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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number: 0-1100

Hawthorne Financial Corporation

Registrant’s telephone number, including area code: (310) 725-5000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

     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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.     o

      As of June 28, 2002 (the last business day of the most recently completed second fiscal quarter), the aggregate market value of voting and non-voting stock held by nonaffiliates of the registrant was approximately $174,107,784 (based upon the last reported sales price of the Common Stock as reported by the Nasdaq National Market). Shares of Common Stock held by each executive officer, director, and shareholders with beneficial ownership of greater than 10% of the outstanding Common Stock of the registrant and persons or entities known to the registrant to be affiliates of the foregoing have been excluded in that such persons may be deemed to be affiliates. This assumption regarding affiliate status is not necessarily a conclusive determination for other purposes.

      Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Act.     Yes þ          No o

      The number of shares of Common Stock, par value $0.01 per share, of the Registrant outstanding as of March 21, 2003 was 7,671,715 shares.

DOCUMENTS INCORPORATED BY REFERENCE

      Part III of this Annual Report incorporates by reference portions of the Proxy Statement to be filed with the Securities and Exchange Commission in connection with the Registrant’s 2003 Annual Meeting of Stockholders.

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HAWTHORNE FINANCIAL CORPORATION

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CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

      When used in this Form 10-K or future filings by Hawthorne Financial Corporation (“Company”) with the Securities and Exchange Commission (“SEC”), 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. Also, the Company wishes to advise readers that various risks and uncertainties could affect the Company’s financial performance and cause actual results for future periods to differ materially from those anticipated or projected. Specifically, the Company cautions readers that the following important factors could affect the Company’s business and cause actual results to differ materially from those expressed in any forward-looking statement made by, or on behalf of, the Company:

	•	Economic Conditions. The Company’s results are strongly influenced by general economic conditions in its market area. The Company operates in the coastal counties of Southern California. Accordingly, deterioration in the economic conditions in these counties could have a material adverse impact on the quality of the Company’s loan portfolio and the demand for its products and services. In particular, changes in economic conditions in the real estate industry or real estate values in the Company’s market may affect its borrowers’ ability to perform, and necessitate further provisions for potential loan losses.
	•	Interest Rate Risk. The Company realizes income principally from the differential or spread between the interest earned on loans, investments, and other interest earning assets, and the interest paid on deposits and borrowings. The volumes and yields on loans, investments, deposits, and borrowings are affected by market interest rates.
		Changes in the market level of interest rates directly and immediately affect the Company’s interest spread, and therefore profitability. Sharp and significant changes to market rates can cause the interest spread to shrink in the near term, principally because of the timing differences between the adjustable rate loans and the maturities (and therefore repricing) of the deposits and borrowings.
		Sharp decreases in interest rates have historically resulted in increased loan refinancings to fixed rate products. Due to the fact that the Bank is a variable rate lender and offers fixed rate products on a limited basis, this interest rate environment could continue to negatively impact the Company’s ability to grow the balance sheet and leverage off of the existing expense base. This could impede the Company’s ability to improve the overall efficiency ratio.
	•	Government Regulation And Monetary Policy. All forward-looking statements presume a continuation of the existing regulatory environment and United States’ government monetary policies. The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeals of, existing laws may cause results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, primarily through open market operations in United States government securities, the discount rate for member bank borrowings and bank reserve requirements, and a material change in these conditions has had and is likely to continue to have a material impact on the Company’s results.
	•	Risks Associated with Litigation. We are, and have been involved, from time to time, in various claims, complaints, proceedings and litigation relating to activities arising from the normal course of our operations, including those discussed herein. Further, our business is primarily conducted in California, which is one of the most highly litigious states in the country. If new facts are developed that would change our current assessment of the litigation matters that we are currently involved in, or

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		if we become subject to significant new litigation, we may incur legal and related costs that could affect our results.
	•	Competition. The financial services business in the Company’s market areas is highly competitive, and is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers. The Company faces competition both in attracting deposits and in making loans. The Company competes for loans principally through the interest rates and loan fees we charge and the efficiency and quality of services we provide. Increasing levels of competition in the banking and financial services businesses may reduce the Company’s market share, cause the interest rates and fees we charge for the Company’s loans and deposit products to fall or impact the Company’s ability to retain loans and/or deposits. This may in turn affect the Company’s net interest income, net interest margin, noninterest income and the Company’s results of operations.
	•	Credit Quality. A significant source of risk arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Company has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying its credit portfolio, but such policies and procedures may not prevent unexpected losses that could materially adversely affect the Company’s results.
	•	Other Initiatives. The Company is continually in the process of evaluating and implementing strategic initiatives designed to enhance its franchise value. The Company’s business performance is highly dependent on successfully executing these initiatives and the Company’s strategic plan. There are no guarantees regarding the Company’s success in implementing these initiatives, or in anticipating changes in the economy and taking advantage of opportunities or fully avoiding risks.
	•	Investment Securities. The securities in the Bank’s investment portfolio (primarily Mortgage Backed Securities) are classified as “available-for-sale.” Changes in the fair value of the investment portfolio result from numerous and often uncontrollable events such as changes in interest rates, prepayment speeds, market perception of risk in the economy and other factors. To the extent that the Bank continues to have both the ability and intent to hold these securities for yield enhancement, changes in the fair value will be included as a component of stockholders’ equity. If the decline in fair value, if any, is deemed to be “other than temporary,” it will be treated as a “permanent impairment” and reflected in earnings. The Bank’s investment securities portfolio is also subject to interest rate risk. Fluctuations in interest rates may cause actual prepayments to vary from the estimated prepayments over the life of the security. This may result in adjustments to the amortization of premiums or accretion of discounts related to these instruments, consequently changing the net yield on such securities. Reinvestment risk is also associated with the cash flows from such securities.
	•	Amortization of Intangible Assets/ Impairment of Goodwill. The Company acquired First Fidelity Bancorp, Inc. on August 23, 2002, and as a result recorded an intangible assets of $1.5 million and $23.0 million for goodwill. See “Business Combinations, Goodwill and Acquired Intangible Assets.” The Company is required to assess goodwill and other intangible assets annually for impairment, or more frequently if impairment indicators arise. If it were deemed that an impairment occurred, the Company would be required to take a charge against earnings to write down the assets.
	•	Other Risks. From time to time, the Company details other risks with respect to its business and/or financial results in press releases and filings with the SEC. Stockholders are urged to review the risks described in such releases and filings.

      The risks highlighted herein should not be assumed to be the only factors 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 that 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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PART I

General

      Hawthorne Financial Corporation (“Hawthorne Financial” or “Company”), a Delaware corporation organized in 1959, is a savings and loan holding company that owns 100% of the stock of Hawthorne Savings, F.S.B. (“Hawthorne Savings” or “Bank”). Hawthorne Savings was incorporated in 1950 and commenced operations on May 11, 1951. The Bank owns 100% of HS Financial Services Corporation (“HSFSC”), a subsidiary of Hawthorne Savings. The Company also owns 100% of HFC Capital Trust I, HFC Capital Trust II, HFC Capital Trust III and HFC Capital Trust IV, which are statutory business trusts and wholly owned subsidiaries of the Company.

      The Bank specializes in real estate secured loans throughout the coastal counties of Southern California, which are funded predominately with retail deposits and advances from the Federal Home Loan Bank of San Francisco (“FHLB”). As of March 28, 2003, the Bank operates thirteen full service retail offices located in the coastal counties of Southern California. The Bank concentrates on providing superior customer service as it continues to enhance the products and services offered to its retail customers. In August 2002, the Company successfully completed the acquisition of First Fidelity Bancorp, Inc. (“First Fidelity”).

      Hawthorne Savings is a federally chartered stock savings bank (referred to in applicable statutes and regulations as a “savings association”) incorporated and licensed under the laws of the United States. The Bank is a member of the Federal Home Loan Bank of San Francisco (“FHLB”), which is a member bank of the Federal Home Loan Bank System. The Savings Association Insurance Fund (“SAIF”), which is a separate insurance fund administered by the Federal Deposit Insurance Corporation (“FDIC”), insures the Bank’s deposit accounts up to the $100,000 maximum amount currently allowable under federal laws. The Bank is subject to examination and regulation by the Office of Thrift Supervision (“OTS”) and the FDIC. Hawthorne Savings is further subject to regulations by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) concerning reserves required to be maintained against deposits and certain other matters.

      HSFSC is a California corporation that was incorporated on April 11, 2002, and is a wholly-owned subsidiary of Hawthorne Savings, F.S.B. HSFSC, which commenced operations in July 2002, offers uninsured investments to its customers and engages in limited insurance agent activities. HSFSC is a licensed life insurance agent for the purpose of receiving commissions on the sale of fixed rate annuities. Licensed representatives of HSFSC sell mutual funds and variable rate annuities in the Bank’s offices through a licensed third party vendor, Duerr Financial Services, a registered broker-dealer. Income to date from this subsidiary has been insignificant.

      The Bank’s website address is www.hawthornesavings.com. We make available free of charge on the Bank’s website the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and the Company’s press releases, as soon as reasonably practicable after such reports are filed with the SEC. None of the information on, or hyperlinked from the Bank’s website, is incorporated into this Annual Report on Form 10-K.

      The Company’s only operating segment is the Bank, which is headquartered in El Segundo, California. The Bank offers a variety of consumer banking products through its network of retail branches, which includes the traditional range of checking and savings accounts, money market accounts and certificates of deposit. The Bank currently has thirteen retail branches, seven of which are located in the South Bay region of Los Angeles

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      In connection with its principal business activities, the Company, through the Bank, generates revenues principally from the interest and fees earned on its loans, from the interest earned on its investment securities portfolio and, to a much lesser extent, the interest earned on its portfolio of overnight liquid investments. The Company’s costs, through the Bank, include primarily interest paid to depositors and to other providers of borrowed funds, including trust preferred securities at the holding company level, and general and administrative expenses.

      The Bank specializes in originating real estate secured loans, particularly in the coastal counties of Southern California, including: 1) permanent loans collateralized by single family residential property, 2) permanent loans secured by multi-family residential and commercial real estate, and 3) loans for the construction of multi-family residential, commercial and individual single family residential properties and the acquisition and development of land for the construction of such projects. In the ordinary course of business, the Bank purchases loans consistent with its current underwriting standards. See “Item 1 — Business — Statistical Financial Data — Loan Portfolio.”

      During 2002, the Bank significantly increased its investment portfolio, which primarily consists of mortgage backed securities (“MBS”) and collateralized mortgage obligations (“CMO”). The Bank funds its loans and investments predominantly with retail deposits generated through its thirteen full service retail offices and FHLB advances. Scheduled payments of loans and investment securities are a reasonably stable source of funds, while prepayments on loans and investment securities and deposit streams are subject to significant fluctuations.

      The Bank’s current loan origination activities are governed by established policies and procedures intended to mitigate the risks inherent to the types of collateral and borrowers financed by the Bank. The Bank’s strategic focus includes (1) an effective, efficient and responsive transaction execution, which is consistent with the Bank’s relatively flat organizational structure and its reliance upon relatively few, highly-skilled lending professionals (including loan officers, loan underwriters, processors and funders, in-house appraisers, and in-house legal staff), and (2) a strategy of holding in its portfolio all new loan originations. Management believes that this combination of competitive, organizational and strategic distinctions contribute to the Bank’s success in attracting new business and in its ability to receive a return believed by management to be commensurate with the inherent and transaction-specific risks assumed and value added to customers.

      The Company concentrates on marketing its services throughout the coastal counties of Southern California. The Company’s operating results and its growth prospects are directly and materially influenced by (1) the health and vibrancy of the Southern California real estate markets and the underlying economic forces which affect such markets, (2) the overall complexion of the interest rate environment, including the absolute level of market interest rates and the volatility of such interest rates, (3) the prominence of competitive forces which provide customers of the Company with alternative sources of mortgage funds or investments which compete with the Company’s products and services, and (4) regulations promulgated by authorities, including those of the OTS, the FDIC and the FRB. The Company’s success in identifying trends in each of these factors, and implementing strategies to exploit such trends, influence the Company’s long-term results and growth prospects.

      The Bank faces significant competition in California for new loans from commercial banks, savings and loan associations, credit unions, credit companies, Wall Street lending conduits, mortgage bankers, life insurance companies and pension funds. Some of the largest savings and loans and banks in the United States operate in California, and have extensive branch systems and advertising programs, which the Bank does not have. Large banks and savings and loans frequently also enjoy a lower cost of funds than the Bank and can therefore charge less than the Bank for loans. The Bank attempts to compensate for competitive pricing disadvantages that may exist by providing a higher level of personal service to borrowers and “hands on” involvement by senior officers to meet borrower’s needs.

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      The Bank competes for deposit funds with other Southern California-based financial companies, including banks, savings associations, credit unions and thrift and loans. These companies generally compete with one another based upon price, convenience and service. Though many of the Bank’s competitors offer customers a larger spectrum of products than the Bank, the Company, as part of its strategic plan, continues to enhance the line of products and services offered to retail customers. The Bank’s cross-sell ratio (deposit and loan products per household) was 2.44 at December 31, 2002, compared with 2.37 at December 31, 2001. The higher the cross-sell ratio, the more likely the customer is to stay with the Bank, which management believes increases the Bank’s franchise value.

Supervision and Regulation

      Savings and loan holding companies and savings associations are extensively regulated under both federal and state laws. This regulation is intended primarily for the protection of depositors and the SAIF and not for the benefit of stockholders of the Company. The following information describes certain aspects of that regulation applicable to the Company and the Bank, and does not purport to be complete. The discussion is qualified in its entirety by reference to all particular statutory or regulatory provisions.

      General. The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its subsidiaries, which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.

      The Company’s securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, the Company is subject to the information, proxy solicitation, insider trading, corporate governance, and other requirements and restrictions of the Exchange Act.

      Activities Restriction Test. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions, provided the Bank satisfies the Qualified Thrift Lender (“QTL”) test or meets the definition of domestic building and loan association pursuant to the Internal Revenue Code of 1986, as amended (the “Code”). The Company presently intends to continue to operate as a unitary thrift savings and loan holding company. Recent legislation terminated the “unitary thrift holding company exemption” for all companies that apply to acquire savings associations after May 4, 1999. Since the Company is grandfathered, its unitary thrift holding company powers and authorities were not affected. See “Financial Modernization Legislation.” However, if the Company acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company. In that event, the activities of the Company and any of its subsidiaries that are not SAIF-insured savings associations could become subject to restrictions applicable to bank holding companies, unless each also qualifies as a QTL or domestic building and loan association and was acquired in a supervisory acquisition. Furthermore, if the Company was in the future to sell control of the Bank to any other company, such company would not succeed to the Company’s grandfathered status and would be subject to the same business activity restrictions. See “— Regulation of the Bank — Qualified Thrift Lender Test.”

      Restrictions on Acquisitions. The Company must obtain approval from the OTS before acquiring control of any other SAIF-insured association. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association.

      Federal law generally provides that no “person,” acting directly or indirectly or through or in concert with one or more other persons, may acquire “control,” as that term is defined in OTS regulations, of a federally

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      On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. This new legislation addresses accounting oversight and corporate governance matters, including:

	•	the creation of a five-member oversight board appointed by the Securities & Exchange Commission (“SEC”) that will set standards for accountants and have investigative and disciplinary powers;
	•	the prohibition of accounting firms from providing various types of consulting services to public clients and requiring accounting firms to rotate partners among public client assignments every five years;
	•	increased penalties for financial crimes;
	•	expanded disclosure of corporate operations and internal controls, including conflict of interest policies, and certification of financial statements;
	•	enhanced controls on and reporting of insider trading; and
	•	statutory separations between investment bankers and analysts.

      Various aspects of the new legislation are dependent on subsequent rule making by the SEC. The Company currently does not anticipate a significant impact on its operations, however, the Company continues to evaluate what the impact of the new legislation and its implementing regulations will have upon its operations, including a likely increase in certain outside professional costs.

      On October 26, 2001, President Bush signed the USA Patriot Act of 2001 (the “Patriot Act”). The Patriot Act is intended to strengthen U.S. law enforcement’s and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws in addition to current requirements, and requires various regulations, including:

	•	due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons;
	•	standards for verifying customer identification at account opening;
	•	rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering;
	•	reports by nonfinancial businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for cash transactions exceeding $10,000; and
	•	the filing of suspicious activities reports involving securities by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.

      On July 23, 2002, the Treasury Department proposed regulations requiring institutions to incorporate into their written money laundering plans, a board approved customer identification program implementing reasonable procedures for (a) verifying the identity of any person seeking to open an account, to the extent

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      The Company is not able to predict the impact of such laws on its financial condition or results of operations at this time.

      General. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act of 1999 (the “GLB”). The general effect of the law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company system to engage in a full range of financial activities through a new entity known as a “Financial Holding Company.” “Financial activities” is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

      The GLB provides that no company may acquire control of an insured savings association, unless that company engages, and continues to engage, only in the financial activities permissible for a Financial Holding Company, unless grandfathered as a unitary savings and loan holding company. The Financial Institution Modernization Act grandfathers any company that was a unitary savings and loan holding company on May 4, 1999 (or became a unitary savings and loan holding company pursuant to an application pending on that date). Such a company may continue to operate under present law as long as the company continues to meet the two tests: it can control only one savings institution, excluding supervisory acquisitions, and each such institution must meet the QTL test. A grandfathered unitary savings and loan holding company also must continue to control at least one savings association, or a successor institution, that it controlled on May 4, 1999.

      The GLB also permits national banks to engage in expanded activities through the formation of financial subsidiaries. A national bank may have a subsidiary engaged in any activity authorized for national banks directly or any financial activity, except for insurance underwriting, insurance investments, real estate investment or development, or merchant banking, which may only be conducted through a subsidiary of a Financial Holding Company. Financial activities include all activities permitted under new sections of the Bank Holding Company Act of 1956 (“BHCA”) or permitted by regulation.

      While the GLB has not had a material adverse effect on the operations of the Company and the Bank in the near-term, to the extent that the act permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. GLB is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis and which unitary savings and loan holding companies already possess. Nevertheless, this act may have the result of increasing the amount of competition that the Company and the Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and the Bank. In addition, because the Company may only be acquired by other unitary savings and loan holding companies or Financial Holding Companies, the legislation may have an anti-takeover effect by limiting the number of potential acquirors or by increasing the costs of an acquisition transaction by a bank holding company that has not made the election to be a Financial Holding Company under the new legislation.

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      Privacy. Under GLB, federal banking regulators are required to adopt rules that will limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. Pursuant to these rules, financial institutions must provide:

	•	initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates;
	•	annual notices of their privacy policies to current customers; and
	•	a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.

      These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. The Bank has implemented privacy policies in accordance with the law. Since enactment, a number of states have implemented their own versions of the privacy law, and privacy legislation is pending in California that, if enacted, would impose more stringent requirements on the Company and its subsidiaries.

      As a federally chartered, SAIF insured savings association, the Bank is subject to extensive regulation by the OTS and the FDIC. Lending activities and other investments of the Bank must comply with various statutory and regulatory requirements. The Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board.

      The OTS, in conjunction with the FDIC, regularly examines the Bank and prepares reports for the consideration of the Bank’s Board of Directors on any deficiencies found in the operations of the Bank. The relationship between the Bank and depositors and borrowers is also regulated by federal and state laws, especially in such matters as the ownership of savings accounts and the form and content of mortgage documents utilized by the Bank.

      The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with or acquisitions of other financial institutions. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the SAIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss allowance for regulatory purposes. Any change in such regulations, whether by the OTS, the FDIC, or the Congress could have a material adverse impact on the Company, the Bank, and their operations.

      Insurance of Deposit Accounts. The SAIF, as administered by the FDIC, insures the Bank’s deposit accounts up to the maximum amount permitted by law. The FDIC may terminate insurance of deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the institution’s primary regulator.

      The FDIC charges an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund. Under this system as of December 31, 2000, SAIF members pay within a range of 0 cents to 27 cents per $100 of domestic deposits, depending upon the institution’s risk classification. This risk classification is based on an institution’s capital group and supervisory subgroup assignment. In addition, all FDIC insured institutions were required to pay assessments to the FDIC at an annual rate for the fourth quarter of 2002 at approximately $0.0170 per $100 of assessable deposits to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the predecessor to the SAIF. These assessments will continue until the FICO bonds mature in 2017.

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      Proposed Legislation. From time to time, new laws are proposed that could have an effect on the financial institutions industry. For example, deposit insurance reform legislation has recently been introduced in the U.S. Senate House of Representatives that would:

	•	merge the BIF and the SAIF;
	•	increase the current deposit insurance coverage limit for insured deposits to $130,000 and index future coverage limits to inflation;
	•	increase deposit insurance coverage limits for municipal deposits;
	•	double deposit insurance coverage limits for individual retirement accounts; and
	•	replace the current fixed 1.25 designated reserve ratio with a reserve range of 1-1.5%, giving the FDIC discretion in determining a level adequate within this range.

      While we cannot predict whether such proposals will eventually become law, they could have an effect on the Bank’s operations and the way business is conducted.

      Regulatory Capital Requirements. OTS capital regulations require savings associations to meet three capital standards: (1) tangible capital equal to 1.5% of total adjusted assets, (2) leverage capital (core capital) equal to 4.0% of total adjusted assets for all but the most highly rated institutions, and (3) risk-based capital equal to 8.0% of total risk-based assets. The Bank must meet each of these standards in order to be deemed in compliance with OTS capital requirements.

      These capital requirements are viewed as minimum standards by the OTS, and most institutions are expected to maintain capital levels well above the minimum. In addition, the OTS regulations provide that minimum capital levels higher than those provided in the regulations may be established by the OTS for individual savings associations, upon a determination that the savings association’s capital is or may become inadequate in view of its circumstances. The OTS regulations provide that higher individual minimum regulatory capital requirements may be appropriate in circumstances where, among others: (1) a savings association has a high degree of exposure to interest rate risk, prepayment risk, credit risk, concentration of credit risk, certain risks arising from nontraditional activities, or similar risks or a high proportion of off-balance sheet risk; (2) a savings association is growing, either internally or through acquisitions, at such a rate that certain supervisory concerns may be presented that OTS regulations do not address; and (3) a savings association may be adversely affected by activities or the condition of its holding company, affiliates, subsidiaries, or other persons, or savings associations with which it has significant business relationships.

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      The following table reflects that the Bank’s regulatory capital exceeded all minimum regulatory capital requirements applicable to it as of December 31, 2002.

(1)	Includes unrealized (gain) on certain available-for-sale investment securities, net of taxes.
(2)	Excess capital is defined as the percentage over well capitalized under Prompt Correction Action (“PCA”) rules.
(3)	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.

      The Home Owners’ Loan Act (“HOLA”) permits savings associations not in compliance with the OTS capital standards to seek an exemption from certain penalties or sanctions for noncompliance. Such an exemption will be granted only if certain strict requirements are met, and must be denied under certain circumstances. If the OTS grants an exemption, the savings association still may be subject to enforcement actions for other violations of law or unsafe or unsound practices or conditions.

      Prompt Corrective Action. The prompt corrective action regulation of the OTS requires certain mandatory actions and authorizes certain other discretionary actions to be taken by the OTS against a savings association that falls within certain undercapitalized capital categories specified in the regulation.

      The regulation establishes five categories of capital classification: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Under the regulation, the risk-based capital, leverage capital, and tangible capital ratios are used to determine an institution’s capital classification. At December 31, 2002, the Bank met the capital requirements of a “well capitalized” institution under applicable OTS regulations.

      In general, the prompt corrective action regulation prohibits an insured depository institution from declaring any dividends, making any other capital distribution, or paying a management fee to a controlling person if, following the distribution or payment, the institution would be within any of the three undercapitalized categories. In addition, adequately capitalized institutions may accept Brokered Deposits only with a waiver from the FDIC and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew, or roll-over Brokered Deposits.

      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

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      As of December 31, 2002, 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 December 31, 2002, 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.

      Predatory Lending. The term “predatory lending,” much like the terms “safety and soundness” and “unfair and deceptive practices,” is far-reaching and covers a potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive definition. But typically predatory lending involves at least one, and perhaps all three, of the following elements:

	•	making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation (“asset-based lending”);
	•	inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (“loan flipping”); and
	•	engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower.

      On October 1, 2002, FRB regulations aimed at curbing such lending became effective. The rule significantly widens the pool of high-cost home-secured loans covered by the Home Ownership and Equity Protection Act of 1994, a federal law that requires extra disclosures and consumer protections to borrowers. The following triggers coverage under the act:

	•	interest rates for first lien mortgage loans in excess of 8 percentage points above comparable Treasury securities; and
	•	subordinate-lien loans of 10 percentage points above Treasury securities, and fees such as optional insurance and similar debt protection costs paid in connection with the credit transaction, when combined with points and fees if deemed excessive.

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      In addition, the regulation bars loan flipping by the same lender or loan servicer within a year. Lenders also will be presumed to have violated the law, which states loans should not be made to individuals unable to repay them unless the lenders document that the borrower has the ability to repay. Lenders who violate the rules face cancellation of loans and penalties equal to the finance charges paid.

      The Company does not believe that it will be impacted by these rule changes, as the Bank does not engage in predatory lending practices.

      Loans-to-One Borrower Limitations. Savings associations generally are subject to the lending limits applicable to national banks. With certain limited exceptions, the maximum amount that a savings association or a national bank may lend to any borrower (including certain related entities of the borrower) at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. Savings associations are additionally authorized to make loans to one borrower, for any purpose, in an amount not to exceed $500,000 or, by order of the Director of OTS, in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop residential housing, provided: (i) the purchase price of each single family dwelling in the development does not exceed $500,000; (ii) the savings association is in compliance with its fully phased-in capital requirements; (iii) the loans comply with applicable loan-to-value requirements, and (iv) the aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus. At December 31, 2002, the Bank’s loans-to-one-borrower limit was $30.9 million based upon the 15% of unimpaired capital and surplus measurement. At December 31, 2002, the Bank’s largest relationship consisted of one borrower with outstanding commitments of $16.8 million, which consisted of approximately 7 loans, with $15.2 million secured by income property development real estate, $1.3 million secured by multi-family real estate and $0.3 million secured by land. All of these loans were performing in accordance with their terms.

      Qualified Thrift Lender Test. Savings associations must meet a QTL test, which may be met either by maintaining a specified level of assets in qualified thrift investments as specified in HOLA or by meeting the definition of a “domestic building and loan association” in the Code. Qualified thrift investments are primarily residential mortgages and related investments, including certain mortgage-related securities. The required percentage of investments under HOLA is 65% of the Bank’s assets which the Code requires investments of 60% of the Bank’s assets. An association must be in compliance with the QTL test or the definition of domestic building and loan association on a monthly basis in nine out of every 12 months. Associations that fail to meet the QTL test will generally be prohibited from engaging in any activity not permitted for both a national bank and a savings association. As of December 31, 2002, the Bank was in compliance with its QTL requirements and met the definition of a domestic building and loan association.

      Affiliate Transactions. Transactions between a savings association and its “affiliates” are quantitatively and qualitatively restricted under the Federal Reserve Act. Affiliates of a savings association include, among other entities, the savings association’s holding company and companies that are under common control with the savings association.

      In general, a savings association or its subsidiaries are limited in their ability to engage in certain “covered transactions” with affiliates to an amount equal to 10% of the association’s capital and surplus, in the case of covered transactions with any one affiliate, and to an amount equal to 20% of such capital and surplus, in the case of covered transactions with all affiliates. In addition, a savings association and its subsidiaries may engage in covered transactions and certain other transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the savings association or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A “covered transaction” includes a loan or extension of credit to an affiliate; a purchase of investment securities issued by an affiliate; a purchase of assets from an affiliate, with certain exceptions; the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; or the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate.

      In addition, under the OTS regulations, a savings association may not make a loan or extension of credit to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies; a savings

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      The OTS regulation generally excludes all non-bank and non-savings association subsidiaries of savings associations from treatment as affiliates, except to the extent that the OTS or the Federal Reserve Board decides to treat such subsidiaries as affiliates. The regulation also requires savings associations to make and retain records that reflect affiliate transactions in reasonable detail, and provides that certain classes of savings associations may be required to give the OTS prior notice of affiliate transactions.

      Capital Distribution Limitations. OTS regulations impose limitations upon all capital distributions by savings associations, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. Under the OTS’s capital distribution limitations, a savings association in some circumstances may be required to file an application and await approval from the OTS before it makes a capital distribution, may be required to file a notice 30 days prior to the capital distribution, or may be permitted to make the capital distribution without notice or application to the OTS.

      An application is required (1) if the savings association is not eligible for expedited treatment of its other applications under OTS regulations; (2) the total amount of all capital distributions (including the proposed capital distribution) for the applicable calendar year exceeds its net income for that year to date plus retained net income for the preceding two years; (3) the savings association would not be at least adequately capitalized, under the prompt corrective action regulations of the OTS following the distribution; or (4) the savings association’s proposed capital distribution would violate a prohibition contained in any applicable statute, regulation, or agreement between the savings association and the OTS (or the FDIC), or violate a condition imposed on the savings association in an OTS-approved application or notice.

      A notice of a capital distribution is required if a savings association is not required to file an application, but: (1) would not be well capitalized under the prompt corrective action regulations of the OTS following the distribution; (2) the proposed capital distribution would reduce the amount of or retire any part of your common or preferred stock or retire any part of debt instruments such as notes or debentures included in capital (other than regular payments required under a debt instrument approved by the OTS); or (3) the savings association is a subsidiary of a savings and loan holding company.

      If neither the savings association nor the proposed capital distribution meet any of the above listed criteria, no application or notice is required for the savings association to make a capital distribution. The OTS may prohibit the proposed capital distribution that would otherwise be permitted if the OTS determines that the distribution would constitute an unsafe or unsound practice. Further, a savings association like the Bank cannot distribute regulatory capital that is needed for its liquidity.

      Activities of Subsidiaries. A savings association seeking to establish a new subsidiary, acquire control of an existing company or conduct a new activity through a subsidiary must provide 30 days prior notice to the FDIC and the OTS and conduct any activities of the subsidiary in compliance with regulations and orders of the OTS. The OTS has the power to require a savings association to divest any subsidiary or terminate any activity conducted by a subsidiary that the OTS determines to pose a serious threat to the financial safety, soundness or stability of the savings association or to be otherwise inconsistent with sound banking practices.

      Community Reinvestment Act and the Fair Lending Laws. Savings associations have a responsibility under the Community Reinvestment Act (“CRA”) and related regulations of the OTS to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act (together, the “Fair Lending Laws”) prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An

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      Effective January 1, 2002, the OTS raised the dollar amount limit in the definition of small business loans from $500,000 to $2.0 million, if used for commercial, corporate, business or agricultural purposes. Furthermore, the rule raises the aggregate level that a thrift can invest directly in community development funds, community centers and economic development initiatives in its communities from the greater of a quarter of 1% percent of total capital, or $100,000, to 1% of total capital, or $250,000.

      Federal Home Loan Bank System. The Bank is a member of the FHLB system. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available to members loans (i.e., advances) in accordance with the policies and procedures established by the Board of Directors of the individual FHLB.

      As a FHLB member, the Bank is required to own capital stock in a FHLB in an amount equal to the greater of: (i) 1% of its aggregate outstanding principal amount of its residential mortgage loans, home purchase contracts and similar obligations at the beginning of each calendar year, or (ii) 5% of its FHLB advances (borrowings). At December 31, 2002, the Bank had $34.7 million in FHLB stock, which was in compliance with this requirement.

      The GLB Act made significant reforms to the FHLB system, including:

	•	Expanded Membership — (i) expands the uses for, and types of, collateral for advances; (ii) eliminates bias toward QTL lenders; and (iii) removes capital limits on advances using real estate related collateral (e.g., commercial real estate and home equity loans).
	•	New Capital Structure — each FHLB is allowed to establish two classes of stock: Class A is redeemable within six months of notice; and Class B is redeemable within five years notice. Class B is valued at 1.5 times the value of Class A stock. Each FHLB will be required to maintain minimum capital equal to 5% of equity. Each FHLB, including the FHLB of San Francisco, submitted capital plans for review and approval by the Federal Housing Finance Board.
	•	Voluntary Membership — federally chartered savings associations, such as the Bank, are no longer required to be members of the system.
	•	REFCorp Payments — changes the amount paid by the system on debt incurred in connection with the thrift crisis in the late 1980s from a fixed amount to 20% of net earnings after deducting certain expenses.

      The new capital plan of the FHLB was approved by the Federal Housing Finance Board on June 12, 2002. The FHLB has not yet established an implementation date for the new capital plan. The Bank will receive at least 240 days’ written notice of the implementation date. The new capital plan incorporates a single class of stock and requires each member to own stock in amount equal to the greater of a membership stock requirement, or an activity based stock requirement. The new capital stock is redeemable on five years’ written notice, subject to certain conditions.

      Management does not believe that the initial implementation of the FHLB new capital plan as approved will have a material impact upon the Company’s financial condition, cash flows, or results of operations. However, the Bank could be required to purchase as much as 50% additional capital stock or sell as much as 50% of its proposed capital stock requirement at the discretion of the FHLB.

      Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain a noninterest bearing allowance at specified levels against their transaction accounts (primarily checking,

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      The OTS and the other federal banking agencies have jointly adopted uniform rules on real estate lending and related Interagency Guidelines for Real Estate Lending Policies. The uniform rules require that associations adopt and maintain comprehensive written policies for real estate lending. The policies must reflect consideration of the Interagency Guidelines and must address relevant lending procedures, such as loan-to-value limitations, loan administration procedures, portfolio diversification standards and documentation, approval and reporting requirements. Although the final rule did not impose specific maximum loan-to-value ratios, the related Interagency Guidelines state that such ratio limits established by an individual association’s board of directors should not exceed levels set forth in the Guidelines, which range from a maximum of 65% for loans secured by raw land to 85% for improved property. No limit is set for single family residence loans, but the guideline states that such loans exceeding a 95% loan-to-value ratio should have private mortgage insurance or some other form of credit enhancement. The Guidelines further permit a limited amount of loans that do not conform to these criteria.

      HSFSC is also subject to regulation by the OTS and other applicable federal and state agencies, including the California Department of Insurance. HSFSC offers securities through an unaffiliated brokerage, which is regulated by the SEC, the National Association of Securities Dealers, Inc. and state securities regulators.

Employees

      The Company employed 357 full time equivalent employees at December 31, 2002. A union or collective bargaining group does not represent employees and the Company considers its employee relations to be satisfactory.

Statistical Financial Data

      The Bank’s loan portfolio is almost exclusively secured by real estate, concentrated primarily in the coastal counties of Southern California. The Bank’s principal lending activities consist of single family residential, single family construction and income property lending. At December 31, 2002, approximately $1.2 billion, or 91.28% of the Bank’s total loan portfolio was tied to adjustable rate indices, such as MTA, LIBOR, Prime, COFI and CMT. The Bank’s portfolio of adjustable rate loans includes approximately $287.7 million of loans with an initial fixed rate term of three to five years prior to transitioning to a semi-annual adjustable rate loan (“hybrid ARMs”). The net loan portfolio grew from $1.7 billion at December 31, 2001, to $2.1 billion at December 31, 2002, which was primarily due to the acquisition of First Fidelity.

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      The table below sets forth the composition of the Bank’s loan portfolio as of the dates indicated.

(1)	Predominantly term loans secured by improved properties, with respect to which the properties’ cash flows are sufficient to service the Bank’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 Bank 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.

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		The table below sets forth the Bank’s average loan size by loan portfolio composition.

      The table below sets forth the Bank’s loan portfolio diversification by size.

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      The table below sets forth the Bank’s net loan portfolio composition, excluding net deferred fees and costs, as of the dates indicated.

      The Bank offers first mortgage loans secured by single family (one-to-four unit) residential (“SFR”) properties located in the Bank’s principal lending area of the coastal counties of Southern California. The Bank originates single family residential loans principally through contact with, and submissions by, approved independent mortgage brokers. The Bank pays a fee, generally ranging from 0.5% to 1.0% of the loan amount, to these mortgage brokers in connection with such loan fundings. The Bank offers primarily adjustable rate mortgage loan products with interest rates that adjust monthly or semi-annually, after an initial introductory period. These loans generally provide for a prepayment penalty of six months interest for the first one to three years after origination. These adjustable rate products generally provide for floors and overall caps on the increase or decrease in interest rates at an adjustment date and over the term of the loan. A portion of the Bank’s adjustable rate mortgage loans have introductory terms below the fully indexed rates. In underwriting these loans, the Bank qualifies the borrowers based upon the fully indexed rate.

      At December 31, 2002, $854.2 million, or 38.32% of the total gross loan portfolio was secured by single-family residential properties (89.82% secured by owner-occupied properties), compared with $918.9 million, or 49.12% of the total gross loan portfolio at December 31, 2001.

      The Bank generally originates SFR loans in amounts of 75% of the appraised value, or the selling price of the property securing the loan, whichever is lower.

      The Bank originates loans secured by multi-family properties and commercial properties, such as office buildings, retail properties, industrial properties and various special purpose properties principally through contact with, and submissions by, approved independent mortgage brokers. The Bank pays a rebate, generally ranging from 0.10% to 1.0% of the loan amount, to these mortgage brokers in connection with such loan fundings. Additionally, in the ordinary course of business, the Bank purchases income property loans consistent with its current underwriting standards.

      The Bank offers primarily adjustable rate loan products and also offers a 3 to 5 year fixed rate loan product that is fixed for the initial period and adjusted semi-annually thereafter. These adjustable rate products generally provide for floors and overall caps on the increase or decrease in interest rates at an adjustment date and over the term of the loan. These loans generally provide for prepayment penalties

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      The Bank typically originates multi-family loans in amounts of 75% of the appraised value of the underlying property. Maturities on these loans are typically 15 years with a 30 year amortization period; however, on a limited basis, on newer properties the Bank may make loans with maturities up to 30 years. In addition, the Bank generally requires a debt coverage ratio of at least 120% on multi-family loans.

      The Bank generally originates adjustable rate commercial loans in amounts up to 75% of the appraised value of the property. Maturities on commercial loans are typically 10 years with a 25 year amortization period; however, the Bank may make loans with maturities up to 15 years. The Bank typically requires a debt coverage ratio of at least 125% on commercial loans.

      Commercial real estate loans are generally larger and involve a greater degree of risk than SFR loans. Since payments on loans secured by commercial properties are frequently reliant upon successful operation of such properties, repayment of these loans may be significantly affected by conditions in the real estate market or the economy. The Bank mitigates these risks through its underwriting standards, which includes assessment of the repayment ability of the property as well as the borrower.

      During 2002, the Bank continued to emphasize its strategic niche as a provider of bridge loans to both apartment owners and income property investors. The Bank’s experienced construction management group closely manages this more complex niche, while providing a valuable source of funding to investors who want to renovate and/or upgrade their properties. These loans are generally originated in amounts up to 75% of the appraised value of the property, as stabilized. These loans generally have terms of eighteen to twenty-four months and include extension options, subject to the Bank’s approval. There are generally no prepayment penalties associated with these loans.

      The Bank provides financing for individual home construction primarily to local builders and, to a lesser extent, homeowners. These loans are generated through the Bank’s standing relationships with local builders/developers and approved independent mortgage brokers. These brokers are paid a fee ranging from 0.5% to 1.0% of the loan amount in connection with certain loan fundings. These loans are adjustable, have maturities of 1 to 2 years and typically include extension options of up to six months, subject to the Bank’s evaluation and approval.

      The Bank’s loan commitments generally include provisions for a portion of the cost of the acquired land and all of the costs of construction (including financing costs). Generally, the Bank’s loan commitments cover approximately 80.0% of the total costs of construction (including the cost of land acquisition, the cost to construct the planned improvements and financing costs), with the borrower providing the remainder of the funds required at the date the Bank records its financing commitment. Loan proceeds are disbursed as construction progresses and satisfactory inspections are completed. The Bank’s inspectors generally visit projects on a monthly basis to assess the progress of construction.

      Land loans are originated with the intent to convert the loan into a construction loan and are underwritten on an individual basis, but typically do not exceed 65% of the lesser of the actual cost or appraised value. In evaluating the feasibility of originating a land loan, the Bank considers the anticipated use of the land, such as the location and the market environment, as well as the repayment ability of the borrower and/or guarantor(s), as applicable. These loans generally have terms of twelve months and include extension options, subject to the Bank’s approval.

      Financing construction loans typically involve a greater degree of credit risk than long term financing on improved owner occupied property. The Bank’s ability to mitigate the risk of loss is primarily dependent upon the accuracy of the initial estimate of the property value upon completion of development or construction compared to the estimated cost of the project. If this was inaccurate, the Bank may be confronted with a

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      In the past, the Bank provided financing to small-to-medium-sized developers of residential subdivisions located throughout Southern California. Generally, the Bank’s tract loans financed land acquisition, site development and home construction. At December 31, 2002 and December 31, 2001, there were no tract loans. The decrease in tract loans reflects the Bank’s decision to cease the origination of such loans for its portfolio, which was announced during the fourth quarter of 1998.

      During 2001, the Bank launched an overdraft protection program for its checking account customers. At December 31, 2002, and December 31, 2001, the outstanding overdraft protection lines totaled $0.7 million and $0.4 million, respectively.

New Business Generation

      The Bank extends credit pursuant to its lending policies; some of the areas covered by the lending policies include loan applications, borrower financial information, and underwriting standards. Appraisal of real property is either performed internally or delegated to an independent appraiser, in which case, the independent appraisal is reviewed by the Bank. Legal documents are prepared or reviewed by the Bank’s in-house legal staff or assigned to outside attorneys.

      The following table sets forth the approximate composition of the Bank’s new real estate loan commitments, net of internal refinances, for the periods indicated, in dollars and as a percentage of total loans originated.