<PAGE> 66
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
This table sets forth the remaining maturities of the certificates of
deposit outstanding for the periods indicated:
<TABLE>
<CAPTION>
CERTIFICATES OF DEPOSIT OUTSTANDING AT DECEMBER 31, 1999
-----------------------------------------------------------
THREE OVER THREE OVER SIX
MONTHS THROUGH THROUGH OVER
OR LESS SIX MONTHS TWELVE MONTHS ONE YEAR TOTAL
(DOLLARS IN THOUSANDS) -------- ---------- ------------- -------- --------
<S> <C> <C> <C> <C> <C>
Balances less than $100,000
4.00% or less......................... $ 1,645 $ 114 $ 74 $ 12 $ 1,845
4.01% - 5.00%......................... 76,930 43,765 14,758 6,704 142,157
5.01% - 6.00%......................... 110,906 93,532 123,972 58,904 387,314
6.01% - 7.00%......................... -- 95 68,582 7,848 76,525
7.01% or more......................... -- 1 -- -- 1
-------- -------- -------- -------- --------
189,481 137,507 207,386 73,468 607,842
Balances greater than $100,000
4.00% or less......................... 1,155 -- -- -- 1,155
4.01% - 5.00%......................... 26,883 12,065 5,133 1,379 45,460
5.01% - 6.00%......................... 45,952 36,074 46,553 24,860 153,439
6.01% - 7.00%......................... 189 421 27,319 2,304 30,233
7.01% or more......................... -- -- -- -- --
-------- -------- -------- -------- --------
74,179 48,560 79,005 28,543 230,287
-------- -------- -------- -------- --------
Total......................... $263,660 $186,067 $286,391 $102,010 $838,129
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
CERTIFICATES OF DEPOSIT OUTSTANDING AT DECEMBER 31, 1998
-----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances less than $100,000
4.00% or less......................... $ 1,821 $ 632 $ 123 $ 17 $ 2,593
4.01% - 5.00%......................... 30,923 33,075 27,410 9,141 100,549
5.01% - 6.00%......................... 147,740 132,013 196,001 35,206 510,960
6.01% - 7.00%......................... 694 343 523 -- 1,560
7.01% or more......................... -- -- 100 -- 100
-------- -------- -------- -------- --------
181,178 166,063 224,157 44,364 615,762
Balances greater than $100,000
4.00% or less......................... -- 100 101 -- 201
4.01% - 5.00%......................... 8,321 9,062 8,797 2,757 28,937
5.01% - 6.00%......................... 61,020 47,719 68,115 8,504 185,358
6.01% - 7.00%......................... 910 1,930 442 178 3,460
7.01% or more......................... -- -- -- -- --
-------- -------- -------- -------- --------
70,251 58,811 77,455 11,439 217,956
-------- -------- -------- -------- --------
Total......................... $251,429 $224,874 $301,612 $ 55,803 $833,718
======== ======== ======== ======== ========
</TABLE>
NOTE 8 -- SHORT-TERM BORROWINGS
A primary alternate-funding source for the Company is a credit line with
the FHLB of up 35% of the Company's total assets. The FHLB system functions as a
source of credit to savings institutions that are members of the FHLB. The
Company's real estate loans and the capital stock of the FHLB owned by the
Company typically secure advances. 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
A-19
<PAGE> 67
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
granting advances, the FHLB considers a member's creditworthiness and other
relevant factors. The table below summarizes the balance and rate of FHLB
advances for the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
1999 1998
--------------------- ---------------------
AVERAGE AVERAGE
RATE AT RATE AT
PRINCIPAL YEAR END PRINCIPAL YEAR END
(DOLLARS IN THOUSANDS) --------- -------- --------- --------
<S> <C> <C> <C> <C>
Original Term:
60 Months............................... $300,000 5.30% $215,000 5.36%
120 Months.............................. 49,000 4.36% 49,000 4.36%
-------- --------
Total........................... $349,000 5.16% $264,000 5.18%
======== ========
</TABLE>
The following table summarizes information relating to the Company's FHLB
advances for the periods or dates indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1999 1998
(DOLLARS IN THOUSANDS) ---------- ----------
<S> <C> <C>
Average balance during the year........................ $343,205 $170,060
Average interest rate during the year.................. 5.18% 5.43%
Maximum month-end balance during the year.............. $379,000 $264,000
Loans underlying the agreements at year end............ $799,866 $750,800
</TABLE>
NOTE 9 -- INCOME TAXES
The (provision) benefit for income taxes consist of the following
components for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------- ------- ------
<S> <C> <C> <C>
Current income tax expense:
Federal.............................................. $(7,409) $ (654) $ --
State................................................ (2) (21) --
------- ------- ------
Total current................................ (7,411) (675) --
Deferred income tax expense:
Federal.............................................. 1,168 (4,013) 2,346
State................................................ (1,787) 14 231
------- ------- ------
Total deferred............................... (619) (3,999) 2,577
------- ------- ------
Income tax (provision)/benefit......................... $(8,030) $(4,674) $2,577
======= ======= ======
</TABLE>
A-20
<PAGE> 68
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The table below summarizes the components of the net deferred income tax
assets for the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
(DOLLARS IN THOUSANDS) -------- -------
<S> <C> <C>
Deferred income tax liabilities:
Loan fees............................................. $ (6,503) $(3,629)
FHLB stock............................................ (2,001) (1,581)
Depreciation.......................................... (962) (395)
Other................................................. (699) (2,835)
-------- -------
Total......................................... (10,165) (8,440)
Deferred income tax assets:
Bad debts............................................. 7,317 5,844
State NOL carryforward................................ -- 1,306
Federal AMT credit carryforward....................... 30 1,303
Federal NOL carryforward.............................. -- 447
Other................................................. 5,021 2,362
-------- -------
Total......................................... 12,368 11,262
-------- -------
Deferred tax assets, net................................ $ 2,203 $ 2,822
======== =======
</TABLE>
The table below summarizes the differences between the statutory income tax
and the Company's effective tax for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
Federal income (tax) benefit.......................... $(6,379) $(5,497) $(2,464)
Reduction (addition) resulting from:
Change in federal valuation allowance............... -- 1,084 4,826
California franchise tax, net of federal income
taxes............................................ (1,163) (5) 152
Other............................................... (488) (256) 63
------- ------- -------
Total....................................... $(8,030) $(4,674) $ 2,577
======= ======= =======
</TABLE>
NOTE 10 -- STOCKHOLDERS' EQUITY
EMPLOYEE BENEFIT PLANS
The Company has an Employee Stock Ownership Plan ("ESOP") that previously
covered substantially all employees over 21 years of age who met minimum service
requirements. As of December 15, 1995, the Company froze the ESOP and all
accounts became fully vested and nonforfeitable. At December 31, 1999, the ESOP
owned 101,452 shares of the Company's common stock. As of December 31, 1998, the
Company had a loan receivable from the ESOP of $79,000 collateralized by 5,833
shares of common stock owned by the ESOP. In June 1999, the Company paid the
ESOP loan in full, which eliminated the loan receivable balance.
Effective April 1, 1996, the ESOP was amended to include a 401(k) plan. The
Company makes a matching contribution equal to 100% of the amount each
participant elects to defer up to a maximum of 5% of the participant's
compensation for the calendar quarter. Employees are eligible to participate if
they were employed by the Company on March 1, 1996 or have been employed for 6
months, worked at least 500 hours, and are over 21 years of age. Contributions
under the plan were $420,935, $382,559 and $201,621 for 1999, 1998 and 1997,
respectively.
A-21
<PAGE> 69
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company had a retirement income plan ("Retirement Plan") that
previously covered substantially all employees over 21 years of age who met
minimum service requirements. The Company terminated the Retirement Plan as of
July 1997.
STOCK OPTION PLANS
The Company has two stock option plans ("Option Plans"), one of which
provides for the issuance of stock options to directors and employees of the
Company and the other of which provides for the issuance of stock options to
employees other than certain executive officers of the Company. At December 31,
1999, the Option Plans provide for the issuance of 1,300,000 maximum aggregate
shares of Company common stock upon exercise of options. The exercise price of
any option may not be less than the fair market value of the common stock on the
date of grant and the term of any option may not exceed 10 years.
Presented below is a summary of the transactions under the stock option
plans described above for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
1999 1998 1997
------------------------- ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------- -------------- ------- -------------- ------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year....... 882,300 $10.19 721,800 $ 7.03 686,000 $ 5.08
Granted............................ 135,000 14.36 255,000 17.23 120,000 16.77
Exercised.......................... (110,000) 5.24 (86,500) 5.06 (60,200) 4.92
Canceled or expired................ (119,500) 15.47 (8,000) 5.26 (24,000) 5.26
-------- ------ ------- ------ ------- ------
Outstanding, end of year............. 787,800 $10.79 882,300 $10.19 721,800 $ 7.03
======== ====== ======= ====== ======= ======
Options exercisable, end of year..... 480,733 580,400 372,934
======== ======= =======
</TABLE>
The table below summarizes information about stock options outstanding and
exercisable at December 31, 1999.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
NUMBER REMAINING CONTRACTUAL NUMBER
EXERCISE PRICE OUTSTANDING LIFE (YEARS) EXERCISABLE
- -------------- ----------- --------------------- -----------
<S> <C> <C> <C>
$ 4.65 269,000 3.92 269,000
5.26 89,800 6.00 84,400
7.81 24,000 6.92 19,000
10.50 20,000 5.42 13,333
13.31 20,000 5.00 20,000
13.73 35,000 8.00 --
15.09 40,000 7.25 --
16.31 140,000 7.00 --
18.02 50,000 5.92 25,000
18.44 100,000 5.58 50,000
------- ---- -------
787,800 5.55 480,733
======= ==== =======
</TABLE>
A-22
<PAGE> 70
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
If compensation costs for the Option Plans had been determined based on the
fair value at the grant date for awards in 1999, 1998 and 1997 consistent with
the provisions of SFAS No. 123, the Company's net income and net earnings per
share would have been reduced to the pro forma amounts indicated below.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) ------- ------- ------
<S> <C> <C> <C>
Net income:
As reported.......................................... $10,200 $11,038 $9,617
Pro forma............................................ $ 8,677 $ 9,371 $8,880
Basic earnings per share:
As reported.......................................... $ 1.93 $ 2.64 $ 1.82
Pro forma............................................ $ 1.64 $ 2.24 $ 1.57
Diluted earnings per share:
As reported.......................................... $ 1.33 $ 1.65 $ 1.00
Pro forma............................................ $ 1.13 $ 1.40 $ 0.86
Weighted average fair value at date of grant........... $ 6.62 $ 8.33 $ 7.99
</TABLE>
The fair value of options granted under the Option Plans was estimated on
the date of grant using the Black-Scholes option-pricing model. In 1999, the
following weighted average assumptions were used: no dividend yield, expected
volatility of 30.55%, risk free interest rate of 6.76%, and expected lives of 4
to 8 years. In 1998, no dividend yield, expected volatility of 33%, risk free
interest rate of 5.25% and expected lives of 5 to 8 years. In 1997, no dividend
yield, expected volatility of 123%, risk free interest rate of 5.7% and expected
lives of 3 to 5 years.
NOTE 11 -- CAPITAL AND DEBT OFFERINGS
In December 1995, the Company sold $27.0 million of "investment units" at a
price of $500,000 per unit in a private placement offering (the "1995
Offering"). Each investment unit consisted of $250,000 principal amount of the
Company's senior notes due 2000 ("1995 Senior Notes"), five shares of the
Company's cumulative preferred stock, series A ("Series A Preferred") and one
warrant to purchase 44,000 shares of the Company's common stock ("Warrants").
The Company contributed $19.0 million of the net proceeds of the Offering as
qualifying Tier I capital to the Bank.
The Company recorded the 1995 Senior Notes, with a face amount of $13.5
million, at $12.0 million. Interest was payable semiannually at a rate of 12.0%
per annum on the face amount and had an effective annual cost of 15.87% during
1997 after recording the effect of the Original Issue Discount ("OID") of $1.5
million. The accretion of the OID was to be recognized using the constant yield
method over the five-year term of the Senior Notes. During 1997 and 1996, the
Company recorded $350,000 and $301,000, respectively, of OID as part of its
interest expense.
The Company also recorded the receipt of $12.8 million from the issuance of
270 shares of Series A Preferred with a par value of $.01 as Capital in Excess
of Par Value -- Cumulative Preferred Stock, Series A. The Series A Preferred
provided for cumulative dividends, payable quarterly commencing June 1997 at an
annual rate of 18% on the $13.5 million liquidation preference of the stock.
The Company recorded $2.2 million of the proceeds from the sale of the
units to the Warrants as additional paid in capital. The Warrants entitle the
holders to purchase up to an aggregate of 2.5 million shares of common stock for
$2.128 per share and expire in December 2005.
On December 31, 1997, the Company sold $40.0 million of 12.5% Senior Notes
due 2004 ("1997 Senior Notes") in a private placement (the "1997 Offering"),
which included registration rights. Concurrent with the completion of the 1997
Offering, the Company prepaid all of its 1995 Senior Notes and redeemed all of
its
A-23
<PAGE> 71
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Series A Preferred. The 1995 Senior Notes and Series A Preferred were retired at
par plus accrued interest and dividends, which approximated $27.2 million. This
repayment and redemption resulted in the write-off of the remaining OID ($0.8
million) and prepaid offering costs ($0.7 million) as an extraordinary item. Net
proceeds after the offering costs and the prepayment of the 1995 Senior Notes
and Series A Preferred amounted to approximately $10.4 million, funds which
became available to the Company for general corporate purposes, inclusive of
supporting the planned business activities of the Bank.
Interest on the 1997 Senior Notes is payable semiannually. On or after
December 31, 2002, the 1997 Senior Notes will be redeemable at any time at the
option of the Company, in whole or in part, at the redemption price of 106.25%
for the twelve-month period beginning December 31, 2002, and 103.125%
thereafter.
In July 1998, the Company sold 2,012,500 shares of its common stock
(including 262,500 shares, issued upon exercise by the underwriters of their
over allotment option) at a price of $15.00 per share, realizing net proceeds
(after offering costs) of approximately $27.6 million. As a result of this
offering, the exercise price of the Warrants was reduced to $2.128 and the
number of shares of common stock acquirable upon the exercise of the Warrants
was increased to 2,512,188.
NOTE 12 -- REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), to average assets (as defined). Management
believes, as of December 31, 1999, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 1999 and 1998, the most recent notification from the OTS
categorized the Bank as well capitalized under the regulatory framework for
Prompt Corrective Action ("PCA") Rules. There are no conditions or events since
that notification that management believes have changed the Bank's category. The
following table sets forth the Bank's actual regulatory capital amounts and
ratios and the regulatory capital
A-24
<PAGE> 72
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
amounts and ratios for the Bank to be "adequately capitalized" and "well
capitalized" as of December 31, 1999 and 1998.
<TABLE>
<CAPTION>
TO BE WELL
FOR CAPITAL CAPITALIZED
ACTUAL ADEQUACY PURPOSES UNDER PCA PROVISIONS
----------------- ------------------ ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(DOLLARS IN THOUSANDS) -------- ----- -------- ------ ---------- -------
<S> <C> <C> <C> <C> <C> <C>
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%
As of December 31, 1998:
Total capital to risk weighted
assets........................ $119,400 11.10% $86,090 8.00% $107,612 10.00%
Core capital to adjusted tangible
assets........................ 108,673 7.65% 56,804 4.00% 71,005 5.00%
Tangible capital to adjusted
tangible assets............... 108,673 7.65% 21,302 1.50% n/a n/a
Tier 1 capital to risk weighted
assets........................ 108,673 10.10% n/a n/a 64,567 6.00%
</TABLE>
NOTE 13 -- COMMITMENTS AND CONTINGENCIES
LITIGATION
The Bank is a defendant in an action entitled Takaki vs. Hawthorne Savings
and Loan Association, filed in the Superior Court of the State of California,
Los Angeles. The plaintiffs were owners of real property that they sold in early
1992 to a third party. The Bank provided escrow services in connection with the
transaction. A substantial portion of the consideration paid to the plaintiffs
took the form of a deed of trust secured by another property then owned by an
affiliate of the purchaser. The value of the collateral securing this deed of
trust ultimately proved to be inadequate. The plaintiffs alleged that the Bank
knew, or should have known, that the security that the plaintiffs received as
sellers was inadequate and should have so advised them. In June 1997, a jury
found for the plaintiffs and awarded compensatory and punitive damages totaling
$9.1 million. In July 1997, the trial judge reduced the combined award to $3.3
million. The Bank filed an appeal and in July, 1998, the Appellate Court
remanded the case to the Superior Court with directions to dismiss the
fraudulent concealment, misrepresentation and punitive damages claims and to
conduct a new trial pertaining solely to damages arising from negligence, in
particular to determine whether any negligence of the Bank contributed to the
plaintiffs' injury and, if so, to apportion liability for negligence between the
Bank and the plaintiffs. On March 30, 1999, the jury returned a verdict in favor
of the plaintiffs in the amount of $2.4 million. In May 1999, the Bank filed a
notice of appeal from the judgment and posted an Appeal Bond with the court to
stay plaintiffs' enforcement of the judgment pending the Appellate Court's
decision. Briefs on appeal were filed in December 1999. The Bank believes that
there is a reasonable likelihood that its position will ultimately be upheld on
appeal. There can be no assurances that this will be the case however.
The Bank is a defendant in an action entitled Mells v. Hawthorne, filed in
the Superior Court of the State of California, San Diego. Plaintiffs alleged
that the Bank concealed and misrepresented the severity of defects in a house
that the Bank sold to them. On September 20, 1999, a second amended judgment was
entered on behalf of the plaintiffs for $767 thousand that includes attorney's
fees and costs. In October of 1999, the Bank filed a notice of appeal from the
judgment and posted an Appeal Bond with the court to stay plaintiffs'
enforcement of the judgment pending the Appellate Court's decision. A briefing
schedule on the appeal has not yet been set. The Bank intends to vigorously
pursue its appeal. However, the Company believes that there
A-25
<PAGE> 73
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
is a reasonable likelihood that its position will ultimately be upheld on
appeal. There can be no assurances that this will be the case however.
The Bank is a defendant in two construction defect cases entitled Marine
Village Townhomes Homeowners' Association v. Hawthorne Savings and Loan
Association, and Stone Water Terrace HOA v. Hawthorne Savings and Loan
Association, both of which were filed in the Superior Court of the State of
California, County of Los Angeles. In each of these actions, Plaintiffs allege,
under several theories of recovery, that the Bank was responsible for
construction defects in multi-unit condominium complexes. The Bank initially
provided construction loans to the developer, but took over the completion of a
portion of the projects after the developer defaulted. Plaintiffs in the Marine
Village Townhomes case are seeking damages of approximately $3.3 million.
Plaintiffs in the Stone Water Terrace matter are seeking damages in an
unspecified amount, plus punitive damages. The Bank has denied the Marine
Village Townhomes claims that it is responsible for all of the defects
Plaintiffs are alleging, and has made claims for indemnification against the
contractor and subcontractors. The Bank has denied the allegations in the
complaint and intends to seek indemnification against the responsible parties.
No assurances can be given that the responsible parties will ultimately
indemnify the Bank. Although the Bank intends to vigorously defend its position
in these actions and to pursuant indemnification, there can be no assurances
that the Company will prevail. In addition, it is probable that the Bank will
incur substantial legal fees defending these cases. In addition, the inherent
uncertainty of jury or judicial verdicts makes it impossible to determine with
certainty the Company's maximum exposure in these actions.
The Company is involved in a variety of other litigation matters in the
ordinary course of its business, and anticipates that it will become involved in
new litigation matters from time to time in the future. Based on the current
assessment of these existing other matters, management does not presently
believe that any one of these existing other matters is likely to have material
adverse impact on the Company's financial condition or result of operations.
However, the Company will incur legal and related costs in connection with the
litigation and may from time to time determine to settle some or all of the
cases, regardless of management's assessment of the Company's legal position.
The amount of legal defense costs and settlements in any period will depend on
many factors, including the status of cases (and the number of cases that are in
trial or about to be brought to trial) and the opposing parties aggressiveness
in pursuing their cases and their perception of their legal position. Further,
the inherent uncertainty of jury or judicial verdicts makes it impossible to
determine with certainty the Company's maximum cost in any pending litigation.
Accordingly, the Company's litigation costs and expenses may vary materially
from period to period, and no assurance can be given that these costs will not
be material in any particular period.
LENDING COMMITMENTS
At December 31, 1999, the Company had commitments to fund the undisbursed
portion of existing construction and land loans of $157.2 million and
commitments to fund the undisbursed portion of existing lines of credit of $38.8
million.
ERRORS AND OMISSIONS INSURANCE
The Company had a mortgagee's errors and omissions insurance policy as of
December 31, 1999. The Company did not have errors and omissions insurance on
other aspects of its operation.
LEASES
The Company has entered into agreements to lease certain office facilities
under noncancelable operating leases that expire at various dates to the year
2010. The leases generally provide that the Company pays
A-26
<PAGE> 74
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
property taxes, insurance and other items. Current rental commitments for the
remaining terms of these noncancelable leases as of December 31, 1999 are as
follows:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) AMOUNT
---------------------- ------
YEAR
<S> <C>
2000...................................................... $ 1,687
2001...................................................... 2,022
2002...................................................... 1,785
2003...................................................... 1,755
2004...................................................... 1,596
Thereafter................................................ 2,681
-------
Total........................................... $11,526
=======
</TABLE>
Lease expense for office facilities was $1.7 million, $1.4 million and $1.0
million for the years ended December 31, 1999, 1998 and 1997, respectively.
NOTE 14 -- ESTIMATED FAIR VALUE INFORMATION
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments." The Company, using
available market information and appropriate valuation methodologies, has
determined the estimated fair value amounts. However, considerable judgment is
required to interpret market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts the Company could realize in a current market exchange. The use of
different market assumptions and or estimation methodologies may have a material
effect on the estimated fair value amounts.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1999 1998
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
(DOLLARS IN THOUSANDS) ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents............... $ 86,722 $ 86,722 $ 45,449 $ 45,449
Loans receivable........................ 1,444,968 1,455,635 1,326,791 1,357,988
Investment in FHLB stock................ 22,236 22,236 13,554 13,554
Liabilities:
Deposits:
Money market......................... 155,537 155,537 112,274 112,274
Passbook............................. 23,568 23,568 17,587 17,587
Checking/NOW......................... 40,563 40,563 35,579 35,579
Certificates of deposit.............. 838,129 836,101 833,718 832,920
Noninterest bearing demand........... 28,838 28,838 20,292 20,292
FHLB advances........................... 349,000 346,881 264,000 268,570
Senior notes............................ 40,000 38,600 40,000 39,200
</TABLE>
The methods and assumptions used to estimate the fair value of each class
of financial instruments for which it is practicable to estimate that value are
explained below:
For cash and cash equivalents, the carrying amounts approximate fair values
due to the short-term nature of these instruments.
A-27
<PAGE> 75
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For FHLB stock, the carrying amount approximates fair value, as the stock
may be sold back to the FHLB at the carrying value.
The carrying amount of loans receivable is their contractual amounts
outstanding reduced by net deferred loan origination fees and the allowance for
loan losses (note 4). Adjustable rate loans consist primarily of loans whose
interest rates float with changes in either a specified bank's reference rate or
the COFI index.
The fair value of both adjustable and fixed rate loans was estimated by
discounting the remaining contractual cash flows using the estimated current
rate at which similar loans would be made to borrowers with similar credit risk
characteristics over the same remaining maturities, reduced by net deferred loan
origination fees and the allocable portion of the allowance for the loan losses.
The estimated current rate for discounting purposes was not adjusted for any
change in borrowers' credit risks since the origination of such loans. Rather,
the allocable portion of the allowance for loan losses is considered to provide
for such changes in estimating fair value.
The fair value of nonaccrual loans (note 4) has been estimated at the
carrying amount of these loans, as it is not practicable to reasonably assess
the credit risk adjustment that would be applied in the market place for such
loans.
The withdrawable amounts for checking, passbook, money market, and
noninterest bearing demand accounts are considered stated at their estimated
fair value. The fair value of fixed-maturity certificates of deposit is
estimated using the rates currently offered for deposits of similar remaining
maturities.
The fair value of FHLB advances is estimated using the rates currently
offered on similar instruments with similar terms.
The fair value of Senior Notes in 1999 is based on quoted market price. The
Senior Notes were issued December 31, 1997 with a stated coupon interest rate of
12.5% and maturity date of December 31, 2004.
Additionally, optional commitments to originate mortgages are excluded from
this presentation because such commitments are typically at market terms, are
typically for adjustable rate loans, and are generally cancelable by borrower
without significant fees or costs upon cancellation.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1999 and 1998. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amounts presented above.
A-28
<PAGE> 76
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 -- PARENT COMPANY ONLY FINANCIAL STATEMENTS
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
(DOLLARS IN THOUSANDS) -------- --------
<S> <C> <C>
Assets:
Cash at the Bank and cash equivalents..................... $ 1,259 $ 20,637
Loan receivable, net...................................... -- 150
Investment in subsidiary.................................. 127,161 108,673
Other assets.............................................. 4,715 2,184
-------- --------
Total Assets...................................... $133,135 $131,644
======== ========
Liabilities and Stockholders' Equity:
Accounts payable and other liabilities.................... $ 831 $ 10,220
Senior notes.............................................. 40,000 40,000
-------- --------
Total Liabilities................................. 40,831 50,220
Stockholders' equity:
Common stock -- $0.01 par value; authorized 20,000,000
shares; Issued and outstanding, 5,309,407 shares
(1999) and 5,194,996 shares (1998).................... 53 52
Capital in excess of par value -- common stock......... 40,981 40,349
Retained earnings...................................... 51,318 41,150
Less:
Treasury stock, at cost -- 5,400 shares................ (48) (48)
Loan to Bank ESOP...................................... -- (79)
-------- --------
Total Stockholders' Equity........................ 92,304 81,424
-------- --------
Total Liabilities and Stockholders' Equity........ $133,135 $131,644
======== ========
</TABLE>
A-29
<PAGE> 77
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 -- PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) ------- ------- -------
<S> <C> <C> <C>
Interest revenues:
Investments............................................... $ 55 $ 571 $ 95
From subsidiary........................................... -- -- 10
------- ------- -------
Total interest revenues........................... 55 571 105
Interest costs.............................................. 5,000 5,000 1,979
------- ------- -------
Net interest income......................................... (4,945) (4,429) (1,874)
Noninterest revenues, net
Operating................................................... -- 1 21
Loss on sale of securities.................................. -- -- (10)
Other non-operating......................................... (808) -- (1)
Operating costs............................................. (939) (1,307) (882)
------- ------- -------
Loss before income taxes, equity in subsidiary, and
extraordinary item........................................ (6,692) (5,735) (2,746)
Income tax benefit.......................................... 2,903 -- --
------- ------- -------
Loss before equity in subsidiary and extraordinary item..... (3,789) (5,735) (2,746)
Equity in earnings of subsidiary............................ 13,989 16,773 13,897
------- ------- -------
Income before extraordinary item............................ 10,200 11,038 11,151
Extraordinary item.......................................... -- -- (1,534)
------- ------- -------
Net income.................................................. $10,200 $11,038 $ 9,617
======= ======= =======
Net income available for common............................. $10,200 $11,038 $ 5,254
======= ======= =======
Basic earnings per share before extraordinary item.......... $ 1.93 $ 2.64 $ 2.35
======= ======= =======
Basic earnings per share.................................... $ 1.93 $ 2.64 $ 1.82
======= ======= =======
Diluted earnings per share before extraordinary item........ $ 1.33 $ 1.65 $ 1.30
======= ======= =======
Diluted earnings per share.................................. $ 1.33 $ 1.65 $ 1.00
======= ======= =======
Weighted average basic shares outstanding................... 5,288 4,176 2,883
======= ======= =======
Weighted average diluted share outstanding.................. 7,697 6,692 5,235
======= ======= =======
</TABLE>
A-30
<PAGE> 78
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 -- PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
(DOLLARS IN THOUSANDS) -------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 10,200 $ 11,038 $ 9,617
Adjustments:
Equity in undistributed earnings of subsidiary........ (13,989) (16,773) (13,897)
Other................................................. (32) -- --
Depreciation and amortization......................... 361 361 582
Decrease (increase) in interest receivable............ -- -- 16
Loss on early extinguishment of debt.................. -- -- 1,534
Loss of sales of investments.......................... -- -- 10
Increase in other assets.............................. (2,890) (44) (2,451)
Increase (decrease) in accounts payable and other
liabilities......................................... (9,390) 10,188 (79)
-------- -------- --------
Net cash (used in) provided by operating
activities....................................... (15,740) 4,770 (4,668)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities.................................. -- (27,900) --
Maturities of securities................................. -- 27,900 795
Proceeds from sale of securities......................... -- -- 2,414
Net (decrease) increase in loans receivable.............. 150 (150) --
-------- -------- --------
Net cash provided by (used in) investing
activities....................................... 150 (150) 3,209
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of options and warrants....... 633 437 296
Net collection of ESOP loan.............................. 79 13 27
Cash contribution to subsidiary.......................... (7,500) (22,000) (3,400)
Cash dividends received.................................. 3,000 -- 1,000
Net proceeds from issuance of senior notes............... -- -- 40,000
Redemption of senior notes............................... -- -- (13,500)
Redemption of preferred stock............................ -- -- (13,500)
Stock offering proceeds, net............................. -- 27,623 --
Cash dividends paid on preferred stock................... -- -- (742)
-------- -------- --------
Net cash (used in) provided by financing
activities....................................... (3,788) 6,073 10,181
-------- -------- --------
(Decrease) increase in cash................................ (19,378) 10,693 8,722
Cash, beginning of year.................................... 20,637 9,944 1,222
-------- -------- --------
Cash, end of year.......................................... $ 1,259 $ 20,637 $ 9,944
======== ======== ========
Non-cash investing and financing items:
Net change in unrealized gain (loss) on
available-for-sale securities......................... -- (6) 19
Accrued dividends on preferred stock....................... -- -- 2,455
</TABLE>
A-31
<PAGE> 79
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16 -- QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED FOR 1999
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Interest revenues............................. $32,014 $32,680 $34,531 $33,522
Interest costs................................ 17,544 18,315 18,782 18,985
------- ------- ------- -------
Net interest income......................... 14,470 14,365 15,749 14,537
Provision for credit losses................... 3,000 2,500 3,500 3,000
------- ------- ------- -------
Net interest income after provision for
credit losses............................ 11,470 11,865 12,249 11,537
Noninterest revenues, net..................... 1,970 1,925 2,045 1,880
Income (loss) from real estate operations,
net......................................... 434 (17) 3 (96)
Noninterest expenses:
General and administrative costs............ 7,798 7,852 7,315 9,398
Other non-operating expense................. 992 8 622 3,050
------- ------- ------- -------
Total noninterest expenses.......... 8,790 7,860 7,937 12,448
------- ------- ------- -------
Income before income taxes.................... 5,084 5,913 6,360 873
Income tax provision.......................... (2,112) (2,487) (2,686) (745)
------- ------- ------- -------
Net income.................................... $ 2,972 $ 3,426 $ 3,674 $ 128
======= ======= ======= =======
Basic earnings per share...................... $ 0.57 $ 0.65 $ 0.69 $ 0.02
======= ======= ======= =======
Diluted earning per share..................... $ 0.38 $ 0.44 $ 0.48 $ 0.02
======= ======= ======= =======
Weighted average basic shares outstanding..... 5,224 5,290 5,312 5,325
======= ======= ======= =======
Weighted average diluted shares outstanding... 7,732 7,723 7,714 7,625
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED FOR 1998
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Interest revenues.............................. $21,994 $25,097 $28,924 $30,977
Interest costs................................. 12,918 14,497 16,622 17,837
------- ------- ------- -------
Net interest income.......................... 9,076 10,600 12,302 13,140
Provision for credit losses.................... 1,485 1,750 1,950 1,950
------- ------- ------- -------
Net interest income after provision for
credit losses............................. 7,591 8,850 10,352 11,190
Noninterest revenues, net...................... 713 1,460 1,375 1,105
Income (loss) from real estate operations,
net.......................................... 333 1,031 616 (71)
Noninterest expenses:
General and administrative costs............. 6,280 6,791 7,240 8,491
Other non-operating expense.................. -- 8 13 10
------- ------- ------- -------
Total noninterest expenses........... 6,280 6,799 7,253 8,501
------- ------- ------- -------
Income before income taxes..................... 2,357 4,542 5,090 3,723
Income tax provision........................... (524) (1,370) (1,632) (1,148)
------- ------- ------- -------
Net income..................................... $ 1,833 $ 3,172 $ 3,458 $ 2,575
======= ======= ======= =======
Basic earnings per share....................... $ 0.58 $ 1.00 $ 0.67 $ 0.50
======= ======= ======= =======
Diluted earning per share...................... $ 0.32 $ 0.56 $ 0.45 $ 0.33
======= ======= ======= =======
Weighted average basic shares outstanding...... 3,157 3,168 5,189 5,190
======= ======= ======= =======
Weighted average diluted shares outstanding.... 5,681 5,663 7,708 7,692
======= ======= ======= =======
</TABLE>
A-32
<PAGE> 1
NUMBER HAWTHORNE SHARES
HAWTHORNE FINANCIAL CORPORATION
INCORPORATED UNDER THE LAWS SEE REVERSE FOR CERTAIN DEFINITIONS
OF THE STATE OF DELAWARE
This Certifies that
is the record holder of
FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, $.01 PAR VALUE, OF
HAWTHORNE FINANCIAL CORPORATION
transferable on the books of the Corporation by the holder hereof in person or
by duly authorized attorney upon surrender of this certificate properly
endorsed. This certificate is not valid until countersigned by the Transfer
Agent and registered by the Registrar.
WITNESS the facsimile seal of the Corporation and the facsimile
signatures of its duly authorized officers.
JAMES D. SAGE SCOTT A. BRALY
SECRETARY PRESIDENT
SEAL
COUNTERSIGNED AND REGISTERED
ChaseMellon Shareholder Services, L.L.C.
Transfer Agent
and Registrar
AUTHORIZED SIGNATURE
<PAGE> 2
The Corporation shall furnish without charge to each stockholder who so
requests a statement of the powers, designations, preferences and relative,
participating, optional or other special rights of each class of stock of the
Corporation or series thereof and the qualifications, limitations or
restrictions of such preferences and/or rights. Such requests shall be made to
the Corporation's Secretary at the principal office of the Corporation.
The following abbreviations, which used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations.
TEN COM -- as tenants in common
TEN ENT -- as tenants by the entireties
JT TEN -- as joint tenants with right of
survivorship and not as tenants
in common
UNIF GIFT MIN ACT - ................Custodian................
(Cust) (Minor)
under Uniform Gifts to Minors
Act......................................
(State)
UNIF TRF MIN ACT - ................Custodian (until age.....)
(Cust)
................. under Uniform Transfers
(Minor)
to Minors Act ...........................
(State)
Additional abbreviations may also be used though not in the above list.
FOR VALUE RECEIVED _______________________ hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------
- --------------------------------------
- --------------------------------------------------------------------------------
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- ------------------------------------------------------------------------- Shares
of the common stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
- ----------------------------------------------------------------------- Attorney
to transfer the said stock on the books of the within named Corporation with
full power of substitution in the premises.
Dated
---------------------------
X
--------------------------------------
X
--------------------------------------
NOTICE: THE SIGNATURE(S) TO THIS ASSIGNMENT
MUST CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN
EVERY PARTICULAR, WITHOUT ALTERATION(S) ENLARGEMENT OR ANY CHANGE WHATEVER.
Signature(s) Guaranteed
By
-------------------------------------------------
THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE
GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS
AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH
MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE
MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15.
<PAGE> 1
EXHIBIT 10.4
Change in Control Agreements
On February 22, 2000, the Compensation Committee of the Board of Directors
approved a change of control pay plan providing for the payment of three years'
base salary and bonus, including an excise tax gross-up payment, for the chief
executive officer of the company, and providing for two years' base salary and
bonus, including an excise tax gross-up payment, for all executive vice
presidents of the company (at present, 4 persons), all senior vice presidents
reporting directly to the president (at present, 2 persons) and the senior vice
president-people development.
The change of control pay plan will be reflected in formal agreements that
have not been finalized as of the date of this filing.
<PAGE> 1
EXHIBIT 21.1
Subsidiaries of Registrant
Hawthorne Savings, F.S.B.
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-74800, 333-23587, 333-59879 and 33-59875 of Hawthorne Financial Corporation
on Form S-8 of our report dated March 20, 2000 appearing in this annual report
on Form 10-K of Hawthorne Financial Corporation for the year ended December 31,
1999.
DELOITTE & TOUCHE LLP
March 30, 2000
Los Angeles, California
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 86,722
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,469,253
<ALLOWANCE> 24,285
<TOTAL-ASSETS> 1,581,153
<DEPOSITS> 1,086,635
<SHORT-TERM> 349,000
<LIABILITIES-OTHER> 13,214
<LONG-TERM> 40,000
0
0
<COMMON> 53
<OTHER-SE> 92,251
<TOTAL-LIABILITIES-AND-EQUITY> 1,581,153
<INTEREST-LOAN> 126,854
<INTEREST-INVEST> 5,893
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 132,747
<INTEREST-DEPOSIT> 50,831
<INTEREST-EXPENSE> 73,626
<INTEREST-INCOME-NET> 59,121
<LOAN-LOSSES> 12,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 32,363
<INCOME-PRETAX> 18,230
<INCOME-PRE-EXTRAORDINARY> 10,200
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,200
<EPS-BASIC> 1.93
<EPS-DILUTED> 1.33
<YIELD-ACTUAL> 8.68
<LOANS-NON> 44,031
<LOANS-PAST> 0
<LOANS-TROUBLED> 34,838
<LOANS-PROBLEM> 25,646
<ALLOWANCE-OPEN> 17,111
<CHARGE-OFFS> 4,872
<RECOVERIES> 46
<ALLOWANCE-CLOSE> 24,285
<ALLOWANCE-DOMESTIC> 24,285
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
