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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 2001
[ ] 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
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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
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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
5,153,788 shares of Common Stock, $0.01 par value per share outstanding, as of
April 30, 2001.
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HAWTHORNE FINANCIAL CORPORATION
FORM 10-Q INDEX
FOR THE QUARTER ENDED MARCH 31, 2001
Page
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PART I -- FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition
at March 31, 2001 and December 31, 2000 1
Consolidated Statements of Income
for the Three Months Ended March 31, 2001 and 2000 2
Consolidated Statement of Stockholders' Equity
for the Three Months Ended March 31, 2001 3
Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2001 and 2000 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 27
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings 28
ITEM 2. Changes in Securities 28
ITEM 3. Defaults upon Senior Securities 28
ITEM 4. Submission of Matters to a Vote of Security Holders 28
ITEM 5. Other Information 28
ITEM 6. Exhibits and Reports on Form 8-K 28
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.
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HAWTHORNE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31, DECEMBER 31,
2001 2000
----------- ------------
(Dollars in thousands) (unaudited)
Assets:
Cash and cash equivalents $ 108,701 $ 99,919
Loans receivable (net of allowance for estimated credit losses
of $30,733 in 2001 and $29,450 in 2000) 1,624,786 1,608,067
Real estate owned 676 2,859
Accrued interest receivable 10,749 11,040
Investment in capital stock of Federal Home Loan Bank, at cost 21,068 20,730
Office property and equipment at cost, net 4,580 4,808
Deferred tax asset, net 4,867 2,867
Other assets 5,646 3,105
----------- -----------
Total assets $ 1,781,073 $ 1,753,395
=========== ===========
Liabilities and Stockholders' Equity:
Liabilities:
Deposits:
Noninterest-bearing $ 33,370 $ 32,994
Interest-bearing 1,203,071 1,181,862
----------- -----------
Total deposits 1,236,441 1,214,856
FHLB advances 384,000 384,000
Senior notes 30,628 39,358
Capital securities 9,000 --
Accounts payable and other liabilities 12,533 11,020
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Total liabilities 1,672,602 1,649,234
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Stockholders' Equity:
Common stock -- $0.01 par value; authorized 20,000,000
shares; issued and outstanding, 5,605,701 shares (2001)
and 5,566,801 shares (2000) 56 56
Capital in excess of par value -- common stock 42,315 42,095
Retained earnings 70,338 65,602
----------- -----------
112,709 107,753
Less:
Treasury stock, at cost -- 431,913 shares (2001) and
391,406 shares (2000) (4,238) (3,592)
----------- -----------
Total stockholders' equity 108,471 104,161
----------- -----------
Total liabilities and stockholders' equity $ 1,781,073 $ 1,753,395
=========== ===========
See Accompanying Notes to Consolidated Financial Statements
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HAWTHORNE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
---------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 2000
-------- --------
Interest revenues:
Loans $ 36,916 $ 32,913
Investments 1,598 1,523
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Total interest revenues 38,514 34,436
-------- --------
Interest costs:
Deposits 17,301 13,843
FHLB advances 5,528 4,598
Senior notes 1,206 1,250
Capital securities 8 --
-------- --------
Total interest costs 24,043 19,691
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Net interest income 14,471 14,745
Provision for credit losses 1,500 1,500
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Net interest income after provision for credit losses 12,971 13,245
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Noninterest revenues:
Loan related and other fees 1,198 1,578
Deposit fees 333 182
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Total noninterest revenues 1,531 1,760
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Income/(loss) from real estate operations, net 160 (59)
Noninterest expenses:
General and administrative expenses:
Employee 4,490 4,052
Operating 2,004 1,513
Occupancy 945 963
Professional 1,109 875
Technology 510 474
SAIF premiums and OTS assessments 243 222
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Total general and administrative expenses 9,301 8,099
Other non-operating expense:
Legal settlement expenses 110 1,703
Other -- 125
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Total noninterest expenses 9,411 9,927
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Income before income taxes 5,251 5,019
Income tax provision 2,258 2,115
-------- --------
Net income $ 2,993 $ 2,904
======== ========
Basic earnings per share (Note 3) $ 0.58 $ 0.53
======== ========
Diluted earnings per share (Note 3) $ 0.40 $ 0.39
======== ========
Weighted average basic shares outstanding (Note 3) 5,178 5,461
======== ========
Weighted average diluted shares outstanding (Note 3) 7,563 7,503
======== ========
See Accompanying Notes to Consolidated Financial Statements
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HAWTHORNE FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
CAPITAL IN
NUMBER OF EXCESS OF TOTAL
COMMON COMMON PAR VALUE - RETAINED TREASURY STOCKHOLDERS'
(IN THOUSANDS) SHARES STOCK COMMON STOCK EARNINGS STOCK EQUITY
--------- --------- ------------ --------- --------- -------------
Balance at January 1, 2001 5,175 $ 56 $ 42,095 $ 65,602 $ (3,592) $ 104,161
Exercised stock options 39 -- 220 -- -- 220
Tax benefit for stock options exercised -- 1,743 -- -- 1,743
Treasury stock (40) -- -- -- (646) (646)
Net income -- -- -- 2,993 -- 2,993
--------- --------- --------- --------- --------- ---------
Balance at March 31, 2001 5,174 $ 56 $ 44,058 $ 68,595 $ (4,238) $ 108,471
========= ========= ========= ========= ========= =========
See Accompanying Notes to Consolidated Financial Statements
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HAWTHORNE FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
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(Dollars in thousands) 2001 2000
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Cash Flows from Operating Activities:
Net income $ 2,993 $ 2,904
Adjustments to reconcile net income to cash provided
by operating activities:
Deferred income tax benefit (2,000) (386)
Provision for credit losses on loans 1,500 1,500
Provision for estimated losses on real estate owned -- (24)
Net (gain)/loss from sale of real estate owned (69) 22
Loan fee and discount accretion (780) (570)
Depreciation and amortization 949 383
FHLB dividends (339) (306)
Decrease/(increase) in accrued interest receivable 291 (1,054)
(Increase)/decrease in other assets (798) 303
Increase in other liabilities 1,552 1,865
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Net cash provided by operating activities 3,299 4,637
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Cash Flows from Investing Activities:
Loans:
New loans funded (88,250) (109,865)
Construction disbursements (62,806) (58,943)
Payoffs 112,117 126,546
Sales proceeds 7,722 --
Purchases (172) --
Principal payments 4,455 8,435
Other, net 9,048 (4,612)
Real estate owned, net:
Sales proceeds 2,256 320
Capitalized costs (5) --
Redemption of FHLB stock -- 1,197
Office property and equipment:
Sales proceeds 1 31
Additions (312) (240)
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Net cash used in investing activities (15,946) (37,131)
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Cash Flows from Financing Activities:
Deposit activity, net 21,585 58,458
Net decrease in FHLB advances -- (25,000)
Net proceeds from exercise of stock options and warrants 220 1,007
Reduction in senior notes (8,730) --
Proceeds from capital securities 9,000 --
Payments to acquire treasury stock (646) --
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Net cash provided by financing activities 21,429 34,465
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Net increase in cash and cash equivalents 8,782 1,971
Cash and cash equivalents, beginning of period 99,919 86,722
--------- ---------
Cash and cash equivalents, end of period $ 108,701 $ 88,693
========= =========
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest $ 22,513 $ 19,696
Income taxes, net 2,000 2,500
Non-cash investing and financing activities:
Real estate acquired in settlement of loans -- 340
Loans originated to refinance existing bank loans 11,433 6,085
Tax benefit for stock options exercised 1,743 --
See Accompanying Notes to Consolidated Financial Statements
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HAWTHORNE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Hawthorne
Financial Corporation and its wholly owned subsidiaries, Hawthorne Savings,
F.S.B. ("Bank") and HFC Capital Trust, 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 condition as of
March 31, 2001 and December 31, 2000, and the related statements of income and
cash flows for the three months ended March 31, 2001 and 2000. These
consolidated financial statements for the three months ended March 31, 2001, are
not necessarily indicative of the results that may be expected for any other
interim period or the full year ending December 31, 2001.
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, 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities," is effective for
all fiscal years beginning after June 15, 2000. SFAS No. 133, as amended,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. Under SFAS No. 133, certain contracts that were not formerly
considered derivatives may now meet the definition of a derivative. The Company
adopted SFAS No. 133 effective January 1, 2001. The adoption of SFAS No. 133 did
not have a significant impact on the financial position, results of operations,
or cash flows of the Company.
In September 2000, the FASB issued SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
which is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001, and for
disclosures relating to securitization transactions and collateral for fiscal
years after December 15, 2000. The Company adopted SFAS No. 140 effective
January 1, 2001. The adoption of SFAS No. 140 did not have a significant impact
on the financial position, results of operations, or cash flows of the Company.
NOTE 2 -- RECLASSIFICATIONS
Certain amounts in the 2000 consolidated financial statements have been
reclassified to conform with classifications in 2001.
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HAWTHORNE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 -- BOOK VALUE AND EARNINGS PER SHARE
The following table sets forth the Company's earnings per share
calculations for the three months ended March 31, 2001 and 2000. In the
following table, (1) "Warrants" refer to the Warrants issued by the Company in
December 1995, which are currently exercisable and which expire December 11,
2005, and (2) "Options" refer to stock options previously granted to employees
of the Company and which were outstanding at each measurement date.
THREE MONTHS ENDED
MARCH 31,
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(In thousands, except per share data) 2001 2000
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Average shares outstanding:
Basic 5,178 5,461
Warrants 2,486 2,486
Options(1) 493 258
Less: Treasury stock(2) (594) (702)
------- -------
Diluted 7,563 7,503
======= =======
Net income $ 2,993 $ 2,904
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Basic earnings per share $ 0.58 $ 0.53
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Diluted earnings per share $ 0.40 $ 0.39
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MARCH 31,
------------------
2001 2000
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Period-end shares outstanding:
Basic 5,174 5,517
Warrants 2,486 2,486
Options(3) 482 167
Less: Treasury stock(2) (587) (704)
------ ------
Diluted 7,555 7,466
====== ======
Basic book value per share $20.97 $17.40
====== ======
Diluted book value per share $14.36 $12.86
====== ======
- -----------
(1) Excludes 88,317 and 320,000 options outstanding for the three months
ended March 31, 2001 and March 31, 2000, respectively, for which the
exercise price exceeded the average market price of the Company's common
stock during the periods.
(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
stock. In this calculation, treasury stock was assumed to be repurchased
at the average closing stock price for the respective period.
(3) Excludes 81,650 options and 360,000 options outstanding at March 31,
2001 and March 31, 2000, respectively, for which the exercise price
exceeded the monthly average market price of the Company's common stock
at period-end.
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HAWTHORNE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 -- COMMITMENTS AND CONTINGENCIES
In April 2001, the Superior Court of the State of California, County of
Los Angeles granted Plaintiff's motion to reinstate a construction defect case
entitled Stone Water Terrace HOA v. Hawthorne Savings and Loan Association, in
which the Bank was named as a defendant. The case had previously been dismissed
because the Plaintiff failed to take certain actions to prosecute its case. In
this action, the Plaintiff alleges, under several theories of recovery, that the
Bank is responsible for construction defects in a multi-unit condominium
complex. The Bank initially provided construction loans to the developer, but
took over the completion of a portion of the project after the developer
defaulted. Plaintiff seeks damages in an unspecified amount, plus punitive
damages. The Bank denies the allegations in the complaint. Although the Bank
intends to vigorously defend its position in these actions and to seek
indemnification from the responsible parties, there can be no assurances that
the Company will prevail. Discovery has not yet commenced, and the Bank is not
in a position to estimate the extent of any liability. In addition, the inherent
uncertainty of jury or judicial verdicts make it impossible to determine the
Company's potential exposure in this action. Nevertheless, it is likely that the
Bank will incur substantial legal fees defending this matter.
There have been no material developments in the case entitled Marine
Village Townhomes HOA v. Hawthorne Savings and Loan Association from what was
discussed in the Annual Report on Form 10-K for the year ended December 31,
2000. The Company is involved in a variety of other litigation in the ordinary
course of its business, including those discussed in the Annual Report on Form
10-K for the year ended December 31, 2000. Management does not presently believe
that any of the existing routine litigation is likely to have a material adverse
impact on the Company's financial condition or results of operations.
NOTE 5 -- PARENT COMPANY ITEMS
During the first quarter of 2001, the Company repurchased $8.7 million
of its 1997 12.50% Senior Notes at an average price of 101.30% of par value. The
Company was able to replace the 1997 12.50% Senior Notes with 10.18% Capital
Securities, thereby lowering the Company's cost of debt. The first quarter 2001
after tax impact of the related premium and acceleration of original debt
issuance costs totaled $0.2 million, or $0.03 per diluted share.
On March 28, 2001, HFC Capital Trust I (the "Trust"), a statutory
business trust and wholly owned subsidiary of the Company, issued in a private
placement transaction $9.0 million of 10.18% capital securities (the "Capital
Securities"), which represent undivided preferred beneficial interests in the
assets of the Trust. The Company is the owner of all the beneficial interests
represented by the common securities of the Trust (the "Common Securities")
(together with the Capital Securities, the "Trust Securities"). The Trust exists
for the sole purpose of issuing the Trust Securities and investing the proceeds
thereof in 10.18% junior subordinated deferrable interest debentures (the
"Junior Subordinated Debentures") issued by the Company and engaging in certain
other limited activities. The Junior Subordinated Debentures held by the Trust
will mature on June 8, 2031, at which time the Company is obligated to redeem
the Capital Securities. The proceeds were used to repurchase $8.7 million of its
1997 12.50% Senior Notes at an average price of 101.30% of par value.
In April 2001, the Company authorized the repurchase of approximately
77,000 shares of its common stock. This was in addition to the two 5% repurchase
authorizations announced in March 2000 and July 2000, which authorized an
aggregate of approximately 541,000 shares. As of May 11, 2001, the Company has
repurchased 466,513 shares at an average price of $10.36.
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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 months ended March 31, 2001, was $3.0 million,
or $0.40 per diluted share, compared with $2.9 million, or $0.39 per diluted
share, for the same period in 2000. This net income resulted in an annualized
return on average assets ("ROA") of 0.68% and an annualized return on average
equity ("ROE") of 11.39% for the three months ended March 31, 2001, compared
with an annualized ROA of 0.72% and an annualized ROE of 12.36%, during the same
period in 2000. Pre-tax income increased 4.62%, for the three months ended March
31, 2001, to $5.3 million from $5.0 million generated during the same period in
2000.
The Company's net interest income before provision for credit losses
decreased 1.86% to $14.5 million during the three months ended March 31, 2001,
compared with $14.7 million for the three months ended March 31, 2000. The
Company's yield on average earning assets was 8.73% for the three months ended
March 31, 2001, compared with 8.64% during the same period in 2000. The average
cost of interest-bearing liabilities for the Company increased to 6.06% during
the three months ended March 31, 2001, compared with 5.41% for the three months
ended March 31, 2000. The Company's resulting net interest margin for the three
months ended March 31, 2001, was 3.28%, compared with 3.70% during the same
period in 2000. The compression in the net interest margin was the result of the
inverted yield curve environment in which short term rates were higher than long
term rates. The adjustable rate assets were repricing off of the lower, long
term rates and interest-bearing liabilities were pricing off of the higher short
term rates. The 150 basis point drop in interest rates during the first quarter
of 2001 caused further compression in the net interest margin due to the
immediate repricing of adjustable rate assets and the lag in liability repricing
resulting from the six month weighted average maturity of certificates of
deposits.
Provisions for credit losses totaled $1.5 million for the three months
ended March 31, 2001 and 2000. At March 31, 2001, the ratio of total allowance
for estimated credit losses to net loans reached 1.86%, compared with 1.80% at
December 31, 2000 and 1.71% at March 31, 2000.
Nonaccrual loans totaled $25.2 million at March 31, 2001 (or 1.41% of
total assets), compared with nonaccrual loans of $31.6 million (or 1.80% of
total assets) at December 31, 2000. Other classified loans were $32.6 million at
March 31, 2001, compared with $40.6 million at December 31, 2000. Delinquent
loans totaled $11.3 million at March 31, 2001, compared with $26.9 million at
December 31, 2000. Other real estate owned totaled $0.7 million at March 31,
2001, compared with $2.9 million at December 31, 2000.
Noninterest revenues were $1.5 million for the three months ended March
31, 2001, compared with noninterest revenues of $1.8 million earned during the
three months ended March 31, 2000. Due to the nature of the loans we are
currently underwriting, loan fees have declined. This decrease has been
partially offset by higher deposit fees as a result of new product offerings and
a new fee schedule rolled out in July 2000.
Total general and administrative expenses ("G&A") were $9.3 million for
the three months ended March 31, 2001, a 14.84% increase over the $8.1 million
of G&A incurred during the same period in 2000. The increase in G&A for the
three months ended March 31, 2001, was primarily due to increases in employee
costs, operating costs and professional fees.
Other non-operating expenses decreased to $0.1 million for the three
months ended March 31, 2001, compared with $1.8 million during the same period
in 2000. The $1.7 million decrease was primarily due to fewer legal settlements
in 2001 compared with 2000.
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NET INTEREST INCOME
The following table shows average balance sheet data, related revenues
and costs and effective weighted average yields and costs, for the three months
ended March 31, 2001 and 2000.
THREE MONTHS ENDED
---------------------------------------------------------------------------
MARCH 31, 2001 MARCH 31, 2000
------------------------------------ -----------------------------------
WEIGHTED WEIGHTED
AVERAGE REVENUES/ AVERAGE AVERAGE REVENUES/ AVERAGE
(Dollars in thousands) BALANCE COSTS YIELD/COST BALANCE COSTS YIELD/COST
---------- ---------- ---------- ---------- ---------- ----------
Assets:
Interest-earning assets:
Loans receivable(1) $1,652,162 $ 36,916 8.94% $1,490,115 $ 32,913 8.84%
Cash and cash equivalents 91,338 1,260 5.52 82,768 1,215 5.87
Investment in capital stock of
Federal Home Loan Bank 20,878 338 6.57 21,550 308 5.75
---------- ---------- ---------- ---------- -----
Total interest-earning assets 1,764,378 38,514 8.73 1,594,433 34,436 8.64
---------- ----- ---------- -----
Noninterest-earning assets 1,455 13,302
---------- ----------
Total assets $1,765,833 $1,607,735
========== ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Deposits $1,186,679 $ 17,301 5.91% $1,079,277 $ 13,843 5.16%
FHLB advances 384,000 5,528 5.76 344,549 4,598 5.28
Senior notes 38,528 1,206 12.52 40,000 1,250 12.50
Capital securities 400 8 8.00 -- -- --
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,609,607 24,043 6.06 1,463,826 19,691 5.41
---------- ----- ---------- ----
Noninterest-bearing checking 31,711 29,608
Noninterest-bearing liabilities 19,388 20,314
Stockholders' equity 105,127 93,987
---------- ----------
Total liabilities and stockholders' equity $1,765,833 $1,607,735
========== ==========
Net interest income $ 14,471 $ 14,745
========== ==========
Interest rate spread 2.67% 3.23%
===== =====
Net interest margin 3.28% 3.70%
===== =====
- -----------
(1) Includes the interest on nonaccrual 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 earned from
its interest-earning assets and the interest expense incurred 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 recorded net interest income of $14.5 million and $14.7
million during the three months ended March 31, 2001 and 2000, respectively.
Average earning assets were $1.8 billion for the three months ended March 31,
2001, compared with $1.6 billion during 2000, reflecting an increase of 10.66%.
The yield on interest-earning assets was 8.73% for the three months ended March
31, 2001, compared with 8.64% during the same period in 2000. The steady growth
in loans was funded through deposit growth and borrowings from the FHLB. The
average cost of interest-bearing liabilities for the Company increased to 6.06%
during the three months ended March 31, 2001, compared with 5.41% during the
same period in 2000. Expressed as a percentage of interest-earning assets, the
Company's resulting net interest margin was 3.28% and 3.70% for the three months
ended March 31, 2001 and 2000, respectively. The compression in the net interest
margin is the result of the inverted yield curve environment in which short term
rates are repricing off the lower, long term rates and interest-bearing
liabilities were pricing off of the higher short term rates. The 150 basis point
drop in interest rates during the first quarter of 2001 caused further
compression in the net interest margin due to the
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immediate repricing of adjustable rate assets and the lag in liability repricing
resulting from the six month weighted average maturity of certificates of
deposits.
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 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 March 31, 2001, 89.96% of the Company's net loan portfolio was
adjustable rate, with 83.95% 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 decline
in the effective yield of these indices, the Company expects that the yield on
its loan portfolio will decline over the coming months to fully incorporate the
recent decrease in market interest rates.
At March 31, 2001, 73.15% 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 March
31, 2001. Generally, the Company's offering rates for certificate accounts move
directionally with the general level of short term interest rates, though the
margin may vary due to competitive pressures. The maturities, as reflected in
the repricing table under "Interest Rate Risk Management," indicate that the
Company will continue to see a compression in the net interest margin in the
first half of 2001. The Company expects that the cost of its certificate
accounts will decrease in the coming months, as maturing and newly acquired
accounts are priced at current, lower offering rates.
As of March 31, 2001, 67.45% 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 32.55% 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 one month LIBOR, and matures in May 2002. Accordingly, the recent
decrease in market interest rates is expected to result in a gradual decrease in
the cost of the Company's currently outstanding FHLB borrowings, and the cost of
any newly acquired borrowings will reflect current market pricing.
10
13
The following table sets 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 MARCH 31, 2001 AND 2000
INCREASE (DECREASE) DUE TO CHANGE IN
----------------------------------------------
VOLUME AND NET
(Dollars in thousands) VOLUME RATE RATE(1) CHANGE
------- ------- --------- -------
Interest-earning assets:
Loans receivable(2) $ 3,579 $ 382 $ 42 $ 4,003
Cash and cash equivalents 126 (73) (8) 45
Investment in capital stock of
Federal Home Loan Bank (10) 41 (1) 30
------- ------- ------- -------
3,695 350 33 4,078
------- ------- ------- -------
Interest-bearing liabilities:
Deposits 1,378 1,892 188 3,458
FHLB advances 526 362 42 930
Senior notes (46) 2 -- (44)
Capital securities 8 -- -- 8
------- ------- ------- -------
1,866 2,256 230 4,352
------- ------- ------- -------
Change in net interest income $ 1,829 $(1,906) $ (197) $ (274)
======= ======= ======= =======
- ------------
(1) Calculated by multiplying change in rate by change in volume.
(2) Includes the interest on nonaccrual only to the extent that it was paid
and recognized as interest income.
The Company's interest revenues increased by $4.1 million, or 11.84%,
during the three months ended March 31, 2001, compared with the same period in
2000. This increase was primarily attributable to a 10.87% increase in the
average balance of loans outstanding and a 10 basis point increase in the yield
on average loans outstanding, which averaged 8.94% during 2001, compared with
8.84% in 2000. Average total loans, net of deferred fees, grew to $1.7 billion
in 2001, compared with $1.5 billion in 2000.
Interest costs increased by $4.4 million, or 22.10%, during the three
months ended March 31, 2001, compared with the same period in 2000. The average
balance of certificates of deposits increased $49.5 million, to $900.5 million
and 6.33% in average cost of funds during the three months ended March 31, 2001,
compared with $851.1 million and 5.49% in average cost of funds during the same
period in 2000. The average balance of money market accounts reflected an
increase of $53.3 million, to $214.3 million and 5.27% in average cost of funds
during the three months ended March 31, 2001, compared with $161.1 million and
4.65% in average cost of funds during the same period in 2000. In addition, the
average balance of FHLB advances reflected an increase of $39.5 million, to
$384.0 million and 5.76% in average cost of funds during the three months ended
March 31, 2001, compared with $344.5 million and 5.28% in average cost of funds
during the same period in 2000. The increase in volume and rates on deposits and
FHLB advances had a negative impact on the Company's average cost of
interest-bearing liabilities during the three months ended March 31, 2001.
These changes in interest revenues and interest costs produced a
decrease of $0.3 million, or 1.86%, in the Company's net interest income for the
three months ended March 31, 2001, compared with the same period in 2000.
Expressed as a percentage of interest-earning assets, the Company's net interest
margin decreased to 3.28% during the three months ended March 31, 2001, compared
with the net interest margin of 3.70% produced during the same period in 2000.
The compression in the net interest margin is the result of the inverted yield
curve environment in which short term rates are higher than long term rates. In
turn, adjustable rate assets are repricing off of the lower, long term rates and
interest bearing liabilities are pricing off of the higher, short term rates.
The 150 basis point drop in interest rates during the first quarter of 2001
caused further compression in the net interest margin due to the immediate
repricing of adjustable rate assets and the lag in liability repricing resulting
from the six month weighted average maturity of certificates of deposits.
11
14
PROVISIONS FOR ESTIMATED CREDIT LOSSES
Provisions for estimated credit losses were $1.5 million for the three
months ended March 31, 2001 and March 31, 2000. The Company's total allowance
for estimated credit losses to loans receivable, net of specific allowances,
increased to 1.86% at March 31, 2001, compared with 1.80% at December 31, 2000
and 1.71% at March 31, 2000. The Company's annualized ratio of charge-offs to
average loans increased from 0.01% during the first three months of 2000 to
0.05% during the first three months of 2001. Additionally, total classified
assets to Bank core capital and general allowance for estimated credit losses
was 34.50% at March 31, 2001, compared with 45.78% at December 31, 2000 and
59.58% at March 31, 2000.
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.
See "Asset Quality" for a more complete discussion of the Company's allowance
for estimated credit losses.
NONINTEREST REVENUES
Noninterest revenues were $1.5 million for the three months ended March
31, 2001, a decrease of $0.2 million, or 13.01%, from $1.8 million earned during
the three months ended March 31, 2000. Due to the nature of the loans we are
currently underwriting, loan fees have declined. This decrease has been
partially offset by an increase of 82.97% in deposit fees as a result of new
product offerings and a new fee schedule rolled out in July 2000.
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
Company anticipates that these loan related fees will decrease as the nature of
loans that we are currently underwriting will not allow us to charge the same
level of fees as in prior years. Noninterest revenues also include deposit fee
income for service fees, nonsufficient fund fees and other miscellaneous check
and service charges.
REAL ESTATE OPERATIONS
The table below sets forth the costs and revenues attributable to the
Company's real estate owned ("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 MARCH 31,
--------------------------------
(DOLLARS IN THOUSANDS) 2001 2000 CHANGE
----- ----- ------
Expenses associated with real estate operations:
Repairs, maintenance and renovation $ (11) $ (85) $ 74
Insurance and property taxes (8) (2) (6)
----- ----- -----
(19) (87) 68
Net recoveries/(loss) from sales of REO 69 (22) 91
Property operations, net 110 26 84
Recovery for estimated losses on REO -- 24 (24)
----- ----- -----
Income/(loss) from real estate operations, net $ 160 $ (59) $ 219
===== ===== =====
Net income/(loss) 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 three months ended March 31, 2001, the
Company sold three properties generating net cash proceeds of $2.3 million and a
net recovery of $0.07 million, compared with sales of three properties
generating net cash proceeds of $0.3 million and a net loss of $0.02 million
during the same period in 2000. As of April 30, 2001, the Company held two
properties totaling $0.7 million.
12
15
NONINTEREST EXPENSES
General and Administrative Expenses
The table below details the Company's general and administrative
expenses for the periods indicated.
THREE MONTHS ENDED MARCH 31,
-----------------------------------
(DOLLARS IN THOUSANDS) 2001 2000 CHANGE
------- ------- -------
Employee $ 4,490 $ 4,052 $ 438
Operating 2,004 1,513 491
Occupancy 945 963 (18)
Professional 1,109 875 234
Technology 510 474 36
SAIF premiums and OTS assessments 243 222 21
------- ------- -------
Total $ 9,301 $ 8,099 $ 1,202
======= ======= =======
Total general and administrative expenses ("G&A") were $9.3 million for
the three months ended March 31, 2001, a 14.84% increase over the $8.1 million
of G&A incurred during the same period in 2000. The increase in G&A for the
three months ended March 31, 2001, was primarily due to increases in employee
costs, operating costs and professional fees. The $0.4 million increase in
employee costs was due to a change in the payroll accrual from bi-weekly to
semi-monthly. This accrual change was initiated in the third quarter of 2000,
therefore, a variance will result for the first half of 2001. The $0.5 million
increase in operating costs was primarily due to the acceleration of $0.3
million in prepaid offering costs in conjunction with the repurchase of $8.7
million in 1997 12.50% Senior Notes during the first quarter of 2001. The $0.1
million in premium paid on the repurchase also contributed to the increase in
operating costs. The $0.2 million increase in professional fees was primarily
comprised of legal fees. These fees were attributable to litigation, as
discussed in the Annual Report on Form 10-K for the year ended December 31,
2000. The $1.2 million increase in G&A 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 three months ended March 31, 2001, increased
to 58.12% compared with 49.07% for the three months ended March 31, 2000.
Other Non-Operating Expense
Other non-operating expense totaled $0.1 million for the three months
ended March 31, 2001, a $1.7 million decrease from the $1.8 million of other
non-operating expense incurred during the same period of 2000. This decrease is
primarily attributable to the $1.7 million expense during 2000 associated with
ongoing litigation and/or satisfaction of judgments against the Company,
including the satisfaction of the judgment in the Takaki vs. Hawthorne Savings
and Loan Association matter, and $0.1 million primarily in connection with the
early termination of the Irvine office lease.
INCOME TAXES
The Company recorded an income tax provision of $2.3 million for the
three months ended March 31, 2001, compared with $2.1 million during the same
period in 2000. The Company's effective tax rate was 43.00% and 42.14% during
the three months ended March 31, 2001 and 2000, respectively.
13
16
FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY
ASSETS
LOANS RECEIVABLE
GENERAL
The Company's loan portfolio consists primarily 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.
MARCH 31, 2001 DECEMBER 31, 2000
----------------------- ------------------------
(DOLLARS IN THOUSANDS) BALANCE PERCENT BALANCE PERCENT
---------- ------ ---------- ------
Single family residential $ 898,569 49.14% $ 888,416 49.16%
Income property:
Multi-family(1) 242,671 13.27% 253,039 14.00%
Commercial(1) 212,892 11.64% 200,372 11.09%
Development(2) 226,811 12.41% 203,894 11.28%
Single family construction:
Single family residential(3) 191,749 10.49% 195,983 10.85%
Tract 2,389 0.13% 3,495 0.19%
Land(4) 44,686 2.44% 46,520 2.58%
Other 8,757 0.48% 15,390 0.85%
---------- ------ ---------- ------
Gross loans receivable(5) 1,828,524 100.00% 1,807,109 100.00%
====== ======
Less:
Undisbursed funds (175,310) (171,789)
Deferred (fees) and costs, net(6) 2,305 2,197
Allowance for estimated credit losses (30,733) (29,450)
---------- ----------
Net loans receivable $1,624,786 $1,608,067
========== ==========
- -------------------------
(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) Predominantly loans for the construction of individual and custom homes.
(4) 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.
(5) Gross loans receivable includes the principal balance of loans
outstanding, plus outstanding but unfunded loan commitments,
predominantly in connection with construction loans.
(6) The balance in deferred fees moved from a deferred fee position to a
deferred cost position due to higher broker fees resulting from
increased single family residential loan volume.
14
17
The table below sets forth the Company's loan portfolio diversification
by loan size.
MARCH 31, 2001 DECEMBER 31, 2000
-------------------- -------------------
NO. OF GROSS NO. OF GROSS
(DOLLARS IN THOUSANDS) LOANS COMMITMENT LOANS COMMITMENT
------ ---------- ------ ----------
Loans in excess of $10.0 million:
Income property:
Commercial 3 $ 32,786 2 $ 22,027
Development 6 68,507 5 59,707
--- ---------- --- ----------
9 101,293 7 81,734
--- ---------- --- ----------
Percentage of total gross loans 5.54% 4.52%
Loans between $5.0 and $10.0 million:
Single family residential 5 31,963 5 33,073
Income property:
Commercial 6 43,554 8 55,568
Development 11 73,850 13 90,672
Single family construction:
Single family residential 2 14,300 2 14,300
Land 1 6,000 1 6,501
Other 2 14,630 1 7,500
--- ---------- --- ----------
27 184,297 30 207,614
--- ---------- --- ----------
Percentage of total gross loans 10.08% 11.49%
Loans less than $5.0 million 1,542,934 1,517,761
---------- ----------
Gross loans receivable $1,828,524 $1,807,109
========== ==========
15
18
The table below sets forth the Company's net loan portfolio composition,
excluding net deferred fees and costs, as of the dates indicated.
MARCH 31, 2001 DECEMBER 31, 2000
---------------------- ----------------------
(DOLLARS IN THOUSANDS) BALANCE PERCENT BALANCE PERCENT
---------- ------- ---------- -------
Single family residential $ 894,789 54.12% $ 883,814 54.04%
Income property:
Multi-family 242,832 14.69% 251,995 15.41%
Commercial 199,254 12.05% 187,680 11.48%
Development 145,953 8.83% 130,263 7.97%
Single family construction:
Single family residential 125,208 7.57% 127,630 7.80%
Land 43,550 2.64% 45,450 2.78%
Other 1,628 0.10% 8,488 0.52%
---------- ------ ---------- ------
Total $1,653,214 100.00% $1,635,320 100.00%
========== ====== ========== ======
The table below sets forth the approximate composition of the Company's
gross new loan commitments, net of internal refinances, for the periods
indicated, by dollars and as a percentage of total loans originated.
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 2001 MARCH 31, 2000
------------------- -------------------
(Dollars in thousands) Amount % Amount %
-------- ------ -------- ------
Single family residential(1) $ 61,097 38.79% $ 76,586 55.73%
Income property:
Multi-family(2) 4,059 2.58% 13,035 9.48%
Commercial(3) 23,260 14.77% 20,237 14.72%
Development(4) 37,323 23.70% -- --
Single family construction:
Single family residential(5) 24,611 15.62% 21,082 15.34%
Land 7,153 4.54% 6,492 4.72%
Other 6 -- 7 0.01%
-------- ------ -------- ------
Total $157,509 100.00% $137,439 100.00%
======== ====== ======== ======
- ------------
(1) Includes unfunded commitments of $0.1 million and $0.3 million as of
March 31, 2001 and 2000, respectively.
(2) Includes unfunded commitments of $0.6 million as of March 31, 2001.
(3) Includes unfunded commitments of $0.4 million and $2.1 million as of
March 31, 2001 and 2000, respectively.
(4) Includes unfunded commitments of $26.2 million as of March 31, 2001.
(5) Includes unfunded commitments of $16.9 million and $14.5 million as of
March 31, 2001 and 2000, respectively.
16
19
ASSET QUALITY
Classified Assets
The table below sets forth information concerning the Company's risk
elements as of the dates indicated. Classified assets include REO, nonaccrual
loans and performing loans which have been adversely classified pursuant to the
Company's classification policies and OTS regulations and guidelines
("performing/classified" loans).
MARCH 31, DECEMBER 31,
(Dollars in thousands) 2001 2000
---------- ------------
Risk elements:
Nonaccrual loans(1) $ 25,194 $ 31,601
Real estate owned, net 676 2,859
---------- ----------
25,870 34,460
Performing loans classified substandard or lower(2) 32,572 40,642
---------- ----------
Total classified assets $ 58,442 $ 75,102
========== ==========
Total classified loans $ 57,766 $ 72,243
========== ==========
Loans restructured and paying in accordance with modified terms(3) $ 14,427 $ 14,933
========== ==========
Gross loans before allowance for estimated credit losses $1,655,519 $1,637,517
========== ==========
Loans receivable, net of specific allowance and deferred (fees) and costs $1,649,741 $1,631,721
========== ==========
Delinquent loans:
30 - 89 days $ 3,641 $ 12,407
90+ days 7,668 14,509
---------- ----------
Total delinquent loans $ 11,309 $ 26,916
========== ==========
Allowance for estimated credit losses:
General $ 24,955 $ 23,654
Specific(4) 5,778 5,796
---------- ----------
Total allowance for estimated credit losses $ 30,733 $ 29,450
========== ==========
Bank core capital $ 144,465 $ 140,387
Net loan charge-offs:
Net charge-offs for the quarter ended $ 217 $ 663
Percent to net loans (annualized) 0.05% 0.16%
Percent to beginning of period allowance for credit losses (annualized) 2.95% 9.27%
Selected asset quality ratios at period end:
Total nonaccrual loans to total assets 1.41% 1.80%
Total allowance for estimated credit losses to loans receivable, net of
specific allowance and deferred (fees) and costs 1.86% 1.80%
Total general allowance for estimated credit losses to loans receivable,
net of specific allowance and deferred (fees) and costs 1.51% 1.45%
Total allowance for estimated credit losses to nonaccrual loans 121.99% 93.19%
Total classified assets to Bank core capital and general
allowance for estimated credit losses 34.50% 45.78%
- ------------
(1) Nonaccrual loans include ten loans, totaling $7.2 million, in bankruptcy
at March 31, 2001 and December 31, 2000. Total troubled debt
restructured loans ("TDRs") were $14.6 million and $18.8 million at
March 31, 2001 and December 31, 2000, respectively. Nonaccrual loans
include no TDRs at March 31, 2001 and $3.7 million at December 31, 2000.
(2) Excludes nonaccrual loans.
(3) Troubled debt restructured loans not classified and not on nonaccrual.
(4) In December 2000, a specific allowance was identified for one nonaccrual
loan requiring a $5.2 million reclassification from general allowance to
specific allowance. No additional provision was required.
17
20
The table below sets forth information concerning the Company's gross
classified loans, by category, as of March 31, 2001.
DELINQUENT LOANS OTHER
-------------------------- NONACCRUAL PERFORMING
(DOLLARS IN THOUSANDS) 90+ DAYS 30 - 89 DAYS(1) LOANS LOANS(2) TOTAL
--------- --------------- ---------- ---------- -------
Single family residential $ 7,245 $ 2,859 $ 2,997 $ 7,048 $20,149
Income property:
Commercial -- -- -- 13,740 13,740
Development -- -- 11,416 -- 11,416
Single family construction:
Single family residential -- -- 725 5,722 6,447
Tract -- -- -- 2,333 2,333
Land 405 -- -- 3,253 3,658
Other 18 5 -- -- 23
------- ------- ------- ------- -------
Gross classified loans $ 7,668 $ 2,864 $15,138 $32,096 $57,766
======= ======= ======= ======= =======
- ------------
(1) Includes $2.4 million in loans on nonaccrual status.
(2) Includes loans that have been restructured and are paying as agreed.
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 for impaired loans, in
accordance with SFAS No. 114, 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.
Executive management reviews these conditions quarterly in discussion
with senior credit officers. To the extent that any of these conditions is
evidenced by a specifically identifiable problem credit or portfolio segment as
of the evaluation date, management's estimate of the effect of such condition
may be reflected as a specific allowance applicable to such credit or portfolio
segment.
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 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 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
18
21
of the current business cycle, (9) bank regulatory examination results and (10)
findings of our internal credit examiners. The unallocated allowance is reviewed
periodically to determine whether they are at a level that management believes
are adequate.
The table below summarizes the activity of the Company's allowance for
estimated credit losses for the periods indicated.
THREE MONTHS ENDED
MARCH 31,
-----------------------------
(Dollars in thousands) 2001 2000
----------- -----------
Average loans outstanding $ 1,652,162 $ 1,490,115
=========== ===========
Total allowance for estimated credit losses at beginning of period $ 29,450 $ 24,285
Provision for credit losses 1,500 1,500
Charge-offs:
Single family residential (218) (107)
Single family construction:
Single family residential (43) --
Recoveries:
Other 44 53
----------- -----------
Net charge-offs (217) (54)
----------- -----------
Total allowance for estimated credit losses at end of period $ 30,733 $ 25,731
=========== ===========
Annualized ratio of charge-offs to average loans
outstanding during the period 0.05% 0.01%
Real estate owned:
Total allowance for estimated losses at beginning of period $ -- $ 29
Provision for estimated losses -- (24)
Charge-offs -- (1)
----------- -----------
Total allowance for estimated losses at end of period $ -- $ 4
=========== ===========
19
22
The table below summarizes the Company's allowance for estimated credit
losses by category for the periods indicated.
MARCH 31, 2001 DECEMBER 31, 2000
----------------------------------- -----------------------------------
PERCENT OF PERCENT OF
RESERVES TO RESERVES TO
TOTAL LOANS(1) TOTAL LOANS(1)
(DOLLARS IN THOUSANDS) BALANCE PERCENT BY CATEGORY BALANCE PERCENT BY CATEGORY
------- ------ -------------- ------- ------ --------------
Single family residential $ 7,479 24.34% 0.83% $ 8,075 27.42% 0.91%
Income property:
Multi-family 819 2.66% 0.34% 906 3.08% 0.36%
Commercial 4,496 14.63% 2.11% 4,236 14.38% 2.11%
Development 7,951 25.87% 3.51% 7,877 26.75% 3.86%
Single family construction:
Single family residential 3,779 12.30% 1.97% 4,382 14.88% 2.24%
Tract 470 1.53% 19.67% 693 2.35% 19.83%
Land 991 3.22% 2.22% 1,914 6.50% 4.11%
Other 169 0.55% 1.93% 260 0.88% 1.69%
Unallocated 4,579 14.90% n/a 1,107 3.76% n/a
------- ------ ------- ------
$30,733 100.00% 1.68% $29,450 100.00% 1.63%
======= ====== ======= ======
- ------------
(1) Percent of allowance for estimated credit losses to gross loan
commitments.
The unallocated allowance is 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 the allocated allowance.
In our assessment of the allowance for estimated credit losses as of
March 31, 2001, management focused on changes in the economic environment, in
particular the observable trends in the national and regional economy and the
business conditions that affect our key lending areas. The resulting increase in
the unallocated allowance was primarily due to three current economic risk
factors, the energy crisis, the forecasted recession and the potential strikes
by the screenwriters' guild and screen actors' guild ("SAG").
The California energy crisis is expected to worsen during the summer
months, including the threat of more rolling blackouts and additional increases
in the cost of utilities, which could result in a sharp reduction in the output
of goods and services. The long term effects of the energy crisis could be more
significant as surplus reserves are spent on utilities' transmission systems
instead of schools and various CalTrans projects, which could result in
increased taxes, as new bonds are used to pay for such projects. The potential
impact of the energy crisis accounts for approximately 6% of the allowance.
The UCLA Anderson Forecast has forecasted negative national growth rates
during the second and third quarter of 2001. As the nation's leading exporter,
California is particularly vulnerable to the slowing U.S. economy. Manufacturing
employment has continued to decrease over the last eight months, with recent job
reports reflecting employment losses in other industry sectors, including
consumer durables and services for both wholesale and retail trade.
Additionally, growth in real personal income in California decreased in the last
half of 2000. The UCLA Anderson Forecast has forecasted a 1.2% growth rate for
2001, compared with growth of 8.4% reflected in 2000. The potential impact of
the recession accounts for approximately 4% of the allowance.
The potential strikes by the screenwriters' guild and SAG could have a
significant impact on the Los Angeles area, the Company's primary real property
market. The motion picture and television production industries directly impact
approximately 185,000 jobs. In anticipation of the strikes, peripheral
businesses have already initiated layoffs and potential strikers appear to have
changed their spending habits. In March 2001, the unemployment rate for Los
Angeles was 4.8% with current estimates increasing this rate to 6.1% for a short
term strike. A prolonged strike could increase the estimated unemployment rate
significantly. Although negotiators for the screenwriters' guild have agreed to
a tentative contract proposal as of May 4, 2001, the three year agreement must
still be ratified by a majority of the guild's 11,500 members in early June. The
potential impact of the two strikes accounts for approximately 3% of the
allowance.
20
23
The remaining unallocated allowance is related to estimation risk. Based
on the additional economic risk factors reflected above, management believes
that the unallocated allowance of $4.6 million as of March 31, 2001 is
appropriate.
REAL ESTATE OWNED
Real estate acquired in satisfaction of loans is transferred to REO at
the lower of the carrying value or the estimated fair value, 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
charge-off if fair value is lower. Any subsequent declines in the fair value of
the REO property 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.
MARCH 31, DECEMBER 31,
(DOLLARS IN THOUSANDS) 2001 2000
-------- ------------
Single family residential(1) $ 676 $2,859
Income property:
Commercial -- --
------ ------
Total real estate owned(2) $ 676 $2,859
====== ======
- ------------
(1) As of March 31, 2001, the Company held two properties.
(2) Fair value of collateral at foreclosure, plus post-foreclosure
capitalized costs.
21
24
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.
MARCH 31, 2001 DECEMBER 31, 2000
------------------------------------- ---------------------------------------
(Dollars in thousands) Balance(1) PERCENT WAIR WARM BALANCE(1) PERCENT WAIR WARM
---------- ------- ---- ---- ---------- ------- ---- ----
Transaction accounts:
Noninterest-bearing checking $ 33,370 2.70% -- -- $ 32,994 2.71% -- --
Checking/NOW 46,592 3.76% 2.68% -- 42,774 3.52% 2.67% --
Passbook 36,341 2.94% 2.80% -- 25,868 2.13% 2.00% --
Money Market 215,727 17.45% 4.73% -- 213,757 17.60% 5.20% --
---------- ------ ---------- ------
Total transaction accounts 332,030 26.85% 315,393 25.96%
---------- ------ ---------- ------
Certificates of deposit:
7 day maturities 20,684 1.67% 4.04% -- 20,905 1.72% 4.04% --
Less than 6 months 11,160 0.90% 4.57% 2 11,248 0.93% 4.93% 2
6 months to 1 year 110,914 8.97% 5.87% 3 106,193 8.74% 6.18% 4
1 year to 2 years 746,057 60.35% 6.35% 6 744,058 61.25% 6.43% 6
Greater than 2 years 15,596 1.26% 5.40% 16 17,059 1.40% 5.35% 14
---------- ------ ---------- ------
Total certificates of deposit 904,411 73.15% 899,463 74.04%
---------- ------ ---------- ------
Total deposits $1,236,441 100.00% 5.54% 6 $1,214,856 100.00% 5.71% 6
========== ====== ========== ======
- ------------
(1) Deposits in excess of $100,000 were 27.06% of total deposits at March
31, 2001, compared to 29.87% of total deposits at December 31, 2000.
FHLB ADVANCES
A primary alternate funding source for the Company is a credit line with
the FHLB with a maximum advance of up 35% of the Company's total assets based on
qualifying collateral. The FHLB system functions as a source of credit to
savings institutions which are members of the FHLB. 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 summarizes the balance and rate of FHLB
advances for the dates indicated:
(DOLLARS IN THOUSANDS) MARCH 31, 2001 DECEMBER 31, 2000
------------------- ---------------------
Original term: PRINCIPAL RATE PRINCIPAL RATE
--------- ---- --------- ----
12 Months $ 25,000 5.81% $ 25,000 5.81%
24 Months 25,000 5.32% 25,000 6.56%
36 Months 100,000 5.73% 100,000 6.73%
60 Months 135,000 5.92% 135,000 5.92%
120 Months 99,000 5.19% 99,000 5.19%
-------- --------
$384,000 5.64%(1) $384,000 5.98%(1)
======== ========
- ------------
(1) Weighted average interest rate at period end.
22
25
The weighted average remaining term of the Company's FHLB advances was 4
years and 2 months as of March 31, 2001. At March 31, 2001, 60.94% of the
Company's FHLB advances outstanding contain options, which allow the FHLB to
call the advances prior to maturity, subject to an initial non-callable period
of one to three years from origination.
SENIOR NOTES
On December 31, 1997, the Company issued $40.0 million of 1997 12.50%
Senior Notes due 2004 ("1997 Senior Notes") in a private placement, which
included registration rights. Interest on the 1997 Senior Notes is payable
semi-annually.
During the first quarter of 2001, the Company repurchased $8.7 million
of its 1997 12.50% Senior Notes at an average price of 101.30% of par value. The
Company was able to replace the 1997 12.50% Senior Notes with 10.18% Capital
Securities, thereby lowering the Company's cost of debt. As of May 11, 2001,
the Company repurchased $9.4 million of its 1997 12.50% Senior Notes at an
average price of 100.96% of par value.
CAPITAL SECURITIES
On March 28, 2001, HFC Capital Trust I (the "Trust"), a statutory
business trust and wholly owned subsidiary of the Company, issued in a private
placement transaction $9.0 million of 10.18% capital securities (the "Capital
Securities"), which represent undivided preferred beneficial interests in the
assets of the Trust. The Company is the owner of all the beneficial interests
represented by the common securities of the Trust (the "Common Securities")
(together with the Capital Securities, the "Trust Securities"). The Trust exists
for the sole purpose of issuing the Trust Securities and investing the proceeds
thereof in 10.18% junior subordinated deferrable interest debentures (the
"Junior Subordinated Debentures") issued by the Company and engaging in certain
other limited activities. The Junior Subordinated Debentures held by the Trust
will mature on June 8, 2031, at which time the Company is obligated to redeem
the Capital Securities. The proceeds were used to repurchase $8.7 million of its
1997 12.50% Senior Notes at an average price of 101.30% of par value.
STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL
The Company's capital consists of common stockholders' equity, which at
March 31, 2001 amounted to $108.5 million and which equaled 6.09% of the
Company's total assets.
As shown below, the Bank's regulatory capital exceeded minimum
regulatory capital requirements applicable to it as of March 31, 2001.
TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL
------------------ ------------------ ------------------
(DOLLARS IN THOUSANDS) BALANCE % BALANCE % BALANCE %
---------- ---- ---------- ---- ---------- -----
Stockholders' equity $ 144,465 $ 144,465 $ 144,465
Adjustments:
General reserves -- -- -- 15,851
Other(1) -- -- -- (715)
---------- ---- ---------- ---- ---------- -----
Regulatory capital 144,465 8.13% 144,465 8.13% 159,601 12.68%
Required capital requirements 26,663 1.50 71,103 4.00 100,720 8.00
---------- ---- ---------- ---- ---------- -----
Excess capital $ 117,802 6.63% $ 73,362 4.13% $ 58,881 4.68%
========== ==== ========== ==== ========== ====
Adjusted assets(2) $1,777,563 $1,777,563 $1,259,003
========== ========== ==========
- ------------
(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 (i) 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 (ii) the term
"risk-weighted assets" as defined in 12 C.F.R. Section 567.5(d) for
purposes of the risk-based capital requirements.
23
26
As of March 31, 2001, the Bank is categorized as "well capitalized"
under the regulatory framework for Prompt Corrective Action ("PCA") Rules. There
are no conditions or events subsequent to March 31, 2001, that management
believes have changed the Bank's category. The following table compares the
Bank's actual capital ratios to those required by regulatory agencies to meet
the minimum capital requirements required by the OTS and to be categorized as
"well capitalized" under the PCA Rules for the periods indicated.
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------- -------------------- -----------------------
(DOLLARS IN THOUSANDS) AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS
--------- ------ --------- ------ --------- ------
As of March 31, 2001
Total capital to risk weighted assets $ 159,601 12.68% $ 100,720 8.00% $ 125,900 10.00%
Core capital to adjusted tangible assets 144,465 8.13% 71,103 4.00% 88,878 5.00%
Tangible capital to adjusted tangible assets 144,465 8.13% 26,663 1.50% n/a n/a
Tier 1 capital to risk weighted assets 144,465 11.47% n/a n/a 75,540 6.00%
As of December 31, 2000
Total capital to risk weighted assets $ 151,914 12.23% $ 99,407 8.00% $ 124,259 10.00%
Core capital to adjusted tangible assets 140,387 8.01% 70,078 4.00% 87,598 5.00%
Tangible capital to adjusted tangible assets 140,387 8.01% 26,279 1.50% n/a n/a
Tier 1 capital to risk weighted assets 140,387 11.30% n/a n/a 74,555 6.00%
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
CAPITAL RESOURCES AND LIQUIDITY
Hawthorne Financial Corporation maintained cash and cash equivalents of
$1.45 million at March 31, 2001. Hawthorne Financial Corporation is a holding
company with no significant business operations outside of the Bank. From time
to time, the Company is dependent upon the Bank for dividends in order to make
future semi-annual interest payments. The ability of the Bank to provide
dividends to Hawthorne Financial Corporation is governed by applicable
regulations of the OTS. The Bank received OTS approval to declare a dividend to
the Holding Company in an amount needed to pay the 2001 interest payments on the
1997 12.50% Senior Notes. Based upon these applicable 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 for the payment of interest on the Company's
1997 12.50% Senior Notes for the foreseeable future. In April 2001, the Company
authorized the repurchase of approximately 77,000 shares of its common stock.
This was in addition to the two 5% repurchase authorizations announced in March
2000 and July 2000, which authorized an aggregate of approximately 541,000
shares. As of May 11, 2001, the Company has repurchased 466,513 shares at an
average price of $10.36.
OTS regulations require a savings association to maintain an average
daily balance of liquid assets (including cash, certain time deposits and
savings accounts, bankers' acceptances, certain government obligations, and
certain other investments) in each calendar quarter of not less than 4% of
either (1) its liquidity base (consisting of certain net withdrawable accounts
plus short term borrowings) as of the end of the preceding calendar quarter, or
(2) the average daily balance of its liquidity base during the preceding
quarter. This liquidity requirement may be changed from time to time by the OTS
to any amount between 4.0% to 10.0%, depending upon certain factors, including
economic conditions and savings flows of all savings associations. The Bank
maintains liquid assets in compliance with these regulations. Monetary penalties
may be imposed upon an institution for violations of liquidity requirements. On
March 14, 2001, the OTS issued an interim final rule that eliminates the 4%
liquidity requirement and replaced it with a general requirement that thrifts
maintain sufficient liquidity to ensure safety and soundness.
24
27
The Company's primary funding resources are deposits, principal payments
on loans, FHLB advances and cash flows from operations. Other possible sources
of liquidity available to the Company include whole loan sales, commercial bank
lines of credit, and direct access, under certain conditions, to borrowings from
the Federal Reserve System. The cash needs of the Company are principally for
the payment of interest on, and withdrawals of, deposit accounts, the funding of
loans and operating costs and expenses.
INTEREST RATE RISK MANAGEMENT
Interest rate risk ("IRR") and credit risk constitute the two greatest
sources of financial exposure for insured financial institutions. IRR represents
the impact that changes in absolute and relative levels of market interest rates
may have upon the Company's net interest income ("NII") and theoretical
liquidation value, also referred to as net portfolio value ("NPV"). NPV is
defined as the present value of expected net cash flows from existing assets
minus the present value of expected net cash flows from existing liabilities.
Changes in the NII (the net interest spread between interest-earning assets and
interest-bearing liabilities) are influenced to a significant degree by the
repricing characteristics of assets and liabilities (timing risk), the
relationship between various rates (basis risk), and changes in the shape of the
yield curve.
The Company utilizes two methods for measuring interest rate risk, gap
analysis and interest rate simulations. Gap analysis focuses on measuring
absolute dollar amounts subject to repricing within certain periods of time,
particularly the one year maturity horizon. Interest rate simulations are
produced using a software model that is based on actual cash flows and repricing
characteristics for all of the Company's financial instruments and incorporates
market-based assumptions regarding the impact of changing interest rates on
current volumes of applicable financial instruments. These assumptions are
inherently uncertain, and, consequently, the model cannot precisely measure net
interest income or precisely predict the impact of changes in interest rates on
net interest income. Actual results will differ from simulated results due to
timing, magnitude and frequency of interest rate changes, as well as changes in
market conditions and management strategies. See "Item 3, Quantitative and
Qualitative Disclosure about Market Risks."
Interest rate simulations provide the Company with an estimate of both
the dollar amount and percentage change in NII under various rate scenarios. All
assets and liabilities are subjected to tests of up to 300 basis points in
increases and decreases in interest rates in 100 basis point increments. 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 in dealing with the tolerance thresholds.
The Company's Asset/Liability Committee ("ALCO") is responsible for
managing the Company's assets and liabilities in a manner that balances
profitability, IRR and various other risks including liquidity. ALCO operates
under policies and within risk limits prescribed by, reviewed and approved by
the Board of Directors.
ALCO seeks to stabilize the Company's NII and NPV by matching its
rate-sensitive assets and liabilities through 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 time periods, the NII generally will be
negatively impacted by increasing rates and positively impacted by decreasing
rates. Conversely, when the amount of rate-sensitive assets exceeds the amount
of rate-sensitive liabilities within specified time periods, net interest income
will generally be positively impacted by increasing rates and negatively
impacted by decreasing rates. The speed and velocity of the repricing of assets
and liabilities will also contribute to the effects on the Company's NII and
NPV, as will the presence or absence of periodic and lifetime interest rate caps
and floors.
25
28
The following table sets forth information concerning repricing
opportunities for the Company's interest-earning assets and interest-bearing
liabilities as of March 31, 2001. The amount of assets and liabilities shown
within a particular period were determined in accordance with their 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 their
maturity or repricing date.
MARCH 31, 2001
------------------------------------------------------------------------------
OVER THREE OVER SIX OVER ONE
THREE THROUGH THROUGH YEAR OVER
MONTHS SIX TWELVE THROUGH FIVE
(DOLLARS IN THOUSANDS) OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL
---------- ---------- ---------- ---------- ---------- ----------
Interest-earning assets:
Cash and cash equivalents(1) $ 92,194 $ -- $ -- $ -- $ -- $ 92,194
Investments and FHLB stock 21,068 -- -- -- -- 21,068
Loans receivable(2) 1,077,841 408,059 36,524 14,026 116,764 1,653,214
---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning assets $1,191,103 $ 408,059 $ 36,524 $ 14,026 $ 116,764 $1,766,476
========== ========== ========== ========== ========== ==========
Interest-bearing liabilities:
Deposits:
Non-certificates of deposit $ 298,660 $ -- $ -- $ -- $ -- $ 298,660
Certificates of deposit 250,377 273,546 346,151 34,337 -- 904,411
FHLB advances 155,000 49,000 25,000 155,000 -- 384,000
Senior notes -- -- -- 30,628 -- 30,628
Capital securities -- -- -- -- 9,000 9,000
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities $ 704,037 $ 322,546 $ 371,151 $ 219,965 $ 9,000 $1,626,699
========== ========== ========== ========== ========== ==========
Interest rate sensitivity gap $ 487,066 $ 85,513 $ (334,627) $ (205,939) $ 107,764 $ 139,777
Cumulative interest rate
sensitivity gap 487,066 572,579 237,952 32,013 139,777 139,777
As a percentage of total
interest-earning assets 27.57% 32.41% 13.47% 1.81% 7.91% 7.91%
- ------------
(1) Excludes noninterest-earning cash balances.
(2) Includes $25.2 million of nonaccrual loans, and are gross of deferred
fees and costs and allowance for estimated credit losses.
26
29
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 or decrease 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.
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 is considered 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 March 31, 2001, based on the Company's internally generated model, it
was estimated that the Company's NPV ratio was 8.86% in the event of a 200 basis
point increase in rates, a decrease of 8.09% from basecase of 9.64%. If rates
were to decrease by 200 basis points, the Company's NPV ratio was estimated at
9.53%, a decrease of 1.14% from basecase.
Presented below, as of March 31, 2001, 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 CHANGE FROM
(DOLLARS IN THOUSANDS) IN RATES $ AMOUNT BASECASE RATIO BASECASE
-------- --------- ------------- ----- -----------
+300 bp $ 140,481 (34,405) 7.97% -167 bp
+200 bp 158,061 (16,825) 8.86% -78 bp
+100 bp 162,765 (12,121) 9.05% -59 bp
0 bp 174,886 9.64%
-100 bp 169,793 (5,093) 9.27% -37 bp
-200 bp 176,972 2,086 9.53% -11 bp
-300 bp 181,950 7,064 9.68% +4 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 normally 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. Through the inclusion of more specific
information regarding the Company's loan portfolio, the internal model reflects
greater sensitivity in both an increasing and a declining rate environment.
27
30
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In April 2001, the Superior Court of the State of California, County of
Los Angeles granted Plaintiff's motion to reinstate a construction defect case
entitled Stone Water Terrace HOA v. Hawthorne Savings and Loan Association, in
which the Bank was named as a defendant. The case had previously been dismissed
because the Plaintiff failed to take certain actions to prosecute its case. In
this action, the Plaintiff alleges, under several theories of recovery, that the
Bank is responsible for construction defects in a multi-unit condominium
complex. The Bank initially provided construction loans to the developer, but
took over the completion of a portion of the project after the developer
defaulted. Plaintiff seeks damages in an unspecified amount, plus punitive
damages. The Bank denies the allegations in the complaint. Although the Bank
intends to vigorously defend its position in these actions and to seek
indemnification from the responsible parties, there can be no assurances that
the Company will prevail. Discovery has not yet commenced, and the Bank is not
in a position to estimate the extent of any liability. In addition, the inherent
uncertainty of jury or judicial verdicts make it impossible to determine the
Company's potential exposure in this action. Nevertheless, it is likely that the
Bank will incur substantial legal fees defending this matter.
There have been no material developments in the case entitled Marine
Village Townhomes HOA v. Hawthorne Savings and Loan Association from what was
discussed in the Annual Report on Form 10-K for the year ended December 31,
2000. The Company is involved in a variety of other litigation in the ordinary
course of its business, including those discussed in the Annual Report on Form
10-K for the year ended December 31, 2000. Management does not presently believe
that any of the existing routine litigation is likely to have a material adverse
impact on the Company's financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Reports on Form 8-K
No current reports on Form 8-K were filed for the three months
ended March 31, 2001
28
31
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HAWTHORNE FINANCIAL CORPORATION
Dated May 15, 2001 /s/ SIMONE LAGOMARSINO
-------------------------------------
Simone Lagomarsino
President and Chief Executive Officer
Dated May 15, 2001 /s/ KAREN C. ABAJIAN
-------------------------------------
Karen C. Abajian
Executive Vice President and
Chief Financial Officer
29