-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Aqk7ENc5Lb/E1PSNWEYlzR7iNHU5lMyErcNS2Xcqj36QKcs7a1K17oh52C8GI2ww wT9QIGgZKuoey0CxxBPlsA== 0000912057-96-017835.txt : 19960816 0000912057-96-017835.hdr.sgml : 19960816 ACCESSION NUMBER: 0000912057-96-017835 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960814 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HAWTHORNE FINANCIAL CORP CENTRAL INDEX KEY: 0000046267 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 952085671 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-01100 FILM NUMBER: 96613728 BUSINESS ADDRESS: STREET 1: 2381 ROSECRANS AVE CITY: EL SEGUNDO STATE: CA ZIP: 90245 BUSINESS PHONE: 3107255000 MAIL ADDRESS: STREET 1: 2381 ROSECRANS AVE CITY: EL SEGUNDO STATE: CA ZIP: 90245 10-Q 1 FORM 10-Q - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 ----------------------- FORM 10-Q ----------------------- X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE --- ACT OF 1934 For the quarter ended June 30, 1996 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______ Commission File Number 0-1100 ----------------------- HAWTHORNE FINANCIAL CORPORATION (Exact Name of Registrant as Specified in its Charter) DELAWARE 95-2085671 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 2381 ROSECRANS AVENUE, EL SEGUNDO, CA 90245 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (310) 725-5000 ----------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: The Registrant had 2,599,275 shares outstanding of Common stock, $0.01 par value per share, as of August 14, 1996. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY FORM 10-Q INDEX FOR THE QUARTER ENDED JUNE 30, 1996 PART I - FINANCIAL INFORMATION Page ---- ITEM 1. Financial Statements Consolidated Statements of Financial Condition at June 30, 1996 (Unaudited) and December 31, 1995 3 Consolidated Statements of Operations (Unaudited) for the Three and Six Months Ended June 30, 1996 and 1995 4 Consolidated Statement of Stockholders' Equity (Unaudited) for the Six Months Ended June 30, 1996 5 Consolidated Statements of Cash Flows (Unaudited) for the Three and Six Months Ended June 30, 1996 and 1995 6 Notes to Consolidated Financial Statements (Unaudited) 8 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 33 ITEM 2. Changes in Securities 33 ITEM 3. Defaults upon Senior Securities 33 ITEM 4. Submission of Matters to a Vote of Security Holders 33 ITEM 5. Other Information 33 ITEM 6. Exhibits and Reports on Form 8-K 33 2 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (DOLLARS ARE IN THOUSANDS)
June 30, December 31, 1996 1995 (unaudited) (audited) ------------- ------------- ASSETS Cash and cash equivalents $ 33,983 $ 14,015 Investment securities available-for-sale 38,448 62,793 Loans held for investment (net of allowance for estimated credit losses of $15,762 in 1996 and $15,192 in 1995) 644,305 617,328 Real estate owned (net of allowance for estimated losses of $11,909 in 1996 and $15,725 in 1995) 22,404 37,905 Investment in capital stock of Federal Home Loan Bank - at cost 6,569 6,312 Office property and equipment-at cost, net 5,081 9,597 Accrued interest receivable 4,256 3,583 Deferred tax assets 3,483 Other assets 2,633 2,050 ------------- ------------- $ 761,162 $ 753,583 ------------- ------------- ------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposit accounts $ 621,965 $ 698,008 Borrowings 75,000 Senior notes 12,150 12,006 Accounts payable and other liabilities 5,910 4,603 ------------- ------------- 715,025 714,617 Stockholders' equity Capital stock - $0.01 par value; authorized, 20,000,000 shares; issued and outstanding, 2,604,675 shares 26 26 Cumulative perpetual preferred stock, series A - $0.01 par value; $50,000 liquidation preference; authorized 10,000,000 shares; issued and outstanding 270 shares Capital in excess of par value - common stock 7,745 7,745 Capital in excess of par value - preferred stock 11,592 11,592 Unrealized gains (losses) on available-for-sale securities, net (140) 6 Retained earnings 27,099 19,788 ------------- ------------- 46,322 39,157 Less Treasury stock, at cost - 5,400 shares (48) (48) Loan to Employee Stock Ownership Plan (137) (143) ------------- ------------- 46,137 38,966 ------------- ------------- $ 761,162 $ 753,583 ------------- ------------- ------------- -------------
3 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (DOLLARS ARE IN THOUSANDS)
Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 1996 1995 1996 1995 -------- -------- -------- -------- Interest revenues Loans $ 14,386 $ 11,387 $ 28,797 $ 22,725 Investments 2,105 492 3,124 1,468 Mortgage-backed securities 839 1,739 -------- -------- -------- -------- 16,491 12,718 31,921 25,932 -------- -------- -------- -------- Interest costs Deposits 9,294 8,349 18,232 15,815 Borrowings 121 138 121 585 Senior notes 484 955 -------- -------- -------- -------- 9,899 8,487 19,308 16,400 -------- -------- -------- -------- Net interest margin inclusive of contractual interest due on nonaccrual loans 6,592 4,231 12,613 9,532 Contractual interest due on nonaccrual loans (447) (677) (1,076) (1,407) -------- -------- -------- -------- Net interest margin 6,145 3,554 11,537 8,125 Provision for estimated credit losses 2,489 3,689 12,745 -------- -------- -------- -------- Net interest margin after provision for credit losses 3,656 3,554 7,848 (4,620) Non-interest revenues 491 278 931 554 Non-interest expenses Employee 2,310 2,641 4,604 5,403 Operating 1,258 870 2,307 1,725 Occupancy 703 663 1,426 1,439 SAIF premium and OTS assessment 594 542 1,179 1,091 Professional 467 489 915 956 Goodwill amortization 12 12 24 24 -------- -------- -------- -------- 5,344 5,217 10,455 10,638 -------- -------- -------- -------- Real estate operations, net (395) 949 46 1,415 Gain on sale of loans 75 68 228 68 Gain on sale of securities 147 3,049 Gain on sale of other assets 6,411 86 6,452 86 Other revenues (expenses) (153) (1) 407 -------- -------- -------- -------- Net earnings (loss) before income taxes 4,741 (135) 5,049 (9,679) Income (taxes) benefit 1,230 3,483 (585) -------- -------- -------- -------- Net earnings (loss) $ 5,971 $ (135) $ 8,532 $(10,264) -------- -------- -------- -------- -------- -------- -------- -------- Net earnings (loss) available for Common (NOTE 3) $ 5,524 $ (135) $ 7,653 $(10,264) -------- -------- -------- -------- -------- -------- -------- -------- Net earnings (loss) per share (NOTE 3) $ 1.07 $ (0.05) $ 1.49 $ (4.11) -------- -------- -------- -------- -------- -------- -------- -------- Weighted average shares outstanding (NOTE 3) 5,155 2,599 5,155 2,599 -------- -------- -------- -------- -------- -------- -------- --------
4 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED) (DOLLARS ARE IN THOUSANDS)
Accrued Change in dividends Balance at unrealized Net on Balance at December 31, gains earnings preferred June 30, 1995 (losses) (loss) stock Repayments 1996 ------------ ----------- --------- ------------ ------------ ------------- Capital stock $ 26 $ 26 Cumulative perpetual - preferred stock Capital in excess of par value Common stock 7,745 7,745 Preferred stock 11,592 11,592 Unrealized gains (losses) on available-for-sale securities, net 6 (146) (140) Retained earnings 19,788 8,532 (1,221) 27,099 Treasury stock (48) (48) Loan to employee stock ownership plan (143) 6 (137) ------------ ----------- --------- ------------ ------------ ------------- Total stockholders' equity $ 38,966 $ (146) $ 8,532 $ (1,221) $ 6 $ 46,137 ------------ ----------- --------- ------------ ------------ ------------- ------------ ----------- --------- ------------ ------------ -------------
5 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS ARE IN THOUSANDS)
Three Months Ended Six Months Ended June 30, June 30, -------------------- ------------------ 1996 1995 1996 1995 -------- -------- -------- -------- NET CASH FLOWS FROM OPERATING ACTIVITIES Net earnings (loss) $ 5,971 $ (135) $ 8,532 $(10,264) Adjustments Provision (benefit) for income taxes (1,230) (3,483) 585 Provision for estimated credit losses on loans 2,489 3,689 12,745 Provision for estimated credit losses on real estate owned 1,011 1,711 Net gain on sale of branches (6,413) (86) (6,413) (86) Net gain on sale of securities (147) (3,049) Net recoveries from sales of real estate owned (538) (324) (1,281) (324) Net gain from sale of other assets (72) (68) (268) (68) Loan fee and discount accretion (831) (415) (1,381) (1,348) Depreciation and amortization 536 458 772 987 FHLB dividends (93) (77) (257) (177) Goodwill amortization 12 12 24 24 (Increase) decrease in accrued interest receivable (329) 661 (663) 330 (Increase) decrease in other assets 209 289 (1,062) (627) Increase (decrease) in other liabilities (56) 918 (2) (717) Other, net (28) 182 (118) 403 -------- -------- --------- -------- Net cash provided (used) by operating activities 638 1,268 (200) (1,586) -------- -------- --------- -------- NET CASH FLOWS FROM INVESTING ACTIVITIES Investment securities Purchases (14,516) (104,482) (111) Maturities 70,797 128,729 Sales proceeds 30,144 45,521 Mortgage-backed securities Principal amortization 1,513 33 2,975 Sales proceeds 1,438 Loans New loans funded (74,477) (40,353) (109,480) (64,710) Construction disbursements (11,836) (2,231) (21,615) (2,600) Payoffs 17,710 5,164 30,386 12,255 Sales proceeds 36,030 19,350 68,750 19,350 Principal amortization 3,350 5,282 7,488 9,142 Other, net (3,905) (2,349) (1,533) (3,689) Real estate owned Sale proceeds 6,747 6,769 17,577 14,330 Capitalized costs (2,474) (3,716) (5,306) (6,448) Other, net (1) 311 (2) 132 Redemption of FHLB stock 1,015 1,015 Office property and equipment Sales proceeds 1,829 565 4,551 565 Additions (139) (502) (180) (1,134) -------- -------- --------- -------- Net cash provided (used) by investing activities 29,115 20,962 14,916 28,031 -------- -------- --------- --------
6 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS ARE IN THOUSANDS)
Three Months Ended Six Months Ended June 30, June 30, -------------------- ------------------ 1996 1995 1996 1995 -------- -------- -------- -------- NET CASH FLOWS FROM FINANCING ACTIVITIES Payment for sale of deposits $(178,884) $(16,807) $(178,884) $(16,807) Net growth in deposits 92,278 5,670 109,130 37,709 Net change in borrowings 75,000 (8,585) 75,000 (47,141) Collection of ESOP loan 2 6 8 --------- -------- --------- -------- Net cash (used) provided by financing activities (11,606) (19,720) 5,252 (26,231) --------- -------- --------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 18,147 2,510 19,974 214 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 15,836 15,767 14,015 18,063 --------- -------- --------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 33,983 $ 18,277 $ 33,983 $ 18,277 --------- -------- --------- -------- --------- -------- --------- -------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for Interest $ 10,193 $ 8,770 $ 18,890 $ 17,008 Non-cash investing and financing activities Real estate acquired in settlement of loans $ 6,404 $ 14,792 $ 10,050 $ 22,629 Loans originated to finance property sales 4,252 231 11,730 446 Net unrealized gains (losses) on available-for-sale securities (80) (140) Transfer of held to maturity securities to available-for-sale 30,168 Loan activity Total commitments and permanent fundings $ 103,606 $ 46,376 $ 167,676 $ 73,956 Less: Change in undisbursed funds on construction commitments (7,559) (3,561) (18,012) (6,200) Loans originated to finance property sales (4,252) (231) (11,730) (446) Undisbursed portion of new lines of credit (5,482) (6,839) --------- -------- --------- -------- Net construction disbursements and loans funded $ 86,313 $ 42,584 $ 131,095 $ 67,310 --------- -------- --------- -------- --------- -------- --------- --------
7 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) June 30, 1996 NOTE 1 - SUMMARY OF ACCOUNTING POLICIES The consolidated financial statements include the accounts of Hawthorne Financial Corporation and its wholly-owned subsidiary, Hawthorne Savings, F.S.B. ("Bank"), collectively referred to as the "Company". All material intercompany transactions and accounts have been eliminated. In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting solely of normal recurring accruals) necessary to present fairly the Company's financial position as of June 30, 1996, and December 31, 1995, and the results of its operations and its cash flows for the six months ended June 30, 1996 and 1995. Certain information and note disclosures normally included in financial statements prepared in accordance with Generally Accepted Accounting Principles ("GAAP") have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Operating results for the six months ended June 30, 1996, are not necessarily indicative of the results that may be expected for the full year ending December 31, 1996. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1995. NOTE 2 - RECLASSIFICATION Certain amounts in the 1995 consolidated financial statements have been reclassified, where practicable, to conform with classifications in 1996. 8 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) June 30, 1996 (AMOUNTS ARE IN THOUSANDS, EXCEPT BOOK VALUE AND PER SHARE DATA) NOTE 3 - BOOK VALUE AND EARNINGS PER SHARE The table below sets forth the Company's book value and earnings per share calculations for June 30, 1996, using the Modified Treasury Stock Method as prescribed under GAAP. All other calculations shown, using alternate methods, are for informational purposes only. In the table below, (1) Warrants refers to the warrants issued by the Company in December 1995, which have an exercise price of $2.25 per share and can be exercised beginning three years from the issue date and for a period of ten years from the issue date, and (2) Preferred Stock refers to the Cumulative Perpetual Preferred Stock issued by the Company in December 1995, which carries an annual dividend equal to 18% of the face amount of the Preferred Stock, permits any dividend thereon to be paid in equivalent value of the Company's common stock and has an initial dividend payment in June 1997.
Three Months Ended June 30, 1996 Six Months Ended June 30, 1996 --------------------------------------- ------------------------------------- Modified Modified Treasury Actual Shares, Treasury Actual Shares, Stock Actual Warrants, Stock Actual Warrants, Method Shares and Options Method Shares and Options ---------- --------- ---------------- ----------- --------- --------------- Shares Outstanding Common 2,599 2,599 2,599 2,599 2,599 2,599 Warrants 2,376 2,376 2,376 2,376 Options 700 700 700 700 Less Treasury shares (520) (520) ----------- --------- ----------- ------------ --------- ----------- Total 5,155 2,599 5,675 5,155 2,599 5,675 ----------- --------- ----------- ------------ --------- ----------- ----------- --------- ----------- ------------ --------- ----------- Stockholders' Equity Common $ 34,545 $ 34,545 $ 34,545 $ 34,545 $ 34,545 $ 34,545 Warrants 5,346 5,346 5,346 5,346 Options 3,462 3,465 3,462 3,465 Less Treasury shares (2) (3,534) (3,094) ----------- --------- ----------- ------------ --------- ----------- Total $ 39,819 $ 34,545 $ 43,356 $ 40,259 $ 34,545 $ 43,356 ----------- --------- ----------- ------------ --------- ----------- ----------- --------- ----------- ------------ --------- ----------- Net Earnings (Loss) Net earnings for the period $ 5,971 $ 8,532 Partial reduction in interest expense (1) 159 342 Preferred stock dividends (606) (1,221) ----------- ------------ Adjusted earnings available for Common $ 5,524 $ 7,653 ----------- ------------ ----------- ------------ Book value per share $ 7.72 $ 13.29 $ 7.64 $ 7.81 $ 13.29 $ 7.64 ----------- --------- ----------- ------------ --------- ----------- ----------- --------- ----------- ------------ --------- ----------- Earnings per share $ 1.07 $ 2.06 $ .95 $ 1.49 $ 2.82 $ 1.29 ----------- --------- ----------- ------------ --------- ----------- ----------- --------- ----------- ------------ --------- -----------
- --------------------------- (1) Under the Modified Treasury Stock Method, it is assumed that the Company will use 20% of the proceeds from the proforma exercise of the Warrants and Options to acquire Treasury shares and use any remaining assumed proceeds to reduce the outstanding balance of the Company's Senior Notes. The partial reduction in interest expense of $159,000 and $342,000 represents the proforma reduction in interest expense as a result of the proforma reduction in the outstanding balance of Senior Notes. (2) Treasury shares were assumed to be repurchased at the average closing stock price for the respective periods. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company reported net earnings of $6.0 million for the quarter ended June 30, 1996, compared to a net loss of $0.1 million for the same period in 1995. The Company earned $2.6 million for the quarter ended March 31, 1996. For the years ended December 31, 1995 and 1994, respectively, the Company reported losses of $14.2 million and $3.0 million. The second quarter of 1996 is the third consecutive quarter in which the Company has reported net earnings, following nearly four years of quarterly and annual losses. For the six months ended June 30, 1996, the Company reported net earnings of $8.5 million as compared to a net loss of $10.3 million for the same period in 1995. The growth in capital produced by the earnings generated during the first half of 1996 increased the Bank's core and risk-based capital ratios to 7.06% and 11.62%, respectively, at June 30, 1996, in excess of the regulatory minimums which define a "well capitalized" institution. During the second quarter of 1996, the Company (1) earned $1.9 million from its core business operations (before credit loss provisions), (2) realized a pretax gain of $6.4 million from the sale of its San Diego County-based deposits, (3) augmented loan and property loss reserves by $3.5 million, (4) recorded income tax benefits of $1.2 million, (5) incurred $0.5 million in interest costs associated with the Senior Notes issued in December 1995 as part of the Company's recapitalization, and (6) realized other net revenues of $0.5 million. For the first six months of 1996, the Company (1) realized pretax earnings (before credit loss provisions) of $3.6 million from its core business operations, (2) increased loan and property loss reserves by $5.4 million, (3) recorded a gain of $6.4 million from the sale of its San Diego deposit franchise, (4) recognized $3.5 million of income tax benefits, (5) incurred $1.0 million of interest costs on the Senior Notes, and (6) realized other net revenues of $1.4 million, principally associated with the Company's property disposal operations. By comparison, the results for the three and six months ended June 30, 1995 include (1) a loss from the Company's core business operations (before credit loss provisions) of $0.7 million and $0.7 million, respectively, (2) additions to loan and property loss reserves of $0 and $12.7 million, respectively, (3) net gains of $0.6 million and $3.7 million, respectively, from sales of securities, properties and loans, and (4) other net revenues of $0.7 million and $0.2 million, respectively. The continuing improvement in the Company's financial performance is attributable to (1) the growing success in penetrating its targeted financing markets, which produced completed financings of $167.7 million during the first half 1996 compared to $74.0 million during the first half of 1995, and (2) the continued reduction in nonperforming assets which, net of all credit losses, declined to $40.5 million at June 30, 1996 from $80.1 million at June 30, 1995. Though still high by comparison to other financial institutions, the Company's net nonperforming assets represented 5.3% of total assets at June 30, 1996, compared to 11.5% of total assets at June 30, 1995. These two factors contributed to the growth in average interest-earning assets, which in turn has significantly enhanced the Company's net interest margins. For the three and six months ended June 30, 1996, the Company's net interest margin, excluding credit loss provisions, was $6.1 million and $11.5 million, respectively. For the same periods in 1995, the Company's net interest margin, before credit loss provisions, was $3.6 million and $8.1 million, respectively. Though most of the Company's financial performance indicators are improving and trending positively, the Company's operating results continue to be diluted by weakness in the performance of loans originated prior to 1994, and the continued high cost of carrying a significant investment in nonperforming assets. Because most of the loans in this segment of the portfolio were originated during the period 1987 through 1992, prior to the steep and prolonged decline in real estate values throughout Southern California, collateral values in many instances are less than the outstanding balance of the Company's loans. As a consequence, the Company remains susceptible to future credit losses arising from adverse borrower performance related to this portfolio, which may require further significant reserve additions. 10 At June 30, 1996, the Company's portfolio of loans originated since 1994 stood at $292.2 million, or 43.8% of total loans, and carried a weighted average interest rate of 9.47%. By comparison, the Company's portfolio of loans originated prior to 1995 represented 56.2% of total loans at June 30, 1996 and carried a weighted average interest rate of 7.81%. At June 30, 1996, none of the loans originated since 1994 were in default, nor had the Company completed foreclosure actions related to any post-1994 financings. Since its re-emergence as an active lender at the beginning of 1995, the Company has provided financing to owners and purchasers of estate-quality homes, income-producing properties, and residential construction, in each instance limited to its core Southern California markets. In late June, the Company completed the sale of deposits from its three San Diego County retail banking offices to Hemet Federal Savings. Total deposits of $185.2 million were sold, which produced a net gain of $6.4 million. The transfer of deposits was principally funded by (1) a net growth since the end of 1995 of $92.3 million in the deposits held by the Company's remaining six retail banking offices, (2) an advance of $75.0 million against the Bank's $200.0 million line of credit with the Federal Home Loan Bank of San Francisco ("FHLB") and (3) the sale of $36.0 million of seasoned, fixed-rate, single-family residence mortgage loans during the quarter. The Company's six remaining retail banking locations in the greater Los Angeles metropolitan area maintained average customer deposit balances of $103.7 million at June 30, 1996. The continued growth of deposit balances in the Company's core markets, coupled with its FHLB line of credit, are expected to provide the Company with sufficient capacity to support its real estate-secured financing opportunities. At June 30, 1996, the Company had total assets of $761.2 million, up from total assets of $753.6 million at year end 1995 and $705.1 million at June 30, 1995. OPERATING RESULTS INTEREST MARGIN The Company's net interest margin, or the difference between the interest earned on loans and investment securities and the cost of deposits and borrowings, is 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 maturity of the Company's adjustable-rate and fixed-rate loans and short-term investment securities and its deposits and borrowings, (3) the relationship between market interest rates and local deposit rates offered by competing institutions, and (4) the magnitude of the Company's nonperforming assets. 11 The table below sets forth the Company's average balance sheet, and the related effective yields and costs on average interest-earning assets and interest-bearing liabilities, for the six months ended June 30, 1996, and 1995. In the table, interest revenues are net of interest associated with nonaccrual loans (dollars are in thousands).
SIX MONTHS ENDED ------------------------------------------------------------ JUNE 30, 1996 JUNE 30, 1995 ---------------------------- ---------------------------- REVENUES/ YIELD/ REVENUES/ YIELD/ AMOUNT COSTS COST AMOUNT COSTS COST -------- ------- ------ -------- ------- ------ ASSETS Interest-earning assets Loans $642,080 $27,721 8.63% $566,915 $21,318 7.52% Investments and other securities 118,682 3,124 5.26% 48,031 1,468 6.11% Mortgage-backed securities 54,999 1,739 6.32% -------- ------- -------- ------- Total interest-earning assets 760,762 30,845 8.10% 669,945 24,525 7.32% Noninterest-earning assets 29,431 ------- ----- 55,135 ------- ---- -------- -------- Total assets $790,193 $725,080 -------- -------- -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities Deposits $726,365 18,232 5.05% $666,084 15,815 4.79% Borrowings 4,120 121 5.91% 19,212 585 6.06% Senior Notes 12,091 955 15.80% -------- ------- -------- ------- Total interest-bearing liabilities 742,623 19,308 5.25% 685,296 16,400 4.83% ------- ----- ------- ---- Noninterest-bearing liabilities 6,016 6,999 Stockholders' equity 41,554 32,785 -------- -------- Total liabilities & stockholders' equity $790,193 $725,080 -------- -------- -------- -------- Net interest margin ($) $11,537 $ 8,125 ------- ------- ------- ------- Net interest margin (% to interest-earning assets) 2.85% 2.49% ----- ---- ----- ----
The table below summarizes the components of the changes in the Company's interest revenues and costs for the six months ended June 30, 1996 and 1995 (dollars are in thousands).
SIX MONTHS ENDED JUNE 30, 1996 AND 1995 INCREASE (DECREASE) DUE TO CHANGE IN -------------------------------------------------- RATE AND NET VOLUME RATE VOLUME (1) OTHER (3) CHANGE ------ ------ ---------- --------- ------- INTEREST REVENUES Loans (2) $2,826 $3,158 $ 419 $ - $ 6,403 Investments and other securities 2,165 (206) (303) 1,656 Mortgage-backed securities (1,739) (1,739) ------ ------ ---------- --------- ------- 3,252 2,952 116 6,320 ------ ------ ---------- --------- ------- INTEREST COSTS Deposits 1,416 850 77 74 2,417 Borrowings (460) (17) 13 (464) Senior notes 955 955 ------ ------ ---------- --------- ------- 1,911 833 90 74 2,908 ------ ------ ---------- --------- ------- NET MARGIN $1,341 $2,119 $ 26 $(74) $ 3,412 ------ ------ ---------- --------- ------- ------ ------ ---------- --------- -------
- ---------- (1) Calculated by multiplying change in rate by change in volume. (2) Interest on loans is net of interest on nonaccrual loans and includes amortization of loan fees and discounts. (3) Extra day of interest expense due to leap year. 12 The Company's net interest margin, expressed as a percentage of interest-earning assets, has been steadily rising over the past eighteen months. The Company commenced operation of several new financing businesses early in 1995, each targeted on a narrow segment of the real estate finance markets in Southern California and designed to produce meaningful new loan volumes with yields substantially higher than the Company's pre-1995 loan portfolio while maintaining the Company's established credit quality standards. During the six months ended June 30, 1996, the Company originated $167.7 million of new permanent and construction loan commitments with a weighted average interest rate of 9.78% at origination. By comparison, new permanent and construction loan commitments during the six months ended June 30, 1995, were $74.0 million, and carried a weighted average interest rate at origination of 9.74%. At June 30, 1996, approximately $292.2 million of the loans originated since 1994 remained in the Company's portfolio and had an aggregate weighted average interest rate of 9.47%. Loans originated prior to 1995 totaled $375.3 million at June 30, 1996, and had an aggregate weighted average interest rate of 7.81%. Most of the loans originated during 1995 and 1996 are adjustable-rate, adjusting quarterly or more frequently, and utilize a variety of indices, including the Eleventh District Cost of Funds Index ("11th DCOFI"), the Prime Rate and the One-Year Constant Maturity Treasury Index. The more frequent adjustments of, and the wider array of indices utilized by, the Company's post-1994 originations have steadily improved the Company's sensitivity to movements in market interest rates. At June 30, 1996, approximately 90% of the Company's adjustable rate loans, and 69% of all loans, had repricing intervals of six months or less. By comparison, at June 30, 1995, 85% of the Company's adjustable rate loans, and 60% of all loans, had repricing intervals of six months or less. PROVISIONS FOR ESTIMATED CREDIT LOSSES ON LOANS For the three and six months ended June 30, 1996, the Company recorded loan loss provisions of $2.5 million and $3.7 million, respectively, compared with provisions of $12.7 million recorded during the six months ended June 30, 1995, all of which was recorded in the first quarter of 1995. The reduction in loan loss provisions from 1995 to 1996 resulted primarily from an improvement in asset quality. At June 30, 1996, net nonperforming assets and performing loans classified "Substandard", "Doubtful" or "Loss" totaled $98.6 million compared with $136.3 million at June 30, 1995. Within these totals, the net carrying value of real estate owned totaled $22.4 million and $63.5 million, respectively, at June 30, 1996, and 1995. The majority of the provisions recorded in the first six months of 1995 were attributable to an increase in the capitalization rates utilized by the Company to value its portfolios of owned apartment buildings and classified apartment loan collateral. Notwithstanding the measurable improvement in the Company's asset quality during the past twelve months, the magnitude of the Company's nonperforming asset and classified performing loan portfolios remains substantially above peer levels and represents a significant portion of the Company's assets. These portfolios dilute the Company's operating results, through a combination of funding and management costs and incremental loss provisions. Further, these assets expose the Company to the potential for additional losses to the extent that borrowers are unable to make their payments to the Company, requiring the Company to pursue foreclosure of its collateral, and to the extent that the submarkets in which the Company's collateral is located (principally the South Bay area of Los Angeles County), or the type of property securing the Company's loans, continue to be resistant to growth in real estate values. As a result, management continues to diligently manage this portfolio of troubled assets and to measure in a timely fashion adverse portfolio migration trends and the adequacy of the Bank's reserves for future credit losses. 13 NON-INTEREST REVENUES The table below sets forth the Company's non-interest revenues for the three-month and six-month periods indicated (dollars are in thousands).
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ---------------------------- 1996 1995 CHANGE 1996 1995 CHANGE ------ ------ ------ ------- ------- ------ Other loan and escrow fees $ 333 $ 137 $ 196 $ 601 $ 233 $ 368 Deposit account fees 118 139 (21) 279 319 (40) Other revenues 40 2 38 51 2 49 ------ ------ ------ ------- ------- ------ $ 491 $ 278 $ 213 $ 931 $ 554 $ 377 ------ ------ ------ ------- ------- ------ ------ ------ ------ ------- ------- ------
Other loan and escrow fees in 1996 were higher than in 1995 due primarily to increased loan production. OPERATING COSTS The table below details the Company's operating costs for the three-month and six-month periods indicated (dollars are in thousands).
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ---------------------------- 1996 1995 CHANGE 1996 1995 CHANGE ------ ------ ------ ------- ------- ------ Employee $2,310 $2,641 $(331) $ 4,604 $ 5,403 $(799) Operating 1,258 870 388 2,307 1,725 582 Occupancy 703 663 40 1,426 1,439 (13) SAIF insurance premium and OTS assessment 594 542 52 1,179 1,091 88 Professional 467 489 (22) 915 956 (41) Goodwill amortization 12 12 24 24 ------ ------ ------ ------- ------- ------ $5,344 $5,217 $ 127 $10,455 $10,638 $(183) ------ ------ ------ ------- ------- ------ ------ ------ ------ ------- ------- ------
The overall reduction in year-to-date operating costs reflects the higher cost deferral under GAAP associated with the Company's expanding loan origination activities. The Company has also reduced its accruals for incentive cash compensation, consistent with the awarding of stock options to all key managers during the fourth quarter of 1995. Offsetting this positive trend, during the second quarter of 1996, the Company had an increase in operating costs, compared to 1995, primarily due to an ongoing participation in an affordable, community based housing program, an increase in the SAIF premium as a result of higher deposit balances, and an adjustment to depreciation on certain fixed assets. 14 REAL ESTATE OPERATIONS The table below sets forth the revenues and costs attributable to the Company's foreclosed properties for the periods indicated. The compensatory and legal costs directly associated with the Company's property management and disposal operations are included in the table above in OPERATING COSTS (dollars are in thousands).
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ---------------------------- 1996 1995 CHANGE 1996 1995 CHANGE ------ ------ ------ ------- ------- ------ EXPENSES ASSOCIATED WITH REAL ESTATE OWNED Property taxes $ (47) $ (9) $ (38) $ (130) $ (32) $ (98) Repairs, maintenance and renovation (57) (80) 23 (98) (208) 110 Insurance (41) (52) 11 (119) (89) (30) ------- ----- ------- ------- ------ ------- (145) (141) (4) (347) (329) (18) NET RECOVERIES FROM SALE OF PROPERTIES 538 324 214 1,282 503 779 RENTAL INCOME, NET 223 766 (543) 822 1,241 (419) PROVISION FOR ESTIMATED LOSSES ON REAL ESTATE OWNED (1,011) (1,011) (1,711) (1,711) ------- ----- ------- ------- ------ ------- $ (395) $ 949 $(1,344) $ 46 $1,415 $(1,369) ------- ----- ------- ------- ------ ------- ------- ----- ------- ------- ------ -------
The costs included in the table above (and, therefore, excluded from operating costs (see OPERATING COSTS), reflect holding costs directly attributable to the portfolio of real estate owned assets. Net revenues from owned properties principally include the net operating income (collected rental revenues less operating expenses and certain renovation costs) from foreclosed apartment buildings or receipt, following foreclosure, of similar funds held by receivers during the period the original loan was in default. During the three and six months ended June 30, 1996, provisions for estimated losses on foreclosed real estate in the amounts of $1.0 million and $1.7 million, respectively, were recorded, principally associated with a continued decline in value on certain owned non-apartment properties and higher-than-expected renovation costs for the Company's owned apartment portfolio. During the six months ended June 30, 1996, the Company sold 103 properties generating net proceeds of $29.3 million and aggregate net recoveries of $1.3 million. During the three months ended June 30, 1996, the Company sold 52 properties generating net proceeds of $18.5 million and aggregate net recoveries of $0.6 million. As of June 30, 1996, the Company's portfolio of properties consisted of 240 individual homes, apartment buildings, and land parcels. In addition, as of that date the Company's defaulted loan portfolio was represented by 84 loans and its portfolio of performing project concentration loans secured 430 individual homes. See RISK ASSETS. Because of the large aggregate number of units represented by these risk portfolios, management expects that the costs incurred to manage the property disposal and loan restructuring operations of the Company, plus the holding costs associated with these portfolios (other than interest lost following a loan's default and subsequent foreclosure), will continue to be significant for the next several quarters. OTHER NON-OPERATING REVENUES Other non-operating revenues include gain on sale of loans, gain on sale of securities, gain on sale of other assets, and other revenues. For the six months ended June 30, 1996, other operating revenues included (1) gains of $6.5 million primarily as a result of the $185.2 million branch deposit sale, (2) gains of $0.2 million as a result of $68.9 million in loan sales, (3) legal recoveries of $0.2 million and (4) other expenses of $0.2 million primarily due to an upward adjustment to the deferred loan fees balance, to correct for overamortization in prior periods. For the six months ended June 30, 1995, other non-operating revenues included (1) gains of $3.0 million primarily as a result of the sale of $11.5 million in marketable equity securities, (2) legal recoveries of $0.4 million, (3) a gain of $0.1 million on the sale of $17.1 million in branch deposits and (4) a gain of $0.1 million on the sale of $19.2 million in loans. 15 INCOME TAXES At December 31, 1995, the Company retained accumulated income tax benefits of $35.5 million, which principally consisted of net operating loss carryforwards. The utilization of these net operating loss carryforwards is limited to the demonstrated ability of the Company to generate pretax earnings during the carryforward period, which generally runs for fifteen years from the date the loss was generated. In accordance with Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES ("SFAS 109"), the Company recorded an income tax benefit of $1.2 million and $3.5 million, respectively, during the three and six months ended June 30, 1996. Among other things, SFAS 109 permits the recognition of an income tax benefit, and the corresponding recording of a deferred tax asset, to the extent pretax earnings are reasonably expected to be generated. For regulatory capital purposes, the Office of Thrift Supervision ("OTS") limits the cumulative amount of any deferred tax asset to the lesser of pretax earnings reasonably expected to be generated during the succeeding twelve month period or 10% of an institution's tangible capital. At June 30, 1996, the deferred tax asset recorded by the Company represented 6.5% of the Bank's tangible capital. FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY ASSETS CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash on hand, deposits at correspondent banks and Federal funds sold. The Company maintains balances at correspondent banks to cover daily inclearings, wire activities and other charges. Cash and cash equivalents at June 30, 1996, were $34.0 million, an increase from $14.0 million at December 31, 1995. This increase in cash balances at June 30, 1996, was due to the accumulation of excess cash in the second quarter in anticipation of the sale of deposits from the Company's three San Diego branches at the end of June. The excess cash was made available through two loan sales totaling approximately $68.9 million, as well as deposit growth in the Company's remaining six branches. INVESTMENT SECURITIES The cost basis and estimated fair value of investment securities available-for-sale are summarized as follows (dollars are in thousands): June 30, 1996 ----------------------------------------------- Estimated Amortized Gross Unrealized Fair ------------------ Cost Gains Losses Value ----------- -------- --------- ------------ U.S. Government $ 38,588 $ 14 $ (154) $ 38,448 ----------- -------- --------- ------------ ----------- -------- --------- ------------ December 31, 1995 ----------------------------------------------- Estimated Amortized Gross Unrealized Fair ------------------ Cost Gains Losses Value ----------- -------- --------- ------------ U.S. Government $ 62,787 $ 11 $ (5) $ 62,793 ----------- -------- --------- ------------ ----------- -------- --------- ------------ The available-for-sale amounts at June 30, 1996 and December 31, 1995, include U.S. Government securities purchased with proceeds from the recapitalization of the Company in December 1995 that have been pledged as security for the payment of interest expense associated with the Senior Notes (as defined herein) that were issued in the recapitalization. These pledged securities had a cost basis and fair value of $4.1 million and $4.0 million, respectively, at June 30, 1996. 16 The cost basis and estimated fair value of investment securities available-for-sale at June 30, 1996, are summarized by contractual maturity as follows (dollars are in thousands): Estimated Fair Cost Basis Value ------------ ----------- Due in less than one year $ 1,633 $ 1,627 Due in one year through five years 36,955 36,821 ------------ ----------- $ 38,588 $ 38,448 ------------ ----------- ------------ ----------- REAL ESTATE LOANS GENERAL The two tables below set forth the composition of the Company's loan portfolio, and the percentage of composition by type of security, delineated by the year of origination and in total, as of the dates indicated (dollars are in thousands). June 30, 1996 ------------------------------------- Pre-1995 Post-1994 Total ----------- ----------- ----------- PERMANENT Single family (non-project) Estate $ - $ 86,855 $ 86,855 Other 125,325 21,287 146,612 Loan concentrations 64,717 1,102 65,819 Multi-family 2 to 4 units 28,334 11,186 39,520 5 or more units 133,506 108,087 241,593 Commercial 2,716 57,512 60,228 Land 851 2,757 3,608 RESIDENTIAL CONSTRUCTION 58,511 58,511 OTHER 18 1,591 1,609 ----------- ----------- ----------- GROSS LOANS RECEIVABLE $ 355,467 $ 348,888 $ 704,355 ----------- ----------- ----------- ----------- ----------- ----------- 17
June 30, 1996 December 31, 1995 June 30, 1995 ------------------- -------------------- -------------------- Balance Percent Balance Percent Balance Percent --------- --------- ---------- --------- ---------- --------- PERMANENT LOANS Single family Non-project $ 233,467 33.1% $ 255,956 39.0% $ 244,371 42.1% Loan concentrations 65,819 9.3% 67,189 10.2% 72,540 12.5% Multi-family 2 to 4 units 39,520 5.6% 44,640 6.8% 47,269 8.2% 5 or more units 241,593 34.4% 216,420 33.0% 184,629 31.9% Commercial 60,228 8.6% 31,258 4.8% 7,407 1.3% Land 3,608 0.5% 5,579 0.9% 3,779 0.7% RESIDENTIAL CONSTRUCTION 58,511 8.3% 33,347 5.1% 16,525 2.9% OTHER 1,609 0.2% 1,554 0.2% 2,226 0.4% --------- --------- ---------- --------- ---------- --------- GROSS LOANS RECEIVABLE 704,355 100.0% 655,943 100.0% 578,746 100.0% --------- --------- --------- --------- --------- --------- LESS Participants' share (2,493) (2,219) (1,949) Undisbursed loan funds (33,605) (15,208) (5,855) Deferred loan fees and credits, net (8,190) (5,996) (3,676) Allowance for estimated losses (15,762) (15,192) (20,690) --------- ---------- ---------- NET LOANS RECEIVABLE $ 644,305 $ 617,328 $ 546,576 --------- ---------- ---------- --------- ---------- ----------
The Company's loan portfolio is exclusively concentrated in Southern California real estate. At June 30, 1996 and 1995, respectively, 42% and 55% of the Company's loan portfolio consisted of permanent loans secured by single family residences, 40% and 40% consisted of permanent loans secured by multi-unit residential properties, and 18% and 5% consisted of loans to finance commercial properties, the acquisition of land and the construction of single family housing. Historically, the Company actively financed the construction of residential properties, principally small-to-medium sized tracts of detached single family homes and condominiums, and small apartment buildings (generally, less than 37 units). With respect to for-sale housing developments, the Company typically provided permanent financing to buyers of individual homes and condominiums within projects for which it provided the construction financing. In addition, the Company generally provided a permanent loan commitment following its financing for the construction of apartment buildings. The Company's performance continues to be adversely affected by the weakness evident in its portfolio of loans originated prior to 1994 and a high volume of foreclosures associated with this pre-1994 portfolio, though foreclosures have been declining over the past six quarters. These asset quality trends reflect the general weakness of the Southern California economy, and the direct translation of this weakness to local real estate markets. These factors have been, and will continue to be, exacerbated by several factors unique to the Company's loan portfolio, including (1) its portfolio of loans secured by apartment buildings, for which property cash flows are, or may become, inadequate to meet borrowers' debt service requirements, (2) the concentration within the Company's loan and property portfolios of multiple permanent loans and foreclosed properties within a single integrated development, and (3) the concentration within the Company's portfolio of loans to one or more individuals, or groups of individuals, who are affiliated and with respect to which there remain limited financial resources to fund debt service payments where property cash flows (either from sales of homes or from income property cash flows) are, or may become, inadequate. 18 LENDING OPERATIONS During 1995, the Company aggressively re-entered the mortgage finance business, specializing in providing financings secured by income properties, very expensive homes and residential construction projects. For the eighteen months ended June 30, 1996, the Company originated $364.7 million of permanent loans and construction loan commitments. The Company's principal competitors in its pursuit of new permanent financing business generally exclude the large, in-market banking and thrift companies, principally because these companies do not offer products similar to those on which the Company now focuses, including financings secured by income-producing properties and very expensive homes. The Company's principal competition for this business tends to come from FDIC-insured thrift and loans (income property financings), small-to-medium sized life insurance companies and mortgage conduits (income property financings) and large investment banking companies (estate financing). On the other hand, competition in the conventional permanent loan business, which is the smallest component of the Company's business, is widespread and extremely price competitive. To acquire new business which meets the Company's goals for profitability, return on capital and credit quality, the Company offers prospective borrowers efficient and effective service (e.g., quick and comprehensive response to financing requests and timely funding), a willingness to tailor the terms and conditions of the transaction to accomplish the borrower's objectives (while satisfying the Company's credit standards), and a real estate orientation which generally permits the Company to contribute proactively in helping borrowers accomplish their near-term or long-term financial objectives. Management believes these attributes, taken together, clearly distinguish the Company from its competitors and permit the Company to charge a premium price for its permanent financing products (except for the modest amount of financings involving conventional single family loan transactions). The Company obtains its permanent financing sourcing through independent mortgage brokers, rather than through a captive sales force. Unlike the Company's narrowly focused permanent financing businesses, its pursuit of development financing opportunities is very competitive, with banks and thrifts of all sizes generally being active in the marketplace. Generally, pricing and underwriting standards in this market are defined around a fairly narrow range. In this environment, the Company distinguishes itself from its competitors by offering prospective customers efficient pre-funding evaluation and post-funding funds control, as well as an intimate knowledge of the development process. Unlike the Company's permanent financing businesses, development financing is generally sourced directly from builders and developers. 19 RISK ASSETS At June 30, 1996, the Company's problem asset ratios were far higher than those of most lenders within its lending markets. The table below sets forth the composition, measured by gross and net investment, of the Company's Risk Asset portfolio. Risk Assets include owned properties, nonaccrual loans, and performing loans which have been adversely classified pursuant to OTS regulations and guidelines ("Performing/Classified" loans). Loans categorized as "Special Mention" are not classified pursuant to regulatory guidelines, but are included in these tables as a broader indication of the Company's asset quality (dollars are in thousands).
JUNE 30, DECEMBER 31, JUNE 30, 1996 1995 1995 -------- ------------ --------- PROPERTIES $ 34,313 $ 53,630 $ 77,016 NONACCRUAL LOANS 22,576 21,709 23,222 Performing loans Classified Loss, Doubtful and Substandard 63,828 57,049 58,592 Designated Special Mention 59,990 54,851 63,655 -------- -------- -------- GROSS RISK ASSETS 180,707 187,239 222,485 LESS Specific reserves (16,265) (18,049) (23,522) General reserves (8,141) (11,160) (6,834) -------- -------- -------- NET RISK ASSETS $156,301 $158,030 $192,129 -------- -------- -------- -------- -------- -------- NET LOANS RECEIVABLE AND PROPERTIES $666,709 $655,233 $610,085 -------- -------- -------- -------- -------- -------- PERCENTAGE TO NET LOANS RECEIVABLE AND PROPERTIES Net risk assets 23.4% 24.1% 31.5% -------- -------- -------- -------- -------- -------- Net classified assets (Net risk assets less net designated Special Mention) 14.8% 16.2% 24.0% -------- -------- -------- -------- -------- -------- PERCENTAGE OF NET CLASSIFIED ASSETS TO CORE CAPITAL 184.4% 244.3% 515.4% -------- -------- -------- -------- -------- --------
The Company currently places loans on nonaccrual status when (1) they become one or more payments delinquent or (2) management believes that, with respect to performing loans, continued collection of principal and interest from the borrower is not reasonably assured. The performance of the Company's loan portfolio continued to improve during the quarter, consistent with the improvement realized since 1993. The carrying value of nonperforming assets (i.e., foreclosed properties, loans delinquent one or more payments and performing loans placed on nonaccrual status) declined to $40.5 million, or 5.3% of total assets, at June 30, 1996, from $55.5 million, or 7.4% of total assets, at December 31, 1995, and $80.8 million, or 11.5% of total assets, at June 30, 1995. The carrying value of nonperforming assets peaked at more than $150.0 million in early 1994. The reduction in nonperforming assets reflects the continued sales of foreclosed properties and the decrease in the rate of borrower defaults. As described above, the Company places any loan delinquent one or more payments on nonaccrual status and includes such amounts as loans in default for reporting purposes. At June 30, 1996, December 31, 1995 and June 30, 1995, the principal amount of nonaccrual loans included $6.6 million, $10.4 million and $9.8 million, respectively, of loans with respect to which payments were either current or delinquent less than three payments. Management classifies the Company's performing loans based upon objective and measurable criteria. For single family-secured (non-project) loans, loans are classified or designated Special Mention based upon a risk grading approach, which considers the value of the Company's collateral in relation to the balance of the Company's loan, the borrower's recent and historical performance, the borrower's credit profile and other factors. Performing loans within loan concentrations (see LOAN CONCENTRATIONS) are classified or designated Special Mention based upon the recent and historical performance of the permanent loans originally made by the Company to finance the purchase of units by individuals from the developer, supply and demand trends for units in each individual project and pricing trends for units. Performing apartment loans are classified or designated Special Mention based upon the debt service coverage afforded by current property cash flows and the valuation of the Company's collateral based 20 upon current and stabilized property cash flows and the imposition of current market capitalization rates. Through June 30, 1996, management has completed one or more loan and collateral reviews for virtually all of the Company's loan concentration and apartment-secured loan portfolios and for over 50% of the Company's pre-1994 single family residence-secured loans. Because of the generally empirical approach to loan classification applied by the Company, management believes that any future decrease in the Company's classified assets will result from either (1) borrower defaults, which will result in foreclosure and sale of the Company's collateral, or (2) an improvement in the underlying economics which support the Company's collateral (i.e., higher operating cash flows from apartment buildings, higher prices for units securing concentration loans). The table below shows the Company's gross loan portfolio, by classification, as of June 30, 1996 (dollars are in thousands).
CLASSIFIED LOANS ----------------------- SPECIAL LOSS, DOUBTFUL NONACCRUAL PASS MENTION AND SUBSTANDARD LOANS TOTAL -------- ------- --------------- ----------- -------- Single family homes Non-project $206,067 $10,210 $ 8,170 $ 9,020 $233,467 Loan concentrations 32,204 19,485 7,306 6,824 65,819 Multi-family 2 to 4 units 34,867 1,943 1,822 888 39,520 5 or more units 172,129 24,721 38,943 5,800 241,593 Commercial properties 50,409 2,623 7,196 60,228 Land 2,165 1,008 391 44 3,608 Residential construction SFR 36,562 36,562 Tract development 21,949 21,949 Other collateralized loans 1,609 1,609 -------- ------- ------- ------- -------- $557,961 $59,990 $63,828 $22,576 $704,355 -------- ------- ------- ------- -------- -------- ------- ------- ------- --------
SINGLE FAMILY (NON-PROJECT) In the preceding table, non-project single family homes consist of defaulted, performing/classified and nonclassified loans secured by single family homes which are not part of an integrated development with respect to which the Company financed the construction of the development or financed the purchase of homes from the developer by individuals. At June 30, 1996, the Company (1) owned 9 homes which were being actively marketed for sale, (2) had 41 defaulted loans secured by single family (non-project) homes, (3) had 21 loans which were performing but had been classified "Substandard", and (4) had 51 loans which were performing but had been designated "Special Mention". The Company has valued its owned single family homes at their estimated net liquidation values. The defaulted loan portfolio secured by single family homes (non-project) has been valued, in the aggregate, consistently with the Company's historical migration and loss rates. LOAN CONCENTRATIONS Prior to 1994, the Company made permanent loans, amortizing over, and maturing at the end of, thirty years, to a large number of purchasers of individual units from developers in for-sale housing developments with respect to which the Company financed construction. A majority of these permanent "takeout" loans were originated during the period 1988 through 1992 and were made on terms that fell outside the parameters normally associated with conforming or conventional single family home loans. Because most of these loans were made on favorable terms to foster sales of units in developments in which unit sales were sluggish, and because the current retail value of units in many developments has declined significantly when compared with the stated purchase price paid by the Company's borrowers, the performance of this portfolio has been extremely poor. 21 At the peak in early 1994, management had identified 63 separate loan concentrations, involving loan principal of $90.6 million and foreclosed inventory of $23.3 million. Approximately two-thirds of this aggregate investment was in 13 projects, with respect to which the Company had provided the initial takeout loans for over 50% of the units in the project or had foreclosed upon more than 50% of the entire project prior to the sale of completed units. At June 30, 1996, the Company's aggregate investment in its portfolio of loan concentrations (loan principal plus foreclosed inventory before reserves) consisted of 53 separate loan concentrations totaling $70.7 million. This represents a decrease of $43.2 million, or 38%, principally as the result of foreclosure of the Company's collateral, sales of foreclosed units and the acceptance of discounted payments from borrowers on several loans. At June 30, 1996, the Company owned 51 foreclosed units and 25 loans, representing $3.7 million of loan principal, which were delinquent one or more payments. Management expects that the performance of this portfolio will continue to be quite poor, principally because the underlying risk factors which have given rise to the historically poor performance - poorly-qualified borrowers and significant declines in the value of the Company's collateral - are not expected to change in the near-term. APARTMENT BUILDINGS At June 30, 1996, the Company owned 27 apartment buildings, and loans secured by 17 apartment buildings were in default. The Company's foreclosed inventory and its defaulted loan collateral are predominantly located in the South Bay region of Los Angeles, are between five and ten years old and average less than 15 units in size. Prior to late 1995, management determined to accumulate the Company's portfolio of foreclosed apartment buildings and to operate them for their cash flow yield. During the Company's holding period, the Company's internal property management staff made necessary capital improvements to each property and upgraded the quality of each buildings' tenants. In September 1995, management commenced an aggressive sales program to liquidate the Company's then portfolio of 71 buildings, premised upon its belief that the buildings had reached sustainable cash flow production and had been improved to the extent required to command a retail, as opposed to a wholesale, price in the market. Commencing in September 30, 1995 and continuing through June 30, 1996, virtually all of the Company's initial inventory of buildings had been sold, largely leaving buildings foreclosed upon during the last three quarters in inventory at the end of June 1996. The Company has financed all building sales involving five or more units, generally on market terms (i.e., the 11th DCOFI plus 3.00%, with downpayments by purchasers of between 20% and 25%). These financings have been discounted to provide the Company with a yield to maturity equivalent to the 11th DCOFI plus 4.00%, which yield approximates the Company's marginal lending rate for new, apartment-secured financings. The Company records its investment in foreclosed apartment buildings at their fair market values, generally by reference to the existing and projected cash flows generated by the building and the application of appropriate market capitalization ratios. Management has concluded that the maximum benefit to the Company is obtainable through the orderly liquidation of this portfolio. The carrying value of the defaulted apartment loan portfolio has been determined on the same basis as for owned apartment buildings, where property- specific information is available, or based upon the average per unit valuation for owned buildings of similar unit size and unit mix. For performing apartment loans either classified "Substandard" or designated "Special Mention", reserves have been established based upon property-specific valuations which utilize current cash flows and estimated stabilized cash flows and incorporate management's assessment of future event risk. 22 RESIDENTIAL CONSTRUCTION At June 30, 1996, the Company maintained investments in 4 residential construction developments previously acquired through foreclosure. These developments, when completed, will entail the construction and sale of 275 homes. At June 30, 1996, the Company had sold 191 homes in these developments, 18 homes had been completed and had not been sold, and 66 homes remained to be built or are model units. The cost to complete construction of the remaining homes within these developments (approximately $11.0 million) has been incorporated into the carrying values for each development at June 30, 1996. LAND At June 30, 1996, the Company's portfolio of owned land parcels consisted of 5 properties with a net carrying value of $2.3 million. The Company also had 3 classified loans totaling $1.4 million. The Company's investment in land has been valued by reference to comparable land sales (where available), current appraisals and discounted cash flow land residual analyses. CREDIT LOSSES The Company maintains reserves against specific assets in those instances in which it believes that full recovery of the Company's gross investment is unlikely. As of June 30, 1996, the Company had established specific reserves based upon (1) management's strategy in managing and disposing of the asset and the corresponding financial consequences, (2) current indications of property values from (a) complete, recent sales from the Company's property portfolio, (b) real estate brokers, and (c) potential buyers of the Company's properties, and (3) current property appraisals. In addition, management establishes general valuation allowances ("GVA") against its loan and property portfolios when sufficient information does not exist to support establishing specific reserves. The loss factors utilized to establish general reserves are based upon (1) the actual loss experience for similar loans and properties within the Company's portfolio, when such loss experience is available and representative of the assets being valued, or (2) estimates of current liquidation values for collateral securing performing loans for a representative sampling of each portfolio segment. The table below sets forth the amounts and percentages of general and specific reserves for the Company's loan and property portfolios as of June 30, 1996 (dollars are in thousands).
LOANS -------------------------- PERFORMING IN DEFAULT PROPERTIES TOTAL ---------- ---------- ---------- ------- AMOUNTS Specific reserves $ 2,371 $3,279 $10,615 $16,265 General reserves 8,933 1,179 1,294 11,406 ------- ------ ------- ------- Total reserves for estimated losses $11,304 $4,458 $11,909 $27,671 ------- ------ ------- ------- ------- ------ ------- ------- PERCENTAGES % of total reserves to gross investment 1.8% 19.7% 34.7% 4.0% % of general reserves to gross investment 1.4% 5.2% 3.8% 1.6%
23 The table below summarizes the activity of the Company's reserves for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 1996 1995 1996 1995 ------------- ------------ ------------- ---------- LOANS Balance at beginning of period $15,353 $ 26,019 $15,192 $ 21,461 Provision for estimated losses 2,489 3,689 12,700 Transfer to property and other reserves (234) (2,796) 166 (9,407) Charge-offs (1,846) (2,533) (3,285) (4,066) ------- -------- ------- -------- Balance at end of period $15,762 $ 20,690 $15,762 $ 20,690 ------- -------- ------- -------- ------- -------- ------- -------- PROPERTIES Balance at beginning of period $12,317 $35,045 $15,725 $ 33,517 Provision for estimated losses 1,011 1,711 Transfer from loan reserves 234 2,796 (166) 9,407 Charge-offs (1,653) (24,334) (5,361) (29,417) ------- -------- ------- -------- Balance at end of period $11,909 $ 13,507 $11,909 $ 13,507 ------- -------- ------- -------- ------- -------- ------- --------
24 Because the Company's loan and property portfolios are not homogeneous, but rather consist of discreet segments with different collateral and borrower risk characteristics, management separately measures reserve adequacy, and establishes and maintains reserves for credit losses, for each identifiable segment of its property and loan portfolios. The table below summarizes credit loss reserves (dollars are in thousands). JUNE 30, 1996 ----------------------------------- LOANS PROPERTIES TOTAL -------- ------------- ---------- PERMANENT Single family homes Non-project $ 2,097 $ 300 $ 2,397 Loan concentrations 4,206 1,980 6,186 Multi-family 2 to 4 units 1,151 483 1,634 5 or more units 7,074 1,938 9,012 Commercial 987 105 1,092 Land 128 980 1,108 RESIDENTIAL CONSTRUCTION 119 6,123 6,242 -------- ------------- ---------- $ 15,762 $ 11,909 $ 27,671 -------- ------------- ---------- -------- ------------- ---------- REAL ESTATE OWNED Real estate acquired in satisfaction of loans is transferred from loans to properties 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. Any subsequent declines in the fair value of the properties after the date of transfer are recorded through the establishment of, or additions to, specific reserves. Recoveries and losses from the disposition of properties are also included in REAL ESTATE OPERATIONS. The table below summarizes the composition of the Company's property portfolio at June 30, 1996 and 1995 and at December 31, 1995 (dollars are in thousands). JUNE 30, DECEMBER 31, JUNE 30, 1996 1995 1995 --------- ------------- ---------- SINGLE FAMILY RESIDENCES Non-project $ 2,135 $ 4,975 $ 3,638 Loan concentrations 5,596 6,419 10,916 MULTI-FAMILY 2 to 4 units 1,930 3,840 1,478 5 or more units 6,539 18,877 32,625 COMMERCIAL 346 346 346 LAND 3,286 3,759 7,719 RESIDENTIAL CONSTRUCTION 14,481 15,414 20,294 --------- ------------- ---------- GROSS INVESTMENT (1) 34,313 53,630 77,016 ALLOWANCE FOR ESTIMATED LOSSES (11,909) (15,725) (13,507) --------- ------------- ---------- NET INVESTMENT $ 22,404 $ 37,905 $ 63,509 --------- ------------- ---------- --------- ------------- ---------- - ------------------------ (1) Loan principal at foreclosure, plus post-foreclosure capitalized costs, less cumulative charge-offs. 25 OFFICE PROPERTY AND EQUIPMENT At June 30, 1996, the Company's office property and equipment of $5.1 million was down from $9.6 million at December 31, 1995. The decrease was primarily due to $3.7 million in sales of branch facilities, of which $2.2 million related to the sale of the Company's Oceanside branch office facility in February 1996 and $1.5 million related to the sale of the Company's Rancho Bernardo and Vista branch facilities in June 1996, in conjunction with the sale of deposits at the Company's three San Diego branches. A gain of $6.4 million was recorded on the sale of these deposits and facilities and is included in gain on sale of other assets. LIABILITIES GENERAL The Company derives funds principally from deposits and, to a lesser extent, from borrowings from the FHLB. In addition, recurring cash flows are generated from loan repayments and payoffs and, since late 1993, from sales of foreclosed properties. In addition to the Company's recurring sources of funds, the Company has generated funds by identifying certain of its securities and seasoned real estate loans as available-for-sale, and selling such assets in the open market. During 1995 and 1996, the Company sold $88.1 million of loan principal secured primarily by single family homes originated prior to 1994 and $93.3 million of securities. Generally, the Company no longer originates the types of loans which have been, or will be, sold and the proceeds therefrom have been redeployed in the Company's current financing activities. DEPOSITS Total deposits at June 30, 1996, were $622.0 million, a decrease from $698.0 million at December 31, 1995, and $670.0 million at June 30, 1995. In June 1996 the Company sold the deposits housed in its three San Diego County branches. At the time of the sale, these branches had total deposits of $185.2 million. The Company funded the transfer of deposits with a combination of borrowings from the FHLB (see BORROWINGS) and excess liquidity, which had been accumulated through loan sales totaling $68.9 million and deposit growth at the Company's remaining six branches. The table below summarizes the balances, weighted average interest rates ("WAIR") and weighted average remaining maturities in months ("WARM") for the Company's deposits (dollars are in thousands).
JUNE 30, 1996 DECEMBER 31, 1995 --------------------------- ----------------------------- DESCRIPTION BALANCE WAIR WARM BALANCE WAIR WARM - ------------------------ --------- ------- --------- ---------- -------- -------- Transaction accounts $ 70,699 1.23% - $ 94,459 1.19% - Certificates of Deposit 7 day maturities 58,345 4.59% 60,552 4.78% Less than 6 months 18,564 4.65% 2 28,053 4.69% 2 6 months to 1 year 343,487 5.40% 5 356,013 5.74% 5 1 year to 2 years 84,349 5.96% 9 90,432 5.85% 9 Greater than 2 years 46,521 6.00% 15 68,499 6.08% 16 --------- ------- --------- ---------- -------- -------- Total $ 621,965 4.95% 5 $ 698,008 5.04% 5 --------- ------- --------- ---------- -------- -------- --------- ------- --------- ---------- -------- --------
26 BORROWINGS A primary alternative funding source for the Company is a $200.0 million credit line with the FHLB. The FHLB system functions as a source of credit to savings institutions which are members of a Federal Home Loan Bank System. Advances are typically secured by the Company's mortgage loans and the capital stock of the FHLB owned by the Company. Subject to the FHLB of San Francisco's advance policies and requirements, these advances can be requested for any business purpose in which the Company is authorized to engage. In granting advances, the FHLB considers a member's credit worthiness and other relevant factors. The balance and rate of the Company's FHLB advances at June 30, 1996, are summarized as follows (dollars are in thousands). TERM PRINCIPAL RATE ----------- --------- ----- 1 Month $ 25,000 5.71% 4 Months 25,000 5.82% 12 Months 25,000 6.24% --------- ----- $ 75,000 5.92% --------- ----- --------- ----- SENIOR NOTES The Company has Senior Notes, which have a face amount of $13.5 million, and a current, amortized fair value of $12.2 million at June 30, 1996. The Senior Notes carry an annual stated interest rate of 12% and have an annual effective rate of approximately 16.5%, after the recording of original issue discount ("OID") of $1.5 million. The OID is accreted using the constant yield method over the five year term of the Senior Notes. Interest, which is required to be paid semi-annually at the stated interest rate, has been prefunded for three years out of the proceeds of the Company's recapitalization in December 1995. This prefunded interest of $4.9 million was invested in U.S. Government securities. Thereafter, interest will be payable either in cash or, as permitted by the relevant agreements, in an equivalent value (determined in accordance with the provisions of the relevant agreement) in common stock of the Company. CAPITAL The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the capital regulations of the OTS thereunder require the Bank to maintain (1) Tangible Capital of at least 1.5% of Adjusted Total Assets (as defined in the regulations); (2) Core Capital of at least 3.0% of Adjusted Total Assets (as defined in the regulations); and (3) Total Risk-based Capital of at least 8.0% of Total Risk-weighted Assets (as defined in the regulations). 27 The following table summarizes the regulatory capital requirements under FIRREA for the Bank at June 30, 1996. As indicated in the table, the Bank's capital levels exceed all three of the currently applicable minimum FIRREA capital requirements (dollars are in thousands).
TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL ---------------- --------------- ------------------ BALANCE % BALANCE % BALANCE % -------- ------ -------- ----- -------- ------- Stockholders' equity $ 53,368 $ 53,368 $ 53,368 Adjustments General valuation allowances 6,494 Unrealized (gains) losses 102 102 102 Interest rate risk component (1) -------- ------ -------- ----- -------- ------- Regulatory capital 53,470 7.06% 53,470 7.06% 59,964 11.62% Required minimum 11,357 1.50% 22,714 3.00% 41,272 8.00% -------- ------ -------- ----- -------- ------- Excess capital $ 42,113 5.56% $ 30,756 4.06% $ 18,692 3.62% -------- ------ -------- ----- -------- ------- -------- ------ -------- ----- -------- ------- Adjusted assets (2) $757,137 $757,137 $515,900 -------- -------- -------- -------- -------- --------
- ------------------- (1) At June 30, 1996, the OTS had temporarily suspended the application of its interest rate risk regulation. Had the regulation been in effect at June 30, 1996, the Bank would not have been required to deduct from risk-based capital any amount due to an interest rate risk exposure component as computed by the OTS as one-half of the excess of the estimated change in the Bank's net portfolio value (determined in accordance with OTS regulations) over a normal change in net portfolio value (2%) assuming an immediate and sustained 200 basis point increase in interest rates, using the Bank's reported balance sheet information as of March 31, 1996. (2) The term "adjusted assets" refers to the term "adjusted total assets" as defined in 12 C.F.R. Section 567.1(a) for purposes of tangible and core capital requirements, and for purposes of risk-based capital requirements, refers to the term "risk-weighted assets" as defined in 12 C.F.R. Section 567.1(b). Under the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), which supplemented FIRREA, the OTS has issued "prompt corrective action" regulations with specific capital ranking tiers for thrift institutions. Progressively more stringent operational limitations and other corrective actions are required as an institution declines in the capital ranking tiers. Principal elements of the five qualifying tiers are set forth below.
RATIO OF RATIO OF RATIO OF CORE CAPITAL TOTAL CAPITAL CORE CAPITAL TO RISK-WEIGHTED TO RISK-WEIGHTED TO TOTAL ASSETS ASSETS ASSETS --------------- ---------------- ---------------- Well capitalized 5% or above 6% or above 10% or above Adequately capitalized 4% or above 4% or above 8% or above Under capitalized Under 4% Under 4% Under 8% Significantly undercapitalized Under 3% Under 3% Under 6% Critically undercapitalized Ratio of tangible equity to adjusted total assets of 2% or less
The Bank's ratios at June 30, 1996 are set forth below. Ratio of Core Capital to Total Assets (Leverage ratio) 7.06% Ratio of Core Capital to Risk-weighted Assets 10.36% Ratio of Total Capital to Risk-weighted Assets 11.62% At June 30, 1996, the Bank's capital ratios exceeded the capital ratio requirements for the Bank to qualify as a "well capitalized" institution. 28 The OTS has authority, after an opportunity for a hearing, to downgrade an institution from "well-capitalized" to "adequately capitalized" or to subject an "adequately capitalized" or "undercapitalized" institution to the supervisory actions applicable to the next lower category, if the OTS deems such action to be appropriate as a result of supervisory concerns. The thrift industry is exposed to economic trends and fluctuations in real estate values. In recent periods, those trends have been recessionary in nature, particularly in Southern California. Accordingly, the trends have adversely affected both the delinquencies being experienced by institutions such as the Company and the ability of such institutions to recoup principal and accrued interest through acquisition and sale of the underlying collateral. No assurances can be given that such trends will not continue in future periods, creating increasing downward pressure on the earnings and capital of thrift institutions. CAPITAL RESOURCES AND LIQUIDITY The Company's liquidity position refers to the extent to which the Company's funding sources are sufficient to meet its current and long-term cash requirements. Federal regulations currently require a savings institution to maintain a monthly average daily balance of liquid and short-term liquid assets equal to at least 5.0% and 1.0%, respectively, of the average daily balance of its net withdrawable accounts and short-term borrowings during the preceding calendar month. The Bank had liquidity and short-term liquidity ratios of 20.06% and 15.61%, respectively, as of June 30, 1996, and 8.50% and 5.95%, respectively, as of December 31, 1995. The Company's current primary funding resources are deposit accounts, principal payments on loans, proceeds from property sales, advances from the FHLB and cash flows from operations. Other possible sources of liquidity available to the Company include reverse repurchase transactions involving the Company's investment securities, 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 Bank 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 foreclosed properties. INTEREST RATE RISK MANAGEMENT The objective of interest rate risk management is to stabilize the Company's net interest income ("NII") while limiting the change in its net portfolio value ("NPV") from interest rate fluctuations. The Company seeks to achieve this objective by matching its interest sensitive assets and liabilities, and maintaining the maturity and repricing of these assets and liabilities at appropriate levels given the interest rate environment. When the amount of rate sensitive liabilities exceeds rate sensitive assets, the net interest income will generally be negatively impacted during a rising rate environment. The speed and velocity of the repricing of assets and liabilities will also contribute to the effects on net interest income. The Company utilizes two methods for measuring interest rate risk. Gap analysis is the first method, with a focus on measuring absolute dollar amounts subject to repricing within periods of time. With the majority of the focus typically at the one-year maturity horizon, a negative gap occurs when the interest sensitive liabilities maturing or repricing in a given period exceed the interest sensitive assets maturing or repricing in that same period. The negative one-year maturity gap indicates, absent offsetting factors, that the Company has more exposure to interest rate risk in an increasing interest rate environment. In addition to utilizing gap analysis in measuring interest rate risk, the Company performs periodic interest rate simulations. These simulations provide the Company with an estimate of both the dollar amount and percentage change in net interest income under various interest rate scenarios. All assets and liabilities are subjected to tests of up 29 to 400 basis points in increases and decreases in interest rates. Under each interest rate scenario, the Company projects its net interest income and the net portfolio value of its current balance sheet. From these results, the Company can then develop alternatives for dealing with the tolerance thresholds. A principal mechanism used by the Company in the past for interest rate risk management was the origination of ARMs tied to the 11th DCOFI. The basic premise was that the Company's actual cost of funds would parallel the 11th DCOFI and, as such, the net interest margins would generate the desired operating results. Loans having adjustable rate characteristics were 87% of the Company's total dollar originations during 1995 and 80% for the six months ended June 30, 1996. ARMs represented 77% and 75% of the Company's loan portfolio at June 30, 1996, and December 31, 1995, respectively. ARMs tied to 11th DCOFI are slower in responding to current interest rate environments than other types of variable rate loans because the index is a compilation of the average rates paid by member institutions of the 11th District of the FHLB. This index typically lags market rate changes in both directions. If interest rates on deposit accounts increase due to market conditions and competition, it may be anticipated that the Company will, absent offsetting factors, experience a decline in the percentage of net interest income to average interest-earning assets (the "Net Interest Margin"). A contributing factor would be the lag in upward pricing of the ARMs tied to the 11th DCOFI. However, the lag inherent in the 11th DCOFI will also cause the ARMs to remain at a higher rate for a longer period after interest rates on deposits begin to decline. The 11th DCOFI lag during a falling rate environment should benefit, in the short-term, the Company's Net Interest Margin, but the actual dynamics of prepayments and the fact that ARMs reprice at various intervals (and are subject to maximum periodic rate adjustment limits) may alter this expected benefit (dollars are in thousands).
June 30, 1996 December 31, 1995 June 30, 1995 ------------------ ----------------- ----------------- Balance Rate Balance Rate Balance Rate --------- ------- --------- ------- --------- ------ Interest-earning assets Loans (1) $ 667,545 8.54% $ 637,472 8.22% $ 570,219 7.68% Cash and investment securities 70,594 5.70% 77,357 4.60% 18,453 5.04% Mortgage-backed securities 52,980 6.22% --------- --------- --------- 738,139 8.26% 714,829 7.82% 641,652 7.49% --------- ------ --------- ----- --------- ----- Interest-bearing liabilities Deposit accounts (621,965) (5.03%) (698,008) (5.04%) (670,019) (5.06%) Borrowings (75,000) (5.92%) Senior notes (12,150) (16.50%) (12,006)(16.50%) --------- --------- --------- (709,115) (5.25%) (710,014) (5.32%) (670,019) (5.06%) --------- ------ --------- ----- --------- ----- Interest-bearing gap/stated interest margin 29,024 3.01% 4,815 2.50% (28,367) 2.20% Nonaccrual loans (22,576) (0.26%) (21,709) (0.28%) (23,222) (0.28%) --------- ------ --------- ----- --------- ----- Adjusted interest-bearing gap $ 6,448 2.75% $ (16,894) 2.22% $ (51,589) 1.92% --------- ------ --------- ----- --------- ----- --------- ------ --------- ----- --------- -----
- ------------------------- (1) Contractual yield, exclusive of the amortization of loan fees deferred at origination. 30 PROSPECTS The Company successfully completed its recapitalization by the sale of investment units in December 1995, from which the majority of the proceeds ($19 million) were contributed to the Bank as additional Tier 1 capital. As a result, the Bank reported core and risk-based capital ratios at December 31, 1995, of 5.80% and 10.27%, respectively, which defined the Bank as a "well-capitalized" institution for regulatory capital purposes. With the net earnings reported for the six months ended June 30, 1996, the Bank's core and risk-based capital ratios increased to 7.06% and 11.62%, respectively. As described more fully elsewhere herein, the Company has been successful since early 1995 in establishing itself as a provider of financings secured by very expensive homes, income properties and residential construction developments. These post-1994 financings account for about one-half of the Company's total loans at June 30, 1996, and carry margins well in excess of those associated with the Company's pre-1995 loans. Management expects that the Company will continue to be successful in further penetrating its target loan markets and will be able to price its financings at a premium to more generic mortgages because of its service levels, portfolio retention strategy and internal real estate expertise. Accordingly, management expects that its post-1994 loan portfolio will continue to grow as a percentage of total loans and will contribute to the gradual growth in the Company's total assets and interest margin. Management expects that the magnitude of the Company's Risk Assets will continue to dilute the margins generated from the Company's new financing activities. Though the Company has been successful in gradually reducing the adverse impact to earnings of nonperforming assets, and the prospective risk to earnings from performing, classified loans, the relationship of these portfolios to total assets and to the Company's capital remain well above peer levels. During the remainder of 1996, management will continue to employ the strategies which have, to date, been successful in reducing these portfolios, including (1) aggressively pursuing foreclosure of the Company's collateral in those circumstances where the borrower defaults on their obligation, (2) considering restructurings of individual loans, or groups of loans, only in limited circumstances in which the borrowers have the financial means and demonstrated intention of satisfying their obligations to the Company, and (3) liquidating the Company's inventory of foreclosed properties in an orderly fashion utilizing retail sales strategies. GENERAL REGULATION The FDIC administers two separate deposit insurance funds. The Bank Insurance Fund ("BIF") insures the deposits of commercial banks and other institutions that were insured by the FDIC prior to the enactment of the FIRREA. The SAIF insures the deposits of savings institutions that were insured by the Federal Savings and Loan Insurance Corporation ("FSLIC") prior to the enactment of FIRREA. The FDIC is authorized to increase insurance premiums payable by institutions of either fund if it determines that such increases are appropriate to maintain the reserves of that fund or to pay the costs of administration of the FDIC. In addition, the FDIC is authorized to levy emergency special assessments on BIF and SAIF members. FDIC deposit insurance premiums are assessed pursuant to a "risk-based" system under which institutions are classified on the basis of capital ratios, supervisory evaluations by their primary federal regulatory agency and other information determined by the FDIC to be relevant. Each of nine resulting subgroups of institutions is assigned a deposit insurance premium assessment rate which, for SAIF-insured institutions, currently ranges from 0.23% to 0.31%. The Bank's current deposit insurance premium assessment rate is 0.29%. The SAIF and the BIF are each required by statute to attain and thereafter to maintain a reserve to deposits ratio of 1.25%. The BIF has reached the required reserve level, whereas, based upon projections by the FDIC, the SAIF is not expected to reach its targeted ratio until at least the year 2002, or later. This disparity arises from the BIF's greater premium revenues and the requirement that a substantial portion of the SAIF premiums be used to repay bonds (commonly referred to as the "FICO Bonds") that were issued by a specially created federal corporation for the purpose of funding failed thrift institutions. In November 1995, the FDIC reduced its deposit insurance premiums for BIF member institutions to a range of 0.00% of deposits plus a statutory minimum of $2,000 in annual assessment per institution to 0.27%, with an historical low average of approximately 0.04%, effective beginning with the semiannual period commencing January 1, 1996. The FDIC maintained the range of deposit insurance premiums assessable against SAIF member institutions at 0.23% to 0.31%. 31 The deposit premium rate disparity between BIF-insured institutions and SAIF-insured institutions places SAIF-insured institutions at a significant competitive disadvantage due to their higher premium costs and may worsen the financial condition of the SAIF by leading to a shrinkage in its deposit base. A number of proposals for assisting the SAIF in attaining its required reserve level, and thereby permitting SAIF deposit insurance premiums to be reduced to levels at or near those paid by BIF-insured institutions, have been under discussion in Congress and among various of the affected parties and relevant government agencies. Congress proposed, as part of the budget reconciliation bill submitted to and vetoed by the President, a one-time, special assessment on all savings institutions to recapitalize the SAIF. The proposal would have required SAIF-insured institutions to pay a one-time special assessment on January 1, 1996 (estimated to be between approximately 80 and 90 basis points on deposits) and would provide for a pro rata sharing by all federally insured institutions of the obligation, now borne entirely by SAIF-insured institutions, to repay the above-mentioned FICO Bonds. Subsequent efforts to enact similar legislation have not been successful to date. If such proposed legislation were ultimately to become law, the special assessment would be reported in the Bank's Statement of Operations in the quarter during which the budget reconciliation bill (or such other bill to which such legislation may be attached) is finally agreed to by Congress and signed by the President. Both houses of Congress have recently passed legislation, which, if signed by the President, will repeal the tax rules formerly applicable to bad debt reserves of thrift institutions for taxable years beginning after December 31, 1995. The Company will thereupon be required to change its tax method of accounting for bad debts from the reserve method formerly permitted under section 593 of the Internal Revenue Code (the "Code") to the "specific charge-off" method effective as of the beginning of the tax year ending September 30, 1997. Under the specific charge-off method, tax deductions may be taken for bad debts only as and to the extent that the loans become wholly or partially worthless. The pending legislation would generally require thrift institutions, such as the Company, which have previously utilized the section 593 reserve method to recapture (i.e., include in taxable income) over a six-year period a portion of their existing bad debt reserves equal to their "applicable excess reserves." The Company does not believe that any of its bad debt reserves will be subject to such recapture. In addition, if the pending legislation becomes law, the remainder of the Company's bad debt reserve balance as of September 30, 1996 (approximately $22.5 million) will in future years be subject to recapture in whole or in part upon the occurrence of certain events such as a distribution to stockholders in excess of the Company's current accumulated earnings and profits, a redemption of shares, or upon a partial or complete liquidation of the Company. Contrary to current law, the amount that would be subject to recapture under such circumstances would be computed without regard to the portion of such reserves that would have been allowed under the experience method. The Company does not intend to make distributions to its stockholders that would result in recapture of any portion of its bad debt reserves. Management cannot predict whether or in what form legislation of the types described above will be enacted or the effect of such legislation, if adopted, on the Bank's operations and financial condition. Management believes, however, that certain of the provisions of such proposed legislation could benefit the Bank and its stockholders through eliminating one source of financial uncertainty facing thrift institutions in the current environment and by providing greater operating flexibility to pursue its business strategies. A significant increase in SAIF premiums or a significant surcharge to recapitalize the SAIF, however, would have an adverse effect on the operating expenses and results of operations of the Bank and the Company during the period thereof and would reduce the Bank's regulatory capital on at least a temporary basis. 32 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings On October 12, 1995, the Company and the directors of the Company, excluding Mr. Herbst, were named as defendants in a class and derivative action entitled ARTHUR GLICK AND WILLIAM GURNEY, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED VS. HAWTHORNE FINANCIAL CORPORATION, ET.AL., filed in the United States District Court of California, Case No. 95-6855-ER (the "Action"). On May 22, 1996, the Action was dismissed by the Court upon declaration by the plaintiffs that they had not suffered any loss and were, therefore, not proper class representatives. The dismissal of the Action barred the individual claims of the plaintiffs with respect to the matters alleged in the complaint. The Company is involved in a variety of other litigation matters which, for the most part, arise out of matters and events which were alleged to have occurred prior to 1994. Many of these lawsuits either allege construction defects or allege improper servicing of the loan. In the opinion of management, none of these cases will have a material adverse effect on the Bank's or the Company's financial condition. ITEM 2. Changes in Securities - None ITEM 3. Defaults upon Senior Securities - None ITEM 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of Stockholders of the Company was held on May 20, 1996. The eight nominees for Director, Marilyn Garton Amato, Scott A. Braly, Timothy R. Chrisman, R. Michael Hall, Charles S. Jacobs, Harry F. Radcliffe, Howard E. Ritt and Robert C. Troost, were all elected to a one year term. ITEM 5. Other Information - None ITEM 6. Exhibits and Reports on Form 8-K 1. Reports on Form 8-K - None 2. Other required exhibits - None 33 Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HAWTHORNE FINANCIAL CORPORATION Dated August 14, 1996 /s/ NORMAN A. MORALES ------------------------------------ Norman A. Morales Executive Vice President and Chief Financial Officer Dated August 14, 1996 /s/ JESSICA VLACO ------------------------------------ Jessica Vlaco Senior Vice President and Principal Accounting Officer 34 EX-27 2 EXHIBIT 27 (FDS)
9 6-MOS DEC-31-1996 JUN-30-1996 8,883 618,695 25,100 0 38,448 0 0 644,305 15,762 761,162 621,965 87,150 5,910 0 0 11,592 26 34,519 761,162 27,721 3,124 0 30,845 9,294 9,899 11,537 3,689 0 10,455 5,049 5,049 0 0 8,532 1.07 1.07 8.10 22,576 0 33,152 63,828 15,192 3,285 0 15,762 15,762 0 0
-----END PRIVACY-ENHANCED MESSAGE-----