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 JUNE 30, 2000 [ ] 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 5,286,401 shares of Common Stock, $0.01 par value per share outstanding, as of July 31, 2000. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY FORM 10-Q INDEX FOR THE QUARTER ENDED JUNE 30, 2000 PAGE ---- PART I -- FINANCIAL INFORMATION ITEM 1. Financial Statements Consolidated Statements of Financial Condition at June 30, 2000 and December 31, 1999.................................. 1 Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2000 and 1999......................... 2 Consolidated Statement of Stockholders' Equity for the Six Months Ended June 30, 2000.................................. 3 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2000 and 1999................................ 4 Notes to Consolidated Financial Statements.................. 5 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 8 ITEM 3. Quantitative and Qualitative Disclosure About Market Risk... 29 PART II -- OTHER INFORMATION ITEM 1. Legal Proceedings........................................... 31 ITEM 2. Changes in Securities....................................... 31 ITEM 3. Defaults upon Senior Securities............................. 31 ITEM 4. Submission of Matters to a Vote of Security Holders......... 31 ITEM 5. Other Information........................................... 31 ITEM 6. Exhibits and Reports on Form 8-K............................ 31 FORWARD-LOOKING STATEMENTS When used in this Form 10-Q or future filings by the Company with the Securities and Exchange Commission, in the Company's press releases or other public or stockholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project", "believe" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers that all forward-looking statements are necessarily speculative and not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various risks and uncertainties, including regional and national economic conditions, changes in levels of market interest rates, credit risks of lending activities, competitive and regulatory factors and the outcome of pending litigation, 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. i 3 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION JUNE 30, DECEMBER 31, 2000 1999 ---------- ------------ (Unaudited) (DOLLARS IN THOUSANDS) Assets: Cash and cash equivalents................................. $ 97,892 $ 86,722 Loans receivable (net of allowance for estimated credit losses of $27,089 in 2000 and $24,285 in 1999)......... 1,531,613 1,444,968 Real estate owned, net.................................... 5,334 5,587 Investment in capital stock of Federal Home Loan Bank, at cost................................................... 20,105 22,236 Accrued interest receivable............................... 10,804 9,250 Office property and equipment at cost, net................ 5,267 5,939 Deferred tax asset, net................................... 3,589 2,203 Other assets.............................................. 3,352 4,248 ---------- ---------- Total assets...................................... $1,677,956 $1,581,153 ========== ========== Liabilities and Stockholders' Equity: Liabilities: Deposits.................................................. $1,167,047 $1,086,635 FHLB advances............................................. 359,000 349,000 Senior notes.............................................. 40,000 40,000 Accounts payable and other liabilities.................... 13,681 13,214 ---------- ---------- Total liabilities................................. 1,579,728 1,488,849 Stockholders' equity: Preferred stock -- $0.01 par value; authorized 10,000,000 shares; no shares outstanding.......................... -- -- Common stock -- $0.01 par value; authorized 20,000,000 shares; issued and outstanding 5,559,301 shares in 2000 and 5,331,301 shares in 1999........................... 55 53 Capital in excess of par value -- common stock............ 42,057 40,981 Retained earnings......................................... 58,294 51,318 ---------- ---------- 100,406 92,352 Less: Treasury stock, at cost -- 272,900 shares in 2000 and 5,400 shares in 1999................................... (2,178) (48) ---------- ---------- Total stockholders' equity........................ 98,228 92,304 ---------- ---------- Total liabilities and stockholders' equity........ $1,677,956 $1,581,153 ========== ========== See accompanying Notes to Consolidated Financial Statements 1 4 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------ 2000 1999 2000 1999 ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Interest revenues: Loans............................................. $34,685 $31,238 $67,598 $62,219 Investments....................................... 1,690 1,442 3,213 2,475 ------- ------- ------- ------- Total interest revenues................... 36,375 32,680 70,811 64,694 ------- ------- ------- ------- Interest costs: Deposits.......................................... 15,024 12,628 28,867 25,062 FHLB advances..................................... 4,594 4,437 9,192 8,297 Senior notes...................................... 1,250 1,250 2,500 2,500 ------- ------- ------- ------- Total interest costs...................... 20,868 18,315 40,559 35,859 ------- ------- ------- ------- Net interest income................................. 15,507 14,365 30,252 28,835 Provision for credit losses......................... 1,500 2,500 3,000 5,500 ------- ------- ------- ------- Net interest income after provision for credit losses......................................... 14,007 11,865 27,252 23,335 ------- ------- ------- ------- Noninterest revenues: Loan related fees................................. 2,134 1,925 3,894 3,895 (Loss)/income from real estate operations, net...... (90) (17) (149) 417 Noninterest expenses: General and administrative expenses: Employee....................................... 4,353 3,576 8,405 7,679 Operating...................................... 1,529 1,599 3,042 3,138 Occupancy...................................... 897 986 1,860 1,979 Technology..................................... 484 518 958 1,078 Professional................................... 1,231 860 2,106 1,164 SAIF premiums and OTS assessments.............. 217 313 439 612 ------- ------- ------- ------- Total general and administrative expenses................................ 8,711 7,852 16,810 15,650 Other non-operating expense....................... 196 8 2,024 1,000 ------- ------- ------- ------- Total noninterest expenses................ 8,907 7,860 18,834 16,650 ------- ------- ------- ------- Income before income taxes.......................... 7,144 5,913 12,163 10,997 Income tax provision................................ 3,072 2,487 5,187 4,599 ------- ------- ------- ------- Net income.......................................... $ 4,072 $ 3,426 $ 6,976 $ 6,398 ======= ======= ======= ======= Basic earnings per share (Note 3)................... $ 0.77 $ 0.65 $ 1.30 $ 1.22 ======= ======= ======= ======= Diluted earnings per share (Note 3)................. $ 0.57 $ 0.44 $ 0.95 $ 0.83 ======= ======= ======= ======= Weighted average basic shares outstanding (Note 3)................................................ 5,286 5,290 5,374 5,257 ======= ======= ======= ======= Weighted average diluted shares outstanding (Note 3)................................................ 7,169 7,723 7,336 7,728 ======= ======= ======= ======= See accompanying Notes to Consolidated Financial Statements 2 5 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY COMPREHENSIVE INCOME BALANCE AT EXERCISED ------------- BALANCE AT DECEMBER 31, STOCK EXERCISED NET TREASURY JUNE 30, 1999 OPTIONS WARRANTS INCOME STOCK 2000 ------------ --------- --------- ------------- -------- ----------- (IN THOUSANDS) (UNAUDITED) Number of common shares......... 5,331 228 -- -- -- 5,559 Treasury stock.................. (5) -- -- -- (268) (273) ------- ------ ------ ------ ------- ------- Total shares outstanding......... 5,326 228 -- -- (268) 5,286 ======= ====== ====== ====== ======= ======= Common stock.................... $ 53 $ 2 $ -- $ -- $ -- $ 55 Capital in excess of par value, common stock.................. 40,981 1,076 -- -- -- 42,057 Retained earnings............... 51,318 -- -- 6,976 -- 58,294 Treasury stock.................. (48) -- -- -- (2,130) (2,178) ------- ------ ------ ------ ------- ------- Total stockholders' equity.............. $92,304 $1,078 $ -- $6,976 $(2,130) $98,228 ======= ====== ====== ====== ======= ======= See accompanying Notes to Consolidated Financial Statements 3 6 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) SIX MONTHS ENDED JUNE 30, ---------------------- 2000 1999 --------- --------- (DOLLARS IN THOUSANDS) Cash Flows from Operating Activities: Net income................................................ $ 6,976 $ 6,398 Adjustments: Deferred income tax (benefit) provision................. (1,386) 226 Provision for estimated credit losses on loans.......... 3,000 5,500 (Recovery) provision for estimated losses on real estate owned.................................................. (24) 80 Net gain from sale of real estate owned................. (7) (629) Loan fee and discount accretion......................... (1,311) (3,125) Depreciation and amortization........................... 1,067 912 FHLB dividends.......................................... (851) (417) Increase in accrued interest receivable................. (1,554) (316) Decrease (increase) in other assets..................... 896 (296) Increase in accounts payable and other liabilities...... 467 1,115 --------- --------- Net cash provided by operating activities.......... 7,273 9,448 --------- --------- Cash Flows from Investing Activities: Loans: New loans funded........................................ (244,559) (172,327) Construction disbursements.............................. (129,918) (185,876) Payoffs................................................. 276,726 269,487 Principal payments...................................... 15,726 12,209 Other, net.............................................. (6,542) (753) Real estate owned, net: Sales proceeds.......................................... 688 2,947 Capitalized costs....................................... (26) (43) Purchase of FHLB stock.................................... (630) (5,209) Redemption of FHLB stock.................................. 3,612 -- Office property and equipment: Sale proceeds........................................... 49 48 Additions............................................... (589) (1,213) --------- --------- Net cash used in investing activities.............. (85,463) (80,730) --------- --------- Cash Flows from Financing Activities: Deposit activity, net..................................... $ 80,412 $ 33,914 Net increase in FHLB advances............................. 10,000 115,000 Net proceeds from exercise of stock options and warrants................................................ 1,078 594 Treasury Stock............................................ (2,130) -- --------- --------- Net cash provided by financing activities.......... 89,360 149,508 --------- --------- Net increase in cash and cash equivalents................... 11,170 78,226 Cash and cash equivalents, beginning of period.............. 86,722 45,449 --------- --------- Cash and cash equivalents, end of period.................... $ 97,892 $ 123,675 ========= ========= Supplemental Cash Flow Information: Cash paid during the period for: Interest................................................ $ 39,393 $ 35,590 Income taxes............................................ 3,800 4,231 Non-cash investing and financing activities: Real estate acquired in settlement of loans............. 494 1,143 Loans originated to finance sales of real estate owned.................................................. -- 1,500 Loans originated to refinance existing bank loans....... 19,393 21,024 See accompanying Notes to Consolidated Financial Statements 4 7 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 significant intercompany transactions and accounts have been eliminated in consolidation. In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting solely of normal recurring accruals) necessary to present fairly the Company's financial position as of June 30, 2000 and December 31, 1999, and the results of its operations and its cash flows for the three and six months ended June 30, 2000 and 1999. Operating results for the three and six months ended June 30, 2000, are not necessarily indicative of the results that may be expected for any other interim period or the full year ending December 31, 2000. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("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, 1999. NEW ACCOUNTING PRONOUNCEMENTS In December 1999, The Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements on Selected Issues, effective December 2000. Management does not believe that there will be a material impact on the financial position or results of operations of the Company from adoption of this bulletin. NOTE 2 -- RECLASSIFICATION Certain amounts in the 1999 consolidated financial statements have been reclassified to conform with classifications in 2000. 5 8 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3 -- BOOK VALUE AND EARNINGS PER SHARE The table below sets forth the Company's earnings per share calculations for the three and six months ended June 30, 2000 and 1999. 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. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ---------------- 2000 1999 2000 1999 ------- ------- ------ ------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Average shares outstanding Basic................................................. 5,286 5,290 5,374 5,257 Warrants.............................................. 2,486 2,503 2,486 2,503 Options(1)............................................ 155 484 197 551 Less Treasury shares(2)............................... (758) (554) (721) (583) ------ ------ ------ ------ Diluted............................................... 7,169 7,723 7,336 7,728 ====== ====== ====== ====== Net income for the period............................... $4,072 $3,426 $6,976 $6,398 ====== ====== ====== ====== Basic earnings per share................................ $ 0.77 $ 0.65 $ 1.30 $ 1.22 ====== ====== ====== ====== Diluted earnings per share.............................. $ 0.57 $ 0.44 $ 0.95 $ 0.83 ====== ====== ====== ====== JUNE 30, ----------------- 2000 1999 ------- ------- Period-end shares outstanding Basic..................................................... 5,286 5,293 Warrants.................................................. 2,486 2,503 Options(3)................................................ 155 498 Less Treasury shares(2)................................... (771) (555) ------- ------- Diluted................................................... 7,156 7,739 ======= ======= Stockholders' equity........................................ $98,228 $88,384 ======= ======= Basic book value per share.................................. $ 18.58 $ 16.70 ======= ======= Diluted book value per share................................ $ 13.73 $ 11.42 ======= ======= - --------------- (1) Excludes 385,000 options outstanding for the three and six months ended June 30, 2000 for which the exercise price exceeded the average market price of the Company's common stock during the periods. Excludes 325,000 options outstanding for the six months ended June 30, 1999 for which the exercise price exceeded the average market price of the Company's common stock during the period. (2) Under the Diluted Method, it is assumed that the Company will use proceeds from the 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 385,000 options outstanding at June 30, 2000 for which the exercise price exceeded the average market price of the Company's common stock at period-end. 6 9 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4 -- COMMITMENTS AND CONTINGENCIES On June 28, 2000, the California Supreme Court denied the Bank's petition for review of the Court of Appeals' decision affirming in part and reversing in part the judgment in the Takaki vs. Hawthorne Savings and Loan Association matter previously disclosed by the Bank. The Bank had previously accrued the full amount of the judgment, including post judgment interest through April 2000, and no material additional accruals were required during the second quarter as a result of the Supreme Court's action and payment of the judgment. The Company is involved in a variety of other litigation matters in the ordinary course of its business, as discussed in the Annual Report on Form 10-K for the year ended December 31, 1999. Management does not presently believe that any of the existing litigative matters are likely to have a material adverse impact on the Company's financial condition or results of operation. 7 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company originates real estate-secured loans throughout Southern California. These loans generally consist of (1) permanent loans collateralized by single family (one to four unit) residential property, (2) permanent and construction loans secured by multi-family residential and commercial real estate, (3) construction loans of single family residential homes and (4) the acquisition and development of land for the construction of such homes. The Company funds its loans predominately with retail deposits and, to a lesser extent, with advances from the Federal Home Loan Bank of San Francisco ("FHLB"). RESULTS OF OPERATIONS Net income for the three and six months ended June 30, 2000 of $4.1 million, or $0.57 per diluted share, and $7.0 million, or $0.95 per diluted share, respectively. This net income resulted in an annualized return on average assets ("ROA") of 1.00% and .86%, respectively, and an annualized return on average equity ("ROE") of 16.93% and 14.67%, respectively, compared with an annualized ROA of .90% and .86%, respectively, and an annualized ROE of 15.97% and 15.21%, respectively, for the three and six months ended June 30, 1999. Pretax income increased 20.82% and 10.60%, for the three and six months ended June 30, 2000, respectively, to $7.1 million and $12.2 million from $5.9 million and $11.0 million generated during the same periods in 1999. The table below identifies the principal components of the Company's pretax income and net income for the three and six months ended June 30, 2000 and 1999. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------ 2000 1999 2000 1999 ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Net interest income................................. $16,757 $15,615 $32,752 $31,335 Provision for credit losses......................... 1,500 2,500 3,000 5,500 ------- ------- ------- ------- Net interest income after provision for credit losses......................................... 15,257 13,115 29,752 25,835 Noninterest revenues: Loan related fees................................. 2,134 1,925 3,894 3,895 (Loss)/income from real estate operations, net...... (90) (17) (149) 417 Noninterest expenses: General and administrative expenses............... 8,711 7,852 16,810 15,650 Other non-operating expense....................... 196 8 2,024 1,000 Interest on senior notes............................ 1,250 1,250 2,500 2,500 ------- ------- ------- ------- Income before income taxes.......................... 7,144 5,913 12,163 10,997 Income tax provision................................ 3,072 2,487 5,187 4,599 ------- ------- ------- ------- Net income.......................................... $ 4,072 $ 3,426 $ 6,976 $ 6,398 ======= ======= ======= ======= The Company's net interest income before interest on senior notes and provision for credit losses rose 7.31% to $16.8 million and 4.52% to $32.8 million during the three and six months ended June 30, 2000, respectively, compared to $15.6 million and $31.3 million for the three and six months ended June 30, 1999, respectively. The Company's yield on average earning assets was 9.01% and 8.82% for the three and six months ended June 30, 2000, respectively, compared to 8.61% and 8.75% during the same periods in 1999. The average cost of funds for the Company increased to 5.69% and 5.55% during the three and six months ended June 30, 2000, respectively, compared to 5.24% and 5.28% for the three and six months ended June 30, 1999, respectively. The Company's resulting net interest margin for the three and six months ended June 30, 2000, was 3.84% and 3.77%, respectively, compared to 3.78% and 3.90% during the same periods in 1999. On a year-to-date basis, the compression in the net interest margin is the result of increased competitive rate pressures in the market place and an increase in the payment of broker rebates on single family residential loans. 8 11 Provisions for credit losses totaled $3.0 million and $5.5 million for the six months ended June 30, 2000 and 1999, respectively. At June 30, 2000, the ratio of total allowance for estimated credit losses to net loans reached 1.74%, compared to 1.65% at December 31, 1999, and 1.43% at June 30, 1999. Noninterest revenues were $2.0 million and $3.7 million for the three and six months ended June 30, 2000, respectively, compared to noninterest revenues of $1.9 million and $4.3 million earned during the three and six months ended June 30, 1999, respectively. Real estate operations resulted in a net loss of $0.1 million for the three and six months ended June 30, 2000, versus a net gain of $17 thousand and a net gain of $0.4 million for the respective periods in 1999. Sales of real estate owned resulted in higher net recoveries during 1999. Other non-operating expense totaled $2.0 million for the six months ended June 30, 2000, a $1.0 million increase over the $1.0 million of other non-operating expense incurred during the same period of 1999, primarily in connection with $1.7 million for ongoing litigation and/or satisfaction of judgments against the Company. On June 28, 2000, the California Supreme Court denied the Bank's petition for review of the Court of Appeals' decision affirming in part and reversing in part the judgment in the Takaki vs. Hawthorne Savings and Loan Association matter previously disclosed by the Bank. The Bank had previously accrued the full amount of the judgment, including post judgment interest through April 2000, and no material additional accruals were required during the second quarter as a result of the Supreme Court's action and payment of the judgment. Nonaccrual loans totaled $36.0 million at June 30, 2000 (or 2.15% of total assets). By comparison, nonaccrual loans were $44.0 million (or 2.78% of total assets) and $32.6 million (or 2.08% of total assets) at December 31, 1999, and June 30, 1999, respectively. Other classified loans were $32.3 million at June 30, 2000, compared to $25.6 million at December 31, 1999, and $17.4 million at June 30, 1999. Delinquent loans totaled $48.4 million at June 30, 2000, compared to $24.0 million at December 31, 1999, and $30.8 million at June 30, 1999. In July 2000, one income property loan with a balance of $10.6 million, which was over 90 days delinquent at June 30, 2000, is now current. Seven loans totaling $4.5 million that were past due at maturity have subsequently been extended. INCOME TAXES The Company's effective tax rate was 42.65% and 41.82% during the first six months of 2000 and 1999, respectively. PARENT COMPANY ITEMS Beginning with the fourth quarter of 1999, the Company, as needed, will continue to rely upon dividends from the Bank to service the semiannual interest payments of approximately $2.5 million each, due in June and December, on its Senior Notes, issued in December 1997. In July 2000, the Company authorized the repurchase of up to an additional 5% of its common stock, or approximately 264,000 shares. This is in addition to the 5% repurchase authorization announced in March 2000, for approximately 277,000 shares. As of August 11, 2000, the Company has repurchased 282,500 shares at an average price per share of $8.09. 9 12 NET INTEREST INCOME The following table sets forth the Company's average balance sheets, and the related weighted average yields and costs on average interest-earning assets (inclusive of nonaccrual loans) and interest-bearing liabilities, for the three months ended June 30, 2000 and 1999. In the tables, interest revenues are net of interest associated with nonaccrual loans. THREE MONTHS ENDED ------------------------------------------------------------------------- JUNE 30, 2000 JUNE 30, 1999 ----------------------------------- ----------------------------------- WEIGHTED WEIGHTED AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST ---------- --------- ---------- ---------- --------- ---------- (DOLLARS IN THOUSANDS) ASSETS: Interest-earning assets: Loans receivable(1)........................... $1,519,760 $34,685 9.13% $1,392,736 $31,238 8.97% Cash and cash equivalents..................... 75,569 1,146 6.07% 108,522 1,222 4.50% Investment in capital stock of Federal Home Loan Bank................................... 19,938 544 10.91% 17,527 220 5.02% ---------- ------- ---------- ------- Total interest-earning assets........... 1,615,267 36,375 9.01% 1,518,785 32,680 8.61% ------- ----- ------- ------ Noninterest-earning assets...................... 10,717 8,414 ---------- ---------- Total assets............................ $1,625,984 $1,527,199 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY: Interest-bearing liabilities: Deposits...................................... $1,111,946 15,024 5.43% $1,018,203 12,628 4.97% FHLB advances................................. 324,295 4,594 5.60% 344,769 4,437 5.09% Senior notes.................................. 40,000 1,250 12.50% 40,000 1,250 12.50% ---------- ------- ---------- ------- Total interest-bearing liabilities...... 1,476,241 20,868 5.69% 1,402,972 18,315 5.24% ------- ----- ------- ------ Noninterest-bearing checking.................... $ 31,093 $ 23,221 Noninterest-bearing liabilities................. 22,431 15,220 Stockholders' equity............................ 96,219 85,786 ---------- ---------- Total liabilities and stockholders' equity................................ $1,625,984 $1,527,199 ========== ========== Net interest income............................. $15,507 $14,365 ======= ======= Interest rate spread............................ 3.32% 3.37% ===== ====== Net interest margin including senior notes...... 3.84% 3.78% ===== ====== Net interest margin excluding senior notes...... 4.15% 4.11% ===== ====== - --------------- (1) Includes the interest on nonaccrual and non-performing loans only to the extent that it was paid and recognized as interest income. 10 13 The following table sets forth the Company's average balance sheets, and the related weighted average yields and costs on average interest-earning assets (inclusive of nonaccrual loans) and interest-bearing liabilities, for the six months ended June 30, 2000 and 1999. In the tables, interest revenues are net of interest associated with nonaccrual loans. SIX MONTHS ENDED ------------------------------------------------------------------------- JUNE 30, 2000 JUNE 30, 1999 ----------------------------------- ----------------------------------- WEIGHTED WEIGHTED AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST ---------- --------- ---------- ---------- --------- ---------- (DOLLARS IN THOUSANDS) ASSETS: Interest-earning assets: Loans receivable(1)........................... $1,504,938 $67,598 8.98% $1,373,666 $62,219 9.06% Cash and cash equivalents..................... 79,168 2,362 5.97% 88,267 2,058 4.66% Investment in capital stock of Federal Home Loan Bank................................... 20,744 851 8.20% 16,397 417 5.09% ---------- ------- ---------- ------- Total interest-earning assets........... 1,604,850 70,811 8.82% 1,478,330 64,694 8.75% ------- ----- ------- ------ Noninterest-earning assets...................... 12,028 12,362 ---------- ---------- Total assets............................ $1,616,878 $1,490,692 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY: Interest-bearing liabilities: Deposits...................................... $1,095,611 28,867 5.30% $1,006,990 25,062 5.02% FHLB advances................................. 334,422 9,192 5.44% 322,729 8,297 5.11% Senior notes.................................. 40,000 2,500 12.50% 40,000 2,500 12.50% ---------- ------- ---------- ------- Total interest-bearing liabilities...... 1,470,033 40,559 5.55% 1,369,719 35,859 5.28% ------- ----- ------- ------ Noninterest-bearing checking.................... $ 30,351 $ 21,751 Noninterest-bearing liabilities................. 21,392 15,098 Stockholders' equity............................ 95,102 84,124 ---------- ---------- Total liabilities and stockholders' equity................................ $1,616,878 $1,490,692 ========== ========== Net interest income............................. $30,252 $28,835 ======= ======= Interest rate spread............................ 3.27% 3.47% ===== ====== Net interest margin including senior notes...... 3.77% 3.90% ===== ====== Net interest margin excluding senior notes...... 4.08% 4.24% ===== ====== - --------------- (1) Includes the interest on nonaccrual and non-performing loans only to the extent that it was paid and recognized as interest income. The operations of the Company are substantially dependent on its net interest income, which is the difference between the interest income received from its interest-earning assets and the interest expense paid on its interest-bearing liabilities. The Company's net interest margin is its net interest income divided by its average interest-earning assets. Net interest income and net interest margin are affected by several factors, including (1) the level of, and the relationship between, the dollar amount of interest-earning assets and interest-bearing liabilities, (2) the relationship between the repricing or maturity of the Company's adjustable-rate and fixed-rate loans and short-term investment securities and its deposits and borrowings, and (3) the magnitude of the Company's noninterest-earning assets, including nonaccrual loans and real estate owned ("REO"). The Company's net interest income before provision for credit losses rose 7.95% to $15.5 million and 4.91% to $30.3 million during the three and six months ended June 30, 2000, respectively, compared to $14.4 million and $28.8 million for the three and six months ended June 30, 1999, respectively. The Company's resulting net interest margin for the three and six months ended June 30, 2000, was 3.84% and 3.77%, respectively, compared to 3.78% and 3.90% during the same periods in 1999. On a year-to-date basis, the compression in the net interest margin is the result of increased competitive rate pressures in the market place, a change in the portfolio mix as reflected in the loan portfolio table contained herein, and an increase in the payment of broker rebates on single family residential loans. 11 14 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 ranging 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-ten years (though such terms are subject to certain early call provisions) and carry both variable and fixed interest rates. As of June 30, 2000, 88.44% of the Company's loans were adjustable-rate, with 83.84% 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 indices, 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 indices, 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. At June 30, 2000, 79.70% of the Company's interest-bearing deposits were comprised of certificate accounts, the majority of which have original terms ranging from six-to-twelve months. The remaining, weighted average term to maturity for the Company's certificate accounts approximated six months at June 30, 2000. 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. As of June 30, 2000, 65.18% of the Company's borrowings from the FHLB are fixed-rate, with remaining terms ranging from one-to-ten years (though such remaining terms are subject to early call provisions). The remaining 34.82% of the borrowings carry an adjustable interest rate, with 80% of the adjustable borrowings tied to the Prime Rate, maturing in February 2003. The remaining 20% is tied to 1-month LIBOR, and matures in May 2002. Accordingly, the recent rise in market interest rates is expected to result in a gradual rise in the cost of the Company's currently outstanding FHLB borrowings, and the cost of any newly acquired borrowings will reflect current market pricing. 12 15 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. THREE MONTHS ENDED JUNE 30, 2000 AND 1999 INCREASE (DECREASE) DUE TO CHANGE IN ------------------------------------------- RATE AND NET VOLUME RATE VOLUME(1) CHANGE ------- ------- ---------- ------- (DOLLARS IN THOUSANDS) Interest-earning assets: Loans receivable(2).................................. $2,849 $ 548 $ 50 $3,447 Cash and cash equivalents............................ (371) 424 (129) (76) Investment in capital stock of Federal Home Loan Bank.............................................. 30 258 36 324 ------ ------ ----- ------ 2,508 1,230 (43) 3,695 ------ ------ ----- ------ Interest-bearing liabilities: Deposits............................................. 1,162 1,130 104 2,396 FHLB advances........................................ (263) 446 (26) 157 ------ ------ ----- ------ 899 1,576 78 2,553 ------ ------ ----- ------ Change in net interest income.......................... $1,609 $ (346) $(121) $1,142 ====== ====== ===== ====== - --------------- (1) Calculated by multiplying change in rate by change in volume. (2) Includes the interest on non-performing loans only to the extent that it was paid and recognized as interest income. The Company's interest revenues increased by $3.7 million, or 11.31%, during the three months ended June 30, 2000, as compared to the same period in 1999. This increase was primarily attributable to a 9.12% increase in the average balance of loans outstanding. Interest costs increased by $2.6 million, or 13.94%, during the three months ended June 30, 2000, as compared to the same period during 1999, primarily due to a 5.22% increase in the average balances of the Company's deposits and borrowings, in conjunction with an increase in the weighted average rates paid on the Company's deposits and FHLB advances. The cost of interest-bearing liabilities averaged 5.69% during the three months ended June 30, 2000, as compared with 5.24% during the same quarter of 1999. 13 16 These changes in interest revenues and interest costs produced an increase of $1.1 million, or 7.95%, in the Company's net interest income during the three months ended June 30, 2000, as compared with the same quarter during 1999. Expressed as a percentage of average interest-earning assets, the Company's net interest margin increased to 3.84% during the three months ended June 30, 2000, as compared with the net interest margin of 3.78% produced during the same period during 1999. SIX MONTHS ENDED JUNE 30, 2000 AND 1999 INCREASE (DECREASE) DUE TO CHANGE IN ---------------------------------------- RATE AND NET VOLUME RATE VOLUME(1) CHANGE ------ ------- --------- ------ (DOLLARS IN THOUSANDS) Interest-earning assets: Loans receivable(2)................................. $5,946 $ (517) $ (50) $5,379 Cash and cash equivalents........................... (212) 575 (59) 304 Investment in capital stock of Federal Home Loan Bank............................................. 110 256 68 434 ------ ------- ----- ------ 5,844 314 (41) 6,117 ------ ------- ----- ------ Interest-bearing liabilities: Deposits............................................ 2,206 1,470 129 3,805 FHLB advances....................................... 300 574 21 895 ------ ------- ----- ------ 2,506 2,044 150 4,700 ------ ------- ----- ------ Change in net interest income......................... $3,338 $(1,730) $(191) $1,417 ====== ======= ===== ====== - --------------- (1) Calculated by multiplying change in rate by change in volume. (2) Includes the interest on non-performing loans only to the extent that it was paid and recognized as interest income. The Company's interest revenues increased by $6.1 million, or 9.46%, during the six months ended June 30, 2000, as compared to the same period in 1999. This increase was primarily attributable to a 9.56% increase in the average balance of loans outstanding, which was partially offset by a decrease in the weighted average yield earned thereon, which averaged 8.98% during 2000, as compared with 9.06% in 1999. The decline in the loan portfolio yield reflected increased competitive rate pressure in the market place, a change in the portfolio mix as reflected in the loan portfolio table contained herein, and an increase in the payment of broker rebates on single family residential loans. Interest costs increased by $4.7 million, or 13.11%, during the six months ended June 30, 2000, as compared to the same period during 1999, primarily due to a 7.32% increase in the average balances of the Company's deposits and borrowings, in conjunction with an increase in the weighted average rates paid on the Company's deposits and FHLB advances. The cost of interest-bearing liabilities averaged 5.55% during the six months ended June 30, 2000, as compared with 5.28% during the same quarter of 1999. These changes in interest revenues and interest costs produced an increase of $1.4 million, or 4.91%, in the Company's net interest income during the six months ended June 30, 2000, as compared with the same period during 1999. Expressed as a percentage of average interest-earning assets, the Company's net interest margin decreased to 3.77% during the six months ended June 30, 2000, as compared with the net interest margin of 3.90% produced during the same period during 1999. PROVISIONS FOR CREDIT LOSSES ON LOANS Provisions for credit losses for the three and six months ended June 30, 2000, were $1.5 million and $3.0 million, respectively, a decrease of 40.0% and 45.5% over provisions of $2.5 million and $5.5 million recorded during the three and six months ended June 30, 1999, respectively. The Company's total allowance for estimated credit losses to loans receivable, net of specific allowances, increased to 1.74% at June 30, 2000, compared with 1.65% at December 31, 1999 and 1.43% at June 30, 1999. The Company's annualized ratio of charge-offs to average loans has improved from 0.60% in the second quarter of 1999 to 0.04% in the second quarter of 2000. Additionally, the ratio of total classified assets to Bank core capital and general allowance for 14 17 estimated credit losses was 46.27% at June 30, 2000, compared to 49.96% at December 31, 1999 and 35.43% at June 30, 1999. Although the Company maintains its allowance for estimated 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 estimated 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 Loan Related Fees Noninterest revenues were $2.1 million and $3.9 million for the three and six months ended June 30, 2000, compared to noninterest revenues of $1.9 million and $3.9 million earned during the three and six months ended June 30, 1999, respectively. Loan related fees primarily consist of fees collected from borrowers (1) for the early repayment of their loans, (2) for the extension of the maturity of loans (predominantly short-term construction loans, with respect to which extension options are often included in the original term of the Company's loan), and (3) in connection with certain loans which contain exit or release fees payable to the Company upon the maturity or repayment of the Company's loan. The increase in loan-related fee revenues during the second quarter of 2000, as compared with the second quarter of 1999, 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. Real Estate Operations The following table sets forth the costs and revenues attributable to the Company's REO properties for the periods indicated. The compensatory and legal costs directly associated with the Company's property management and disposal operations are included in general and administrative expenses. THREE MONTHS ENDED SIX MONTHS ENDED JUNE JUNE 30, 30, --------------------- ---------------------- 2000 1999 CHANGE 2000 1999 CHANGE ----- ---- ------ ----- ----- ------ {(DOLLARS IN THOUSANDS) Expenses associated with real estate operations: Repairs, maintenance and renovation............ $(106) $(71) $(35) $(191) $(151) $ (40) Insurance and property taxes................... (7) -- (7) (9) -- (9) ----- ---- ---- ----- ----- ----- (113) (71) (42) (200) (151) (49) Net recoveries from sale of REO.................. 29 80 (51) 7 638 (631) Property operations, net......................... (6) 9 (15) 20 10 10 ----- ---- ---- ----- ----- ----- Total.................................. 23 89 (66) 27 648 (621) ----- ---- ---- ----- ----- ----- (Provision)/recovery for estimated losses on real estate owned................................... -- (35) 35 24 (80) 104 ----- ---- ---- ----- ----- ----- (Loss)/income from real estate operations, net... $ (90) $(17) $(73) $(149) $ 417 $(566) ===== ==== ==== ===== ===== ===== Net (loss)/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 six months ended June 30, 2000, the Company sold seven properties generating net cash proceeds of $0.7 million and a net recovery of $7 thousand, as compared to sales of eleven properties generating net cash proceeds of $2.9 million and a net recovery of $0.6 million during the six months ended June 30, 1999. As of June 30, 2000, the Company holds seven properties. 15 18 NONINTEREST EXPENSES General and Administrative Expenses The table below details the Company's general and administrative expenses for the periods indicated. THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------------- ---------------------------- 2000 1999 CHANGE 2000 1999 CHANGE ------- ------- ------- ------- ------- ------ (DOLLARS IN THOUSANDS) General and administrative expenses: Employee.......................... $4,353 $3,576 $777 $ 8,405 $ 7,679 $ 726 Operating......................... 1,529 1,599 (70) 3,042 3,138 (96) Occupancy......................... 897 986 (89) 1,860 1,979 (119) Technology........................ 484 518 (34) 958 1,078 (120) Professional...................... 1,231 860 371 2,106 1,164 942 SAIF premiums and OTS assessments.................... 217 313 (96) 439 612 (173) ------ ------ ---- ------- ------- ------ Total general and administrative expenses................ $8,711 $7,852 $859 $16,810 $15,650 $1,160 ====== ====== ==== ======= ======= ====== Total general and administrative expenses ("G&A") were $8.7 million and $16.8 million for the three and six months ended June 30, 2000, respectively, a 10.94% and 7.41% increase over the $7.9 million and $15.7 million of G&A incurred during the same periods in 1999. The increase in G&A for the first half of 2000 was primarily in professional fees comprised of outside consultants working on operational projects and legal fees attributable to loan documentation and restructurings and ongoing litigation matters previously disclosed. The increase in G&A and the decrease in noninterest revenues discussed previously had a negative impact on the Company's efficiency ratio (defined as total general and administrative expenses divided by net interest income before provision and noninterest revenues, excluding REO, net). The efficiency ratio for the six months ended June 30, 2000, increased to 49.23% compared to 47.82% for the six months ended June 30, 1999. Other Non-operating Expense Other non-operating expense totaled $2.0 million for the six months ended June 30, 2000, a $1.0 million increase over the $1.0 million of other non-operating expense incurred during the same period of 1999, primarily in connection with $1.7 million for ongoing litigation and/or satisfaction of judgments against the Company as previously discussed (see page 7). 16 19 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. JUNE 30, 2000 DECEMBER 31, 1999 --------------------- --------------------- BALANCE PERCENT BALANCE PERCENT ---------- ------- ---------- ------- {(DOLLARS IN THOUSANDS) Single family residential........................ $ 796,620 46.4% $ 683,250 41.0% Income property: Multi-family(1)................................ 235,484 13.7% 222,616 13.4% Commercial(1).................................. 201,716 11.8% 208,859 12.5% Development(2)................................. 157,630 9.2% 148,092 8.9% Land(3).......................................... 52,395 3.1% 59,095 3.5% Single family construction: Single family residence(4)..................... 219,703 12.8% 274,697 16.5% Tract.......................................... 10,751 0.6% 24,056 1.4% Other............................................ 41,769 2.4% 46,132 2.8% ---------- ----- ---------- ----- Gross loans receivable(5)........................ 1,716,068 100.0% 1,666,797 100.0% ===== ===== Less: Undisbursed funds.............................. (158,358) (196,249) Deferred fees and credits, net................. 992 (1,295) Allowance for estimated losses................. (27,089) (24,285) ---------- ---------- Net loans receivable............................. $1,531,613 $1,444,968 ========== ========== - --------------- (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) Includes the funded principal balance under recorded loan commitments, plus outstanding but unfunded loan commitments, predominantly in connection with construction loans. 17 20 The table below sets forth the Company's loan portfolio diversification by loan size. JUNE 30, 2000 DECEMBER 31, 1999 ------------------- ------------------- NO. OF GROSS NO. OF GROSS LOANS COMMITMENT LOANS COMMITMENT ------ ---------- ------ ---------- (DOLLARS IN THOUSANDS) Loans in excess of $10.0 million: Single family residential............. 1 $ 13,000 1 $ 13,000 Income property: Multi-family....................... -- -- -- -- Commercial......................... 5 56,484 3 32,622 Development........................ 2 24,750 3 33,900 Land.................................. -- -- -- -- Other................................. -- -- 1 16,000 -- ---------- -- ---------- 8 94,234 8 95,522 -- ---------- -- ---------- Percentage of total gross loans....... 5.5% 5.7% Loans between $5.0 and $10.0 million: Single family residential............. 4 24,400 7 39,364 Income property: Multi-family....................... -- -- 1 6,655 Commercial......................... 9 68,023 9 65,998 Development........................ 12 81,763 11 71,049 Land.................................. 1 6,501 1 6,501 Single family construction: Single family residence............ 3 19,562 4 24,812 Tract.............................. 1 6,743 2 11,040 Other................................. 2 18,190 3 27,466 -- ---------- -- ---------- 32 225,182 38 252,885 -- ---------- -------- Percentage of total gross loans....... 13.1% 15.2% Loans less than $5 million.............. 1,396,652 1,318,390 ---------- ---------- Gross loans receivable........... $1,716,068 $1,666,797 ========== ========== - ---------- (1) Based on current credit review, management determined that a bulk sale value would be a more conservative valuation for calculating the LTV ratio. 18 21 The table below sets forth the Company's net loan portfolio composition, excluding net deferred fees and credits, as of the dates indicated. JUNE 30, 2000 DECEMBER 31, 1999 --------------------- --------------------- BALANCE PERCENT BALANCE PERCENT ---------- ------- ---------- ------- {(DOLLARS IN THOUSANDS) SFR -- Permanent................................. $ 788,711 50.6% $ 674,917 45.9% SFR -- Construction.............................. 157,485 10.1% 198,066 13.5% Land............................................. 49,690 3.2% 50,161 3.4% Income Property -- Permanent..................... 441,915 28.4% 434,242 29.5% Income Property -- Construction.................. 105,031 6.7% 99,296 6.8% Other............................................ 14,878 1.0% 13,866 0.9% ---------- ----- ---------- ----- Total.................................. $1,557,710 100.0% $1,470,548 100.0% ========== ===== ========== ===== The following table sets forth the approximate composition of the Company's gross new loan commitments, net of internal refinances, for the period indicated, in dollars and as a percentage of total loans originated. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 2000 JUNE 30, 2000 ------------------- ----------------- AMOUNT % AMOUNT % --------- ------ -------- ----- {(DOLLARS IN THOUSANDS) Single family residential(1).......................... $103,694 46.0% $180,280 49.7% Income property: Multi-family........................................ 18,756 8.3% 31,791 8.8% Commercial(2)....................................... 12,227 5.4% 32,464 8.9% Development(3)...................................... 46,545 20.6% 46,545 12.8% Land(4)............................................... 8,894 3.9% 15,385 4.2% Single family construction: Single family residence(5).......................... 35,463 15.7% 56,545 15.6% Other................................................. 16 -- 24 -- -------- ----- -------- ----- Total....................................... $225,595 100.0% $363,034 100.0% ======== ===== ======== ===== - --------------- (1) Includes unfunded commitments of $0.1 million as of June 30, 2000. (2) Includes unfunded commitments of $0.4 million as of June 30, 2000. (3) Includes unfunded commitments of $29.4 million as of June 30, 2000. (4) Includes unfunded commitments of $0.1 million as of June 30, 2000. (5) Includes unfunded commitments of $26.6 million as of June 30, 2000. 19 22 ASSET QUALITY Classified Assets The table below sets forth information concerning the Company's classified assets as of the dates indicated. Classified assets include REO, nonaccrual loans and performing loans which have been adversely classified pursuant to OTS regulations and guidelines ("Performing/Classified" loans). JUNE 30, DECEMBER 31, 2000 1999 ---------- ------------ {(DOLLARS IN THOUSANDS) Risk elements: Nonaccrual loans(1)....................................... $ 36,047 $ 44,031 Real estate owned, net.................................... 5,334 5,587 ---------- ---------- 41,381 49,618 Performing loans classified substandard or lower.......... 32,284 25,646 ---------- ---------- Total classified assets................................... $ 73,665 $ 75,264 ========== ========== Total classified loans.................................... $ 68,331 $ 69,677 ========== ========== Average LTV on classified loans........................... 74% 69% ========== ========== Loans restructured and paying in accordance with modified terms(2).................................................. $ 15,553 $ 15,394 ========== ========== Gross loans before allowance for estimated credit losses.... $1,558,702 $1,469,253 ========== ========== Loans receivable net of specific reserves and deferred fees...................................................... $1,556,465 $1,468,445 ========== ========== Delinquent Loans 30 - 89 days.............................................. $ 17,968 $ 9,063 90+ days.................................................. 30,441 14,916 ---------- ---------- Total delinquent loans............................ $ 48,409 $ 23,979 ========== ========== Allowance for estimated credit losses: General................................................... $ 24,852 $ 23,476 Specific.................................................. 2,237 809 ---------- ---------- Total allowance for estimated credit losses....... $ 27,089 $ 24,285 ========== ========== Net loan charge-offs: Net charge-offs for the quarter ended..................... $ 142 $ 1,409 Percent to net loans (annualized)......................... 0.04% 0.38% Percent to beginning of period allowance for credit losses (annualized)........................................... 2.21% 24.83% Selected asset quality ratios at period end: Total nonaccrual loans to total assets.................... 2.15% 2.78% Total allowance for estimated credit losses to loans receivable, net of specific reserves and deferred fees................................................... 1.74% 1.65% Total general allowance for estimated credit losses to loans receivable, net of specific reserves and deferred fees................................................... 1.60% 1.60% Total reserves to nonaccrual loans........................ 75.15% 55.15% Total classified assets to Bank core capital and general loan loss reserves..................................... 46.27% 49.96% - --------------- (1) Total troubled debt restructured loans ("TDRs") were $24.9 million and $34.9 million at June 30, 2000 and December 31, 1999, respectively. Nonaccrual loans include TDRs of $9.3 million and $18.7 million at June 30, 2000 and December 31, 1999, respectively. (2) TDRs not classified and not on nonaccrual. 20 23 The table below sets forth information concerning the Company's gross classified loans, by category, as of June 30, 2000. See page 9 for further discussion. DELINQUENT LOANS --------------------------- OTHER 90+ NONACCRUAL PERFORMING DAYS(1) 30-89 DAYS(2) LOANS(3) LOANS TOTAL ----------- ------------- ---------- ---------- ------- {(DOLLARS IN THOUSANDS) Single family residential................ $17,054 $3,682 $ 131 $ 7,285 $28,152 Income property: Multi-family........................... 348 -- -- -- 348 Commercial............................. 10,622 -- 8,538 6,462 25,622 Land..................................... 2,075 3,971 -- 2,878 8,924 Single family construction: Single family residence................ -- 434 879 350 1,663 Tract.................................. 70 -- 3,527 -- 3,597 Other.................................... 22 -- -- 3 25 ------- ------ ------- ------- ------- Total.......................... $30,191 $8,087 $13,075 $16,978 $68,331 ======= ====== ======= ======= ======= - --------------- (1) Includes $12.7 million in classified loans 90 days past due and still accruing interest. (2) Includes $2.6 million in loans 30-89 days past due and still accruing interest. (3) Loans classified as substandard for which interest payment reserves were established from loan funds rather than borrower funds. ALLOWANCE FOR ESTIMATED CREDIT LOSSES Management establishes specific allowances for estimated credit losses on individual loans when it has determined that recovery of the Company's gross investment is not probable and when the amount of loss can be reasonably determined. In making this determination, management considers (1) the status of the asset, (2) the probable future status of the asset, (3) the value of the asset or underlying collateral and (4) management's intent with respect to the asset. In quantifying the loss, if any, associated with individual loans, management 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 allowances"). General allowances are maintained for each of the Company's principal loan segments, and supplemented by periodic additions through provisions for credit losses. In measuring the adequacy of the Company's general allowances, 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 Allowances. In addition to the amount of allowance determined by applying individual loss factors to the portfolio, the general allowance may also include an unallocated amount. The unallocated allowance recognizes the model and estimation risk associated with the allowance formula and specific allowances. In addition, the unallocated allowance is based upon management's evaluation of various conditions, the effects of which are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated 21 24 allowance include (1) general economic and business conditions affecting our key lending areas, (2) credit quality trends (including trends in nonperforming loans expected to result from existing conditions), (3) collateral values, (4) loan volumes and concentrations, (5) seasoning of the loan portfolio, (6) specific industry conditions within portfolio segments (7) recent loss experience in particular segments of the portfolio, (8) duration of the current business cycle, (9) bank regulatory examination results and (10) findings of our internal credit examiners. Specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate the probability that a loss has been incurred. The table below sets forth the general and specific allowance for estimated credit losses for the Company's loan portfolio as of June 30, 2000. LOANS ------------------------ PERFORMING DELINQUENT TOTAL ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Specific allowances............................. $ 1,181 $ 1,056 $ 2,237 General allowances.............................. 19,521 5,331 24,852 ---------- ------- ---------- Total................................. $ 20,702 $ 6,387 $ 27,089 ========== ======= ========== Percentages: Total allowance for estimated credit losses to loans receivable before allowance for credit losses.............................. 1.37% 13.19% 1.74% Total general allowances for estimated credit losses to loans receivable, net of specific reserves................................... 1.29% 11.26% 1.60% Loans receivable before allowance for credit losses........................................ $1,510,293 $48,409 $1,558,702 Loans receivable net of specific reserves....... 1,509,112 47,353 1,556,465 22 25 The table below summarizes the activity of the Company's allowance for estimated credit losses for the periods indicated. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2000 1999 2000 1999 ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Average loans outstanding................. $1,519,760 $1,392,736 $1,504,938 $1,373,666 ========== ========== ========== ========== Total allowance for estimated credit losses at beginning of period........... $ 25,731 $ 19,958 $ 24,285 $ 17,111 Provision for estimated credit losses..... 1,500 2,500 3,000 5,500 Charge-offs: Single family........................... (51) (1,623) (158) (1,776) Income property: Commercial.............................. -- (512) -- (512) Single family construction: Tract................................... (147) -- (147) -- Other..................................... (15) -- (15) -- Recoveries: Other................................... 71 -- 124 -- ---------- ---------- ---------- ---------- Net charge-offs........................... (142) (2,135) (196) (2,288) ---------- ---------- ---------- ---------- Total allowance for estimated credit losses at end of period........................ $ 27,089 $ 20,323 $ 27,089 $ 20,323 ========== ========== ========== ========== Annualized ratio of charge-offs to average loans outstanding during the period..... 0.04% 0.61% 0.03% 0.33% Real estate owned: Total allowance for estimated losses at beginning of period........................ $ 4 $ 90 $ 29 $ 45 Provision for estimated losses............ -- 35 -- 80 Charge-offs............................... (4) (87) (29) (87) ---------- ---------- ---------- ---------- Total allowance for estimated losses at end of period....... $ -- $ 38 $ -- $ 38 ========== ========== ========== ========== 23 26 The table below summarizes the allocation of the Company's allowance for estimated credit losses for each principal loan portfolio segment. JUNE 30, 2000 DECEMBER 31, 1999 ------------------------- ------------------------- PERCENT OF PERCENT OF RESERVES TO RESERVES TO TOTAL LOANS(1) TOTAL LOANS(1) BALANCE BY CATEGORY BALANCE BY CATEGORY ------- -------------- ------- -------------- (DOLLARS IN THOUSANDS) Single family residential.................. $ 6,432 0.81% $ 7,095 1.04% Income property: Multi-family............................. 743 0.32% 646 0.29% Commercial............................... 5,437 2.70% 6,738 3.23% Development.............................. 4,615 2.93% 2,067 1.40% Land....................................... 2,384 4.55% 1,470 2.49% Single family construction: Single family residence.................. 2,226 1.01% 3,946 1.44% Tract.................................... 983 9.14% 855 3.55% Other...................................... 873 2.09% 480 1.04% Unallocated................................ 3,396 n/a 988 n/a ------- ------- $27,089 1.58% $24,285 1.46% ======= ======= - --------------- (1) Percent of allowance for estimated credit losses to gross loan commitments, which exclude 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. Unallocated reserves are established based on management's judgment in order to appropriately reflect the presence of indicators of inherent losses that are not fully reflected in the historical loss information and analysis used in the development of allocated reserves. The factors considered in establishing the unallocated reserve include: nonperforming, charge-off, delinquency and portfolio growth and concentration trends and the likely impact of known changes in the economy or other events that may affect loss performance. The unallocated reserves are reviewed periodically to determine whether they are at a level that management believes are adequate. Based on the $24.4 million increase in delinquent loans, from $24.0 million at December 31, 1999 to $48.4 million at June 30, 2000, and other factors discussed elsewhere herein, management believes that the unallocated reserve of $3.4 million as of June 30, 2000 is appropriate. 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 a write-down of the asset. The table below summarizes the composition of the Company's real estate owned properties for the dates indicated. JUNE 30, DECEMBER 31, 2000 1999 -------- ------------ (DOLLARS IN THOUSANDS) Single family(1)....................................... $ 946 $1,218 Income property: Commercial(2)........................................ 4,388 4,398 ------ ------ Gross investment(3).................................... 5,334 5,616 Less allowance for estimated losses.................... -- 29 ------ ------ Real estate owned, net................................. $5,334 $5,587 ====== ====== - --------------- (1) As of June 30, 2000, the Company holds six properties. (2) In December 1999, the Bank acquired 18 lots of a tract development in La Quinta, California with a carrying value of $4.4 million. (3) Fair value of collateral at foreclosure, plus post-foreclosure capitalized costs. 24 27 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. JUNE 30, 2000 DECEMBER 31, 1999 -------------------------- -------------------------- BALANCE WAIR WARM BALANCE WAIR WARM ---------- ---- ---- ---------- ---- ---- (DOLLARS IN THOUSANDS) Noninterest-bearing checking.... $ 30,877 -- -- $ 28,838 -- -- Checking/NOW.................... 41,487 2.16% -- 40,563 2.17% -- Passbook........................ 24,250 1.65% -- 23,568 1.41% -- Money market.................... 164,887 4.85% -- 155,537 4.45% -- Certificates of deposit: 7 day maturities.............. 27,207 4.06% -- 30,631 4.08% -- Less than 6 months............ 20,991 4.86% 1 42,082 4.78% 2 6 months to 1 year............ 149,035 5.97% 3 147,407 5.24% 3 1 year to 2 years............. 679,478 6.04% 7 584,488 5.46% 8 Greater than 2 years.......... 28,835 5.32% 10 33,521 5.31% 12 ---------- ---------- $1,167,047 5.39% 5 $1,086,635 4.86% 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. JUNE 30, 2000 DECEMBER 31, 1999 ----------------- ----------------- ORIGINAL TERM PRINCIPAL RATE PRINCIPAL RATE ------------- --------- ---- --------- ---- (DOLLARS IN THOUSANDS) 24 Months............................................. $ 25,000 6.59% $ -- -- 36 Months............................................. 100,000 6.73% -- -- 60 Months............................................. 135,000 5.92% 300,000 5.30% 120 Months............................................ 99,000 5.19% 49,000 4.36% -------- -------- $359,000 5.99%(1) $349,000 5.16%(1) ======== ======== - --------------- (1) Weighted average interest rate. The weighted average remaining term of the Company's FHLB advances was 4 years and 11 months and 4 years and 6 months as of June 30, 2000 and December 31, 1999, respectively. All of the Company's FHLB advances outstanding at June 30, 2000, with the exception of one, contain options which allow the FHLB to 25 28 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 ("1997 Senior Notes") in a private placement, which included registration rights. The 1997 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 June 30, 2000 amounted to $98.2 million and which equaled 5.85% of the Company's total assets. As indicated in the table below, the Bank's capital levels exceeded minimum regulatory capital requirements. TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL ------------------ ----------------- ------------------- BALANCE % BALANCE % BALANCE % ---------- ---- ---------- ---- ---------- ----- (DOLLARS IN THOUSANDS) Stockholders' equity............. $ 134,350 $ 134,350 $ 134,350 Adjustments: General reserves............... -- -- 15,121 Other(1)....................... -- -- (5,565) ---------- ---- ---------- ---- ---------- ----- Regulatory capital............... 134,350 8.01% 134,350 8.01% 143,906 11.99% Required minimum................. 25,145 1.50 67,054 4.00 96,001 8.00 ---------- ---- ---------- ---- ---------- ----- Excess capital................... $ 109,205 6.51% $ 67,296 4.01% $ 47,905 3.99% ========== ==== ========== ==== ========== ===== Adjusted assets(2)............... $1,676,356 $1,676,356 $1,200,012 ========== ========== ========== - --------------- (1) Includes the portion of non-residential construction loans and land loans which exceed a loan-to-value ratio of 80%. (2) The term "adjusted assets" refers to the term "adjusted total assets", as defined in 12 C.F.R. Section 567.1(a), for purposes of tangible and core capital requirements, and for purposes of risk-based capital requirements, refers to the term "risk-weighted assets", as defined in 12 C.F.R. Section 567.1(d). 26 29 As of June 30, 2000, the Bank is categorized as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events subsequent to June 30, 2000 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. MINIMUM TO BE WELL CAPITALIZED UNDER MINIMUM PROMPT CAPITAL CORRECTIVE ACTION ACTUAL REQUIREMENT PROVISIONS ----------------- ---------------- ------------------ AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS -------- ------ ------- ------ -------- ------ (DOLLARS IN THOUSANDS) As of June 30, 2000 Total Capital (to Risk Weighted Assets)......... $143,906 11.99% $96,001 8.00% $120,001 10.00% Core Capital (to Adjusted Tangible Assets)...... 134,350 8.01% 67,054 4.00% 83,818 5.00% Tangible Capital (to Adjusted Tangible Assets)....................................... 134,350 8.01% 25,145 1.50% N/A N/A Tier 1 Capital (to Risk Weighted Assets)........ 134,350 11.20% N/A N/A 72,001 6.00% As of December 31, 1999 Total Capital (to Risk Weighted Assets)......... $139,815 12.50% $89,468 8.00% $111,835 10.00% Core Capital (to Adjusted Tangible Assets)...... 127,160 8.05% 63,174 4.00% 78,967 5.00% Tangible Capital (to Adjusted Tangible Assets)....................................... 127,160 8.05% 23,690 1.50% N/A N/A Tier 1 Capital (to Risk Weighted Assets)........ 127,160 11.37% N/A N/A 67,101 6.00% 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 $2.9 million at June 30, 2000. Hawthorne Financial Corporation has no other significant assets beyond its investment in the Bank. From time-to-time, the Company is 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. The Company made its June 2000 semiannual interest payment on its 1997 Senior Notes. 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 1997 Senior Notes. In April 2000, Hawthorne Financial Corporation received a dividend of $1.5 million to fund the stock repurchase as disclosed previously herein. In July 2000, the Company authorized the repurchase of up to an additional 5% of its common stock, or approximately 264,000 shares. This is in addition to the 5% repurchase authorization announced in March 2000, for approximately 277,000 shares. As of August 11, 2000, the Company has repurchased 282,500 shares at an average price per share of $8.09. 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 June 30, 2000 was 6.54%, which exceeded the applicable minimum requirements. The Company's current primary funding resources are deposits, principal payments on loans, FHLB advances and cash flows from operations. Other possible sources of liquidity available to the Company include whole loan sales, commercial bank lines of credit, and direct access, under certain conditions, to borrowings 27 30 from the Federal Reserve System. The cash needs of the Company are principally for the payment of interest on, and withdrawals of, deposit accounts, the funding of loans and operating costs and expenses. INTEREST RATE RISK MANAGEMENT The objective of interest rate risk management is to stabilize the Company's net interest income ("NII") while limiting the change in its Net Portfolio Value ("NPV") from interest rate fluctuations. The Company seeks to achieve this objective by matching its interest sensitive assets and liabilities, and maintaining the maturity and repricing of these assets and liabilities at appropriate levels given the interest rate environment. When the amount of rate-sensitive liabilities exceeds rate-sensitive assets within specified periods, the NII generally will be negatively impacted by increasing interest rates and positively impacted by decreasing interest rates during such periods. Conversely, when the amount of rate-sensitive assets exceeds the amount of rate-sensitive liabilities within specified periods, net interest income generally will be positively impacted by increasing interest rates and negatively impacted by decreasing interest rates during such periods. The speed and velocity of the repricing of assets and liabilities will also contribute to the effects on NII. The Company utilizes two methods for measuring interest rate risk, 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. 28 31 The table below sets forth information concerning repricing opportunities for the Company's interest-earning assets and interest-bearing liabilities as of June 30, 2000. The amounts of assets and liabilities shown within a particular period were determined in accordance with the contractual maturities, except that adjustable-rate products 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. JUNE 30, 2000 ------------------------------------------------------------------------ OVER THREE OVER SIX OVER ONE THREE THROUGH THROUGH YEAR OVER MONTHS SIX TWELVE THROUGH FIVE OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL ---------- ---------- --------- ---------- -------- ---------- (DOLLARS IN THOUSANDS) Interest-earning assets: Cash and cash equivalents(1)........... $ 83,025 $ -- $ -- $ -- $ -- $ 83,025 Investments and FHLB stock.................... 20,105 -- -- -- -- 20,105 Loans(2).................... 981,006 393,524 34,370 28,496 120,314 1,557,710 ---------- -------- --------- --------- -------- ---------- Total interest-earning assets............ $1,084,136 $393,524 $ 34,370 $ 28,496 $120,314 $1,660,840 ========== ======== ========= ========= ======== ========== Interest-bearing liabilities: Deposits: Non-certificates of deposit................ $ 230,624 $ -- $ -- $ -- $ -- $ 230,624 Certificates of deposit................ 215,188 239,213 350,243 100,902 -- 905,546 FHLB advances............... -- 30,000 125,000 204,000 -- 359,000 Senior notes................ -- -- -- 40,000 -- 40,000 ---------- -------- --------- --------- -------- ---------- Total interest-bearing liabilities....... $ 445,812 $269,213 $ 475,243 $ 344,902 $ -- $1,535,170 ========== ======== ========= ========= ======== ========== Interest rate sensitivity gap...................... $ 638,324 $124,311 $(440,873) $(316,406) $120,314 $ 125,670 Cumulative interest rate sensitivity gap.......... 638,324 762,635 321,762 5,356 125,670 125,670 Cumulative interest rate sensitivity gap as a percentage of total interest-earning assets................... 38.4% 45.9% 19.4% 0.3% 7.6% 7.6% - --------------- (1) Excludes noninterest earning cash balances. (2) Loans include $36.0 million of nonaccrual loans, and are exclusive of deferred fees and loan loss reserves. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company realizes income principally from the differential or spread between the interest earned on loans, investments, other interest-earning assets and the interest paid on deposits and borrowings. The Company, like other financial institutions, is subject to interest rate risk ("IRR") to the degree that its interest-earning assets reprice differently than its interest-bearing liabilities. The Company's primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on the Company's net interest income and capital, while structuring the Company's asset-liability mix to obtain the maximum yield-cost spread on that structure. A sudden and substantial increase in interest rates may adversely impact the Company's income to the extent that the interest rates borne by the assets and liabilities do not change at the same speed, to the same extent, or on the same basis. The Company has adopted formal policies and practices to monitor its interest rate risk exposure. As a part of this effort, the Company uses the Net Portfolio Value ("NPV") methodology to gauge interest rate risk exposure. 29 32 Using an internally generated model, the Company monitors interest rate sensitivity by estimating the change in NPV over a range of interest rate scenarios. NPV is the discounted present value of the difference between incoming cashflows on interest-earning assets and other assets, and the outgoing cashflows on interest-bearing liabilities and other liabilities. The NPV ratio is defined as the NPV for a given rate scenario divided by the market value of the assets in the same scenario. The Sensitivity Measure is the decline in the NPV ratio, in basis points, caused by a 200 basis point increase or decrease in interest rates, whichever produces the largest decline. The higher an institution's Sensitivity Measure, the greater its exposure to IRR. The OTS also produces a similar analysis using its own model, based upon data submitted on the Bank's quarterly Thrift Financial Report ("TFR"). At June 30, 2000, based on the Company's internally generated model, it was estimated that the Company's NPV ratio was 7.95% in the event of a 200 basis point increase in rates, a decrease of 13.59% from basecase of 9.20%. If rates were to decrease by 200 basis points, the Company's NPV ratio was estimated at 10.10%, an increase of 9.78% from basecase. Presented below, as of June 30, 2000, is an analysis of the Company's IRR as measured in the NPV for instantaneous and sustained parallel shifts of 100, 200, and 300 basis point increments in market interest rates. NET PORTFOLIO VALUE ------------------------- CHANGE $ CHANGE FROM NPV CHANGE FROM IN RATES $ AMOUNT BASECASE RATIO BASECASE -------- -------- ------------- ----- ----------- (DOLLARS IN THOUSANDS) +300 bp................................ $110,024 (46,096) 6.75% -245 bp +200 bp................................ 131,755 (24,365) 7.95% -125 bp +100 bp................................ 146,263 (9,857) 8.71% -49 bp basecase............................... 156,120 9.20% - -100 bp................................ 162,566 6,446 9.48% +28 bp - -200 bp................................ 176,368 20,248 10.10% +90 bp - -300 bp................................ 192,539 36,419 10.80% +160 bp Management believes that the NPV methodology overcomes three shortcomings of the typical maturity gap methodology. First, it does not use arbitrary repricing intervals and accounts for all expected cash flows, weighing each by its appropriate discount factor. Second, because the NPV method projects cash flows of each financial instrument under different rate environments, it can incorporate the effect of embedded options on an association's IRR exposure. Third, it allows interest rates on different instruments to change by varying amounts in response to a change in market interest rates, resulting in more accurate estimates of cash flows. On a quarterly basis, the results of the internally generated model are reconciled to the results of the OTS model. Historically the OTS has valued the NPV higher, but the changes in NPV as a result of the rate increases and decreases are directionally consistent between the two models. The difference between the two models resides in the prepayment assumptions, the ability of the Company to analyze each individual rate index in a changing environment, and the ability of the Company's model to include caps and floors on loans in the rate shock analyses. 30 33 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On June 28, 2000, the California Supreme Court denied the Bank's petition for review of the Court of Appeals' decision affirming in part and reversing in part the judgment in the Takaki vs. Hawthorne Savings and Loan Association matter previously disclosed by the Bank. The Bank had previously accrued the full amount of the judgment, including post judgment interest through April 2000, and no material additional accruals were required during the second quarter as a result of the Supreme Court's action and payment of the judgment. The Company is involved in a variety of other litigation matters in the ordinary course of its business, as discussed in the Annual Report on Form 10-K for the year ended December 31, 1999. Management does not presently believe that any of the existing litigative matters are likely to have a material adverse impact on the Company's financial condition or results of operation. ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Stockholders of the Company was held on May 20, 2000. At the Annual Meeting the following seven nominees were elected until the 2001 Annual Meeting of Stockholders and their successors have been duly elected and qualified as directors. NUMBER OF SHARES --------------------- DIRECTOR FOR WITHHELD -------- --------- -------- Marilyn Garton Amato................................... 4,630,614 194,748 Gary W. Brummett....................................... 4,645,076 180,286 Timothy R. Chrisman.................................... 4,642,787 182,575 Simone Lagomarsino..................................... 4,639,755 185,607 Anthony W. Liberati.................................... 4,643,476 181,886 Harry F. Radcliffe..................................... 4,643,576 181,786 Howard E. Ritt......................................... 4,642,927 182,435 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 six months ended June 30, 2000 2. Other required exhibits: Exhibit 10.1 -- Deferred Compensation Loan Agreement between Company and Karen Abajian* Exhibit 10.2 -- Form of Change in Control Employment Agreement* Exhibit 10.3 -- Form of Change in Control Employment Agreement between Company and Simone Lagomarsino* Exhibit 27.1 -- Financial Data Schedule * Denotes management compensation agreement. 31 34 Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HAWTHORNE FINANCIAL CORPORATION Dated August 14, 2000 /s/ SIMONE LAGOMARSINO -------------------------------------- Simone Lagomarsino President and Chief Executive Officer Dated August 14, 2000 /s/ KAREN C. ABAJIAN -------------------------------------- Karen C. Abajian Executive Vice President and Chief Financial Officer 32