-----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, O2GCdCXCrXqBkR1Vvc4WxvrGeT3OMb/bdD5b49P80k5k7BCkqSNqLJKyfVn0sjwI F/E2YZRzLMo4S/nb/AdqLA== 0000950150-98-001780.txt : 19981116 0000950150-98-001780.hdr.sgml : 19981116 ACCESSION NUMBER: 0000950150-98-001780 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 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: SEC FILE NUMBER: 000-01100 FILM NUMBER: 98748132 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 FOR THE QUARTER ENDED SEPTEMBER 30, 1998 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q ------------------------ [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ . COMMISSION FILE NUMBER 0-1100 HAWTHORNE FINANCIAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-2085671 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 2381 ROSECRANS AVENUE, EL SEGUNDO, CA 90245 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 725-5000 ------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: The Registrant had 5,194,996 shares of Common Stock, $0.01 par value per share outstanding, as of October 30, 1998. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY FORM 10-Q INDEX FOR THE QUARTER ENDED SEPTEMBER 30, 1998 PART I -- FINANCIAL INFORMATION
PAGE ---- Item Financial Statements 1.... Consolidated Statements of Financial Condition at September 30, 1998 and December 31, 1997.............................. 3 Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 1998 and 1997........... 4 Consolidated Statement of Stockholders' Equity for the Nine Months Ended September 30, 1998............................. 5 Consolidated Statements of Cash Flows for the Three Months and Nine Months Ended September 30, 1998 and 1997........... 6 Notes to Consolidated Financial Statements.................. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 9 Item 3. Quantitative and Qualitative Disclosure About Market Risk... 29
PART II -- OTHER INFORMATION Item 1. Legal Proceedings........................................... 31 Item 2. Changes in Securities....................................... 31 Item 3. Defaults upon Senior Securities............................. 31 Item 4. Submission of Matters to a Vote of Security Holders......... 31 Item 5. Other Information........................................... 31 Item 6. Exhibits and Reports on Form 8-K............................ 31
FORWARD-LOOKING STATEMENTS When used in this Form 10-Q or future filings by the Company with the Securities and Exchange Commission, in the Company's press releases or other public or stockholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project", "believe" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers that all forward-looking statements are necessarily speculative and not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various risks and uncertainties, including regional and national economic conditions, changes in levels of market interest rates, credit risks of lending activities, and competitive and regulatory factors, could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected. The risks highlighted herein should not be assumed to be the only things that could affect future performance of the Company. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. 2 3 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (DOLLARS ARE IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------ Cash and cash equivalents................................... $ 143,775 $ 51,620 Investment securities available-for-sale, at market......... 22,679 578 Loans receivable (net of allowance for estimated credit losses of $16,160 in 1998 and $13,274 in 1997)............ 1,190,382 838,251 Real estate owned (net of allowance for estimated losses of $0 in 1998 and $2,563 in 1997)............................ 2,178 9,859 Investment in capital stock of Federal Home Loan Bank -- at cost...................................................... 13,313 7,213 Office property and equipment -- at cost, net............... 6,535 4,200 Accrued interest receivable................................. 8,166 5,298 Deferred tax asset, net..................................... 4,344 6,820 Other assets................................................ 3,692 4,358 ---------- -------- $1,395,064 $928,197 ========== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits.................................................. $ 994,932 $799,501 FHLB advances............................................. 264,000 40,000 Senior notes.............................................. 40,000 40,000 Accounts payable and other liabilities.................... 17,095 6,377 ---------- -------- 1,316,027 885,878 Stockholders' equity Preferred stock -- $0.01 par value; authorized 10,000,000 shares; none issued and outstanding.................... -- -- Common stock -- $0.01 par value; authorized, 20,000,000 shares; issued, 5,200,396 shares in 1998 and 3,095,996 shares in 1997......................................... 52 31 Capital in excess of par value -- common stock............ 40,528 12,310 Accumulated other comprehensive income -- unrealized gain on available-for-sale securities, net.................. 10 6 Retained earnings......................................... 38,575 30,112 ---------- -------- 79,165 42,459 Less Treasury stock, at cost -- 5,400 shares................... (48) (48) Loan to Employee Stock Ownership Plan..................... (80) (92) ---------- -------- 79,037 42,319 ---------- -------- $1,395,064 $928,197 ========== ========
See accompanying Notes to Consolidated Financial Statements. 3 4 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS ARE IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ------------------ 1998 1997 1998 1997 ------- ------- ------- ------- Interest revenues Loans, net of nonaccrual income................... $27,441 $17,799 $73,077 $50,480 Cash and investment securities.................... 1,483 1,583 2,938 4,657 ------- ------- ------- ------- Total interest revenues................... 28,924 19,382 76,015 55,137 ------- ------- ------- ------- Interest costs Deposits.......................................... 12,422 10,188 34,533 28,467 FHLB advances..................................... 2,950 598 5,740 2,322 Senior notes...................................... 1,250 489 3,764 1,468 ------- ------- ------- ------- Total interest costs...................... 16,622 11,275 44,037 32,257 ------- ------- ------- ------- Net interest income................................. 12,302 8,107 31,978 22,880 Provision for estimated credit losses on loans...... 1,950 1,500 5,185 3,739 ------- ------- ------- ------- Net interest income after provision for credit losses............................................ 10,352 6,607 26,793 19,141 Noninterest revenues, net........................... 1,362 1,345 3,527 2,895 Noninterest expenses General and administrative costs Employee....................................... 3,683 2,622 10,373 7,903 Operating...................................... 1,681 1,142 4,256 3,182 Occupancy...................................... 851 697 2,439 2,113 Technology..................................... 567 177 1,561 524 Professional................................... 211 357 979 1,088 SAIF premium and OTS assessment................ 247 208 703 1,063 ------- ------- ------- ------- Total general and administrative costs.... 7,240 5,203 20,311 15,873 Income from real estate operations, net........... (616) (490) (1,980) (228) ------- ------- ------- ------- Total noninterest expenses................ 6,624 4,713 18,331 15,645 ------- ------- ------- ------- Net earnings before income taxes.................... 5,090 3,239 11,989 6,391 Income tax provision (benefit)...................... 1,632 25 3,526 (1,602) ------- ------- ------- ------- Net earnings........................................ $ 3,458 $ 3,214 $ 8,463 $ 7,993 ======= ======= ======= ======= Net earnings available for Common Stock (Note 3).... $ 3,458 $ 2,606 $ 8,463 $ 6,171 ======= ======= ======= ======= Basic earnings per share (Note 3)................... $ 0.67 $ 0.85 $ 2.21 $ 2.19 ======= ======= ======= ======= Diluted earnings per share (Note 3)................. $ 0.45 $ 0.47 $ 1.33 $ 1.21 ======= ======= ======= ======= Weighted average basic shares outstanding (Note 3)................................................ 5,189 3,058 3,838 2,814 ======= ======= ======= ======= Weighted average diluted shares outstanding (Note 3)................................................ 7,708 5,507 6,351 5,087 ======= ======= ======= =======
See accompanying Notes to Consolidated Financial Statements. 4 5 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DOLLARS ARE IN THOUSANDS)
COMPREHENSIVE INCOME --------------------- BALANCE AT EXERCISED CHANGE IN BALANCE AT DECEMBER 31, STOCK STOCK UNREALIZED NET SEPTEMBER 30, 1997 OPTIONS OFFERING GAINS EARNINGS REPAYMENTS 1998 ------------ --------- -------- ---------- -------- ---------- ------------- Common stock....................... $ 31 $ 1 $ 20 $ -- $ -- $ -- $ 52 Capital in excess of par value Common stock..................... 12,310 436 27,782 -- -- -- 40,528 Accumulated other comprehensive income -- unrealized gain on available-for-sale securities.... 6 -- -- 4 -- -- 10 Retained earnings.................. 30,112 -- -- -- 8,463 -- 38,575 Treasury stock..................... (48) -- -- -- -- -- (48) Loan to employee stock ownership plan............................. (92) -- -- -- -- 12 (80) ------- ---- ------- ---- ------ ---- ------- Total stockholders' equity.................. $42,319 $437 $27,802 $ 4 $8,463 $ 12 $79,037 ======= ==== ======= ==== ====== ==== ======= Comprehensive income............... $ 4 $8,463 $ 8,467 ==== ====== =======
See accompanying Notes to Consolidated Financial Statements. 5 6 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS ARE IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------- ---------------------- 1998 1997 1998 1997 --------- -------- --------- --------- NET CASH FLOWS FROM OPERATING ACTIVITIES Net earnings............................................... $ 3,458 $ 3,214 $ 8,463 $ 7,993 Adjustments Provision (benefit) for income taxes..................... 1,632 25 3,526 (1,627) Provision for estimated credit losses on loans........... 1,950 1,500 5,185 3,739 Provision for estimated credit losses on real estate owned.................................................. -- 50 15 811 Net recoveries from sales of real estate owned........... (545) (2,220) (1,012) Loan fee and discount accretion.......................... (1,781) (1,040) (4,734) (2,863) Depreciation and amortization............................ 481 453 1,258 1,357 FHLB dividends........................................... (121) (102) (330) (306) (Increase) decrease in: Accrued interest receivable............................ (1,095) 939 (2,910) (803) Other assets........................................... 3,126 (382) 823 (1,393) Decrease in other liabilities............................ 9,055 2,412 9,797 (13,444) Other, net............................................... 6 29 (19) 23 --------- -------- --------- --------- Net cash provided by (used in) operating activities........ 15,885 6,553 18,854 (7,525) --------- -------- --------- --------- NET CASH FLOWS FROM INVESTING ACTIVITIES Investment securities Purchases................................................ (27,681) (9) (27,698) (40,562) Maturities............................................... 5,000 -- 5,000 795 Sales proceeds........................................... 597 10,054 597 12,468 Loans New loans funded........................................... (130,925) (57,660) (356,660) (157,005) Construction disbursements............................... (89,760) (46,769) (258,102) (93,878) Advances on lines of credit.............................. (22,449) (9,321) (61,692) (14,380) Payoffs.................................................. 115,123 64,303 263,663 145,284 Principal amortization and paydowns...................... 28,859 7,408 55,687 15,392 Other, net............................................... 2,248 (1,054) 4,563 (2,738) Real estate owned Sale proceeds............................................ 2,590 7,653 10,827 23,592 Capitalized costs........................................ (364) (2,018) (942) (5,910) Other, net............................................... (602) (551) Purchase of FHLB stock..................................... (2,337) (5,770) Net change in office property and equipment................ (665) (164) (3,303) (375) --------- -------- --------- --------- Net cash used in investing activities...................... (120,366) (27,577) (374,381) (117,317) --------- -------- --------- --------- NET CASH FLOWS FROM FINANCING ACTIVITIES Deposit activity, net.................................... $ 103,457 $ 21,888 $ 195,431 $ 58,468 Net change in FHLB advances.............................. 49,000 -- 224,000 (10,000) Net proceeds from exercise of options.................... 36 31 438 282 Proceeds from stock offering............................. 28,376 -- 28,376 -- Offering costs........................................... (573) -- (573) -- Collection of ESOP loan.................................. (2) 6 10 20 --------- -------- --------- --------- Net cash provided by financing activities................ 180,294 21,925 447,682 48,770 --------- -------- --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 75,813 901 92,155 (76,072) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 67,962 17,005 51,620 93,978 --------- -------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 143,775 $ 17,906 $ 143,775 $ 17,906 ========= ======== ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid (received) during the period for: Interest............................................... $ 15,616 $ 10,700 $ 42,598 $ 31,632 Income taxes........................................... 2,753 (149) 2,828 25 Non-cash investing and financing activities Real estate acquired in settlement of loans............ 772 5,001 3,847 18,547 Loans originated to finance sales of real estate owned................................................ -- 1,651 1,970 4,198 Net change in unrealized gains (losses) on available-for-sale securities........................ 5 350 4 199 Common stock issued in lieu of cash dividends to Preferred shareholders............................... -- 608 -- 4,273 Loan activity Total commitments and permanent fundings............... $ 272,000 $136,645 $ 713,000 $ 325,200 Total disbursements on new loans, construction and lines of credit...................................... 243,134 113,750 676,454 265,263
See accompanying Notes to Consolidated Financial Statements. 6 7 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (AMOUNTS ARE IN THOUSANDS, EXCEPT FOR BOOK VALUE AND PER SHARE DATA) NOTE 1 -- SUMMARY OF ACCOUNTING POLICIES The consolidated financial statements include the accounts of Hawthorne Financial Corporation and its wholly-owned subsidiary, Hawthorne Savings, F.S.B. ("Bank"), which are collectively referred to herein as the "Company". All material intercompany transactions and accounts have been eliminated. In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting solely of normal recurring accruals) necessary to present fairly the Company's financial position as of September 30, 1998 and December 31, 1997, and the results of its operations and its cash flows for the three and nine months ended September 30, 1998 and 1997. Operating results for the three and nine months ended September 30, 1998, are not necessarily indicative of the results that may be expected for any other interim period or the full year ending December 31, 1998. Certain information and note disclosures normally included in financial statements prepared in accordance with Generally Accepted Accounting Principles ("GAAP") have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K/A for the year ended December 31, 1997. In January 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," which requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement did not have a material impact on the Company's consolidated financial statements. NOTE 2 -- RECLASSIFICATION Certain amounts in the 1997 consolidated financial statements have been reclassified, where practicable, to conform with classifications in 1998. NOTE 3 -- BOOK VALUE AND EARNINGS PER SHARE The table below sets forth the Company's earnings per share calculations for the three and nine months ended September 30, 1998 and 1997. The Diluted and Basic Methods were used for all four periods as prescribed under GAAP. In the table below, (1) Warrants refers to the warrants issued by the Company in December 1995, which can be exercised beginning three years from the issue date and for a period of ten years thereafter, (2) Options refers to the outstanding stock options granted under the Company's stock option plans, and (3) Preferred Stock refers to the Cumulative Perpetual Preferred Stock issued by the Company in December 1995, and redeemed in December 1997, which carried an annual dividend equal to 18% of the face amount of the Preferred Stock. On July 10, 1998, the Company completed an offering of 2,012,500 of its common shares (which amount includes issuance of 262,500 shares representing exercise by the Company's underwriters of their over-allotment option) at a price of $15.00 per share, realizing net proceeds (after offering costs) of approximately $27.5 million. As an additional result of the completion of the Company's offering, the exercise price of the 7 8 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1998 (AMOUNTS ARE IN THOUSANDS, EXCEPT FOR BOOK VALUE AND PER SHARE DATA) Company's Warrants was reduced to $2.128, and the number of shares of Common Stock purchasable upon the exercise of the Warrants was increased to 2,512,188.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ----------------- 1998 1997 1998 1997 -------- ------- ------ ------- Average Shares Outstanding Basic............................................. 5,189 3,058 3,838 2,814 Warrants.......................................... 2,512 2,376 2,421 2,376 Options........................................... 738 651 677 658 Less Treasury shares(1)........................... (731) (578) (585) (761) -------- ------- ------ ------- Diluted........................................... 7,708 5,507 6,351 5,087 ======== ======= ====== ======= Net Earnings Net earnings for the period....................... $ 3,458 $ 3,214 $8,463 $ 7,993 Preferred stock dividends......................... -- (608) -- (1,822) -------- ------- ------ ------- Net earnings available for Common Stock........... $ 3,458 $ 2,606 $8,463 $ 6,171 ======== ======= ====== ======= Basic earnings per share............................ $ 0.67 $ 0.85 $ 2.21 $ 2.19 ======== ======= ====== ======= Diluted earnings per share.......................... $ 0.45 $ 0.47 $ 1.33 $ 1.21 ======== ======= ====== =======
SEPTEMBER 30, ------------------- 1998 1997 -------- ------- Period End Shares Outstanding Basic............................................. 5,189 3,088 Warrants.......................................... 2,512 2,376 Options........................................... 738 648 Less Treasury shares(2)........................... (814) (505) -------- ------- Diluted........................................... 7,625 5,607 ======== ======= Stockholders' Equity Basic............................................. $ 79,037 $43,273 Warrants.......................................... 5,346 5,346 Options........................................... 6,622 3,410 Less Treasury shares(2)........................... (11,968) (8,756) -------- ------- Diluted........................................... $ 79,037 $43,273 ======== ======= Basic book value per share.......................... $ 15.23 $ 14.01 ======== ======= Diluted book value per share........................ $ 10.37 $ 7.72 ======== =======
- --------------- (1) Under the Diluted Method, it is assumed that the Company will use proceeds from the proforma exercise of the Warrants and Options to acquire actual shares currently outstanding, thus increasing Treasury shares. Treasury shares were assumed to be repurchased at the average closing stock price for the respective period. (2) Treasury shares were assumed to be repurchased at the average closing stock price for the month. 8 9 ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company earned $3.5 million, or $0.45 per diluted share, for the quarter ended September 30, 1998, which represented a 9% increase over the net earnings of $3.2 million, or $0.47 per diluted share, reported for the third quarter of 1997. For the nine months ended September 30, 1998, net earnings were $8.5 million, or $1.33 per diluted share, as compared with net earnings of $8.0 million, or $1.21 per diluted share for the same period in 1997. Net earnings reported for the 1997 periods were significantly enhanced by the realization of income tax benefits. Had the pretax earnings for the three and nine months ended September, 1997 been tax-effected consistently with the corresponding periods in 1998, net earnings would have been $2.2 million and $4.5 million, respectively. CORE BUSINESS ACTIVITY The Company originates real estate-secured loans throughout Southern California, generally consisting of permanent loans collateralized by very large homes and unique estates, permanent and construction loans secured by multi-family residential and commercial real estate, and loans for the construction of individual and tracts of single family residential homes and the acquisition and development of land for the construction of such homes. The Company funds its loans predominately with retail deposits and, to a lesser extent, advances from the Federal Home Loan Bank of San Francisco ("FHLB"). The interest spreads earned from this core business generally exceed the interest spreads available on typical real estate-secured financings within the Company's market area. The Company's consolidated capital structure has changed significantly during the past three years, initially as a result of its recapitalization in December 1995, and then again in December 1997, due to its successful refinancing of the securities issued in the 1995 recapitalization. Finally, in July 1998, the Company completed a public offering of approximately 2.0 million of its common shares, which raised approximately $27.5 million of net proceeds. In addition to these positive changes to the Company's capital structure, the Company returned to taxable status during the first quarter of 1998, following several years in which it recorded substantial income tax benefits from utilization of accumulated operating loss carryforwards. Together, these factors make meaningful comparisons of consolidated operating results, and related per share amounts, between the 1998 and 1997 periods somewhat difficult. Because of the significant changes to the Company's capital structure and taxable status, management believes that pretax core earnings are the most relevant measure of the Company's underlying operating and earnings performance. Core earnings are earnings before interest on parent company debt, income taxes, real estate operations and non-operating items. For the third quarter of 1998, core earnings were $5.7 million, more than 20% greater than the $4.8 million of core earnings produced during the second quarter of 1998, and nearly 90% greater than the core earnings of $3.0 million generated during the third quarter of 1997. For the nine months ended September 30, 1998, core earnings were $13.8 million, nearly 86% greater than the core earnings of $7.4 million realized during the first nine months of 1997. 9 10 The table below isolates the principal components of the Company's core and net earnings for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ -------------------- 1998 1997 1998 1997 ------- ------- -------- -------- Net interest income............................... $13,552 $ 8,596 $ 35,742 $ 24,348 Provision for credit losses....................... (1,950) (1,500) (5,185) (3,739) ------- ------- -------- -------- Net interest income after provision for credit losses.......................................... 11,602 7,096 30,557 20,609 Noninterest revenues.............................. 1,372 1,126 3,541 2,690 General and administrative costs.................. (7,240) (5,203) (20,311) (15,873) ------- ------- -------- -------- Core earnings..................................... 5,734 3,019 13,787 7,426 Other items Real estate operations, net..................... 616 490 1,980 228 Other, net...................................... (10) 219 (14) 205 Interest on senior notes........................ (1,250) (489) (3,764) (1,468) ------- ------- -------- -------- (644) 220 (1,798) (1,035) ------- ------- -------- -------- Pretax earnings................................... 5,090 3,239 11,989 6,391 Income tax (provision) benefit.................... (1,632) (25) (3,526) 1,602 ------- ------- -------- -------- Net earnings...................................... $ 3,458 $ 3,214 $ 8,463 $ 7,993 ======= ======= ======== ========
The growth in earning assets results directly from the continuing successful expansion of the Company's financing businesses. During the third quarter of 1998, the Company generated net new permanent and construction loan commitments of $272.0 million which, net of repayments and undisbursed funds, produced net growth of $97.1 million in the Company's retained loan portfolio during the quarter, an annualized rate of 36%. For the nine months ended September 30, 1998, net new loan commitments totaled $713.0 million which, net of repayments and undisbursed funds, produced net growth of $352.1 million in the Company's retained loan portfolio during the first nine months of 1998, an annualized rate of 56%. By comparison, the Company recorded net new loan commitments of $136.6 million and $325.2 million for the three and nine months ended September 30, 1997, respectively, and net growth in the Company's retained loan portfolio approximated $94.7 million during the first nine months of 1997. The Company's mix of financings, and its willingness and ability to provide customers with tailored terms and highly-efficient transaction execution when necessary, contributes to its ability to produce relatively higher yields on the incremental growth in its loan portfolio. Concurrently, the Company has been successful in keeping its funding costs (excluding interest on parent company debt) virtually unchanged during the past several quarters. As a result of declining rates during the third quarter of 1998, partially caused by reductions in indices used for its adjustable loan portfolio, the Company's interest margin (before interest on parent company debt and loan loss provisions) declined slightly, reaching 4.32% as compared with its interest margin of 4.42% realized during the second quarter of 1998, and increasing 29 basis points over the Company's interest margin of 4.03% realized during the third quarter of 1997. For the nine months ended September 30, 1998, the Company's interest margin was 4.36%, as compared with its interest margin of 3.92% realized during the first nine months of 1997, an improvement of 44 basis points or 11%. Nonperforming assets ("NPAs"), which consist of the carrying value of properties acquired through foreclosure and loan principal delinquent 90 days or greater, stood at $16.6 million at September 30, 1998, down from their level of $20.7 million at December 31, 1997. Since December 31, 1997, the Company's real estate owned portfolio has been reduced to $2.2 million (13% of NPAs) from $9.9 million (48% of NPAs) due to sales of individual properties in the ordinary course of business. The Company continues to experience very modest levels of foreclosures of its collateral securing delinquent loans, with most such loans being cured by borrowers with no concessions offered by the Company. As previously reported, in mid-1997 the Company commenced a series of initiatives intended to enhance its management depth, to convert its technology platform from an outsourced, host-based system to an 10 11 in-house, client server-based system, and to design and implement a plan to ensure Year 2000 compliance. These and related initiatives were expected to increase the Company's general and administrative costs during 1998 by about 15% as compared with 1997. During the three and nine months ended September 30, 1998, general and administrative costs were $7.2 million and $20.3 million, respectively, as compared with general and administrative costs of $5.2 million and $15.9 million, respectively, for the corresponding periods during 1997. The actual 28% growth rate in general and administrative expenses for the first nine months of 1998, as compared with the same period in 1997, reflects the initiatives described above plus additional compensation costs attributable to the Company's financial performance during the first nine months of 1998. INCOME TAXES During the three and nine months ended September 30, 1998, the Company's effective tax rate was 32.1% and 29.4%, respectively. During the corresponding periods of 1997, the Company recorded income tax expense of $25,000 and tax benefits of $1.6 million, respectively. During the past several years, the Company has benefited from utilization of income tax benefits, principally tax loss carryforwards, accumulated during the early 1990s. The Company expects that these accumulated benefits will be fully utilized during 1998. PARENT COMPANY ITEMS The Company's capital structure has changed significantly during the past three years. The Company's issues of Preferred Stock ($13.5 million face amount) and Senior Notes due 2000 ($13.5 million face amount), issued in December 1995 in connection with a recapitalization of the Company and the Bank, were repaid in full in December 1997 with the proceeds from a single, $40 million issue of Senior Notes due 2004, which carry a coupon interest rate of 12.50% and an effective cost of approximately 13.40% (after including the effect of issue cost amortization). Through September 30, 1998, the Company had contributed all of the proceeds from its current Senior Notes issue to the Bank, which has permitted the Bank to support its recent asset growth while maintaining core and risk-based capital ratios well above the regulatory ratios which define a well-capitalized institution. In July 1998, the Company completed an offering of approximately 2.0 million of its common shares, realizing net proceeds (after offering costs) of approximately $27.5 million. The Company expects to contribute the majority of the net proceeds from the offering to the Bank, as may be necessary over time, to support the Bank's future asset growth while preserving the Bank's status as a well-capitalized institution. At September 30, 1998, the Bank maintained core and risk-based capital ratios of 6.92% and 10.90%, respectively, which compared favorably to the well-capitalized regulatory thresholds of 5.00% and 10.00%, respectively. RESULTS OF OPERATIONS NET INTEREST INCOME The operations of the Company are substantially dependent on its net interest income, which is the difference between the interest income received from its interest-earning assets and the interest expense paid on its interest-bearing liabilities. The Company's net interest margin is its net interest income divided by its average interest-earning assets. Net interest income and net interest margin are affected by several factors, including (1) the level of, and the relationship between, the dollar amount of interest-earning assets and interest-bearing liabilities, (2) the relationship between repricing or maturity of the Company's adjustable-rate and fixed-rate loans and short-term investment securities and its deposits and borrowings and (3) the magnitude of the Company's noninterest-earning assets, including nonaccrual loans and real estate owned ("REO"). 11 12 The following tables set forth the Company's average balance sheets, and the related weighted average yields and costs on average interest-earning assets (inclusive of nonaccrual loans) and interest-bearing liabilities, for the three and nine months ended September 30, 1998 and 1997. In the tables, interest revenues are net of interest associated with nonaccrual loans (dollars are in thousands).
THREE MONTHS ENDED ----------------------------------------------------------------------- SEPTEMBER 30, 1998 SEPTEMBER 30, 1997 ----------------------------------- --------------------------------- WEIGHTED WEIGHTED AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST ---------- --------- ---------- -------- --------- ---------- ASSETS Interest-earning assets Loans(1)(2)................ $1,146,124 $27,441 9.58% $749,531 $17,799 9.50% Cash and cash equivalents............. 79,961 1,105 5.53 20,636 274 5.31 Investment securities...... 17,438 258 5.92 74,989 1,206 6.43 Investment in capital stock of Federal Home Loan Bank..... 10,933 120 4.39 7,028 103 5.86 ---------- ------- -------- ------- Total interest-earning assets........... 1,254,456 28,924 9.22 852,184 19,382 9.10 ------- ----- ------- ----- Noninterest-earning assets... 18,042 27,332 ---------- -------- Total assets....... $1,272,498 $879,516 ========== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities Deposits................... $ 938,250 12,422 5.31 $765,680 10,188 5.34 FHLB Advances.............. 215,544 2,950 5.49 40,000 598 6.00 Senior notes (3)........... 40,000 1,250 12.53 12,517 489 15.63 ---------- ------- -------- ------- Total interest-bearing liabilities...... 1,193,794 16,622 5.58 818,197 11,275 5.53 ------- ----- ------- ----- Noninterest-bearing liabilities................ 997 8,352 Stockholders' equity......... 77,707 52,967 ---------- -------- Total liabilities & stockholders' equity........... $1,272,498 $879,516 ========== ======== Net interest income.......... $12,302 $ 8,107 ======= ======= Interest rate spread......... 3.64% 3.57% ===== ===== Net interest margin.......... 3.92% 3.81% ===== ===== Net interest margin excluding senior notes............... 4.32% 4.03% ===== =====
- --------------- (1) Includes nonaccrual loans of $23.3 million and $11.5 million for the three months ended September 30, 1998 and September 30, 1997, respectively. (2) Includes amortization of loan fees and discounts of $1.8 million and $1.0 million for the three months ended September 30, 1998 and September 30, 1997, respectively. (3) Excludes issue cost amortization of $92,000 and $58,000 for the three months ended September 30, 1998 and September 30, 1997, respectively. 12 13
NINE MONTHS ENDED ----------------------------------------------------------------------- SEPTEMBER 30, 1998 SEPTEMBER 30, 1997 ----------------------------------- --------------------------------- WEIGHTED WEIGHTED AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST ---------- --------- ---------- -------- --------- ---------- ASSETS Interest-earning assets Loans(1)(2)................ $1,020,795 $73,077 9.55% $722,126 $50,480 9.32% Cash and cash equivalents............. 57,415 2,330 5.41 32,769 1,261 5.13 Investment securities...... 5,635 278 6.58 66,066 3,090 6.24 Investment in capital stock of Federal Home Loan Bank.................... 8,659 330 5.08 6,928 306 5.89 ---------- ------- -------- ------- Total interest-earning assets........... 1,092,504 76,015 9.28 827,889 55,137 8.88 ------- ----- ------- ----- Noninterest-earning assets... 18,006 28,908 ---------- -------- Total assets....... $1,110,510 $856,797 ========== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities Deposits................... $ 872,849 34,533 5.29 $732,390 28,467 5.20 FHLB Advances.............. 138,403 5,740 5.54 51,433 2,322 6.04 Senior notes(3)............ 40,000 3,764 12.58 12,431 1,468 15.79 ---------- ------- -------- ------- Total interest-bearing liabilities...... 1,051,252 44,037 5.60 796,254 32,257 5.42 ------- ----- ------- ----- Noninterest-bearing liabilities................ 4,707 12,847 Stockholders' equity......... 54,551 47,696 ---------- -------- Total liabilities & stockholders' equity........... $1,110,510 $856,797 ========== ======== Net interest income.......... $31,978 $22,880 ======= ======= Interest rate spread......... 3.68% 3.46% ===== ===== Net interest margin.......... 3.90% 3.68% ===== ===== Net interest margin excluding senior notes............... 4.36% 3.92% ===== =====
- --------------- (1) Includes nonaccrual loans of $22.5 million and $20.1 million for the nine months ended September 30, 1998 and September 30, 1997, respectively. (2) Includes amortization of loan fees and discounts of $4.7 million and $2.8 million for the nine months ended September 30, 1998 and September 30, 1997, respectively. (3) Excludes issue cost amortization of $274,000 and $175,000 for the nine months ended September 30, 1998 and September 30, 1997, respectively. 13 14 ANALYSIS OF CHANGES IN NET INTEREST INCOME The following tables present the dollar amount of changes in interest revenues and interest costs attributable to changes in the balances of interest-earning assets and interest-bearing liabilities, and changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (i) changes in volume (i.e., changes in volume multiplied by old rate), (ii) changes in rate (i.e., changes in rate multiplied by old volume) and (iii) changes attributable to both rate and volume (dollars are in thousands).
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 INCREASE (DECREASE) DUE TO CHANGE IN ------------------------------------- RATE AND NET VOLUME RATE VOLUME CHANGE ------ ----- -------- ------ INTEREST REVENUES Loans................................................ $9,417 $ 147 $ 78 $9,642 Cash and cash equivalents............................ 788 11 32 831 Investment securities................................ (925) (97) 74 (948) Investment in capital stock of Federal Home Loan Bank.............................................. 57 (26) (14) 17 ------ ----- ----- ------ 9,337 35 170 9,542 ------ ----- ----- ------ INTEREST COSTS Deposits............................................. 2,296 (51) (11) 2,234 FHLB Advances........................................ 2,624 (50) (222) 2,352 Senior notes......................................... 1,074 (98) (215) 761 ------ ----- ----- ------ 5,994 (199) (448) 5,347 ------ ----- ----- ------ Increase in Net Interest Income........................ $3,343 $ 234 $ 618 $4,195 ====== ===== ===== ======
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 INCREASE (DECREASE) DUE TO CHANGE IN ---------------------------------------- RATE AND NET VOLUME RATE VOLUME CHANGE ------- ------ -------- ------- INTEREST REVENUES Loans.............................................. $20,878 $1,216 $ 503 $22,597 Cash and cash equivalents.......................... 948 69 52 1,069 Investment securities.............................. (2,826) 169 (155) (2,812) Investment in capital stock of Federal Home Loan Bank............................................ 76 (42) (10) 24 ------- ------ ------ ------- 19,076 1,412 390 20,878 ------- ------ ------ ------- INTEREST COSTS Deposits........................................... 5,459 509 98 6,066 FHLB Advances...................................... 3,926 (189) (319) 3,418 Senior notes....................................... 3,255 (298) (661) 2,296 ------- ------ ------ ------- 12,640 22 (882) 11,780 ------- ------ ------ ------- Increase in Net Interest Income...................... $ 6,436 $1,390 $1,272 $ 9,098 ======= ====== ====== =======
The Company's interest income (net of interest due on nonaccrual loans) increased by $20.9 million or 37.9% during the first nine months of 1998 as compared to the same period in 1997. This increase was primarily attributable to increases in the average balance of loans outstanding and, to a lesser extent, increases in the weighted average yield earned thereon. Interest expense increased by $11.8 million or 36.6%, during the first nine months of 1998, as compared to the same period in the prior year, which was primarily due to an increase in the average balances of the Company's deposits and borrowings and to a lesser extent, increases in the weighted average rate paid on the Company's deposits. 14 15 As a result of the foregoing, the Company's net interest income increased by $9.1 million, or 39.8%, from $22.9 million during the first nine months of 1997 to $32.0 million during the comparable period in 1998, and the Company's net interest margin (net interest income divided by average interest-earning assets) increased by 22 basis points, or 6.0%, from 3.68% to 3.90% during the same respective periods. PROVISIONS FOR POSSIBLE CREDIT LOSSES ON LOANS For the three and nine months ended September 30, 1998, the Company recorded provisions for possible credit losses on loans of $2.0 million and $5.2 million, respectively, compared with provisions for credit losses of $1.5 million and $3.7 million, recorded during the three and nine months ended September 30, 1997, respectively. These increases reflected the Company's efforts to maintain adequate levels of loan reserves given the continuing successful expansion of the Company's financing business and growing loan portfolio. The Company has established internal guidelines for loan loss reserves which consider the composition and size of the loan portfolio, as well as the composition and amount of its nonperforming loans. At September 30, 1998, the Company's allowance for credit losses amounted to $16.2 million, of which $11.6 million was general reserves. Although the Company maintains its allowance for credit losses at a level which it considers to be adequate to provide for probable losses based on presently known conditions, there can be no assurance that such losses will not exceed the estimated amounts, thereby adversely affecting future results of operations. The calculation of the adequacy of the allowance for credit losses, and therefore the requisite amount of provision for credit losses, is based on several factors, including underlying loan collateral values, delinquency trends and historical loan loss experience, all of which can change without notice based on market and economic conditions and other factors. NONINTEREST REVENUES The table below sets forth information concerning the Company's noninterest revenues for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------------ 1998 1997 CHANGE 1998 1997 CHANGE ------ ------ ------ ------ ------ ------ Loan-related fees.............................. $1,184 $ 944 $240 $2,915 $2,063 $852 Other.......................................... 178 401 (223) 612 832 (220) ------ ------ ---- ------ ------ ---- $1,362 $1,345 $ 17 $3,527 $2,895 $632 ====== ====== ==== ====== ====== ====
Loan-related fees consist of prepayment, extension, modification, escrow and exit fees collected from customers. Other non-interest revenues for the quarter ended September 30, 1997, principally included a non-recurring benefit from the termination of a Company-sponsored retirement plan. NONINTEREST EXPENSES -- GENERAL AND ADMINISTRATIVE COSTS The table below details the Company's general and administrative costs for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER SEPTEMBER 30, 30, ------------------------ ----------------------------- 1998 1997 CHANGE 1998 1997 CHANGE ------ ------ ------ -------- -------- ------- Employee..................................... $3,570 $2,511 $1,059 $10,195 $ 7,818 $2,377 Operating.................................... 2,045 1,264 781 5,351 3,572 1,779 Occupancy.................................... 1,054 752 302 2,905 2,247 658 Professional................................. 324 468 (144) 1,157 1,173 (16) SAIF insurance premium and OTS assessment.... 247 208 39 703 1,063 (360) ------ ------ ------ ------- ------- ------ $7,240 $5,203 $2,037 $20,311 $15,873 $4,438 ====== ====== ====== ======= ======= ======
15 16 During the last half of 1997 and continuing into mid 1998, the Company increased its lending staff, including retaining new senior managers for each of its primary financing groups, in response to the substantial growth in the volume of new business generated since the third quarter of 1997. During this period, the Company has also hired personnel to prepare for, and to implement, new computer-based systems during 1998. The cost of these personnel caused employee-related costs to increase by 30% during the first nine months of 1998 as compared with the same period in 1997, which amount is also inclusive of additional compensation costs attributable to the Company's financial performance during the period. The Company has also experienced an increase in operating costs primarily as a result of its efforts related to the ongoing computer systems conversions and expenditures related to its focused efforts to expand the Company's retail banking presence. NONINTEREST EXPENSES -- REAL ESTATE OPERATIONS The table below sets forth the revenues and costs attributable to the Company's REO for the periods indicated. The compensatory and legal costs directly associated with the Company's property management and disposal operations are included in the table above in NONINTEREST EXPENSES -- GENERAL AND ADMINISTRATIVE COSTS (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- --------------------------- 1998 1997 CHANGE 1998 1997 CHANGE ----- ----- ------ ------- ------- ------- Expenses associated with real estate operations Property taxes..................... $ -- $ 48 $ (48) $ 3 $ 90 $ (87) Repairs, maintenance and renovation....................... 146 7 139 183 38 145 Insurance.......................... 50 58 (8) 91 138 (47) ----- ----- ----- ------- ------- ------- Total......................... 196 113 83 277 266 11 Net recoveries from sale of properties............................ (826) (545) (281) (2,221) (1,013) (1,208) Property operations, net................ 14 (108) 122 (51) (292) 241 Provision for estimated losses on real estate owned.......................... -- 50 (50) 15 811 (796) ----- ----- ----- ------- ------- ------- (Income) loss from real estate owned, net................................... $(616) $(490) $(126) $(1,980) $ (228) $(1,752) ===== ===== ===== ======= ======= =======
The costs included in the table above (and, therefore, excluded from operating costs (see NONINTEREST EXPENSES -- GENERAL AND ADMINISTRATIVE COSTS)), reflect holding costs directly attributable to the Company's REO. Net recoveries from sales of REO represent the difference between the proceeds received from property disposal and the carrying value of such properties upon disposal. Property operations principally include the net operating income (collected rental revenues less operating expenses and certain renovation costs) from foreclosed income properties or receipt, following foreclosure, of similar funds held by receivers during the period the original loan was in default. During the three and nine months ended September 30, 1998, the Company recorded gains on the sale of foreclosed properties, principally two parcels of land. These two liquidations represented the last remaining large real estate owned acquired whose origins pre-date 1995, and the gains realized are not expected to be repeated. INCOME TAXES The Company recorded income tax provisions of $1.6 million and $3.5 million for the three and nine months ended September 30, 1998, respectively, as compared to tax provision of $25,000 and a tax benefit of $1.6 million, recorded during the same periods in 1997. The effective tax rates were 32.1% and 29.4% for the three and nine months ended September 30, 1998, which reflects the benefit of the reduction of deferred tax valuation allowance previously established. At September 30, 1998, $1.4 million of income tax benefits, consisting primarily of net operating loss carryforwards and future tax deductions, remained available 16 17 for financial statement purposes. The recognition of these accumulated income tax benefits is subject to limitations under GAAP and for regulatory capital purposes. The primary factor affecting the timing and magnitude of recognition of these accumulated income tax benefits is the current and future profitability of the Company. Additionally, no more than 10% of the Bank's regulatory capital can be represented by a deferred tax asset created pursuant to anticipated future utilization of an institution's income tax benefits. Should the Company cease to be profitable, or should the Company record substantial operating losses in the future, all or a portion of the deferred tax asset established to date may need to be reversed. FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY ASSETS CASH AND CASH EQUIVALENTS Cash and cash equivalents at September 30, 1998 and at December 31, 1997 consisted of the following (dollars are in thousands).
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------ Cash....................................... $ 22,075 $ 9,520 Federal funds sold......................... 121,700 42,100 -------- ------- $143,775 $51,620 ======== =======
INVESTMENT SECURITIES The table below summarizes the cost basis and estimated fair value of investment securities available-for-sale at September 30, 1998 and at December 31, 1997 (dollars are in thousands).
GROSS UNREALIZED ESTIMATED AMORTIZED ----------------- FAIR COST GAINS LOSSES VALUE --------- ------ ------- --------- September 30, 1998.......... U.S. Treasuries $22,669 10 -- $22,679 December 31, 1997........... Mutual Fund $ 572 6 -- $ 578
Investment securities are classified as available-for-sale, with both a cost basis and an estimated fair value of $22.7 million at September 30, 1998, had a weighted average yield of 5.22%, and were due in less than one year. 17 18 LOANS RECEIVABLE GENERAL The Company's loan portfolio consists almost exclusively of loans secured by real estate located in Southern California. The table below sets forth the composition of the Company's loan portfolio as of the dates indicated (dollars are in thousands).
SEPTEMBER 30, 1998 DECEMBER 31, 1997 --------------------- ------------------- BALANCE PERCENT BALANCE PERCENT ---------- ------- -------- ------- Single family Estate(1).............................. $ 311,969 21.5% $173,764 18.0% Conventional........................... 208,681 14.4 222,865 23.0 Income property Multi-family........................... 249,609 17.2 225,738 23.2 Commercial real estate................. 187,075 12.9 111,893 11.6 Construction........................... 54,088 3.7 7,310 0.8 Land..................................... 82,442 5.7 39,475 4.1 Single family construction Individual residences.................. 249,611 17.2 107,989 11.2 Tract development...................... 75,989 5.2 68,653 7.1 Other.................................... 31,947 2.2 9,698 1.0 ---------- ----- -------- ----- Gross loans receivable(2)................ 1,451,411 100.0% 967,385 100.0% ===== ===== Less Undisbursed loan funds................. (238,078) (108,683) Deferred loan fees and credits, net.... (6,791) (7,177) Reserves............................... (16,160) (13,274) ---------- -------- Net loans receivable..................... $1,190,382 $838,251 ========== ========
- --------------- (1) Generally defined as individual loans with principal balances of more than $1.0 million originated since 1994. (2) Gross loans receivable includes outstanding balance plus undisbursed commitments. The table below sets forth the approximate composition of the Company's gross new loan commitments, net of internal refinances, for the periods indicated in dollars and as a percentage of total loans originated (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 1998 SEPTEMBER 30, 1998 ------------------- ------------------- TYPE OF SECURITY AMOUNT % AMOUNT % ---------------- --------- ------ --------- ------ Single family Estate.................................... $ 84,200 31.0% $197,500 27.7% Conventional.............................. 7,800 2.9 20,600 2.9 Income property Multi-family.............................. 21,000 7.7 50,900 7.1 Commercial real estate.................... 12,600 4.6 74,200 10.4 Construction.............................. 27,400 10.1 64,200 9.0 Land........................................ 18,800 6.9 75,200 10.5 Single family construction Individual residences..................... 69,800 25.7 178,200 25.0 Tract development......................... 29,300 10.8 37,700 5.3 Other....................................... 1,100 0.4 14,500 2.0 -------- ----- -------- ----- $272,000 100.0% $713,000 100.0% ======== ===== ======== =====
18 19 ASSET QUALITY NONACCRUAL AND TROUBLED DEBT RESTRUCTURED LOANS The Company places loans on nonaccrual status when (1) they become 30 or more days 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 following table provides information regarding the Company's nonaccrual loans as of the dates indicated (dollars are in thousands).
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------ Loans past due 90 days or more............................. $14,446 $10,793 Loans past due 30-89 days.................................. 11,738 4,435 Other nonaccrual loans..................................... 1,900 168 ------- ------- Total(1)......................................... $28,084 $15,396 ======= ======= Reserves to loans past due 90 days or more................. 111.9% 123.0% Reserves to total nonaccrual loans......................... 57.5% 86.2%
- --------------- (1) Includes $5.5 million and $0.5 million of troubled debt restructured loans ("TDRs") at September 30, 1998 and December 31, 1997, respectively. Excludes $31.0 million and $29.1 million of TDRs which were performing in accordance with their modified terms at September 30, 1998 and December 31, 1997, respectively. Although management of the Company has successfully reduced its nonperforming assets in recent years, the real estate markets and the overall economy in its market area are likely to be significant determinants of the quality of the Company's assets in the future periods and, thus, its financial condition and results of operations. The Company's financial condition and results of operations may also be adversely affected to the extent the Company's newly originated loans experience asset quality problems. In addition, in the view of the relatively large size of many of the Company's loans, the movement of even a few loans into the nonperforming category could have a material impact on the Company's asset quality ratios and adversely affect its results of operations. 19 20 CLASSIFIED ASSETS The table below sets forth information concerning the Company's classified assets at the dates indicated. Classified assets include REO, delinquent loans and performing loans which have been adversely classified pursuant to OTS regulations and guidelines ("Performing/Classified" loans) (dollars are in thousands).
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------ Real estate owned, net..................................... $ 2,178 $ 9,859 Nonperforming loans(1)..................................... 14,446 10,793 ---------- -------- Total nonperforming assets................................. 16,624 20,652 Other delinquent loans(2).................................. 11,738 4,435 Performing loans classified substandard(3)................. 39,715 36,013 ---------- -------- Total classified assets.................................... $ 68,077 $ 61,100 ========== ======== Classified loans(4)........................................ $ 65,899 $ 51,241 ========== ======== Loans receivable(5)........................................ $1,222,702 $851,525 ========== ======== Reserves on loans Specific................................................. $ 4,527 $ 3,878 General.................................................. 11,633 9,396 ---------- -------- $ 16,160 $ 13,274 ========== ======== Total reserves to loans receivable......................... 1.3% 1.6% Total reserves to classified loans......................... 24.5% 25.9% Total reserves to nonperforming loans...................... 111.9% 123.0% Gross nonperforming assets to total assets................. 1.2% 2.2%
- --------------- (1) Loans 90 days or more delinquent. All such loans are on nonaccrual status. (2) Loans 30 to 89 days delinquent. All such loans are on nonaccrual status. (3) Includes $1.9 million and $0.2 million of performing loans on nonaccrual status at September 30, 1998 and at December 31, 1997, respectively. (4) Includes $28.1 million and $15.4 million of nonaccrual loans at September 30, 1998, and at December 31, 1997, respectively. (5) Loans receivable are exclusive of the allowance for credit losses. The carrying value of nonperforming assets (i.e., real estate owned and loans 90 days or more delinquent) decreased to $16.6 million, or 1.2% of total assets, at September 30, 1998, from $20.7 million, or 2.2% of total assets, at December 31, 1997. 20 21 The table below sets forth information concerning the Company's total classified loans as of September 30, 1998 (dollars are in thousands).
CLASSIFIED LOANS -------------------------------------------------- OTHER PERFORMING NONPERFORMING(1) DELINQUENCIES(2) LOANS TOTAL ---------------- ---------------- ---------- ------- Single family Estate............................... $ 7,902 $ 7,560 $20,237 $35,699 Conventional......................... 2,446 2,346 11,760 16,552 Income property Multi-family......................... -- 1,063 784 1,847 Commercial real estate............... 2,000 -- -- 2,000 Construction......................... -- -- -- -- Land................................... -- -- -- -- Single family construction Individual residences................ 2,098 769 1,089 3,956 Tract development.................... -- -- 4,847 4,847 Other.................................. -- -- 998 998 ------- ------- ------- ------- Total........................ $14,446 $11,738 $39,715 $65,899 ======= ======= ======= =======
- --------------- (1) Loans 90 days or more delinquent. All such loans are on nonaccrual status. (2) Loans 30 to 89 days delinquent. All such loans are on nonaccrual status. RESERVES Management establishes specific reserves for losses on individual loans and REO when it has determined that recovery of the Company's gross investment is not probable and when the amount of loss can be reasonably determined. In making this determination, management considers (1) the status of the asset, (2) the probable future status of the asset, (3) the value of the asset or underlying collateral and (4) management's intent with respect to the asset. In quantifying the loss, if any, associated with individual loans and REO, management utilizes external sources of information (i.e. appraisals, price opinions from real estate professionals, comparable sales data and internal estimates). In establishing specific reserves, management estimates the revenues expected to be generated from the disposal of the Company's collateral or owned property, less construction and renovation costs (if any), holding costs and transaction costs. For tract construction and land developments, the resulting projected cash flows are discounted utilizing a market rate of return to determine their value. Management establishes general reserves against the Company's portfolio of loans. Generally, such general reserves are established for each segment of the Company's loan portfolio. In establishing general reserves, management incorporates (1) the recovery rate for similar properties previously sold by the Company, (2) valuations of groups of similar assets, (3) the probability of future adverse events (i.e., performing loans which became nonperforming, loans in default which proceed through foreclosure) and (4) guidelines published by the OTS. 21 22 The table below sets forth the general and specific reserves for the Company's loan portfolio as of September 30, 1998 (dollars are in thousands).
LOANS ------------------------ PERFORMING DELINQUENT TOTAL ---------- ---------- ------- Specific reserves................................... $ 3,243 $1,284 $ 4,527 General reserves.................................... 11,308 325 11,633 ------- ------ ------- Total..................................... $14,551 $1,609 $16,160 ======= ====== ======= Percentages % of total reserves to gross investment............. 1.2% 6.1% 1.3% % of general reserves to gross investment........... 0.9% 1.2% 1.0%
The table below summarizes the activity of the Company's reserves for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 1998 1997 1998 1997 ---------- -------- ---------- -------- Loans Average loans outstanding............ $1,146,124 $749,531 $1,020,795 $722,126 ========== ======== ========== ======== Reserve balance at beginning of period............................. $ 14,541 $ 12,381 $ 13,274 $ 13,515 Provision for credit losses.......... 1,950 1,500 5,185 3,739 Charge-offs: Single family Estate.......................... (170) -- (170) -- Conventional.................... (156) (349) (891) (2,705) Income property Multi-family.................... (5) (279) (1,038) (1,135) Commercial real estate.......... -- -- (200) -- Other.............................. -- -- -- (11) Land............................... -- -- -- (150) ---------- -------- ---------- -------- Total charge-offs.......... (331) (628) (2,299) (4,001) ---------- -------- ---------- -------- Balance at end of period............. $ 16,160 $ 13,253 $ 16,160 $ 13,253 ========== ======== ========== ======== Ratio of net charge-offs to average loans outstanding during the period............................. 0.0% 0.1% 0.2% 0.6% Real estate owned Reserve balance at beginning of period.......................... $ 12 $ 9,377 $ 2,563 $ 11,871 Provision for credit losses.......... -- 50 15 811 Charge-offs.......................... (12) (305) (2,578) (3,560) ---------- -------- ---------- -------- Balance at end of period............. $ -- $ 9,122 $ -- $ 9,122 ========== ======== ========== ========
22 23 Because the Company's loan portfolio is not homogeneous, but rather consists of discreet segments with different collateral and borrower risk characteristics, management separately measures reserve adequacy, and establishes and maintains reserves for credit losses, for each identifiable segment of this portfolio. The table below summarizes the allocation of the Company's reserves by type of collateral at the dates indicated (dollars are in thousands).
DECEMBER 31, 1997 SEPTEMBER 30, 1998 ---------------------- ------------------------- PERCENT OF PERCENT OF RESERVES TO RESERVES TO TOTAL TOTAL LOANS(1) LOANS(1) BALANCE BY CATEGORY BALANCE BY CATEGORY ------- -------------- ------- ----------- Single family Estate............................. $ 3,738 1.2% $ 1,975 1.1% Conventional....................... 3,571 1.7% 4,696 2.1% Income property Multi-family....................... 1,136 0.5% 2,000 0.9% Commercial real estate............. 3,566 1.9% 2,252 2.0% Construction....................... 189 0.3% 10 0.1% Land................................. 334 0.4% 162 0.4% Single family construction Individual residences.............. 783 0.3% 503 0.5% Tract development.................. 950 1.3% 807 1.2% Other................................ 464 1.5% 226 2.3% Unallocated.......................... 1,429 --% 643 --% ------- ------- $16,160 1.1% $13,274 1.4% ======= =======
- --------------- (1) Percent of reserves to gross loan commitments, which include undisbursed commitments. The table below summarizes reserves at the dates indicated for each of the REO by type of property (dollars are in thousands).
SEPTEMBER 30, 1998 DECEMBER 31, 1997 ------------------------ ------------------------ PERCENT OF PERCENT OF RESERVES TO RESERVES TO TOTAL REO TOTAL REO PROPERTIES BY CATEGORY PROPERTIES BY CATEGORY ---------- ----------- ---------- ----------- Single family Conventional............................... $-- % $1,523 19.8% Income property Multi-family............................... -- % 18 0.8% Land......................................... -- % 1,022 43.2% Unallocated -- ------ $-- % $2,563 20.6% == ======
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 NONINTEREST EXPENSES -- REAL ESTATE OPERATIONS. 23 24 The table below summarizes the composition of the Company's REO at the dates indicated (dollars are in thousands).
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------- ------------ Single family Conventional............................................. $1,574 $7,695 Income property Multi-family............................................. 604 2,362 Land....................................................... -- 2,365 ------ ------ Gross investment(1)........................................ 2,178 12,422 Allowance for estimated losses............................. -- (2,563) ------ ------ Net investment............................................. $2,178 $9,859 ====== ======
- --------------- (1) Fair value of collateral at foreclosure, plus post-foreclosure capitalized costs. SOURCES OF FUNDS GENERAL The Company's principal sources of funds in recent years have been deposits obtained on a retail basis through its branch offices and, to a lesser extent, advances from the FHLB. In addition, funds have been obtained from maturities and repayments of loans and securities, and sales of loans, securities and other assets, including real estate owned. DEPOSITS Total deposits at September 30, 1998, were $994.9 million, an increase from $799.5 million at December 31, 1997. The table below summarizes the balances by original term, weighted average interest rates ("WAIR") and weighted average remaining maturities in months ("WARM") for the Company's deposits at the dates indicated (dollars are in thousands).
SEPTEMBER 30, 1998 DECEMBER 31, 1997 ------------------------ ------------------------ DESCRIPTION BALANCE WAIR WARM BALANCE WAIR WARM ----------- -------- ---- ---- -------- ---- ---- Transaction accounts............... $144,159 2.87% -- $105,812 2.44% -- Certificates of deposit 7 day maturities................. 37,494 4.42% -- 42,907 4.43% -- Less than 6 months............... 154,163 5.43% 3 35,418 5.57% 2 6 months to 1 year............... 555,796 5.70% 6 456,072 5.80% 8 1 year to 2 years................ 32,485 5.63% 11 146,674 5.74% 7 Greater than 2 years............. 70,835 5.82% 9 12,618 5.45% 13 -------- -------- Total.............................. $994,932 5.21% 5 $799,501 5.26% 6 ======== ========
24 25 FHLB ADVANCES The Company has a credit line with the FHLB with a maximum advance of up to 35% of total assets. The FHLB system functions as a source of credit to savings institutions which are members. 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's advance policies and requirements, these advances can be requested for any business purpose in which the Company is authorized to engage. In granting advances, the FHLB considers a member's creditworthiness and other relevant factors. The table below sets forth certain information regarding the Company's FHLB advances (dollars are in thousands)
REMAINING ORIGINAL TERM WEIGHTED TERM --------------- AVERAGE NUMBER BALANCE YEARS YEARS MONTHS RATE ------ -------- -------- ----- ------ -------- September 30, 1998................. 7 $264,000 5 & 10 5 7 5.18% December 31, 1997.................. 1 40,000 1 6 5.95%
Each of the Company's advances outstanding at September 30, 1998, contain an option by the FHLB which allows them to call in the advance prior to maturity, subject to an initial non-callable period of two to five years from origination. SENIOR NOTES On December 31, 1997, the Company completed the issuance of $40.0 million of Senior Notes due 2004. These notes bear an interest rate of 12.5%, and are callable after December 31, 2002. Interest is required to be paid semiannually at the stated interest rate. STOCKHOLDERS' EQUITY; REGULATORY CAPITAL The Company's capital consists of common stockholders' equity, which at September 30, 1998, amounted to $79.0 million and represented 5.7% of the Company's total assets. The following table summarizes the regulatory capital requirements under the Home Owners' Loan Act ("HOLA") for the Bank at September 30, 1998. As indicated in the table, the Bank's capital levels exceed all three of the currently applicable minimum HOLA capital requirements (dollars are in thousands).
TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL ------------------ ------------------ ------------------- BALANCE % BALANCE % BALANCE % ---------- ---- ---------- ---- --------- ------ Stockholders' equity(1).......... $ 94,752 $ 94,752 $ 94,752 Adjustments General reserves............... -- -- 11,633 Unrealized (gains) losses, net......................... -- -- -- ---------- ---- ---------- ---- -------- ----- Regulatory capital............... 94,752 6.92% 94,752 6.92% 106,385 10.90% Required minimum................. 20,551 1.50 41,103 3.00 78,052 8.00 ---------- ---- ---------- ---- -------- ----- Excess capital................... $ 74,201 5.42% $ 53,649 3.92% $ 28,333 2.90% ========== ==== ========== ==== ======== ===== Adjusted assets(2)............... $1,370,097 $1,370,097 $975,654 ========== ========== ========
- --------------- (1) Reflects capital contributions totaling $12.0 million from the parent company made during 1998 (2) The term "adjusted assets" refers to the term "adjusted total assets", as defined in 12 C.F.R. Section 567.1(a), for purposes of tangible and core capital requirements, and for purposes of risk-based capital requirements, refers to the term "risk-weighted assets", as defined in 12 C.F.R. Section 567.1(d). 25 26 As of September 30, 1998, the most recent notification from the OTS categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's actual capital amounts and ratios and the capital amounts and ratios required in order for an institution to be "well capitalized" and "adequately" capitalized are presented in the table below (dollars are in thousands).
TO BE CATEGORIZED AS ADEQUATELY TO BE CATEGORIZED AS CAPITALIZED WELL CAPITALIZED UNDER PROMPT UNDER PROMPT CORRECTIVE CORRECTIVE ACTUAL ACTION PROVISIONS ACTION PROVISIONS ------------------ --------------------- --------------------- AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS -------- ------ --------- -------- --------- -------- AS OF SEPTEMBER 30, 1998 Total Capital (to Risk Weighted Assets)......... $106,385 10.90% $78,052 8.00% $97,565 10.00% Core Capital (to Adjusted Tangible Assets)..... 94,752 6.92% 41,103 3.00% 68,505 5.00% Tangible Capital (to Adjusted Tangible Assets)..... 94,752 6.92% 20,551 1.50% N/A N/A Tier 1 Capital (to Risk Weighted Assets)......... 94,752 9.70% N/A N/A 58,539 6.00% AS OF DECEMBER 31, 1997 Total Capital (to Risk Weighted Assets)......... $ 78,454 11.48% $54,679 8.00% $68,349 10.00% Core Capital (to Adjusted Tangible Assets)..... 69,900 7.55% 27,773 3.00% 46,289 5.00% Tangible Capital (to Adjusted Tangible Assets)..... 69,900 7.55% 13,887 1.50% N/A N/A Tier 1 Capital (to Risk Weighted Assets)......... 69,900 10.23% N/A N/A 41,009 6.00%
The OTS has authority, after an opportunity for a hearing, to downgrade an institution from "well capitalized" to "adequately capitalized" or to subject an "adequately capitalized" or "undercapitalized" institution to the supervisory actions applicable to the next lower category, if the OTS deems such action to be appropriate as a result of supervisory concerns. CAPITAL RESOURCES AND LIQUIDITY The parent company had $0.7 million of cash on hand and $22.7 million in short-term securities, at September 30, 1998. The parent company is a holding company with no significant business operations outside of the Bank. Its requisite obligations in relation to its debt and operations are primarily dependent upon dividends from the Bank, the payment of which is subject to the requirements of applicable laws and regulations. The Company's liquidity position refers to the extent to which the Company's funding sources are sufficient to meet its current and long-term cash requirements. Federal regulations currently require a savings association to maintain a monthly average daily balance of liquid assets (including cash, certain time deposits, bankers' acceptances, and specified United States Government, state or federal agency obligations) equal to 4.0% of the average daily balance of its net withdrawable accounts and short-term borrowings during the preceding calendar quarter. This liquidity requirement may be changed from time to time by the OTS to any amount within the range of 4.00% to 10.00% of such accounts and borrowings depending upon economic conditions and the deposit flows of member associations. Monetary penalties may be imposed for failure to meet this liquidity ratio requirement. The Company's liquidity for the calculation period ended September 30, 1998 was 10.1%, which exceeded the applicable minimum requirements. 26 27 The Company's current primary funding resources are deposits, principal payments on loans, FHLB advances and cash flows from operations. Other possible sources of liquidity available to the Company include 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 Company are principally for the payment of interest on and withdrawals of deposit accounts, the funding of loans and operating costs and expenses. YEAR 2000 COMPLIANCE The following constitutes a "Year 2000 Readiness" disclosure under the Year 2000 Information and Readiness Disclosure Act. The Year 2000 issue arises because many existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If a bank does not resolve problems related to the Year 2000 issue, computer systems may incorrectly compute payment, interest or delinquency information. In addition, because payment and other important data systems are linked by computer, if the banks or other third parties with which the Company conducts ongoing operations do not resolve this potential problem in time, the Company may experience significant data processing delays, mistakes or failures. These delays, mistakes or failures may have a significant adverse impact on the financial condition, results of operations and cash flows of the Company. The Company, however, has adopted, and is implementing, a plan to address the Year 2000 issue. The plan includes the assessment of all internal systems, programs and data processing applications (with respect to the Company, including the new applications which are integral to the conversion of its computer-based systems), as well as those provided to the Company by third-party vendors. The Company has recently completed the process of converting from an outsourced, host-based system to an in-house client-server computer system. The Company no longer relies on any third-party provider for loan or deposit accounting. The Company currently is performing its own Year 2000 testing by creating a database that will roll forward systematically until the in-house computer systems process data into what it believes is early 2000. Additionally, in reviewing its most likely worst case scenarios, the Company has begun establishing contingency plans that will provide for alternative methods of conducting business for critical functions. These plans will be completed by year end 1998. The Company has conducted an extensive review of all of its critical third party service providers' Year 2000 compliance efforts and identified certain providers that require additional examination. In the process, the Company identified six critical core data systems that are third party supported or developed. Five of these providers have asserted that their systems are compliant with the sixth core data system expected to be compliant by December 1998. The Company has also has identified fifteen critical service providers (non-data service related) of which two have asserted that they are Year 2000 compliant and seven have indicated they will be so by mid-1999. The company is developing contingency plans for business continuity for all critical functions. While the Company has received assurances from vendors as to compliance, such assurances are not guarantees and may not be enforceable. The Company, through the Bank, extends principally all of its credit on a real estate-secured basis. The Company's primary source of repayment is by cash flow of the borrower, although the underlying real estate collateral is the ultimate security. The Company has approximately 2,400 loans within its portfolio of assets and has begun Year 2000 assessments on the portfolio, beginning with an assessment of larger commercial income property loans (greater than $3.0 million). Within this first priority assessment group, the Company has identified eighteen loans, totaling approximately $110.0 million, and have a contractual maturity beyond December 31, 1999. Because these loans have an ongoing business operations aspect, the Company believes that they may be more susceptible to Year 2000 concerns. The Company has not yet taken steps to assess such borrowers' Year 2000 compliance. If the borrowers fail to be Year 2000 compliant, the Company cannot at this time determine whether such noncompliance would affect their ability to service their debt obligation. The Company continues to assess its exposure related to larger borrowers (those with loans over $3.0 million) 27 28 that may be adversely impacted by Year 2000 issues and expects to complete its assessment of such borrowers by June 1999. Additionally, the Company has added a Year 2000 assessment as a component to its internal review process of the remainder of its existing loan portfolio, including smaller (less than $3.0 million) loans, and expects to complete its assessment of all borrowers by June 1999. The Company cannot at this time determine if any borrower's failure to be Year 2000 compliant will affect their ability to service their debt obligation. In all such instances, the credit extended to these borrowers is collateralized by real estate, which inherently minimizes the Company's exposure. In general, the Company does not believe that any Year 2000 issues will materially affect the Company's products, services or competitive conditions. Expense incurred and to be incurred by the Company to ensure Year 2000 compliance is substantially integrated and included with the expense associated with the conversion of its computer-based systems. In addition, the Company does not believe that the cost of addressing Year 2000 issues is a material event. The Company anticipates incurring approximately $3.3 million in costs related to data processing conversions and the implementation of the Company's Year 2000 plan. Approximately $1.2 million of such costs are expected to be expensed during 1998 while approximately $2.1 million of such costs are expected to be capitalized and expensed over a three-year period. INTEREST RATE RISK MANAGEMENT The objective of interest rate risk management is to stabilize the Company's net interest income ("NII") while limiting the change in its net portfolio value ("NPV") from interest rate fluctuations. The Company seeks to achieve this objective by matching its interest sensitive assets and liabilities, and maintaining the maturity and repricing of these assets and liabilities at appropriate levels given the interest rate environment. When the amount of rate-sensitive liabilities exceeds rate-sensitive assets within specified periods, the NII generally will be negatively impacted by increasing interest rates and positively impacted by decreasing interest rates during such periods. Conversely, when the amount of rate-sensitive assets exceeds the amount of rate-sensitive liabilities within specified periods, net interest income generally will be positively impacted by increasing interest rates and negatively impacted by decreasing interest rates during such periods. The speed and velocity of the repricing of assets and liabilities will also contribute to the effects on NII. The Company utilizes two methods for measuring interest rate risk, gap analysis and interest rate simulations. Gap analysis focuses on measuring absolute dollar amounts subject to repricing within certain periods of time, particularly the one-year maturity horizon. Interest rate simulations provide the Company with an estimate of both the dollar amount and percentage change in NII under various interest rate scenarios. All assets and liabilities are subjected to tests of up to 400 basis points in increases and decreases in interest rates. Under each interest rate scenario, the Company projects its net interest income and the NPV of its current balance sheet. From these results, the Company can then develop alternatives to dealing with the tolerance thresholds. The Company's interest rate risk strategy emphasizes the management of asset and liability balances within repricing categories in order to limit the Bank's exposure to earnings variations as well as variations in the value of assets and liabilities due to changes in interest rates over time. The Company does not currently utilize off balance sheet hedging instruments in order to hedge it's interest rate exposure. Instead, the Company hedges such exposure internally through the use of core deposit accounts and FHLB advances together with an emphasis on investing in shorter-term or adjustable-rate assets. 28 29 The following table sets forth information concerning sensitivity of the Company's interest-earning assets and interest-bearing liabilities as of September 30, 1998. The amounts of assets and liabilities shown within a particular period were determined in accordance with the contractual maturities of the assets and liabilities, except that adjustable-rate loans are included in the period in which they are first scheduled to adjust and not in the period in which they mature. Such assets and liabilities are classified by the earlier of maturity or repricing date (dollars are in thousands).
OVER THREE OVER SIX OVER ONE THREE THROUGH THROUGH YEAR OVER MONTHS SIX TWELVE THROUGH FIVE OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL -------- ---------- --------- ---------- -------- ---------- INTEREST-EARNING ASSETS Cash and cash equivalents(1)............ $143,775 $ -- $ -- $ -- $ -- $ 143,775 Investments and FHLB Stock... 35,992 -- -- -- -- 35,992 Loans(2)..................... 783,250 248,083 32,193 29,088 120,719 1,213,333 -------- -------- --------- --------- -------- ---------- Total interest-earning assets............. $963,017 $248,083 $ 32,193 $ 29,088 $120,719 $1,393,100 ======== ======== ========= ========= ======== ========== INTEREST-BEARING LIABILITIES Deposits Transaction accounts...... $144,149 $ -- $ -- $ -- $ -- $ 144,149 Certificates of deposit... 37,504 154,163 555,796 103,320 -- 850,783 FHLB advances................ -- -- -- 215,000 49,000 264,000 Senior Notes................. -- -- -- -- 40,000 40,000 -------- -------- --------- --------- -------- ---------- Total interest-bearing liabilities........ $181,653 $154,163 $ 555,796 $ 318,320 $ 89,000 $1,298,932 ======== ======== ========= ========= ======== ========== Interest rate sensitivity gap....................... $781,364 $ 93,920 $(523,603) $(289,232) $ 31,719 $ 94,168 Cumulative interest rate sensitivity gap........... 781,364 875,284 351,681 62,449 94,168 94,168 Cumulative interest rate sensitivity gap as a percentage of total interest-earning assets... 56.1% 62.8% 25.2% 4.5% 6.8% 6.8%
- --------------- (1) Excludes noninterest-earning cash balances. (2) Loans include $28.1 million of nonaccrual loans, and are exclusive of loan loss reserves. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Bank seeks to control its interest rate risk exposure in a manner that will allow for adequate levels of earnings and capital over a range of possible interest rate environments. The Bank has adopted formal policies and practices to monitor and manage interest rate risk exposure. As part of this effort, the Bank uses the market value ("MV") methodology, a type of sensitivity analysis, to gauge interest rate risk exposure. Generally, MV is the discounted present value of the difference between incoming cash flows on interest-earning assets and other assets and outgoing cash flows on interest-bearing liabilities and other liabilities. The application of the methodology attempts to quantify interest rate risk as the change in the MV which would result from changes in market interest rates in theoretical increments of 100 basis points, up to 400 basis points in either direction. At December 31, 1997, it was estimated that the Bank's MV would decrease 8.8% and 18.0% in the event of 200 and 400 basis point increases in market interest rates, respectively. The Bank's MV at the same date would increase 9.3% and 19.4% in the event of 200 and 400 basis point decreases in market rates, respectively. 29 30 Presented below, as of June 30, 1998, is an analysis of the Bank's MV interest rate risk as measured by changes in MV for instantaneous and sustained parallel shifts of 200 and 400 basis point increments in market interest rates (dollars are in thousands).
MARKET VALUE ------------------------------ CHANGE IN RATES $ AMOUNT $ CHANGE % CHANGE - --------------- -------- -------- -------- +400 bp.... $113,909 $(10,971) (8.79%) +200 bp.... 124,139 (741) (0.59%) 0 bp....... 124,880 -- --% - -200 bp.... 117,885 (6,995) (5.60%) - -400 bp.... 114,205 (10,675) (8.55%)
The Bank's overall improvement in its sensitivity to changes in market rates from the period ended December 31, 1997 to June 30, 1998, is principally attributable to an increase in its interest-earning assets with repricing frequencies of three months or less, which have been supported by longer term interest-bearing liabilities. The effect of these two actions has been a moderation in the Bank's sensitivity to significant changes in market rates. 30 31 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Bank is a defendant in an action entitled Takaki vs. Hawthorne Savings and Loan Association, filed in the Superior Court of the State of California, Los Angeles, as Case No. YC021815. The plaintiffs were owners of real property which they sold in early 1992 to a third party. The Bank provided escrow services in connection with the transaction. A substantial portion of the consideration paid to the plaintiffs took the form of a deed of trust secured by another property then owned by an affiliate of the purchaser. The value of the collateral securing this deed of trust ultimately proved to be inadequate. The plaintiffs alleged that the Bank knew, or should have known, that the security for the plaintiffs' loan was inadequate and should have so advised them. In late June 1997, a trial jury found for the plaintiffs and awarded compensatory and punitive damages totaling $9.1 million. In late July 1997, the trial judge reduced the combined award to $3.3 million. The trial court's judgment was appealed. On July 21, 1998 the Court of Appeal reversed the jury's findings on two of the three causes of action alleged by the plaintiffs, upholding only the trial jury's finding that the Bank's escrow department was negligent in failing to provide copies of escrow amendments to the plaintiff's real estate broker. In rendering its opinion, the Court of Appeals also reversed the jury's findings of compensatory and punitive damages, with instructions to the trial court to retry the matter to determine the amount of damages, if any, attributable to the Bank on the sole issue of negligence. A hearing to schedule a new trial date will be held in November, 1998. Management believes that the amount of damages, if any, attributable to the Bank in this matter will be insignificant. The Company is involved in a variety of other litigation matters. In the opinion of management, none of these cases will have a materially adverse effect on the Bank's or the Company's financial condition or results of operations. ITEM 2. CHANGES IN SECURITIES -- NONE ITEM 3. DEFAULTS UPON SENIOR SECURITIES -- NONE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS -- NONE ITEM 5. OTHER INFORMATION -- NONE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 1. Reports on Form 8-K -- None 2. Other required exhibits -- Exhibit 27.1 -- Financial Data Schedule 31 32 Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HAWTHORNE FINANCIAL CORPORATION Dated November 13, 1998 /s/ NORMAN A. MORALES -------------------------------------- Norman A. Morales Executive Vice President and Chief Financial Officer Dated November 13, 1998 /s/ H. MELISSA LANFRE -------------------------------------- H. Melissa Lanfre Vice President and Principal Accounting Officer 32 EX-27.1 2 FINANCIAL DATA SCHEDULE
9 0000046267 HAWTHORNE FINANCIAL CORPORATION 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 143,775 978,170 0 0 22,679 0 0 1,190,382 16,160 1,395,064 994,932 264,000 17,095 40,000 0 0 52 78,985 1,395,064 73,077 2,938 0 76,015 34,533 44,037 31,978 5,185 0 20,311 11,989 8,463 0 0 8,463 2.21 1.33 9.28 28,084 14,446 36,450 39,715 13,274 2,299 0 16,160 16,160 0 0
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