-----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, TBnxxaUX3G2eDvM3vklZPyy6WtdMJSA2NZ4Csx4+F/ZSzIrzYVN3OIlWZCt64xx/ bs+2jKu3PXG8HxWOEcLEtA== 0000950150-98-000815.txt : 19980514 0000950150-98-000815.hdr.sgml : 19980514 ACCESSION NUMBER: 0000950150-98-000815 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980513 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HAWTHORNE FINANCIAL CORP CENTRAL INDEX KEY: 0000046267 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 952085671 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-01100 FILM NUMBER: 98619002 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 DATED 03/31/1998 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 March 31, 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 3,164,096 shares of Common Stock, $0.01 par value per share, outstanding as of April 30, 1998. ================================================================================ 2 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY FORM 10-Q INDEX For the quarter ended March 31, 1998
PART I - FINANCIAL INFORMATION Page ---- ITEM 1. Financial Statements Consolidated Statements of Financial Condition at March 31, 1998 and December 31, 1997 3 Consolidated Statements of Operations for the Three Months Ended March 31, 1998 and 1997 4 Consolidated Statement of Stockholders' Equity for the Three Months Ended March 31, 1998 5 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 1998 and 1997 6 Notes to Consolidated Financial Statements 8 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 30 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 32 ITEM 2. Changes in Securities 32 ITEM 3. Defaults upon Senior Securities 32 ITEM 4. Submission of Matters to a Vote of Security Holders 32 ITEM 5. Other Information 32 ITEM 6. Exhibits and Reports on Form 8-K 32
FORWARD LOOKING STATEMENTS When used in this Form 10-Q or future filings by Hawthorne Financial Corporation and Subsidiary (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. For an additional discussion of the risks that could affect the Company's results of operations, readers are advised to refer to the section captioned "Risk Factors" in the Company's 10-K. 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)
MARCH 31, DECEMBER 31, 1998 1997 ----------- ----------- ASSETS Cash and cash equivalents $ 60,636 $ 51,620 Investment securities available-for-sale, at market 586 578 Loans receivable (net of allowance for estimated credit losses of $14,092 in 1998 and $13,274 in 1997) 950,589 838,251 Real estate owned (net of allowance for estimated losses of $862 in 1998 and $2,563 in 1997) 6,551 9,859 Investment in capital stock of Federal Home Loan Bank - at cost 7,318 7,213 Deferred tax asset, net 6,350 6,820 Accrued interest receivable 6,235 5,298 Office property and equipment - at cost, net 4,656 4,200 Other assets 3,986 4,358 ----------- ----------- $ 1,046,907 $ 928,197 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits $ 848,870 $ 799,501 FHLB advances 105,000 40,000 Senior notes 40,000 40,000 Accounts payable and other liabilities 8,508 6,377 ----------- ----------- 1,002,378 885,878 Stockholders' equity Preferred stock - $0.01 per share; authorized 10,000,000 shares; none issued and outstanding -- -- Common stock - $0.01 par value; authorized, 20,000,000 shares; issued and outstanding, 3,169,496 shares in 1998 and 3,095,996 shares in 1997 32 31 Capital in excess of par value - common stock 10,770 10,402 Accumulated other comprehensive income - unrealized gain on available-for-sale securities 6 6 Retained earnings 33,853 32,020 ----------- ----------- 44,661 42,459 Less Treasury stock, at cost - 5,400 shares (48) (48) Loan to Employee Stock Ownership Plan (84) (92) ----------- ----------- 44,529 42,319 ----------- ----------- $ 1,046,907 $ 928,197 =========== ===========
See accompanying Notes to Consolidated Financial Statements 3 4 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED MARCH 31, ------------------------- 1998 1997 -------- -------- Interest revenues Loans, net of nonaccrual income $ 21,161 $ 15,506 Investments 833 1,501 -------- -------- Total interest revenues 21,994 17,007 -------- -------- Interest costs Deposits 10,737 8,892 FHLB advances 917 780 Senior notes 1,264 483 -------- -------- Total interest costs 12,918 10,155 -------- -------- Net interest income 9,076 6,852 Provision for credit losses 1,485 1,220 -------- -------- Net interest income after provision for credit losses 7,591 5,632 Noninterest revenues, net Operating 709 732 Non-operating 4 (13) -------- -------- Total noninterest revenues, net 713 719 Noninterest expenses General and administrative costs Employee 3,237 2,769 Operating 1,625 1,181 Occupancy 863 754 Professional 330 348 SAIF premium and OTS assessment 225 372 -------- -------- Total general and administrative costs 6,280 5,424 (Income) loss from real estate operations, net (333) 260 -------- -------- Total noninterest expenses 5,947 5,684 -------- -------- Net earnings before income taxes 2,357 667 Income tax (provision) benefit (524) 692 -------- -------- Net earnings $ 1,833 $ 1,359 ======== ======== Net earnings available for Common Stock (NOTE 3) $ 1,833 $ 750 ======== ======== Basic earnings per share (NOTE 3) $ 0.58 $ 0.29 ======== ======== Diluted earnings per share (NOTE 3) $ 0.32 $ 0.16 ======== ======== Weighted average basic shares outstanding (NOTE 3) 3,157 2,617 ======== ======== Weighted average diluted shares outstanding (NOTE 3) 5,681 4,795 ======== ========
See accompanying Notes to Consolidated Financial Statements. 4 5 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DOLLARS ARE IN THOUSANDS)
COMPREHENSIVE INCOME -------------------- BALANCE AT EXERCISED CHANGE IN BALANCE AT DECEMBER 31, STOCK UNREALIZED NET MARCH 31, 1997 OPTIONS GAINS EARNINGS REPAYMENTS 1998 ----------- ---------- ---------- -------- ---------- -------- Common stock $ 31 $ 1 $ -- $ -- $ -- $ 32 Capital in excess of par value Common stock 10,402 368 -- -- -- 10,770 Accumulated other comprehensive income - unrealized gain on available-for-sale securities 6 -- -- -- 6 Retained earnings 32,020 -- -- 1,833 -- 33,853 Treasury stock (48) -- -- -- -- (48) Loan to employee stock ownership plan (92) -- -- -- 8 (84) -------- -------- ------ -------- -------- -------- Total stockholders' equity $ 42,319 $ 369 $ -- $ 1,833 $ 8 $ 44,529 ======== ======== ====== ======== ======== ======== Comprehensive income $ -- $ 1,833 $ 1,833 ====== ======== ========
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 MARCH 31, ------------------------- 1998 1997 --------- --------- NET CASH FLOWS FROM OPERATING ACTIVITIES Net earnings $ 1,833 $ 1,359 Adjustments Provision (benefit) for income taxes 524 (692) Provision for estimated credit losses on loans 1,485 1,220 Provision for estimated losses on real estate owned 15 280 Net recoveries from sales of real estate owned (299) (24) Net gain from sale of other assets (4) -- Loan fee and discount accretion (1,364) (905) Depreciation and amortization 401 445 FHLB dividends (105) (110) (Increase) decrease in: Accrued interest receivable (937) 80 Other assets 226 (2,340) Increase (decrease) in other liabilities 2,131 (15,365) Other, net - (43) --------- --------- Net cash provided by (used in ) operating activities 3,906 (16,095) --------- --------- NET CASH FLOWS FROM INVESTING ACTIVITIES Investment securities Purchases (8) (40,000) Loans New loans funded (110,673) (43,991) Construction disbursements (61,551) (17,950) Advances on lines of credit (20,491) (3,486) Payoffs 62,470 29,194 Principal amortization 16,417 4,336 Other, net 1,580 1,224 Real estate owned Sales proceeds 3,575 5,728 Capitalized costs (253) (2,256) Other, net 59 -- Office property and equipment Sales proceeds 4 -- Additions (765) (111) --------- --------- Net cash used in investing activities (109,636) (67,312) --------- ---------
See accompanying Notes to Consolidated Financial Statements. 6 7 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS ARE IN THOUSANDS)
Three Months Ended MARCH 31, ------------------------- 1998 1997 --------- --------- NET CASH FLOWS FROM FINANCING ACTIVITIES Deposit activity, net $ 49,369 $ (9,696) Net change in FHLB advances 65,000 15,000 Net proceeds from exercise of options 369 142 Collection of ESOP loan 8 7 --------- --------- Net cash provided by financing activities 114,746 5,453 --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 9,016 (77,954) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 51,620 93,978 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 60,636 $ 16,024 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for Interest $ 11,202 $ 9,803 Income taxes 54 2 Non-cash investing and financing activities Real estate acquired in settlement of loans 1,770 6,719 Loans originated to finance sales of real estate owned 1,612 2,192 Net change in unrealized gains (losses) on available-for-sale securities -- (697) Loan activity Total commitments and permanent fundings $ 192,976 $ 74,079 Less: Change in undisbursed funds on construction commitments (19,140) (1,958) Loans originated to finance sales of real estate owned (1,612) (2,192) Non-cash portion of refinanced loans -- (6,300) Undisbursed portion of new lines of credit -- (1,688) --------- --------- Net construction disbursements and loans funded $ 172,224 $ 61,941 ========= =========
See accompanying Notes to Consolidated Financial Statements. 7 8 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 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 March 31, 1998 and the results of its operations for the three months ended March 31, 1998 and 1997, and its cash flows for the three months ended March 31, 1998 and 1997. Operating results for the three months ended March 31, 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 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 with the same prominence as other financial statements. This statement did not have an 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 In 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share", which establishes standards for computing and presenting earnings per share. The table below sets forth the Company's earnings per share calculations for the three months ended March 31, 1998 and 1997. The Diluted and Basic Methods were used for both periods as prescribed under GAAP. In the table below, (1) Warrants refers to the warrants issued by the Company in December 1995, which have an exercise price of $2.25 per share and can be exercised beginning three years from the issue date and for a period of ten years 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. 8 9 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1998 (AMOUNTS ARE IN THOUSANDS, EXCEPT FOR BOOK VALUE AND PER SHARE DATA) NOTE 3 - BOOK VALUE AND EARNINGS PER SHARE - CONTINUED
THREE MONTHS ENDED MARCH 31, ------------------------ 1998 1997 -------- -------- SHARES OUTSTANDING Basic 3,157 2,617 Warrants 2,376 2,376 Options 655 668 Less Treasury shares(1) (507) (866) -------- -------- Diluted 5,681 4,795 ======== ======== STOCKHOLDERS' EQUITY Basic $ 44,529 $ 32,532 Warrants 5,346 5,346 Options 4,704 3,342 Less Treasury shares(1) (10,087) (8,745) -------- -------- Diluted $ 44,492 $ 32,475 ======== ======== NET EARNINGS Net earnings for the period $ 1,833 $ 1,359 Preferred stock dividends -- (609) -------- -------- Net earnings available for Common stock $ 1,833 $ 750 ======== ======== BASIC BOOK VALUE PER SHARE $ 14.10 $ 12.43 ======== ======== BASIC EARNINGS PER SHARE $ 0.58 $ 0.29 ======== ======== DILUTED BOOK VALUE PER SHARE $ 7.83 $ 6.77 ======== ======== DILUTED EARNINGS PER SHARE $ 0.32 $ 0.16 ======== ========
- ---------- (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. 9 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company earned $1.8 million, or $0.32 per diluted share, for the quarter ended March 31, 1998, an increase of 35% over net earnings of $1.4 million, or $0.16 per diluted share, for the first quarter of 1997. This growth in net earnings reflects a 19% increase in average earning assets, and a 67 basis point increase in the Bank's interest margin during the first quarter of 1998 as compared to the first quarter of 1997, as well as a $24.5 million or 59% decline in nonperforming assets ("NPAs") from March 31, 1997 to March 31, 1998. These positive influences were partially offset by the Company's return to taxable status, an increase in consolidated operating costs and higher parent company interest costs, attributable to a tripling of the Company's outstanding indebtedness. 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 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. In addition, the Company returned to taxable status during the first quarter of 1998, following several years in which it recorded income tax benefits from utilization of accumulated operating loss carryforwards. Accordingly, the consolidated operating results, and related per share amounts for the first quarter of 1998 are not comparable to the results for the first quarter of 1997. Because of these factors, the Company believes that core earnings is a more useful measure of its underlying operating performance. Core earnings are earnings before interest on parent company debt, income taxes, real estate operations and nonoperating items. For the first quarter of 1998, core earnings were $3.3 million, more than double the core earnings of $1.4 million generated during the first quarter of 1997. 10 11 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 MARCH 31, ------------------------- 1998 1997 -------- -------- Net interest income $ 10,340 $ 7,335 Provision for credit losses 1,485 1,220 -------- -------- Net interest income after provision for credit losses 8,855 6,115 Noninterest operating revenues 709 732 General and administrative costs (6,280) (5,424) -------- -------- CORE EARNINGS 3,284 1,423 -------- -------- Nonrecurring gains (losses) Real estate operations, net 333 (260) Other, net 4 (13) Other items Interest on senior notes (1,264) (483) Income tax (provision) benefit (524) 692 -------- -------- (1,451) (64) -------- -------- NET EARNINGS $ 1,833 $ 1,359 ======== ========
This substantial growth in core earnings resulted from (1) a 19% growth in average earning assets, (2) a 59% decline in NPAs, and (3) an increase of 67 basis points in the Bank's interest margin (before loan loss provisions), in each instance comparing the March 1998 and March 1997 quarters. The growth in average earning assets resulted from the continuing successful expansion of the Company's financing businesses. During the first quarter of 1998, the Company generated new permanent and construction loan commitments of $193.0 million, which, net of loan repayments, produced net growth of $112.3 million in the Company's retained net loan portfolio during the quarter, an annualized growth rate of 54%. Since March 31, 1997, net loans have increased by $252.4 million, or 36%. The Company recorded new permanent and construction loan commitments of $74.1 million during the first quarter of 1997. The Company retains virtually all of its new loans for its own account, rather than selling them into the secondary mortgage markets. NPAs, which consist of the net carrying value of properties acquired through foreclosure ("REO") and loan principal three or more payments delinquent, amounted to $16.8 million at March 31, 1998, down 59% from $41.2 million at March 31, 1997. Since March 31, 1997, the Company's REO has been reduced to $6.6 million (39% of NPAs) from $21.0 million (51% 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, which amount to an annualized rate of 0.8% of the average loans outstanding for the quarter. The Company's mix of financings, and its willingness and ability to provide its customers with tailored terms and highly-efficient transaction execution when necessary, contributes to its ability to produce yields on the incremental growth in its loan portfolio which are higher than the average yield on the entire portfolio. Concurrently, the Company has been successful in keeping its funding costs (excluding parent company debt) virtually unchanged during the past several quarters. As a result, during the first quarter of 1998, the Bank's interest margin (before interest on parent company debt and loan loss provisions) reached 4.34%, an increase of 67 basis points from the interest margin of 3.67% realized during the first quarter of 1997. Net of interest on parent company 11 12 debt and loan loss provisions, the Company's consolidated interest margin was 3.18% during the first quarter of 1998, as compared with 2.82% during the first quarter of 1997. In late 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 in-house, client server-based system, and to design and implement a plan to ensure Year 2000 compliance. These and related initiatives are expected to increase the Company's consolidated general and administrative costs during 1998 by about 15% as compared with 1997. During the first quarter of 1998, general and administrative costs of $6.3 million were $0.9 million, or 16%, higher than for the first quarter of 1997, which was in line with expectations. INCOME TAXES During the quarter ended March 31, 1998, the Company's earnings were reduced by an income tax provision of $0.5 million, or an estimated effective tax rate of 22% of consolidated pretax earnings. During the first quarter of 1997, the Company recorded an income tax benefit of $0.7 million. 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 last three years. Separate issues of Preferred Stock and Senior Notes due 2000, issued in December 1995 in connection with a recapitalization of the Company and the Bank, were refinanced in December 1997 with proceeds from the issuance by the Company of its Senior Notes due 2004, which carry a coupon interest rate of 12.5% and have an effective cost of approximately 13.4% (after including the effect of issue cost amortization). Through March 31, 1998, the Company had contributed approximately $35.0 million of the proceeds from the Senior Notes 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 under regulation of the Office of Thrift Supervision ("OTS"). At March 31, 1998, the Bank's core and risk-based capital ratios were 7.45% and 11.45%, respectively, which were comfortably in excess of 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. These percentage measures 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 nonaccrual loans and REO. 12 13 The following table sets forth the Company's average balance sheet, and the related weighted average yields and costs on average interest-earning assets (inclusive of nonaccrual loans) and interest-bearing liabilities, for the three months ended March 31, 1998 and 1997. In the table, interest revenues are net of interest associated with nonaccrual loans (dollars are in thousands).
THREE MONTHS ENDED ------------------------------------------------------------------------------ MARCH 31, 1998 MARCH 31, 1997 ------------------------------------ ------------------------------------- WEIGHTED WEIGHTED AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST -------- -------- ----- -------- -------- ----- ASSETS Interest-earning assets Loans(1)(2) $892,060 $ 21,161 9.49% $688,597 $ 15,506 9.01% Cash and cash equivalents 53,506 720 5.38 58,945 738 5.01 Investment securities 574 8 5.57 45,315 653 5.76 Investment in capital stock of Federal Home Loan Bank 7,251 105 5.79 6,847 110 6.43 -------- -------- -------- -------- Total interest-earning assets 953,391 21,994 9.23 799,704 17,007 8.51 -------- ----- -------- ----- Noninterest-earning assets 23,902 31,064 -------- -------- Total assets $977,293 $830,768 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities Deposits $819,886 10,737 5.31 $705,507 8,892 5.11 FHLB Advances 63,988 917 5.81 51,935 780 6.09 Senior notes 40,000 1,264 12.82 12,345 483 15.87 -------- -------- -------- -------- Total interest-bearing liabilities 923,874 12,918 5.67 769,787 10,155 5.35 -------- ----- -------- ----- Noninterest-bearing liabilities 10,026 17,065 Stockholders' equity 43,393 43,916 -------- -------- Total liabilities & stockholders' equity $977,293 $830,768 ======== ======== Net interest income $ 9,076 $ 6,852 ======== ======== Interest rate spread 3.56% 3.16% ===== ===== Net interest margin 3.81% 3.43% ===== ===== Net interest margin excluding parent company indebtedness 4.34% 3.67% ===== =====
(1) Includes nonaccrual loans of $21.4 million and $29.0 million for the three months ended March 31, 1998 and March 31, 1997, respectively. (2) Includes amortization of loan fees and discounts of $1.4 million and $0.9 million for the three months ended March 31, 1998 and March 31, 1997, respectively. 13 14 ANALYSIS OF CHANGES IN NET INTEREST INCOME The following table presents 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 MARCH 31, 1998 AND 1997 INCREASE (DECREASE) DUE TO CHANGE IN ------------------------------------------------------------- RATE AND NET VOLUME RATE VOLUME CHANGE ------- ------- ------- ------- INTEREST REVENUES Loans $ 4,582 $ 828 $ 245 $ 5,655 Cash and cash equivalents (68) 55 (5) (18) Investment securities (645) (22) 22 (645) Investment in capital stock of Federal Home Loan Bank 6 (10) (1) (5) ------- ------- ------- ------- 3,875 851 261 4,987 ------- ------- ------- ------- INTEREST COSTS Deposits 1,442 347 56 1,845 FHLB Advances 181 (36) (8) 137 Senior notes 1,082 (93) (208) 781 ------- ------- ------- ------- 2,705 218 (160) 2,763 ------- ------- ------- ------- INCREASE IN NET INTEREST INCOME $ 1,170 $ 633 $ 421 $ 2,224 ======= ======= ======= =======
The Company's interest income (net of interest due on nonaccrual loans) increased by $5.0 million or 29.3% during the first quarter 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. The increase in interest income during the first quarter of 1998 was partially offset by a $2.8 million, or 27.2%, increase in interest expense, 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 an increase in the weighted average rate paid on the Company's deposits. As a result of the foregoing, the Company's net interest income increased by $2.2 million, or 32.5%, from $6.9 million during the first quarter of 1997 to $9.1 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 38 basis points, or 11.1%, from 3.43% to 3.81% during the same respective periods. PROVISIONS FOR CREDIT LOSSES For the three months ended March 31, 1998, the Company recorded provisions for credit losses of $1.5 million, compared with provisions for credit losses of $1.2 million recorded during the three months ended March 31, 1997. At March 31, 1998, the Company's allowance for credit losses amounted to $14.1 million, of which $9.9 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 14 15 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 MARCH 31, ------------------------------------- OPERATING 1998 1997 CHANGE ----- ----- ----- Loan related fees $ 458 $ 466 $ (8) Other 251 266 (15) ----- ----- ----- $ 709 $ 732 $ (23) ===== ===== ===== NON-OPERATING Other, net $ 4 $ (13) $ 17 ----- ----- ----- $ 4 $ (13) $ 17 ===== ===== =====
Loan related fee revenues consist of prepayment, extension, modification, escrow and exit fees collected from customers. 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 March 31, --------------------------------------- 1998 1997 CHANGE ------ ------ ------ Employee $3,237 $2,769 $ 468 Operating 1,625 1,181 444 Occupancy 863 754 109 Professional 330 348 (18) SAIF premium and OTS assessment 225 372 (147) ------ ------ ------ $6,280 $5,424 $ 856 ====== ====== ======
During the last half of 1997 and continuing into the first quarter of 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 17% during the first quarter of 1998 as compared with the 1997 first quarter, in line with expectations. The Company has experienced an increase in operating costs primarily as a result of its efforts related to the ongoing computer system conversions and expenditures related to its focused efforts to expand the Company's retail banking presence. 15 16 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 MARCH 31, ------------------------------------- 1998 1997 CHANGE ----- ----- ----- EXPENSES ASSOCIATED WITH REAL ESTATE OWNED Property taxes $ 3 $ 21 $ (18) Repairs, maintenance and renovation 15 13 2 Insurance 30 44 (14) ----- ----- ----- Total 48 78 (30) NET RECOVERIES FROM SALE OF PROPERTIES (299) (24) (275) PROPERTY OPERATIONS, NET (97) (74) (23) PROVISION FOR ESTIMATED LOSSES ON REAL ESTATE OWNED 15 280 (265) ----- ----- ----- (INCOME) LOSS FROM REAL ESTATE OPERATIONS, NET $(333) $ 260 $(593) ===== ===== =====
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. During the three months ended March 31, 1998 and March 31, 1997, the Company sold 17 properties generating net cash proceeds of $3.6 million and a net gain of $0.3 million, as compared to 40 properties generating net cash proceeds of $5.7 million and a nominal gain, respectively. 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 months ended March 31, 1997, the Company recorded $0.3 million in provisions associated with its then remaining foreclosed residential construction projects. As of March 31, 1998, the homes within these projects had been sold. INCOME TAXES The Company recorded an income tax provision of $0.5 million for the quarter ended March 31, 1998, as compared to a $0.7 million income tax benefit recorded during the three months ended March 31, 1997. The effective income tax rate has been reduced to 22% to reflect the benefit of the reduction of deferred tax valuation allowance previously established. At March 31, 1998, the Company had approximately $2.0 million of accumulated income tax benefits, consisting primarily of net operating loss carryforwards and future tax deductions which had not been recognized for financial statement purposes and which are available to be utilized to shield future earnings from income taxes, both for financial reporting and income tax reporting 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. 16 17 FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY ASSETS CASH AND CASH EQUIVALENTS Cash and cash equivalents at March 31, 1998 and at December 31, 1997 consisted of the following (dollars are in thousands).
March 31, December 31, 1998 1997 ------- ------- Cash $12,136 $ 9,520 Federal funds sold 48,500 42,100 ------- ------- $60,636 $51,620 ======= =======
INVESTMENT SECURITIES The table below summarizes the cost basis and estimated fair value of investment securities available-for-sale at March 31, 1998 and at December 31, 1997 (dollars are in thousands).
GROSS UNREALIZED ESTIMATED AMORTIZED ------------------------ FAIR COST GAINS LOSSES VALUE ----------- ------------ ---------- ----------- MUTUAL FUND March 31, 1998 $580 6 - $586 December 31, 1997 $572 6 - $578
Investment securities with both a cost basis and an estimated fair value of $0.6 million at March 31, 1998, had a weighted average yield of 6.39%, 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).
MARCH 31, 1998 DECEMBER 31, 1997 ------------------------- ------------------------- BALANCE PERCENT BALANCE PERCENT ----------- ------- ---------- -------- SINGLE FAMILY Estate(1) $ 216,575 19.6% $ 173,764 17.9% Conventional 218,721 19.8 224,006 23.1 INCOME PROPERTY Multi-family 233,520 21.2 225,738 23.3 Commercial real estate 132,171 12.0 114,293 11.8 LAND 62,999 5.7 39,475 4.1 SINGLE FAMILY CONSTRUCTION Individual residences 151,587 13.7 112,899 11.7 Tract development 61,774 5.6 68,653 7.1 OTHER 26,596 2.4 9,698 1.0 ----------- ----- ----------- ------ GROSS LOANS RECEIVABLE(2) 1,103,943 100.0% 968,526 100.0% ===== ====== LESS Participants' share (1,088) (1,141) Undisbursed loan funds (130,371) (108,683) Deferred loan fees and credits, net (7,803) (7,177) Reserves (14,092) (13,274) ----------- ---------- NET LOANS RECEIVABLE $ 950,589 $ 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 construction commitments. 18 19 The table below sets forth the approximate composition of the Company's new loan commitments, net of internal refinances, for the period indicated in dollars and a percentage of total loans originated (dollars are in thousands).
THREE MONTHS ENDED MARCH 31, 1998 ---------------------- TYPE OF SECURITY AMOUNT % - ------------------------------------- -------- ------ SINGLE FAMILY Estate (1) $ 57,000 29.5% Conventional 4,900 2.5 INCOME PROPERTY Multi-family (2) 13,800 7.2 Commercial real estate (3) 23,500 12.2 LAND (4) 21,300 11.0 SINGLE FAMILY CONSTRUCTION Individual residences (5) 55,500 28.8 Tract development (6) 10,200 5.3 OTHER 6,800 3.5 --------- ----- $ 193,000 100.0% ========= =====
- ---------- (1) Includes unfunded commitments under lines of credit of $1.3 million at March 31, 1998. (2) Includes $1.6 million of financings provided in connection with sales of previously foreclosed properties for the three months ended March 31, 1998. (3) Includes unfunded commitments under lines of credit of $2.5 million at March 31, 1998. (4) Includes unfunded commitments of $0.6 million at March 31, 1998. (5) Includes unfunded commitments of $36.1 million at March 31, 1998. (6) Includes unfunded commitments of $9.8 million at March 31, 1998. ASSET QUALITY NONACCRUAL AND TROUBLED DEBT RESTRUCTURED LOANS The Company places loans on nonaccrual status when (1) they become one or more payments delinquent or (2) management believes that, with respect to performing loans, continued collection of principal and interest from the borrower is not reasonably assured. 19 20 The following table provides information regarding the Company's nonaccrual loans as of the dates indicated (dollars are in thousands).
MARCH 31, DECEMBER 31, 1998 1997 ------- ------- Loans past due 90 days or more $10,223 $10,793 Loans past due 30-89 days 8,887 4,435 Other nonaccrual loans 148 168 ------- ------- Total(1) $19,258 $15,396 ======= ======= Reserves to loans past due 90 days or more 137.8% 123.0% Reserves to total nonaccrual loans 73.2% 86.2%
- ---------- (1) Includes $0.2 million and $0.5 million of troubled debt restructured loans ("TDRs") at March 31, 1998 and December 31, 1997, respectively. Excludes $31.4 million and $29.1 million of TDRs which were performing in accordance with their modified terms at March 31, 1998 and December 31, 1997, respectively. During the past several years, the Company's lending areas, which are concentrated in Southern California, experienced adverse economic conditions, including declining real estate values. These factors adversely affected the ability of certain borrowers to repay loans according to their stated terms. Although management believes the level of allowance for estimated credit losses on loans is adequate to absorb losses inherent in the loan portfolio, continuing weakness in the local economy may result in increasing loan losses that cannot be reasonably predicted at December 31, 1997. 20 21 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).
MARCH 31, DECEMBER 31, 1998 1997 -------- -------- Real estate owned, net $ 6,551 $ 9,859 Nonperforming loans(1) 10,223 10,793 -------- -------- GROSS NONPERFORMING ASSETS 16,774 20,652 Other delinquent loans(2) 8,887 4,435 Performing loans classified loss, doubtful and substandard(3) 34,307 36,013 -------- -------- GROSS CLASSIFIED ASSETS $ 59,968 $ 61,100 ======== ======== CLASSIFIED LOANS(4) $ 53,417 $ 51,241 ======== ======== LOANS RECEIVABLE(5) $964,681 $851,525 ======== ======== RESERVES ON LOANS Specific $ 4,172 $ 3,878 General 9,920 9,396 -------- -------- $ 14,092 $ 13,274 ======== ======== Total reserves to loans receivable 1.5% 1.6% Total reserves to classified loans 26.4% 25.9% Total reserves to nonperforming loans 137.8% 123.0% Gross nonperforming assets to total assets 1.6% 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 $0.1 million and $0.2 million of performing loans on nonaccrual status at March 31, 1998, and December 31, 1997, respectively. (4) Includes $19.3 million and $15.4 million of nonaccrual loans at March 31, 1998, and at December 31, 1997, respectively. (5) Loans receivable are exclusive of the allowance for credit losses. The carrying value of NPA (i.e., real estate owned and loans 90 days or more delinquent) decreased to $16.8 million, or 1.6% of total assets, at March 31, 1998, from $20.7 million, or 2.2% of total assets, at December 31, 1997. The carrying value of NPA peaked at $151.2 million in December 1993. 21 22 The table below sets forth information concerning the company's total classified loans as of March 31, 1998 (dollars are in thousands).
CLASSIFIED LOANS ------------------------------------------------------------------ OTHER PERFORMING NONPERFORMING (1) DELINQUENCIES(2) LOANS (3) TOTAL ----------------- ---------------- -------------- -------- SINGLE FAMILY Estate $ 7,904 $ 4,235 $ 8,569 $20,708 Conventional 2,276 2,028 13,880 18,184 INCOME PROPERTY Multi-family -- 2,230 4,177 6,407 Commercial real estate -- -- 2,000 2,000 LAND 43 394 -- 437 SINGLE FAMILY CONSTRUCTION Individual residences -- -- 831 831 Tract development -- -- 3,661 3,661 OTHER -- -- 1,189 1,189 ------- ------- ------- ------- Total $10,223 $ 8,887 $34,307 $53,417 ======= ======= ======= =======
(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 $0.1 million of performing loans 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. 22 23 The table below sets forth the general and specific reserves for the Company's loan and REO portfolios as of March 31, 1998 (dollars are in thousands).
LOANS -------------------------------- REAL ESTATE PERFORMING DELINQUENT OWNED TOTAL ---------- ---------- ------- -------- Specific reserves $ 3,310 $ 862 $ 836 $ 5,008 General reserves 9,447 473 26 9,946 ------- ------- ------- ------- Total $12,757 $ 1,335 $ 862 $14,954 ======= ======= ======= ======= PERCENTAGES % of total reserves to gross investment 1.3% 7.0% 11.6% 1.5% % of general reserves to gross investment 1.0% 2.5% 0.4% 1.0%
The table below summarizes the activity of the Company's reserves for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED MARCH 31, ------------------------------- 1998 1997 --------- --------- LOANS Average loans outstanding $ 892,060 $ 688,597 ========= ========= Reserve balance at beginning of period $ 13,274 $ 13,515 Provision for credit losses 1,485 1,220 Charge-offs: Single family - conventional (467) (413) Income property Multi-family -- (515) Commercial real estate (200) -- Land -- (150) --------- --------- Total charge-offs (667) (1,078) --------- --------- Balance at end of period $ 14,092 $ 13,657 ========= ========= Ratio of net charge-offs to average loans outstanding during the period 0.1% 0.2% REAL ESTATE OWNED Reserve balance at beginning of period $ 2,563 $ 11,871 Provision for credit losses 15 280 Charge-offs (1,716) (2,492) --------- --------- Balance at end of period $ 862 $ 9,659 ========= =========
23 24 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).
MARCH 31, 1998 DECEMBER 31, 1997 ------------------------------ ----------------------------- PERCENT OF PERCENT OF RESERVES TO RESERVES TO TOTAL LOANS TOTAL LOANS BALANCE BY CATEGORY BALANCE BY CATEGORY ------------ ----------- --------- ----------- SINGLE FAMILY Estate $ 2,311 1.1% $ 1,975 1.1% Conventional 4,216 1.9% 4,696 2.1% INCOME PROPERTY Multi-family 2,398 1.0% 2,000 0.9% Commercial real estate 2,539 1.9% 2,252 2.0% LAND 329 0.5% 162 0.4% SINGLE FAMILY CONSTRUCTION Individual residences 463 0.3% 503 0.4% Tract development 1,006 1.6% 817 1.2% OTHER 264 1.0% 226 2.3% UNALLOCATED 566 -- % 643 -- % ---------- -------- $ 14,092 1.3% $ 13,274 1.4% ========== ========
The table below summarizes reserves at the dates indicated for each of the REO by type of property (dollars are in thousands). MARCH 31, 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 $ 36 0.7% $ 1,523 19.8% INCOME PROPERTY Multi-family -- -- % 18 0.8% LAND 800 36.8% 1,022 43.2% UNALLOCATED 26 -- % -- -- % ------ -------- $ 862 11.6% $ 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. 24 25 The table below summarizes the composition of the Company's REO at the dates indicated (dollars are in thousands).
MARCH 31, DECEMBER 31, 1998 1997 -------- -------- SINGLE FAMILY Conventional $ 4,995 7,695 INCOME PROPERTY Multi-family 247 2,362 LAND 2,171 2,365 -------- -------- GROSS INVESTMENT (1) 7,413 12,422 ALLOWANCE FOR ESTIMATED LOSSES (862) (2,563) -------- -------- NET INVESTMENT $ 6,551 $ 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 and securities sold under agreements to repurchase ("reverse repurchase agreements"). 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 March 31, 1998, were $848.9 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).
MARCH 31, 1998 DECEMBER 31, 1997 -------------------------------------------- ------------------------------------ DESCRIPTION BALANCE WAIR WARM BALANCE WAIR WARM - ------------------------------- ----------------- ----------- --------- ------------ -------- ----- Transaction accounts $ 121,111 2.54% -- $ 105,812 2.44% -- Certificates of deposit 7 day maturities 42,006 4.43% -- 42,907 4.43% -- Less than 6 months 33,501 5.51% 3 35,418 5.57% 2 6 months to 1 year 525,828 5.77% 6 456,072 5.80% 8 1 year to 2 years 115,665 5.74% 7 146,674 5.74% 7 Greater than 2 years 10,759 5.41% 12 12,618 5.45% 13 ----------- ---------- Total $ 848,870 5.22% 5 $ 799,501 5.26% 6 =========== ==========
25 26 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. At March 31, 1998, the Company had two FHLB advances outstanding totaling $105.0 million with an original and remaining weighted average term of three years and four months and three years and one month, respectively. These advances are securitized by mortgage collateral and have a weighted average rate of 5.59%. SENIOR NOTES On December 31, 1997, the Company completed the issuance of $40.0 million of Senior Notes due 2004. The Notes carry 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 The Company's capital consists of common stockholders' equity, which at March 31, 1998, amounted to $44.5 million and represented 4.3% 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 March 31, 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 (2) $ 77,773 $ 77,773 $ 77,773 Adjustments General valuation allowances -- -- 9,539 Unrealized (gains) losses, net (6) (6) (6) ----------- ----- ----------- ----- ----------- ------- Regulatory capital 77,767 7.45% 77,767 7.45% 87,306 11.45% Required minimum 15,667 1.50% 31,334 3.00% 61,021 8.00% ----------- ----- ----------- ----- ----------- ------- Excess capital $ 62,100 5.95% $ 46,433 4.45% $ 26,285 3.45% =========== ===== =========== ===== =========== ======= Adjusted assets (1) $ 1,044,473 $ 1,044,473 $ 762,760 =========== =========== ===========
- ---------- (1) 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). (2) Reflects a capital contribution of $4.5 million from the parent company made in March 1998. 26 27 As of March 31, 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 TO BE CATEGORIZED AS ADEQUATELY CAPITALIZED WELL CAPITALIZED UNDER PROMPT CORRECTIVE UNDER PROMPT CORRECTIVE ACTUAL ACTION PROVISIONS ACTION PROVISIONS ----------------------- ---------------------- ---------------------- AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS ----------- -------- ------------- ------- --------- -------- AS OF MARCH 31, 1998 Total Capital (to Risk Weighted Assets) $87,306 11.45% $61,021 8.00% $76,276 10.00% Core Capital (to Adjusted Tangible Assets) 77,767 7.45% 31,334 3.00% 52,224 5.00% Tangible Capital (to Adjusted Tangible Assets) 77,767 7.45% 15,667 1.50% N/A N/A Tier 1 Capital (to Risk Weighted Assets) 77,767 10.20% N/A N/A 45,766 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 $5.7 million of cash on hand at March 31, 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 March 31, 1998 was 7.7%, which exceeded the applicable minimum requirements. The Company's current primary funding resources are deposits, principal payments on loans, FHLB advances and cash flows from operations. Other possible sources of liquidity available to the Company include reverse 27 28 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. 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. Since 1995, the Company has been utilizing interest rate floors to mitigate the risk of interest margin compression on its new loans in a decreasing interest rate environment. Typically, these floors represent the rate at underwriting. Additionally, on most new income property loans, the Company utilizes interest rate caps. These caps apply to the term of the loan and are usually five points above the rate at underwriting or at an amount that would still allow for one-to-one debt service coverage at the maximum rate, thereby reducing the likelihood of borrower default in a rising interest rate environment. The risk to the Company that is associated with interest rate caps is that interest rates will exceed the maximum loan rates on such loans, and while the Company's cost of funds continues to rise, the interest income derived from these loans will be fixed, resulting in an overall compression on net interest income. 28 29 The following table sets forth information concerning sensitivity of the Company's interest-earning assets and interest-bearing liabilities as of March 31, 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) $ 48,500 $ -- $ -- $ -- $ -- $ 48,500 Investments and FHLB Stock 7,904 -- -- -- -- 7,904 Loans (2) 563,802 197,599 42,159 40,094 128,830 972,484 ---------- ---------- ---------- ---------- ---------- ---------- Total interest-earning assets $ 620,206 $ 197,599 $ 42,159 $ 40,094 $ 128,830 $1,028,888 ========== ========== ========== ========== ========== ========== INTEREST-BEARING LIABILITIES Deposits Transaction accounts $ 121,111 $ -- $ -- $ -- $ -- $ 121,111 Certificates of deposit 223,919 169,390 306,514 27,936 -- 727,759 FHLB advances 40,000 -- -- 65,000 -- 105,000 Senior Notes -- -- -- -- 40,000 40,000 ---------- ---------- ---------- ---------- ---------- ---------- Total interest-bearing liabilities $ 385,030 $ 169,390 $ 306,514 $ 92,936 $ 40,000 $ 993,870 ========== ========== ========== ========== ========== ========== Interest rate sensitivity gap $ 235,176 $ 28,209 $ (264,355) $ (52,842) $ 88,830 $ 35,018 Cumulative interest rate sensitivity gap 235,176 263,385 (970) (53,812) 35,018 35,018 Cumulative interest rate sensitivity gap as a percentage of total interest-earning assets 22.9% 25.6% (0.1%) (5.2%) 3.4% 3.4%
- ---------- (1) Excludes noninterest-earning cash balances. (2) Loans include $19.3 million of nonaccrual loans. 29 30 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. Presented below, as of March 31, 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 $ 80,749 $ (7,478) (8.48%) +200 bp 84,861 (3,366) (3.82%) 0 bp 88,227 -- --% - -200 bp 91,771 3,544 4.02% - -400 bp 95,553 7,326 8.30%
30 31 The Bank's overall improvement in its sensitivity to changes in market rates from the period ended December 31, 1997 to March 31, 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. 31 32 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 plaintiffs accepted the reduced judgment. The Bank has filed a Notice of Appeal from the judgment and has posted an Appeal Bond with the court to stay plaintiffs enforcement of the judgment pending the Appellate Court's decision. Based upon its view that the law in California is unambiguous that there is no duty which attaches to escrow providers to advise parties to an escrow, the Bank believes that its position will ultimately be upheld on appeal and accordingly, that no amounts will be paid by the Bank to the plaintiffs in this matter. There can be no assurances that this will be the case, however. The defendant's appellate brief and the plaintiffs' appellate brief have been filed with the Court. The defendant's reply brief was filed April 6, 1998. After the plaintiffs' reply, hearing for oral arguments will be scheduled by the Court. 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 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 The Company filed a Form 8-K on March 26, 1998, announcing the extension of Exchange Offer for Senior Notes. The Company filed a Form 8-K on February 23, 1998, announcing Exchange Offer of Senior Notes. The Company filed a Form 8-K on January 28, 1998, announcing financial results for the year ended December 31, 1997. 2. Other required exhibits - None 32 33 Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HAWTHORNE FINANCIAL CORPORATION Dated May 13, 1998 /s/ NORMAN A. MORALES ----------------------------- Norman A. Morales Executive Vice President and Chief Financial Officer Dated May 13, 1998 /s/ JULIE A. MOODY ----------------------------- Julie A. Moody Vice President and Controller 33 EX-27 2 EXHIBIT-27 FINANCIAL DATA SCHEDULE
9 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 12,136 839,675 48,500 0 586 0 0 950,589 14,092 1,046,907 848,870 105,000 8,508 40,000 0 0 32 44,497 1,046,907 21,161 833 0 21,994 10,737 2,181 9,076 1,485 0 5,947 2,357 2,357 0 0 1,833 0.58 0.32 9.23 19,258 10,223 37,441 34,307 13,274 667 0 14,092 14,092 0 0
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