-----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, WVsh2UHFk8dU7b0Gt+G3C+MUOoSptBM1GtEbp0FSG+zncBJCa+1aYy+T80pFOphG tElFJBINA2lIeoT6gOqsnA== 0000950150-99-001252.txt : 19991117 0000950150-99-001252.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950150-99-001252 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 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: 99756324 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 PERIOD ENDED SEPTEMBER 30, 1999 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, 1999 __ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from___________ to___________ Commission File Number 0-1100 ---------------------- HAWTHORNE FINANCIAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) 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 5,328,801 shares of Common Stock, $0.01 par value per share outstanding, as of October 31, 1999. 2 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY FORM 10-Q INDEX For the quarter ended September 30, 1999 PART I - FINANCIAL INFORMATION
Page ---- ITEM 1. Financial Statements Consolidated Statements of Financial Condition at September 30, 1999 and December 31, 1998 3 Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 1999 and 1998 4 Consolidated Statements of Stockholders' Equity for Nine Months Ended September 30, 1999 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1999 and 1998 6 Notes to Consolidated Financial Statements 8 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 ITEM 3. Quantitative and Qualitative Disclosure About Market Risk 32 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 33 ITEM 2. Changes in Securities 33 ITEM 3. Defaults upon Senior Securities 33 ITEM 4. Submission of Matters to a Vote of Security Holders 34 ITEM 5. Other Information 34 ITEM 6. Exhibits and Reports on Form 8-K 34
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. 3 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (DOLLARS ARE IN THOUSANDS)
SEPTEMBER 30 DECEMBER 31 1999 1998 ----------- ----------- (Unaudited) ASSETS Cash and cash equivalents $ 121,217 $ 45,449 Loans receivable (net of allowance for estimated credit losses of $22,694 in 1999 and $17,111 in 1998) 1,434,426 1,326,791 Real estate owned (net of allowance for estimated losses of $38 in 1999 and $45 in 1998) 1,175 4,070 Investment in capital stock of Federal Home Loan Bank - at cost 20,701 13,554 Office property and equipment - at cost, net 6,101 6,513 Accrued interest receivable 9,289 8,424 Other assets 4,382 7,633 ----------- ----------- TOTAL ASSETS $ 1,597,291 $ 1,412,434 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits $ 1,093,493 $ 1,019,450 FHLB advances 359,000 264,000 Senior notes 40,000 40,000 Accounts payable and other liabilities 12,636 7,560 ----------- ----------- TOTAL LIABILITIES 1,505,129 1,331,010 Stockholders' Equity Preferred stock - $0.01 par value; authorized 10,000,000 shares; none outstanding -- -- Common stock - $0.01 par value; authorized 20,000,000 shares; outstanding 5,328,530 shares in 1999 and 5,194,996 shares in 1998 53 52 Capital in excess of par value-common stock 40,935 40,349 Retained earnings 51,222 41,150 ----------- ----------- 92,210 81,551 Less Treasury stock, at cost - 5,400 shares (48) (48) Employee stock ownership plan-loan -- (79) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 92,162 81,424 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,597,291 $ 1,412,434 =========== ===========
See accompanying Notes to Consolidated Financial Statements. 3 4 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (AMOUNTS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 -------------------------- ------------------------- 1999 1998 1999 1998 -------- -------- -------- -------- INTEREST REVENUES Loans $ 32,745 $ 27,441 $ 94,956 $ 73,077 Cash and investment securities 1,786 1,483 4,269 2,938 -------- -------- -------- -------- TOTAL INTEREST REVENUES 34,531 28,924 99,225 76,015 -------- -------- -------- -------- INTEREST COSTS Deposits 12,818 12,422 37,880 34,533 FHLB advances 4,714 2,950 13,011 5,740 Senior notes 1,250 1,250 3,750 3,764 -------- -------- -------- -------- TOTAL INTEREST COSTS 18,782 16,622 54,641 44,037 -------- -------- -------- -------- NET INTEREST INCOME 15,749 12,302 44,584 31,978 PROVISION FOR ESTIMATED CREDIT LOSSES ON LOANS 3,500 1,950 9,000 5,185 -------- -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES ON LOANS 12,249 10,352 35,584 26,793 -------- -------- -------- -------- NONINTEREST REVENUES Loan related fees 1,783 1,184 5,129 2,915 Other 253 188 802 626 -------- -------- -------- -------- TOTAL NONINTEREST REVENUES 2,036 1,372 5,931 3,541 -------- -------- -------- -------- NONINTEREST EXPENSES General and administrative expenses Employee 3,204 3,683 10,999 10,373 Operating 1,481 1,681 4,621 4,256 Occupancy 1,059 851 3,038 2,439 Technology 459 567 1,537 1,561 Professional 796 211 1,842 979 SAIF premiums and OTS assessments 310 247 922 703 -------- -------- -------- -------- Total general and administrative expenses 7,309 7,240 22,959 20,311 -------- -------- -------- -------- Income from real estate operations, net 8 616 425 1,980 Other non-operating (income)/expense 624 10 1,624 14 -------- -------- -------- -------- TOTAL NONINTEREST EXPENSES 7,925 6,634 24,158 18,345 -------- -------- -------- -------- NET EARNINGS BEFORE INCOME TAXES 6,360 5,090 17,357 11,989 INCOME TAX PROVISION 2,686 1,632 7,285 3,526 -------- -------- -------- -------- NET EARNINGS $ 3,674 $ 3,458 $ 10,072 $ 8,463 ======== ======== ======== ======== BASIC EARNINGS PER SHARE (NOTE 3) $ 0.69 $ 0.67 $ 1.91 $ 2.21 ======== ======== ======== ======== DILUTED EARNINGS PER SHARE (NOTE 3) $ 0.48 $ 0.45 $ 1.30 $ 1.33 ======== ======== ======== ======== WEIGHTED AVERAGE BASIC SHARES OUTSTANDING (NOTE 3) 5,312 5,189 5,275 3,838 ======== ======== ======== ======== WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING (NOTE 3) 7,714 7,708 7,722 6,351 ======== ======== ======== ========
See accompanying Notes to Consolidated Financial Statements. 4 5 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (AMOUNTS ARE IN THOUSANDS)
COMPREHENSIVE INCOME ------------- BALANCE AT EXERCISED BALANCE AT DECEMBER 31, STOCK EXERCISED NET SEPTEMBER 30, 1998 OPTIONS WARRANTS EARNINGS OTHER 1999 ------------ --------- --------- -------- ----- ------------- (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited) NUMBER OF COMMON SHARES 5,195 108 26 -- -- 5,329 ======== ======== ======== ========== ======== ======== Common stock $ 52 $ 1 $ -- $ -- $ -- $ 53 Capital in excess of par value common stock 40,349 563 55 -- (32) 40,935 Retained earnings 41,150 -- -- 10,072 -- 51,222 Treasury stock (48) -- -- -- -- (48) Employee stock ownership plan-loan (79) -- -- -- 79 -- -------- -------- -------- ---------- -------- -------- TOTAL STOCKHOLDERS' EQUITY $ 81,424 $ 564 $ 55 $ 10,072 $ 47 $ 92,162 ======== ======== ======== ========== ======== ========
See accompanying Notes to Consolidated Financial Statements 5 6 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (DOLLARS ARE IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30 -------------------------- 1999 1998 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net earnings $ 10,072 $ 8,463 Adjustments Provision for estimated credit losses on loans 9,000 5,185 Provision for estimated credit losses on real estate owned 80 15 Net recoveries from sales of real estate owned (757) (2,220) Net gain from sale of other assets (7) (7) Loan fee and discount accretion (4,409) (4,734) Depreciation and amortization 2,016 1,258 FHLB dividends (665) (330) Increase in accrued interest receivable (865) (2,910) Increase in deferred tax assets, net 3,052 2,476 (Increase)/decrease in other assets (70) 1,854 Increase in other liabilities 5,076 9,797 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 22,523 18,847 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Investment securities -- (22,101) Loans New loans funded (282,642) (347,044) Construction disbursements (266,625) (258,102) Payoffs 414,481 263,663 Sales proceeds 3,000 -- Principal amortization and paydowns 19,051 28,239 Lines of credit activity, net (5,611) (43,860) Other, net (59) 4,563 Real estate owned Sale proceeds 9,858 10,827 Capitalized costs (105) (942) Other, net -- (551) Purchase of FHLB stock (6,482) (5,770) Office property and equipment Sale proceeds 60 29 Additions (1,421) (3,325) --------- --------- NET CASH USED IN INVESTING ACTIVITIES (116,495) (374,374) --------- ---------
See accompanying Notes to Consolidated Financial Statements. 6 7 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (DOLLARS ARE IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30 ---------------------------- 1999 1998 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Deposit activity, net $ 74,042 $ 195,431 Net FHLB advances 95,000 224,000 Net proceeds from exercise of stock options and warrants 619 438 Proceeds from stock offering -- 28,376 Offering costs -- (573) Collection of ESOP loan 79 10 --------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES 169,740 447,682 --------- --------- Net increase in cash and cash equivalents 75,768 92,155 Cash and cash equivalents at beginning of period 45,449 51,620 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 121,217 $ 143,775 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION CASH PAID DURING THE PERIOD FOR Interest $ 50,058 $ 42,598 Income taxes 4,233 2,828 NON-CASH INVESTING AND FINANCING ACTIVITIES Real estate acquired in settlement of loans 7,563 3,847 Loans originated to finance sales of real estate owned 1,500 1,970 Net change in unrealized gains (losses) on available-for-sale securities -- 4 Loans originated to refinance existing bank loans 33,385 37,885 LOAN ACTIVITY Total commitments $ 523,529 $ 713,000 Less: Change in undisbursed funds on construction commitments 39,338 (97,654) Loans originated to finance sales of real estate owned (1,500) -- New lines of credit (12,100) (10,200) --------- --------- Net construction disbursements and loans funded $ 549,267 $ 605,146 ========= =========
See accompanying Notes to Consolidated Financial Statements. 7 8 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 (AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT 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, 1999 and December 31, 1998, and the results of its operations and its cash flows for the three and nine months ended September 30, 1999 and 1998. Operating results for the three and nine months ended September 30, 1999, are not necessarily indicative of the results that may be expected for any other interim period or the full year ending December 31, 1999. 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, 1998. NOTE 2 - RECLASSIFICATION Certain amounts in the 1998 consolidated financial statements have been reclassified, where practicable, to conform with classifications in 1999. 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, 1999 and 1998. In the table below, "Warrants" refer to the Warrants issued by the Company in December 1995, which are currently exercisable and which expire December 11, 2005, and "Options" refer to stock options previously granted to employees of the Company and which were outstanding at each measurement date. In July 1998, the Company completed an offering of 2,012,500 shares of its Common Stock at a price of $15.00 per share, realizing net proceeds (after offering costs) of approximately $27.6 million. As a result of this offering, the exercise price of the 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. 8 9 NOTE 3 - BOOK VALUE AND EARNINGS PER SHARE - CONTINUED (AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ------------------------ ------------------------ 1999 1998 1999 1998 -------- -------- -------- -------- AVERAGE SHARES OUTSTANDING Basic 5,312 5,189 5,275 3,838 Warrants 2,492 2,512 2,499 2,421 Options (1) 462 738 519 677 Less Treasury shares (2) (552) (731) (571) (585) -------- -------- -------- -------- Diluted 7,714 7,708 7,722 6,351 ======== ======== ======== ======== NET EARNINGS FOR THE PERIOD $ 3,674 $ 3,458 $ 10,072 $ 8,463 ======== ======== ======== ======== BASIC EARNINGS PER SHARE $ 0.69 $ 0.67 $ 1.91 $ 2.21 ======== ======== ======== ======== DILUTED EARNINGS PER SHARE $ 0.48 $ 0.45 $ 1.30 $ 1.33 ======== ======== ======== ========
SEPTEMBER 30 ------------------------ 1999 1998 -------- -------- PERIOD-END SHARES OUTSTANDING Basic 5,323 5,189 Warrants 2,486 2,512 Options (3) 405 738 Less Treasury shares (2) (537) (814) -------- -------- Diluted 7,677 7,625 ======== ======== Stockholders' equity $ 92,162 $ 79,037 ======== ======== BASIC BOOK VALUE PER SHARE $ 17.31 $ 15.23 ======== ======== DILUTED BOOK VALUE PER SHARE $ 12.00 $ 10.37 ======== ========
- ---------------------- (1) Excludes 340,000 options outstanding for the three and nine months ended September 30, 1999 for which the exercise price exceeded the average market price of the Company's Common Stock during the period. Excludes 210,000 options outstanding for the three months ended September 30, 1998 for which the exercise price exceeded the average market price of the Company's Common Stock during the period. (2) Under the Diluted Method, it is assumed that the Company will use proceeds from the proforma exercise of the Warrants and Options to acquire actual shares currently outstanding, thus increasing Treasury shares. In this calculation, Treasury shares were assumed to be repurchased at the average closing stock price for the respective period. (3) Excludes 365,000 and 210,000 options outstanding at September 30, 1999 and September 30, 1998, respectively, for which the exercise price exceeded the average market price of the Company's Common Stock during the period. 9 10 NOTE 4 - COMMITMENTS AND CONTINGENCIES The Bank is a defendant in an action entitled Takaki vs. Hawthorne Savings and Loan Association, filed in the Superior Court of the State of California, Los Angeles. The plaintiffs were owners of real property 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 that the plaintiffs received as sellers was inadequate and should have so advised them. In June 1997, a jury found for the plaintiffs and awarded compensatory and punitive damages totaling $9.1 million. In July 1997, the trial judge reduced the combined award to $3.3 million. The Bank filed an appeal and in July, 1998, the Appellate Court remanded the case to the Superior Court with directions to dismiss the fraudulent concealment, misrepresentation and punitive damages claims and to conduct a new trial pertaining solely to damages arising from negligence, in particular to determine whether any negligence of the Bank contributed to the plaintiffs' injury and, if so, to apportion liability for negligence between the Bank and the plaintiffs. On March 30, 1999, the jury returned a verdict in favor of the plaintiffs in the amount of $2.4 million. In May 1999, the Bank filed a notice of appeal from the judgment and posted an Appeal Bond with the Court to stay plaintiffs' enforcement of the judgment pending the Appellate Court's decision. The Bank believes that there is a reasonable likelihood that its position will ultimately be upheld on appeal and accordingly, that no amounts having a materially adverse effect on the Bank's or the Company's financial conditions or operations 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 Bank is a defendant in an action entitled Mells v. Hawthorne, filed in the Superior Court of the State of California, San Diego. Plaintiffs alleged that the Bank concealed and misrepresented the severity of defects in a house that the Bank sold to them. On September 20, 1999, a second amended judgment was entered on behalf of the plaintiffs for $767 thousand which includes attorney's fees and costs. In October, the Bank filed a notice of appeal from the judgment and posted an Appeal Bond with the court to stay plaintiffs' enforcement of the judgment pending the Appellate Court's decision. The Bank intends to vigorously pursue its position and believes that there is a reasonable likelihood that the amount of the judgment will be reduced and, accordingly, that no amounts having a materially adverse effect on the Bank's or the Company's financial condition or operations will be paid by the Bank to the plaintiffs in this matter. However, there can be no assurances that this will be the case. The Company is involved in a variety of other litigation matters in the ordinary course of its business, and anticipates that it will become involved in new litigation matters from time to time in the future. Based on the current assessment of these existing other matters, management does not presently believe that any one of these existing other matters is likely to have a material adverse impact on the Company's financial condition or result of operations. However, the Company will incur legal and related costs in connection with the litigation and may from time to time determine to settle some or all of the cases, regardless of management's assessment of the Company's legal position. The amount of legal defense costs and settlements in any period will depend on many factors, including the status of cases (and the number of cases that are in trial or about to be brought to trial) and the opposing parties aggressiveness in pursuing their cases and their perception of their legal position. Further, the inherent uncertainty of jury or judicial verdicts makes it impossible to determine with certainty the Company's maximum cost in any pending litigation. Accordingly, the Company's litigation costs and expenses may vary materially from period to period, and no assurance can be given that these costs will not be material in any particular period. NOTE 5 - SUBSEQUENT EVENTS In November, the Bank paid $700 thousand to settle an action related to a foreclosure sale of one of the Bank's REO properties. The Bank's President was also named as a defendant in the action and the Bank intends to pursue a claim against its directors and officers insurance carrier for full reimbursement of the settlement, however, no assurances can be given that the Bank will be successful in recovering the amount of the settlement from the carrier. The cost of this settlement will reduce net earnings for the 4th quarter 1999 by approximately $406 thousand or $0.05 per share. 10 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net earnings for the three months ended September 30, 1999 were $3.7 million, or $0.48 per diluted share. This compares with net earnings of $3.5 million, or $0.45 per diluted share, for the three months ended September 30, 1998. Net earnings for the first nine months of 1999 were $10.1 million, or $1.30 per diluted share, compared to net earnings of $8.5 million, or $1.33 per diluted share, for the first nine months of 1998. CORE BUSINESS ACTIVITY The Company originates real estate-secured loans throughout Southern California, generally consisting of permanent loans collateralized by single family (one to four unit) residential property, 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, with advances from the Federal Home Loan Bank of San Francisco ("FHLB"). The Company's consolidated capital structure has changed significantly since 1995, initially as a result of its recapitalization in December 1995, and then again in December 1997, due to its successful refinancing of the securities issued in the 1995 recapitalization, through the sale of Senior Notes ("Senior Notes"). In July 1998, the Company completed a public offering of approximately 2.0 million shares of its Common Stock which raised approximately $27.6 million of net proceeds. In addition, the Company returned to taxable status during 1998, following several years in which it realized substantial income tax benefits from utilization of accumulated operating loss carryforwards. Together, these factors make meaningful comparisons of consolidated operating results, and related per share amounts, between the 1999 and 1998 periods somewhat difficult. Because of the significant changes to the Company's capital structure and taxable status, management believes that pretax core earnings ("Bank Core Earnings") are the most useful measure of the Company's underlying operating and earnings performance. Bank Core Earnings are earnings before interest on parent company debt, income taxes, real estate operations and non-operating items. For the quarter, Bank Core Earnings were $8.4 million, 47.4% more than the $5.7 million of Bank Core Earnings produced during the third quarter of 1998. Bank Core Earnings of $22.9 million for the first nine months of 1999 were 59.0% higher than the Bank Core Earnings of $14.4 million during the first nine months of 1998. This growth in Bank Core Earnings results from the continued growth in earning assets, which was partially offset by a slight decline in the Bank's net interest margin. 11 12 The table below isolates the principal components of the Bank's Core Earnings and the Company's net earnings for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ---------------------- ---------------------- 1999 1998 1999 1998 -------- -------- -------- -------- Net interest income (excluding interest expense for Senior Notes) $ 16,996 $ 13,265 $ 48,290 $ 35,422 Less provision for estimated credit losses on loans 3,500 1,950 9,000 5,185 -------- -------- -------- -------- Net interest income after provision for estimated credit losses on loans 13,496 11,315 39,290 30,237 Noninterest revenues 2,075 1,409 6,043 3,653 Less general and administrative costs 7,163 7,005 22,397 19,477 -------- -------- -------- -------- BANK CORE EARNINGS 8,408 5,719 22,936 14,413 -------- -------- -------- -------- Other items Income from real estate operations, net 8 616 425 1,980 Hawthorne Financial Corp. non-operating (expense)/income, net (182) 15 (630) (626) Other non-operating income/(expense), net (624) (10) (1,624) (14) Interest cost on senior notes (1,250) (1,250) (3,750) (3,764) -------- -------- -------- -------- OTHER ITEMS, NET (2,048) (629) (5,579) (2,424) -------- -------- -------- -------- Pretax earnings 6,360 5,090 17,357 11,989 Income tax provision 2,686 1,632 7,285 3,526 -------- -------- -------- -------- NET EARNINGS $ 3,674 $ 3,458 $ 10,072 $ 8,463 ======== ======== ======== ========
The Bank's net interest income, excluding interest expense for Senior Notes, increased 28.1% during the third quarter of 1999, to $17.0 million, from the $13.3 million of net interest income during the third quarter of 1998. This growth in net interest income resulted from a 23.1% increase in the Bank's average interest-earning assets, which rose to $1.6 billion during the three months ended September 30, 1999, from $1.3 billion during the three months ended September 30, 1998. The Bank's net interest income, excluding interest expense for Senior Notes, increased 36.3% during the nine months of 1999, to $48.3 million from $35.4 million of net interest income during the nine months of 1998. This growth in net interest income resulted from a 36.4% increase in the Bank's average interest-earning assets, which rose to $1.5 billion during the nine months ended September 30, 1999, from $1.1 billion during the nine months ended September 30, 1998. Non-interest revenues were $2.1 million and $6.0 million for the three and nine months ended September 30, 1999, respectively, compared to non-interest revenues of $1.4 million and $3.7 million for the three and nine months ended September 30, 1998, respectively. The year-over-year increase in non-interest revenues resulted primarily from a greater amount of exit and release fees and prepayment penalties in connection with loans repaid during the 1999 period. INCOME TAXES During the first nine months of 1999, the Company's effective tax rate was 42.0%. During the first nine months of 1998, the Company's effective tax rate was 29.4%, which reflected utilization of accumulated income tax benefits, principally tax loss carryforwards. PARENT COMPANY ITEMS In July 1998, the Company completed a public offering of approximately 2.0 million shares of its Common Stock, realizing net proceeds (after offering costs) of approximately $27.6 million. Through September 30, 1999, the Company had contributed $22.5 million of these net proceeds to the Bank and had made its June 30, 1999 and December 31, 1998 semiannual interest payments on its Senior Notes of approximately $2.5 million each. Accordingly, the Company will now rely upon dividends from the Bank for its payment of interest on its Senior Notes, the next payment of which is due in December 1999. 12 13 Because the Company has contributed to the Bank substantially all of the net proceeds raised during 1998 from its sale of Common Stock, the Company and the Bank will not have excess capital during 1999 to the same extent excess capital was available during 1998. Accordingly, management does not expect that growth in the Company's assets will approach the percentage growth achieved during 1998, absent the issuance of additional debt or equity securities by the Company or the Bank. The Company and the Bank have no present intention of issuing debt or equity securities in 1999. RESULTS OF OPERATIONS The following table sets forth the Company's average balance sheets, and the related weighted average yields and costs on average interest-earning assets and average interest-bearing liabilities, for the three months ended September 30, 1999 and 1998 (dollars are in thousands).
THREE MONTHS ENDED -------------------------------------------------------------------------------- SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 ------------------------------------- ---------------------------------------- WEIGHTED WEIGHTED AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST ---------- ---------- ---------- ---------- ---------- ---------- ASSETS Interest-earning assets Loans (1) (2) $1,437,346 $ 32,745 9.11% $1,146,124 $ 27,441 9.58% Cash and cash equivalents 119,719 1,538 5.14% 79,961 1,105 5.53% Investment securities -- -- -% 17,438 258 5.92% Investment in capital stock of Federal Home Loan Bank 19,282 248 5.14% 10,933 120 4.39% ---------- ---------- ---------- ---------- Total interest-earning assets 1,576,347 34,531 8.76% 1,254,456 28,924 9.22% ---------- ---- ---------- ----- Noninterest-earning assets 11,648 18,042 ---------- ---------- TOTAL ASSETS $1,587,995 $1,272,498 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities Deposits $1,058,051 12,818 4.81% $ 922,748 12,422 5.34% FHLB advances 360,087 4,714 5.12% 215,544 2,950 5.36% Senior notes 40,000 1,250 12.50% 40,000 1,250 12.50% ---------- ---------- ---------- ---------- Total interest-bearing liabilities 1,458,138 18,782 5.11% 1,178,292 16,622 5.60% ---------- ----- ---------- ----- Noninterest-bearing liabilities 40,295 16,499 Stockholders' equity 89,562 77,707 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,587,995 $1,272,498 ========== ========== Net interest income $ 15,749 $ 12,302 ========== ========== INTEREST RATE SPREAD 3.65% 3.63% ===== ===== NET INTEREST MARGIN INCLUDING SENIOR NOTES 4.00% 3.92% ===== ===== NET INTEREST MARGIN EXCLUDING SENIOR NOTES 4.31% 4.32% ===== =====
- -------------------------- (1) Average Balance includes nonaccrual loans of $29.8 million and $23.3 million for the three months ended September 30, 1999 and September 30, 1998, respectively. (2) Revenues/Costs includes amortization of loan fees and discounts of $1.3 million and $1.8 million for the three months ended September 30, 1999 and September 30, 1998, respectively. 13 14 The table below sets forth the Company's average balance sheets, and the related weighted average yields and costs on average interest-earning assets and average interest-bearing liabilities, for the nine months ended September 30, 1999 and 1998 (dollars are in thousands).
NINE MONTHS ENDED -------------------------------------------------------------------------------- SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 ------------------------------------- ---------------------------------------- WEIGHTED WEIGHTED AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST ---------- ---------- ---------- ---------- ---------- ---------- ASSETS Interest-earning assets Loans (1) (2) $1,395,125 $ 94,956 9.08% $1,020,795 $ 73,077 9.55% Cash and cash equivalents 98,866 3,604 4.86% 57,415 2,330 5.41% Investment securities -- -- --% 5,635 278 6.58% Investment in capital stock of Federal Home Loan Bank 17,369 665 5.10% 8,659 330 5.08% ---------- ---------- ---------- ---------- Total interest-earning assets 1,511,360 99,225 8.75% 1,092,504 76,015 9.28% ---------- ---- ---------- ----- Noninterest-earning assets 12,123 18,006 ---------- ---------- TOTAL ASSETS $1,523,483 $1,110,510 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities Deposits $1,024,197 37,880 4.94% $ 861,522 34,533 5.36% FHLB advances 335,319 13,011 5.12% 138,403 5,740 5.47% Senior notes 40,000 3,750 12.50% 40,000 3,764 12.55% ---------- ---------- ---------- ---------- Total interest-bearing liabilities 1,399,516 54,641 5.22% 1,039,925 44,037 5.66% ---------- ----- ---------- ----- Noninterest-bearing liabilities 38,010 16,034 Stockholders' equity 85,957 54,551 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,523,483 $1,110,510 ========== ========== Net interest income $ 44,584 $ 31,978 ========== ========== INTEREST RATE SPREAD 3.53% 3.62% ===== ===== NET INTEREST MARGIN INCLUDING SENIOR NOTES 3.93% 3.90% ===== ===== NET INTEREST MARGIN EXCLUDING SENIOR NOTES 4.26% 4.36% ===== =====
- -------------------------- (1) Includes nonaccrual loans of $26.4 million and $22.5 million for the nine months ended September 30, 1999 and September 30, 1998, respectively. (2) Revenues/costs include amortization of loan fees and discounts of $4.4 million and $4.7 million for the nine months ended September 30, 1999 and September 30, 1998, respectively. NET INTEREST INCOME The operations of the Company are substantially dependent on its net interest income, which is the difference between the interest income received from its interest-earning assets and the interest expense paid on its interest-bearing liabilities. The Company's net interest margin is its net interest income divided by its average interest-earning assets. Net interest income and net interest margin are affected by several factors, including (1) the level of, and the relationship between, the dollar amount of interest-earning assets and interest-bearing liabilities, (2) the relationship between the repricing or maturity of the Company's adjustable-rate and fixed-rate loans and short-term investment securities and its deposits and borrowings, and (3) the magnitude of the Company's non-interest-earning assets, including nonaccrual loans and real estate owned ("REO"). For the quarter, the decline in the Company's earning asset yield, to 8.76% from 9.22%, was closely matched by the decline in the Company's funding costs, to 5.11% from 5.60%. As a result, the Company's net interest margin for the third quarter of 1999 (before interest expense on the Company's Senior Notes), remained virtually unchanged from the third quarter of 1998, declining slightly to 4.31% from 4.32%. For the nine month periods, the same pattern was evident, with earning asset yields declining by 53 basis points, funding costs declining by 44 basis points, and the Bank's net interest margin (before interest expense on the Company's Senior Notes) declining by 10 basis points (or by 2.3%). 14 15 During the third quarter of 1999, market interest rates (as measured by the effective yields for issues of the U.S. Government, the London Interbank Offer Rate (LIBOR), and the Prime Rate), returned to levels most recently observed during the third quarter of 1998. However, during the intervening period, such market interest rates declined substantially (in some instances by as much as 1.50%), before rising again. The substantial majority of the Company's earning assets (principally loans) are adjustable-rate. The Company's deposits are primarily comprised of term certificate accounts, which carry fixed interest rates and predominantly possess original terms of from six-to-twelve months. The Company's borrowings, which are principally derived from the Federal Home Loan Bank of San Francisco (the "FHLB"), are for terms ranging from one-to-five years (though such terms are subject to certain early call provisions) and carry fixed interest rates. As of September 30, 1999, 87% of the Company's loans were adjustable-rate, with 92% of such loans subject to repricing no less frequently than annually. The substantial majority of such loans are priced at a margin over various market-sensitive indicies, including the One-year CMT, the One-month CMT, the MTA, LIBOR and the Prime Rate. Based upon the recent rise in the effective yield of these indicies, the Company expects that the yield on its loan portfolio will rise moderately over the coming months to fully incorporate the recent rise in market interest rates. The substantial majority of the Company's adjustable-rate loans were underwritten during periods in which the market indicies utilized, approximated the current level of such indicies. Such loans were also underwritten utilizing the fully-indexed interest rate at the loans' inception (rather than any introductory interest rate which may have been offered). Accordingly, current required payments by borrowers have not changed materially since the origination of such loans (and in many instances are lower now than they were when such loans were originated). At September 30, 1999, approximately 76% of the Company's deposits were comprised of certificate accounts, the majority of which have original terms of from six-to-twelve months. The remaining, weighted average term to maturity for the Company's certificate accounts approximated six months at September 30, 1999. Generally, the Company's offering rates for certificate accounts move directionally with the general level of interest rates, though typically not by the same magnitude. Accordingly, the Company expects that the cost of its certificate accounts will gradually rise in the coming months, as maturing and newly-acquired accounts are priced at current, higher offering rates. The Company's borrowings from the FHLB are fixed-rate, with remaining terms of from one-to-four years (though such remaining terms are subject to early call provisions). Accordingly, the recent rise in market interest rates is expected to have no immediate impact upon the cost of the Company's currently outstanding FHLB borrowings (though the cost of newly acquired borrowings would reflect current market pricing, which is substantially higher than the cost of the Company's currently outstanding FHLB borrowings). Taken together, the Company expects that the influences described above on its earning asset yields and funding costs will likely produce a stable-to-rising net interest margin during the coming months, because the Company's earning assets are expected to reprice more quickly than its interest-bearing liabilities. However, this result could fail to materialize if (1) the level of nonaccrual loans increases, (2) the percentage of earning assets held in cash and equivalents increases, or (3) the composition of its loan portfolio changes. The following tables set forth the dollar amount of changes in interest revenues and interest costs attributable to changes in the balances of interest-earning assets and interest-bearing liabilities, and changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume (i.e., changes in volume multiplied by old rate), (2) changes in rate (i.e., changes in rate multiplied by old volume) and (3) changes attributable to both rate and volume (dollars are in thousands). 15 16
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 INCREASE (DECREASE) DUE TO CHANGE IN ------------------------------------------------------------------- RATE AND NET VOLUME RATE VOLUME CHANGE ------- ------- ------- ------- INTEREST REVENUES Loans $ 6,972 $(1,331) $ (338) $ 5,303 Cash and cash equivalents 549 (77) (38) 434 Investment securities (258) (258) 258 (258) Investment in capital stock of Federal Home Loan Bank 92 20 16 128 ------- ------- ------- ------- 7,355 (1,646) (102) 5,607 ------- ------- ------- ------- INTEREST COSTS Deposits 1,821 (1,243) (182) 396 FHLB advances 1,978 (128) (86) 1,764 Senior notes -- -- -- -- ------- ------- ------- ------- 3,799 (1,371) (268) 2,160 ------- ------- ------- ------- INCREASE IN NET INTEREST INCOME $ 3,556 $ (275) $ 166 $ 3,447 ======= ======= ======= =======
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 INCREASE (DECREASE) DUE TO CHANGE IN ------------------------------------------------------------------- RATE AND NET VOLUME RATE VOLUME CHANGE ------- ------- ------- ------- INTEREST REVENUES Loans $26,798 $(3,599) $(1,320) $21,879 Cash and cash equivalents 1,682 (237) (171) 1,274 Investment securities (278) (278) 278 (278) Investment in capital stock of Federal Home Loan Bank 332 1 2 335 ------- ------- ------- ------- 28,534 (4,113) (1,211) 23,210 ------- ------- ------- ------- INTEREST COSTS Deposits 6,521 (2,670) (504) 3,347 FHLB advances 8,167 (370) (526) 7,271 Senior notes -- (14) -- (14) ------- ------- ------- ------- 14,688 (3,054) (1,030) 10,604 ------- ------- ------- ------- INCREASE IN NET INTEREST INCOME $13,846 $(1,059) $ (181) $12,606 ======= ======= ======= =======
The Company's interest revenues increased by $5.6 million, or 19.4%, during the three months ended September 30, 1999 as compared to the same period in 1998. This increase was primarily attributable to a 25.4% increase in the average balance of loans outstanding, which was partially offset by a decrease in the weighted average yield earned thereon, which averaged 9.11% during 1999 as compared with 9.58% in 1998. Interest costs increased by $2.2 million, or 13.0%, during the three months ended September 30, 1999, as compared to the same period during 1998, primarily due to a 14.7% increase in the average balances of the Company's deposits and borrowings, which was partially offset by a decrease in the weighted average rates paid on the Company's deposits and FHLB advances, which together averaged 4.90% during the three months ended September 30, 1999, as compared with 5.36% during the same quarter of 1998. These changes in interest revenues and interest costs produced an increase of $3.5 million, or 28.0%, in the Company's net interest income during the three months ended September 30, 1999, as compared with the same quarter during 1998. Expressed as a percentage of average interest-earning assets, the Company's net interest margin 16 17 increased to 4.00% during the three months ended September 30, 1999, as compared with the net interest margin of 3.92% produced during the same period during 1998. The Company's interest revenues increased by $23.2 million, or 30.5%, during the first nine months of 1999 as compared to the same period in 1998. This increase was primarily attributable to a 36.7% increase in the average balance of loans outstanding, which was partially offset by a decrease in the weighted average yield earned thereon, which averaged 9.08% during 1999 as compared with 9.55% in 1998. Interest costs increased by $10.6 million, or 24.1%, during the first nine months of 1999, as compared to the same period during 1998, primarily due to a 36% increase in the average balances of the Company's deposits and borrowings, which was partially offset by a decrease in the weighted average rates paid on the Company's deposits and FHLB advances, which together averaged 5.00% during the first nine months of 1999, as compared with 5.38% during the first nine months of 1998. These changes in interest revenues and interest costs produced an increase of $12.6 million, or 39.4%, in the Company's net interest income during the first nine months of 1999 as compared with the same period during 1998. Expressed as a percentage of average interest-earning assets, the Company's net interest margin increased to 3.93% during the first nine months of 1999, as compared with the net interest margin of 3.90% produced during the same period during 1998. PROVISIONS FOR ESTIMATED CREDIT LOSSES ON LOANS For the three and nine months ended September 30, 1999, the Company recorded provisions for estimated credit losses on loans of $3.5 million and $9.0 million, respectively, an increase of 79.5% and 73.6% over provisions of $2.0 million and $5.2 million recorded during the three and nine months ended September 30, 1998, respectively. The provisions for estimated credit losses during the nine months of 1999 were recorded to the Company's general valuation reserve, compared to a provision of $2.7 million to specific valuation reserve and $2.5 million to general valuation reserve during the first nine months of 1998. The increase in the level of loan loss provisions reflects management's intention to increase the ratio of the Company's general valuation reserves to 1.50% of net loans by the end of 1999, a level deemed by management to be prudent in view of the significant growth in the Company's loan portfolio since 1997, the relative lack of seasoning of many of the Company's loans, and the significant amount of construction loans in the Company's loan portfolio directed at financing real estate development. At September 30, 1999, the Company's general reserves totaled 1.45% of net loans compared to 0.89% and 0.97% at December 31, 1998, and September 30, 1998, respectively. Although the Company maintains its allowance for credit losses at a level which it considers to be adequate to provide for potential losses based on 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 SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30 ------------------------------------ ------------------------------------ 1999 1998 CHANGE 1999 1998 CHANGE ------ ------ ------ ------ ------ ------ NONINTEREST REVENUES Loan-related fees $1,783 $1,184 $ 599 $5,129 $2,915 $2,214 Other 253 188 65 802 626 176 ------ ------ ------ ------ ------ ------ TOTAL NONINTEREST REVENUES $2,036 $1,372 $ 664 $5,931 $3,541 $2,390 ====== ====== ====== ====== ====== ======
Loan-related fees primarily consist of fees collected from borrowers (1) for the early repayment of their loans, (2) for the extension of the maturity of loans (predominantly short-term construction loans, with respect to which extension options are often included in the original term of the Company's loan), and (3) in connection with certain loans which contain exit or release fees payable to the Company upon the maturity or repayment of the 17 18 Company's loan. The significant increase in loan-related fee revenues during the first nine months of 1999, as compared with the first nine months of 1998, was occasioned by the prepayment of a larger number of loans to which prepayment penalties were attached, and the repayment of a small number of loans requiring exit fees due upon repayment. The increase in prepayments was due to the sharp drop in market interest rates that occurred during the last half of 1998, resulting in an increase in the volume of prepayments and refinancings during the first half of 1999. NONINTEREST EXPENSES - GENERAL AND ADMINISTRATIVE EXPENSES As the Company's business activities have grown and expanded, additional personnel have been hired into the Company's various business and staff support groups. During the first nine months of 1999, the Company employed an average of 271 full-time equivalents. By comparison, the Company employed an average of 233 full-time equivalents during the first nine months of 1998. The corresponding year-over-year growth in employee-related expenses, which consist primarily of base salaries, incentive compensation and the Company's share of benefit expenses, was substantially less than the growth in the dollar amount of the Company's net interest margin. The year-over-year growth in operating and occupancy expenses approximates, and is directly tied to, the growth in the number of full-time equivalents employed by the Company. General and administrative expenses were $7.3 million during the three months ended September 30, 1999, which is $0.5 million less than the general and administrative costs during the second quarter of 1999, and is 1.4% more than the general and administrative costs during the third quarter of 1998, which were $7.2 million. For the nine months ended September 30, 1999, general and administrative costs were $23.0 million, representing a 13.3% increase over general and administrative costs of $20.3 million for the same period in 1998. The growth in general and administrative expenses during the third quarter of 1999, as compared with the same quarter in 1998, resulted from increases of $0.6 million in professional fees which was somewhat offset by a reduction of employee related costs of $0.5 million. Professional fees increased $0.9 million during the first nine months of 1999 as compared with 1998, primarily due to increased legal fees. Non-operating expenses increased to $1.6 million compared to $14 thousand due to $1.3 million in connection with actual or proposed legal settlements; see further discussion under "Legal Matters". Employee related costs, occupancy and operating expenses also increased year-over-year, as a direct consequence of the growth in staff. In addition, during the first nine months of 1999, the Company paid $ 0.3 million, which is included in other non-operating expenses, for the remaining cost of a long-term lease in connection with one of its former branch offices, which management determined was no longer part of the Company's operating plant. LEGAL MATTERS The Company and the Bank are involved in a variety of litigation matters in the ordinary course of its business. A majority of these actions involve allegations with respect to properties acquired by the Bank through foreclosure and subsequently sold by the Bank. The Bank was found liable in two cases that went to trial in 1999; see "Legal Proceedings" for a discussion of these two cases. The amount of legal defense costs and settlements in any period will depend on many factors, including the status of cases (and in the number of cases that are in trial or about to be brought to trial) and the opposing parties aggressiveness in pursuing their cases and their perception of their legal position. For the nine months ended September 30, 1999, legal expenses totaled $0.9 million compared to $0.5 million during the first nine months of 1998. Additionally, other non-operating expenses included $1.3 million in connection with actual or proposed legal settlements during the first nine months of 1999. As set forth in Note 5, SUBSEQUENT EVENTS, the Bank agreed to pay the sum of $700 thousand to settle an action related to a foreclosure sale of one of the Bank's REO properties. The cost of this settlement will reduce net earnings for the 4th quarter by approximately $406 thousand, or $0.05 per share. 18 19 NONINTEREST EXPENSES - REAL ESTATE OPERATIONS The table below sets forth the costs and revenues 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 General and Administrative Expenses (dollars are in thousands).
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30 --------------------------------- --------------------------------- 1999 1998 CHANGE 1999 1998 CHANGE ------- ------- ------- ------- ------- ------- EXPENSES ASSOCIATED WITH REAL ESTATE OPERATIONS Property taxes, repairs, maintenance, renovations, and insurance $ 82 $ 196 $ (114) $ 233 $ 277 $ (44) REVENUES ASSOCIATED WITH REAL ESTATE OPERATIONS Net recoveries from sale of REO and property operations 90 812 (722) 738 2,272 (1,534) PROVISION FOR ESTIMATED LOSSES ON REAL ESTATE OWNED -- -- -- 80 15 65 ------- ------- ------- ------- ------- ------- INCOME FROM REAL ESTATE $ 8 $ 616 $ (608) $ 425 $ 1,980 $(1,555) ======= ======= ======= ======= ======= =======
Net recoveries from sales of REO properties represent the difference between the proceeds received from property disposal and the carrying value of such properties upon disposal. Property operations principally include the net operating income (collected rental revenues less operating expenses and certain renovation costs) from foreclosed income-producing properties or receipt, following foreclosure, of similar funds held by receivers during the period the original loan was in default. During the nine months ended September 30, 1999, the Company sold seventeen properties generating net cash proceeds of $9.9 million and a net recovery of $0.8 million, as compared to sales of eighty properties generating net cash proceeds of $10.8 million and a net recovery of $2.2 million during the nine months ended September 30, 1998. INCOME TAXES The Company recorded income tax provisions of $2.7 million and $7.3 million for the three and nine months ended September 30, 1999, respectively, as compared to income tax provisions of $1.6 million and $3.5 million, during the same periods in 1998. The Company returned to taxable status during 1998, following several years in which it realized substantial income tax benefits from utilization of accumulated operating loss carryforwards. The Company's effective tax rate was 42.2% and 42.0%, respectively, for the three and nine months ended September 30, 1999 and 32.1% and 29.4%, for the same periods in 1998. 19 20 FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY ASSETS LOANS RECEIVABLE GENERAL The Company's loan portfolio consists almost exclusively of loans secured by real estate located in Southern California. The table below sets forth the composition of the Company's loan portfolio as of the dates indicated (dollars are in thousands).
SEPTEMBER 30, 1999 DECEMBER 31, 1998 ---------------------------- -------------------------------- BALANCE PERCENT BALANCE PERCENT ------------ ------- ------------ ------- Single family $ 636,036 38.2% $ 576,032 35.9% Income property Multi-family (1) 226,308 13.6 250,876 15.6 Commercial (1) 207,484 12.5 222,558 13.9 Development (2) 140,986 8.5 78,425 4.9 Land (3) 86,543 5.2 69,581 4.3 Single family construction Single residence (4) 288,823 17.3 275,888 17.2 Tract 36,546 2.2 85,942 5.3 Other 41,013 2.5 46,615 2.9 ------------ ----- ------------ ------------ GROSS LOANS RECEIVABLE (5) 1,663,739 100.0% 1,605,917 100.0% ===== ==== LESS Undisbursed funds (204,282) (256,096) Deferred fees and credits, net (2,337) (5,919) Allowance for estimated losses (22,694) (17,111) ------------ ------------ NET LOANS RECEIVABLE $ 1,434,426 $ 1,326,791 ============ ============
- ------------------- (1) Predominantly term loans secured by improved properties, with respect to which the properties' cash flows are sufficient to service the Company's loan. (2) Predominantly loans to finance the construction of income-producing improvements. Also includes loans to finance the renovation of existing improvements. (3) The Company expects that a majority of these loans will be converted into construction loans, and the land-secured loans repaid with the proceeds of these construction loans, within 12 months. (4) Predominantly loans for the construction of individual and custom homes. (5) The funded principal balance under recorded loan commitments, plus undisbursed funds associated with such loan commitments. The following table sets forth the approximate composition of the Company's gross new loan commitments, net of internal refinances, for the periods indicated, in dollars and as a percentage of total loans originated (dollars are in thousands). 20 21
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 1999 SEPTEMBER 30, 1999 ----------------------------- ----------------------------- TYPES OF COLLATERAL AMOUNT % AMOUNT % - -------------------------- -------- ----- -------- ----- Single family (1) $ 89,900 54.3% $215,300 41.1% Income property Multi-family 3,500 2.1 18,000 3.4 Commercial (2) 17,000 10.3 50,700 9.7 Development (3) 13,300 8.0 53,200 10.2 Land (4) 14,300 8.6 39,400 7.5 Single family construction Single residence (5) 24,700 14.9 129,500 24.7 Tract (6) 3,000 1.8 9,700 1.9 Other (7) -- -- 7,700 1.5 -------- ----- -------- ----- $165,700 100.0% $523,500 100.0% ======== ===== ======== =====
- -------------------- (1) Includes unfunded commitments of $0.2 million as of September 30, 1999. (2) Includes unfunded commitments of $2.0 million as of September 30, 1999. (3) Includes unfunded commitments of $25.9 million as of September 30, 1999. (4) Includes unfunded commitments of $9.2 million as of September 30, 1999. (5) Includes unfunded commitments of $67.1 million as of September 30, 1999. (6) Includes unfunded commitments of $4.4 million as of September 30, 1999. (7) Includes unfunded commitments of $5.5 million as of September 30, 1999. ASSET QUALITY Nonaccrual and Troubled Debt Restructured Loans The Company generally places a loan on nonaccrual status when (1) it becomes 30 or more days delinquent or (2) management believes that, with respect to a performing loan, 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, 1999 1998 ------------- ------------ NONACCRUAL LOANS Loans past due 90 days or more $13,502 $13,042 Loans past due 30-89 days (1) 8,091 20,002 Other nonaccrual loans 4,800 14,644 ------- ------- TOTAL (2) $26,393 $47,688 ======= ======= RATIO OF TOTAL NONACCRUAL LOANS TO Total assets 1.7% 3.4% Net loans receivable 1.8% 3.6% Core capital plus General Reserves 17.4% 39.5%
- --------------------- (1) Excludes a $2.2 million loan that was delinquent and accruing at September 30, 1999, which was paid in full on October 1, 1999. (2) Includes $10.0 million and $2.7 million of troubled debt restructured loans ("TDRs") at September 30, 1999 and December 31, 1998, respectively. Excludes $26.4 million and $31.6 million of TDRs which were performing in accordance with their modified terms at September 30, 1999 and December 31, 1998, respectively. 21 22 Nonperforming assets ("NPAs"), which consist of the carrying value of properties acquired through foreclosure and loan principal delinquent three or more payments, were at $14.7 million at September 30, 1999 (or 0.9% of total assets). By comparison, NPAs were $17.1 million (or 1.2% of total assets) at December 31, 1998. The dollar amounts of nonaccrual and nonperforming loans have steadily declined over the past several years, reaching their current level of $26.4 million and $13.5 million, respectively, at September 30, 1999, or 1.7% and 0.8%, respectively, of total assets, their lowest level since the 1980's. Because a portion of the Company's lending involves greater potential risk than conventional lending, and because certain of the Company's loans are large relative to the Company's and the Bank's capital, management expects that the dollar amount of the Company's nonaccrual and nonperforming loans is likely to be more volatile than that of its competitors. Accordingly, the Company's earnings may be measurably affected by periodic changes in the dollar amounts of nonaccrual and nonperforming loans. Classified Assets The table below sets forth information concerning the Company's classified assets as of 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, 1999 1998 ------------- ------------ Real estate owned, net $ 1,175 $ 4,070 Total nonaccrual loans 26,393 47,688 ---------- ---------- Gross nonaccrual assets 27,568 51,758 Performing loans classified substandard or lower (1) 65,938 45,397 ---------- ---------- Gross classified assets $ 93,506 $ 97,155 ========== ========== Gross classified loans $ 92,331 $ 93,085 ========== ========== Gross loans receivable $1,457,120 $1,343,902 ========== ========== Bank core capital $ 130,622 $ 108,673 ========== ========== Bank risk-based capital $ 143,332 $ 119,400 ========== ========== Ratio of classified assets to: Loans receivable 6.4% 7.2% ========== ========== Core capital 71.6% 89.4% ========== ========== Risk-based capital 65.2% 81.4% ========== ==========
- --------------------- (1) Includes $18.1 million in loans at December 31, 1998, of which $13.1 million were past due for maturity but current with respect to interest and, if applicable, principal payments; all $18.1 million of loans were renewed, paid current, or paid off during the first quarter of 1999. 22 23 The table below sets forth information concerning the Company's gross classified loans, by category, as of September 30, 1999 (dollars are in thousands).
DELINQUENT LOANS OTHER --------------------------- NONACCRUAL PERFORMING 90+ DAYS 30-89 DAYS LOANS(1) LOANS TOTAL -------- ---------- ---------- ------- ------- Single family $11,527 $ 3,789 $ 2,500 $26,909 $44,725 Income property -- -- -- 196 196 Multi-family -- -- -- 21,529 21,529 Commercial -- -- -- -- -- Development -- 6,508 2,300 9,310 18,118 Land -- -- -- -- -- Single family construction Single residence -- -- -- 5,512 5,512 Tract 1,946 -- -- 1,946 Other 29 2 -- 274 305 ------- ------- ------- ------- ------- TOTAL $13,502 $10,299 $ 4,800 $63,730 $92,331 ======= ======= ======= ======= =======
- --------------------- (1) Loans which have been restructured and are paying as agreed. ALLOWANCE FOR ESTIMATED LOSSES Management establishes specific allowances for estimated losses on individual loans and REO when it has determined that recovery of the Company's gross investment is not probable and when the amount of loss can be reasonably determined. In making this determination, management considers (1) the status of the asset, (2) the probable future status of the asset, (3) the value of the asset or underlying collateral and (4) management's intent with respect to the asset. In quantifying the loss, if any, associated with individual loans and REO, management utilizes external sources of information (i.e., appraisals, price opinions from real estate professionals, comparable sales data and internal estimates). In establishing specific allowances, management estimates the revenues expected to be generated from disposal of the Company's collateral or owned property, less construction and renovation costs (if any), holding costs and transaction costs. For tract construction and land development, the resulting projected cash flows are discounted utilizing a market rate of return to determine their value. The Company maintains an allowance for estimated credit losses which is not tied to individual loans or properties ("General Reserves"). General Reserves are maintained for each of the Company's principal loan segments, and supplemented by periodic additions through provisions for estimated credit losses. In measuring the adequacy of the Company's General Reserves, management considers (1) the Company's historical loss experience for each loan portfolio segment and in total, (2) the historical migration of loans within each portfolio segment and in total (i.e., from performing to nonperforming, from nonperforming to REO), (3) observable trends in the performance of each loan portfolio segment, (4) observable trends in the region's economy and in its real property markets and (5) guidelines published by the OTS for maintaining General Reserves. Because a significant majority of the Company's loans have been originated since 1994, a period during which the Southern California region has experienced substantial and sustained economic growth, and property values have risen sharply, the Company's loan portfolio lacks substantial seasoning and the Company has little historical experience to aid management in measuring the impact of a pronounced and sustained economic downturn on the performance of the Company's loan portfolio. For these reasons, and because of the generally higher risk profile and individual size of many of the Company's loans, in each instance when compared with conventional home lenders, management has determined to increase the level of General Reserves during 1999, to an amount which represents 1.50% of net loans by the end of 1999. 23 24 The table below sets forth the general and specific allowance for estimated credit losses for the Company's loan portfolio as of September 30, 1999 (dollars are in thousands).
LOANS ------------------------------- PERFORMING DELINQUENT TOTAL ---------- ---------- ----- Specific reserves $ 494 $ 1,074 $ 1,568 General reserves 20,004 1,122 21,126 ------- ------- ------- TOTAL $20,498 $ 2,196 $22,694 ======= ======= ======= PERCENTAGES % of total reserves to gross loans 1.43% 9.22% 1.56% % of general reserves to net loans 1.40% 4.94% 1.45%
The table below summarizes the activity of the Company's allowance for estimated credit losses for the periods indicated (dollars are in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ----------------------------- ----------------------------- 1999 1998 1999 1998 ----------- ----------- ----------- ----------- LOANS Average loans outstanding $ 1,437,346 $ 1,146,124 $ 1,395,125 $ 1,020,795 =========== =========== =========== =========== Total allowance for estimated credit losses at beginning of period $ 20,323 $ 14,541 $ 17,111 $ 13,274 Provision for estimated credit losses 3,500 1,950 9,000 5,185 Charge-offs Single family(1) (80) (326) (1,856) (1,061) Income property Multi-family (186) (5) (186) (1,038) Commercial -- (512) (200) Other (863) (863) ----------- ----------- ----------- ----------- Total charge-offs (1,129) (331) (3,417) (2,299) ----------- ----------- ----------- ----------- TOTAL ALLOWANCE FOR ESTIMATED CREDIT LOSSES AT END OF PERIOD $ 22,694 $ 16,160 $ 22,694 $ 16,160 =========== =========== =========== =========== Ratio of charge-offs to average loans outstanding during the period 0.08% 0.03% 0.24% 0.23% REAL ESTATE OWNED Total allowance for estimated losses at beginning of period $ 38 $ 12 $ 45 $ 2,563 Provision for estimated losses -- -- 80 15 Charge-offs -- (12) (87) (2,578) ----------- ----------- ----------- ----------- Total allowance for estimated losses at end of period $ 38 $ -- $ 38 $ -- =========== =========== =========== ===========
- --------------------- (1) In April 1999, the Bank sold a single family loan which resulted in a charge-off of $1.5 million. 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 maintains an allowance for estimated credit losses, for each identifiable segment of the Company's loan portfolio. The table below summarizes the allocation of the Company's allowance for estimated credit losses for each principal loan portfolio segment (dollars are in thousands). 24 25
SEPTEMBER 30, 1999 DECEMBER 31, 1998 ------------------------------- ------------------------------- PERCENT OF PERCENT OF RESERVES TO RESERVES TO TOTAL LOANS (1) TOTAL LOANS (1) BALANCE BY CATEGORY BALANCE BY CATEGORY ------- --------------- ------- --------------- Single family $ 4,687 0.74% $ 7,836 1.36% Income Property Multi-family 736 0.33% 1,063 0.42% Commercial 5,548 2.67% 4,334 1.95% Development 2,302 1.63% 354 0.45% Land 2,800 3.24% 293 0.42% Single family construction Single residence 2,479 0.86% 789 0.29% Tract 816 2.23% 1,092 1.27% Other 3,326 8.11% 1,350 2.90% ------- ------- $22,694 1.56% $17,111 1.28% ======= =======
- --------------------- (1) Percent of allowance for estimated credit losses to gross loan commitments, which include the undisbursed portion of such commitments. The change in the percentage of reserves to total loans by category is a result of different levels of classified assets within each category. Also in June 1999, the Bank changed its reserve methodology to individually risk weight a vast majority of certain types of loans. REAL ESTATE OWNED Real estate acquired in satisfaction of loans is transferred from loans to properties at the lower of the carrying values or the estimated fair values, less any estimated disposal costs. The difference between the fair value of the real estate collateral and the loan balance at the time of transfer is recorded as a loan charge-off. Any subsequent declines in the fair value of the properties after the date of transfer are recorded through the establishment of, or additions to, specific allowances. Recoveries and losses from the disposition of properties are also included in NONINTEREST EXPENSES - REAL ESTATE OPERATIONS. The table below summarizes the composition of the Company's REO at the dates indicated (dollars are in thousands).
SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------- ------------ Single family $ 1,213 $ 2,509 Income property Multi-family -- 213 Commercial -- 1,393 ------- ------- GROSS INVESTMENT (1) 1,213 4,115 Less allowance for estimated losses (38) (45) ------- ------- NET REAL ESTATE OWNED $ 1,175 $ 4,070 ======= =======
- --------------------- (1) Fair value of collateral at foreclosure, plus post-foreclosure capitalized costs. In August 1999, the Bank acquired a property with a carrying value of $6.24 million, which was sold for $6.27 million. The Bank made a loan in connection with the sale of the property and recorded $32 thousand in deferred profit, which will be recognized upon maturity in August 2000. 25 26 LIABILITIES SOURCES OF FUNDS GENERAL The Company's principal sources of funds in recent years have been deposits obtained on a retail basis through its branch offices and, to a lesser extent, advances from the FHLB. In addition, funds have been obtained from maturities and repayments of loans and securities, and sales of loans, securities and other assets, including real estate owned. DEPOSITS The table below summarizes the Company's deposit portfolio by original term, weighted average interest rates ("WAIR") and weighted average remaining maturities in months ("WARM") as of the dates indicated (dollars are in thousands).
SEPTEMBER 30, 1999 DECEMBER 31, 1998 ----------------------------------------- ------------------------------------------ PRODUCT TYPE BALANCE WAIR WARM BALANCE WAIR WARM - ----------------------------- ---------- ----- ---- ---------- ---- ---- Non-interest bearing checking $ 27,196 0.00% -- $ 20,275 0.00% Checking/NOW 38,839 2.11% -- 35,596 2.03% -- Passbook 23,883 1.59% -- 25,723 2.10% -- Money market 166,687 4.35% -- 104,137 4.53% -- Certificates of deposit 7 day maturities 32,173 4.08% -- 36,091 4.08% -- Less than 6 months 57,242 5.17% 2 5,688 4.60% 2 6 months to 1 year 168,356 5.07% 4 207,964 5.25% 3 1 year to 2 years 543,535 5.23% 7 537,815 5.51% 7 Greater than 2 years 35,582 5.22% 14 46,161 5.40% 16 ---------- ---------- $1,093,493 4.71% 5 $1,019,450 4.98% 5 ========== ==========
FHLB ADVANCES The Company has a credit line with the FHLB with a maximum advance of up to 35% of total assets based on qualifying collateral. The FHLB system functions as a source of credit to savings institutions which are members. Advances are secured by the Company's mortgage loans and the capital stock of the FHLB owned by the Company. Subject to the FHLB's advance policies and requirements, these advances can be requested for any business purpose in which the Company is authorized to engage. In granting advances, the FHLB considers a member's creditworthiness and other relevant factors. The table below sets forth certain information regarding the Company's FHLB advances (dollars are in thousands).
SEPTEMBER 30, 1999 DECEMBER 31, 1998 ------------------------- ------------------------- ORIGINAL TERM PRINCIPAL RATE PRINCIPAL RATE --------- ---- --------- ---- 60 Months $310,000 5.24% $215,000 5.36% 120 Months 49,000 4.36% 49,000 4.36% --------- --------- $359,000 5.12% (1) $264,000 5.18% (1) ========= =========
- --------------------- (1) Weighted average The weighted average remaining term of the Company's FHLB advances was 4 years and 6 months and 5 years and 3 months as of September 30, 1999 and December 31, 1998, respectively. All of the Company's FHLB advances 26 27 outstanding at September 30, 1999, with the exception of one, contain options which allow the FHLB to call the advances prior to maturity, subject to an initial non-callable period of one-to-three years from origination. SENIOR NOTES On December 31, 1997, the Company issued $40.0 million of Senior Notes due 2004. These Senior Notes bear interest payable semiannually at a rate of 12.5%, and are callable after December 31, 2002. Interest is required to be paid semiannually at the stated interest rate. STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL The Company's capital consists of common stockholders' equity, which at September 30, 1999 amounted to $92.2 million and which equaled 5.8% of the Company's total assets. The following table summarizes the regulatory capital requirements under the Home Owners' Loan Act ("HOLA") for the Bank as of September 30, 1999. 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) $ 130,622 $ 130,622 $ 130,622 Adjustments General reserves -- -- 14,036 Other (2) -- -- (1,326) ------------- ------------- ------------- ------------- ------------- ------------- Regulatory capital 130,622 8.19% 130,622 8.19% 143,332 12.86% Required minimum 23,931 1.50 63,800 4.00 89,200 8.00 ------------- ------------- ------------- ------------- ------------- ------------- Excess capital $ 106,691 6.69% $ 66,822 4.19% $ 54,132 4.86% ============= ============= ============= ============= ============= ============= Adjusted assets (3) $ 1,595,388 $ 1,595,388 $ 1,114,457 ============= ============= =============
- --------------------- (1) Reflects capital contributions totaling $7.5 million from the parent company made during 1999. (2) Includes the portion of non-residential construction loans which exceed a loan-to-value of 80%. (3) 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). 27 28 As of September 30, 1999, 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 Bank's category. The Bank's actual capital amounts and ratios and the capital amounts and ratios required in order for an institution to be "well capitalized" and "adequately" capitalized are presented in the table below (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 SEPTEMBER 30, 1999 Total Capital (to Risk Weighted Assets) $143,332 12.86% $ 89,200 8.00% $111,446 10.00% Core Capital (to Adjusted Tangible Assets) 130,622 8.19% 63,800 4.00% 79,769 5.00% Tangible Capital (to Tangible Assets) 130,622 8.19% 23,931 1.50% N/A N/A Tier 1 Capital (to Risk Weighted Assets) 130,622 11.72% N/A N/A 66,867 6.00% AS OF DECEMBER 31, 1998 Total Capital (to Risk Weighted Assets) $119,400 11.10% $ 86,090 8.00% $107,612 10.00% Core Capital (to Adjusted Tangible Assets) 108,673 7.65% 56,804 4.00% 71,005 5.00% Tangible Capital (to Tangible Assets) 108,673 7.65% 21,302 1.50% N/A N/A Tier 1 Capital (to Risk Weighted Assets) 108,673 10.10% N/A N/A 64,567 6.00%
The OTS has authority, after an opportunity for a hearing, to downgrade an institution from "well capitalized" to "adequately capitalized" or to subject an "adequately capitalized" or "undercapitalized" institution to the supervisory actions applicable to the next lower category, if the OTS deems such action to be appropriate as a result of supervisory concerns. CAPITAL RESOURCES AND LIQUIDITY Hawthorne Financial Corporation maintained cash and cash equivalents of $.9 million at September 30, 1999. Hawthorne Financial Corporation has no other significant assets beyond its investment in the Bank. As discussed elsewhere in this report, the Company paid its June 1999 semiannual interest payment on its Senior Notes from its current liquidity. The Company will be dependent upon the Bank for dividends in order to make future semiannual interest payments. The ability of the Bank to provide dividends to Hawthorne Financial Corporation is governed by applicable regulations of the OTS. Based upon these regulations, the Bank's supervisory rating, and the Bank's current and projected earnings rate, management fully expects the Bank to maintain the ability to provide dividends to Hawthorne Financial Corporation, as necessary, for the payment of interest on the Company's Senior Notes. 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, 1999 was 10.46%, which exceeded the applicable minimum requirements. 28 29 The Company's current primary funding resources are deposits, principal payments on loans, FHLB advances and cash flows from operations. Other possible sources of liquidity available to the Company include whole loan sales, commercial bank lines of credit, and direct access, under certain conditions, to borrowings from the Federal Reserve System. The cash needs of the Company are principally for the payment of interest on, and withdrawals of, deposit accounts, the funding of loans and operating costs and expenses. YEAR 2000 COMPLIANCE The following constitutes a "Year 2000 Readiness" disclosure under the Year 2000 Information and Readiness Disclosure Act. The Year 2000 issue refers to the inability of some computers to read the Year 2000 correctly. To conserve storage space, many older computers were programmed to read dates using only the last two digits of the century. When the Year 2000 arrives, these computers may interpret "00" as the year 1900. 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. In 1997, the Company adopted a plan to address Year 2000 issues and also created a Year 2000 committee. The Year 2000 project was divided into five phases: the Awareness phase, the Assessment phase, the Renovation phase, the Validation phase, and the Implementation phase. All phases have been successfully completed. In 1998, the Company completed the process of converting from an outsourced, host-based computer system to an in-house client-server computer system. This loan/deposit accounting software was certified as Year 2000 compliant and was tested by the vendor. The Company also tested the system by creating a database that rolled forward systematically until it processed data into what it believed was early 2000. The test results were predictable and no issues were noted. The Company has also addressed the Year 2000 efforts of other critical third party vendors and service providers. Year 2000 compliance certifications have been obtained from these critical vendors/service providers and testing has been performed in accordance with the Company's testing plan. The systems that have been tested include, but are not limited to, the following: (1) deposit system; (2) loan payment system; (3) loan origination system; (4) accounting system; (5) ATMs; (6) wire transfer system; and (7) direct deposit interfaces. Year 2000 testing occurs on a continual basis upon receipt of all new releases of Year 2000 compliant hardware and software. While the Company anticipates a smooth transition into the Year 2000, there is no way to guarantee that the Company has eliminated every conceivable problem that might affect its systems or those controlled by third parties. Accordingly, the Company has developed a comprehensive contingency plan outlining emergency procedures should key services be disrupted. In addition, the Company has identified the following worst case scenarios that could occur as a result of the calendar date change: (1) loss of electrical power, (2) loss of communication systems, (3) loss of water, (4) failure of a security system, (5) failure of a critical third party system, (6) failure of an operating system, (7) failure of a critical third party electronic data interface, (8) equipment failure, and (9) large deposit account withdrawals. The Company's contingency plan provides for alternative methods of conducting business for critical functions in the event one or more of these circumstances occurs. The Company has conducted an extensive review of all of its critical third party software service providers' Year 2000 compliance efforts. In the process, the Company identified five critical core data systems that are third party supported or developed. All of these providers have asserted that their systems are compliant. The Company has also identified twenty critical service providers (non-data service related) of which seventeen have asserted that they are Year 2000 compliant. Two providers have indicated that they will be Year 2000 ready by the end of the year and one provider has not committed to a date of compliance. Contingency plans have been developed for those who have not yet submitted compliance statements. While the Company has received assurances from providers as to compliance, such assurances are not guarantees and may not be enforceable. With respect to equipment, Year 2000 testing of servers and PC's in workstations has been successfully completed. 29 30 The Company's loan portfolio consists almost entirely of real estate secured loans. While the financial condition of any borrower is susceptible to Year 2000 problems, the Company believes that its credit risk relating to Year 2000 issues is greater with commercial mortgage loans where the borrowers have an ongoing business. In September 1998, the Company began reviewing all of its commercial mortgage loans maturing after December 31, 1999 to identify those borrowers having ongoing business operations as property securing the Company's loans. As a result of this review, as of September 30, 1999, the Company had identified seven borrowers with aggregate outstanding loans of approximately $45.2 million maturing after December 31, 1999, which would fit into this higher risk profile. The Company performs quarterly evaluations on these borrowers to monitor their compliance status. If the borrowers are non-compliant, the Company will have difficulty in assessing whether such non-compliance will adversely affect the borrowers' ability to service the loans. Further, the financial condition of these borrowers (and all borrowers) may be adversely affected if their major customers or providers of critical goods and services (including telephone, gas, water, and electricity) are not Year 2000 compliant. The expense incurred and to be incurred by the Company to ensure Year 2000 compliance is substantially integrated and was included with the expense associated with the planned conversion of its computer-based systems. The Company incurred approximately $3.8 million in costs related to its data processing conversion and implementation of the Year 2000 plan. Approximately $1.2 million and $0.4 million of these costs were expensed during 1998 and 1999, respectively. The Company capitalized $2.1 million of these costs which are amortized over a three year period and expensed the remaining $0.1 million of these costs during 1999. The Company does not anticipate any material additional expenses in 1999 related to Year 2000 software or hardware. INTEREST RATE RISK MANAGEMENT The objective of interest rate risk management is to stabilize the Company's net interest income ("NII") while limiting the change in its Net Portfolio Value ("NPV") from interest rate fluctuations. The Company seeks to achieve this objective by matching its interest sensitive assets and liabilities, and maintaining the maturity and repricing of these assets and liabilities at appropriate levels given the interest rate environment. When the amount of rate-sensitive liabilities exceeds rate-sensitive assets within specified periods, the NII generally will be negatively impacted by increasing interest rates and positively impacted by decreasing interest rates during such periods. Conversely, when the amount of rate-sensitive assets exceeds the amount of rate-sensitive liabilities within specified periods, net interest income generally will be positively impacted by increasing interest rates and negatively impacted by decreasing interest rates during such periods. The speed and velocity of the repricing of assets and liabilities will also contribute to the effects on NII. The Company utilizes two methods for measuring interest rate risk, namely, gap analysis and interest rate simulations. Gap analysis focuses on measuring absolute dollar amounts subject to repricing within certain periods of time, particularly the one-year maturity horizon. Interest rate simulations provide the Company with an estimate of both the dollar amount and percentage change in NII under various interest rate scenarios. All assets and liabilities are subjected to tests of up to 300 basis points in increases and decreases in interest rates. Under each interest rate scenario, the Company projects its net interest income and the NPV of its current balance sheet. From these results, the Company can then develop alternatives to dealing with the tolerance thresholds. The Company's interest rate risk strategy emphasizes the management of asset and liability balances within repricing categories in order to limit the Bank's exposure to earnings variations as well as variations in the value of assets and liabilities due to changes in interest rates over time. The Company does not currently utilize off balance sheet hedging instruments in order to hedge its interest rate exposure. Instead, the Company utilizes interest rate floors, prepayment penalties, and exit fees on its new loans to mitigate the risk of interest margin compression. Additionally, the Company hedges such exposure internally by extending the duration of interest-bearing liabilities through the use of FHLB advances, to better match the repricing sensitivity of the interest-earning assets. 30 31 The following table sets forth information concerning sensitivity of the Company's interest-earning assets and interest-bearing liabilities as of September 30, 1999. 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).
SEPTEMBER 30, 1999 ---------------------------------------------------------------------------------- OVER THREE OVER SIX OVER ONE THREE THROUGH THROUGH YEAR OVER MONTHS SIX TWELVE THROUGH FIVE OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL ---------- ---------- ---------- ---------- ---------- ---------- INTEREST-EARNING ASSETS Cash and cash equivalents(1) $ 100 $ -- $ -- $ -- $ -- $ 100 Investments and FHLB Stock 20,701 -- -- -- -- 20,701 Loans(2) 957,368 296,904 41,399 45,252 118,534 1,459,457 ---------- ---------- ---------- ---------- ---------- ---------- TOTAL INTEREST-EARNING ASSETS $ 978,169 $ 296,904 $ 41,399 $ 45,252 $ 118,534 $1,480,258 ========== ========== ========== ========== ========== ========== INTEREST-BEARING LIABILITIES Deposits Transaction accounts $ 232,846 $ -- $ -- $ -- $ -- $ 232,846 Certificates of deposit 270,959 195,566 273,285 97,078 -- 836,888 FHLB advances -- -- 310,000 49,000 359,000 Senior notes -- -- -- 40,000 40,000 ---------- ---------- ---------- ---------- ---------- ---------- TOTAL INTEREST-BEARING LIABILITIES $ 503,805 $ 195,566 $ 273,285 $ 407,078 $ 89,000 $1,468,734 ========== ========== ========== ========== ========== ========== Interest rate sensitivity gap $ 474,364 $ 101,338 $ (231,886) $ (361,826) $ 29,534 $ 11,524 Cumulative interest rate sensitivity gap 474,364 575,702 343,816 (18,010) 11,524 11,524 Cumulative interest rate sensitivity gap as a percentage of total interest earning assets 32.0% 38.9% 23.2% (1.2%) 0.8% 0.8%
- --------------------- (1) Excludes noninterest earning cash balances. (2) Loans include $26.4 million of nonaccrual loans, and are exclusive of loan loss reserves. 31 32 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 a Net Portfolio Value analysis (NPV), which in essence "marks-to-market" the balance sheet under various interest rate scenarios to determine how the Bank's NPV changes in response to changes in interest rates. Net Portfolio Value is calculated as 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 NPV which would result from changes in market interest rates in theoretical increments of 100 basis points, up to 300 basis points in either direction. Presented below, as of September 30, 1999, is an analysis of the Bank's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts of 100, 200 and 300 basis points in market interest rates, in either direction. These results reflect that the Bank has "minimal interest rate risk exposure" based on the OTS guidelines (dollars are in thousands).
NET PORTFOLIO VALUE --------------------------------- CHANGE $ CHANGE FROM NPV % CHANGE FROM IN RATES $ AMOUNT BASECASE RATIO BASECASE - -------- -------- ------------- ----- ------------- +300 bp $137,161 (10,490) 8.68% -0.52% +200 bp 144,296 (3,355) 9.06% -0.13% +100 bp 147,309 (342) 9.21% 0.01% basecase 147,651 -- 9.20% -- -100 bp 149,384 1,733 9.25% 0.05% -200 bp 143,201 (4,450) 8.80% -0.40% -300 bp 138,592 (9,059) 8.46% -0.74%
32 33 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. 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 that the plaintiffs received as sellers was inadequate and should have so advised them. In June 1997, a jury found for the plaintiffs and awarded compensatory and punitive damages totaling $9.1 million. In July 1997, the trial judge reduced the combined award to $3.3 million. The Bank filed an appeal and in July, 1998, the Appellate Court remanded the case to the Superior Court with directions to dismiss the fraudulent concealment, misrepresentation and punitive damages claims and to conduct a new trial pertaining solely to damages arising from negligence, in particular to determine whether any negligence of the Bank contributed to the plaintiffs' injury and, if so, to apportion liability for negligence between the Bank and the plaintiffs. On March 30, 1999, the jury returned a verdict in favor of the plaintiffs in the amount of $2.4 million. In May 1999, the Bank filed a notice of appeal from the judgment and posted an Appeal Bond with the court to stay plaintiffs' enforcement of the judgment pending the Appellate Court's decision. The Bank believes that there is a reasonable likelihood that its position will ultimately be upheld on appeal and accordingly, that no amounts having a materially adverse effect on the Bank's or the Company's financial conditions or operations 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 Bank is a defendant in an action entitled Mells v. Hawthorne, filed in the Superior Court of the State of California, San Diego. Plaintiffs alleged that the Bank concealed and misrepresented the severity of defects in a house that the Bank sold to them. On September 20, 1999, a second amended judgment was entered on behalf of the plaintiffs for $767 thousand which includes attorney's fees and costs. In October, the Bank filed a notice of appeal from the judgment and posted an Appeal Bond with the court to stay plaintiffs' enforcement of the judgment pending the Appellate Court's decision. The Bank intends to vigorously pursue its position and believes that there is a reasonable likelihood that the amount of the judgment will be reduced and, accordingly, that no amounts having a materially adverse effect on the Bank's or the Company's financial condition or operations will be paid by the Bank to the plaintiffs in this matter. However, there can be no assurances that this will be the case. The Company is involved in a variety of other litigation matters in the ordinary course of its business, and anticipates that it will become involved in new litigation matters from time to time in the future. Based on the current assessment of these existing other matters, management does not presently believe that any one of these existing other matters is likely to have material adverse impact on the Company's financial condition or result of operations. However, the Company will incur legal and related costs in connection with the litigation and may from time to time determine to settle some or all of the cases, regardless of management's assessment of the Company's legal position. The amount of legal defense costs and settlements in any period will depend on many factors, including the status of cases (and the number of cases that are in trial or about to be brought to trial) and the opposing parties aggressiveness in pursuing their cases and their perception of their legal position. Further, the inherent uncertainty of jury or judicial verdicts makes it impossible to determine with certainty the Company's maximum cost in any pending litigation. Accordingly, the Company's litigation costs and expenses may vary materially from period to period, and no assurance can be given that these costs will not be material in any particular period. ITEM 2. CHANGES IN SECURITIES - None ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None 33 34 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None ITEM 5. OTHER INFORMATION - None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 1. Reports on Form 8-K No current reports on Form 8-K were filed for the three months ended September 30, 1999 2. Other required exhibits - Exhibit 27.1 - Financial Data Schedule 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 15, 1999 /s/ SCOTT A. BRALY ------------------------------- Scott A. Braly President and Chief Executive Officer Dated November 15, 1999 /s/ SIMONE LAGOMARSINO ------------------------------- Simone Lagomarsino Executive Vice President and Chief Financial Officer 34 EX-27.1 2 FINANCIAL DATA SCHEDULE
9 0000046267 HAWTHORNE FINANCIAL CORP. 1,000 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 121,217 100 0 0 0 0 0 1,457,120 22,694 1,597,291 1,093,493 0 12,636 399,000 0 0 53 92,109 1,597,291 94,956 4,269 0 99,225 37,880 54,641 44,584 9,000 0 24,158 17,357 17,357 0 0 10,072 1.91 1.30 8.75 26,393 0 36,441 65,938 17,111 3,417 0 22,694 22,694 0 0
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