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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER: 0-1100
HAWTHORNE FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-2085671
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2381 ROSECRANS AVENUE, 2ND FLOOR 90245
EL SEGUNDO, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(TITLE OF CLASS)
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 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. [ ]
As of March 23, 2001, the aggregate market value of voting stock held by
nonaffiliates of the registrant was approximately $74,292,094 (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.
The number of shares of Common Stock, par value $0.01 per share, of the
Registrant outstanding as of March 23, 2001 was 5,178,788 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 2001 Annual Meeting of Stockholders.
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HAWTHORNE FINANCIAL CORPORATION
ANNUAL REPORT ON FORM 10-K
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 26
Item 3. Legal Proceedings........................................... 27
Item 4. Submission of Matters to a Vote of Security Holders......... 28
Item 4A. Executive Officers.......................................... 28
PART II
Market for Registrant's Common Equity and Related
Item 5. Stockholder Matters......................................... 30
Item 6. Selected Financial Data..................................... 31
Management's Discussion and Analysis of Financial Condition
Item 7. and Results of Operations................................... 33
Quantitative and Qualitative Disclosure about Market
Item 7A. Risks....................................................... 46
Item 8. Financial Statements and Supplementary Data................. 47
Changes in and Disagreements with Accountants on Accounting
Item 9. and Financial Disclosure.................................... 47
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 48
Item 11. Executive Compensation...................................... 48
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................. 48
Item 13. Certain Relationships and Related Transactions.............. 48
PART IV
Exhibits, Financial Statement Schedules and Reports on Form
Item 14. 8-K......................................................... 48
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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. Accordingly,
deterioration in these conditions 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 may affect its performance.
- 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, deposits, and borrowings are
affected by market interest rates. As of December 31, 2000, 89.45% of the
Company's net loan portfolio was tied to adjustable rate indices such as
Prime Rate, 11th district cost of funds (COFI), MTA, CMT and LIBOR. The
majority of the Company's deposits are time deposits with a stated
maturity (generally one year or less) and a fixed rate of interest. The
borrowings from the FHLB also carry a fixed interest rate for a term of
up to 10 years, although the weighted average maturity of the borrowings
as of December 31, 2000, was four years and two months.
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 or expense significantly 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. The Bank offers fixed rate
products on a limited basis.
- 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.
- Competition. The Company competes with numerous other domestic and
foreign financial institutions and non depository financial
intermediaries. The Company's results may differ if circumstances
affecting the nature or level of competition change, such as the merger
of competing financial institutions or the acquisition of California
institutions by out-of-state companies.
- 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
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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 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 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 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
ITEM 1. BUSINESS
GENERAL
ORGANIZATION
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. As of March 30, 2001, the Bank's eight full service retail offices
located in Southern California included the Hermosa Beach branch, which opened
in January 2001.
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").
HAWTHORNE SAVINGS
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 of the Board of
Governors of the Federal Reserve System ("Federal Reserve Board" or "FRB")
concerning reserves required to be maintained against deposits and certain other
matters.
GENERAL
The Company's only operating segment is the Bank. The Bank offers a variety
of consumer banking products through its network of eight retail branches, which
includes the traditional range of checking and savings accounts, money market
accounts and certificates of deposit. The Bank's primary target market is the
South Bay region of Southern California, where it currently ranks seventh in
terms of deposit market share based on branch information provided to the FDIC
as of June 30, 2000. The Bank also has branches in the San Fernando Valley and
Westlake Village areas of Los Angeles County.
In connection with its principal business activities, the Company generates
revenues from the interest and fees charged to customers and, to a much lesser
extent, the interest earned on its portfolio of overnight liquid investments.
The Company's costs include primarily interest paid to depositors and to other
providers of borrowed funds, general and administrative expenses and other
operating expenses.
The Company's lending activities include single family residential,
multi-family residential and commercial real estate loans for the construction
of single family residential homes, and the acquisition and development of land
for the construction of such homes. See "Item 1 -- Business -- Statistical
Financial Data -- Loan Portfolio." The Company also offers consumer loans on a
referral fee basis through an unaffiliated financial institution. The Company
funds its loans predominately with its retail deposits and, to a lesser extent,
with advances from the FHLB. See "Item 1 -- Business -- Statistical Financial
Data -- Sources of Funds."
The Company's current loan origination activities are governed by
established policies and procedures appropriate to the risks inherent to the
types of collateral and borrowers financed by the Company. The
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Company's primary competitive advantages, which include (1) a willingness and
competence to tailor the terms and conditions of individual transactions to
accommodate both the borrower's and the Company's transaction-specific
objectives, (2) a strategy of holding in portfolio virtually all new loan
originations, and (3) highly effective, efficient and responsive transaction
execution, are consistent with the Company'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). Management believes
that this combination of competitive, organizational and strategic distinctions
contribute to the Company'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.
MARKET AREA AND COMPETITION
The Company concentrates on marketing its services throughout 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, significantly
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 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 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. Due to intense competition within the lending area, the
Company has experienced a decline in the yield within its commercial real estate
lending portfolio over the last several years.
Generally, the Company competes for deposit funds with other Southern
California-based financial companies, including banks, savings associations and
thrift and loans. These companies generally compete with one another based upon
price, convenience and service. Many of the Bank's competitors offer a greater
array of products to customers than the Bank. For example, the Bank does not
currently offer internet banking, and thus has a competitive disadvantage to
other commercial banks and savings associations in attracting depositors. As
part of the Company's strategic plan, the Bank has targeted implementation of
internet banking in 2001. The Bank attempts to compensate for the lack of a full
array of services in its branches by providing superior personal service and
enhancing our current product line. The Company will continue to focus on
expansion of the products and services we offer our retail customers during
2001.
Because the Company does not have a critical mass of retail banking
facilities, and because its smaller size does not afford it the economies of
scale to advertise its basic products to the extent of its principal
competitors, the Company primarily competes on service and convenience. The
average tenure of all households with the Bank is approximately five years. The
Company solicits deposits from the public throughout its service area and
attained a cross-sell ratio (products per household) of 1.51 at December 31,
2000, compared to 1.32 at December 31, 1999.
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SUPERVISION AND REGULATION
GENERAL
Savings and loan holding companies and savings associations are extensively
regulated under both federal and state law. 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.
REGULATION OF THE COMPANY
General. The Company is a unitary thrift 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.
Activities Restriction Test. As a unitary thrift 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 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, and the activities of
the Company and any of its subsidiaries (other than the Bank or any other SAIF
insured savings association) would become subject to restrictions applicable to
bank holding companies unless such other associations each also qualify as a QTL
or domestic building and loan association and were acquired in a supervisory
acquisition. Furthermore, if the Company were in the future to sell control of
the Bank to any other company, such company would not succeed to the Company
grandfathered status and would be subject to the same business activity
restrictions. See "-- Regulation of the Bank -- Qualified Thrift Lender Test."
On October 27, 2000 the OTS issued a proposed rule that would require some
savings and loan holding companies to notify the OTS 30 days before undertaking
certain significant new business activities. As proposed, thrift companies would
have to give the OTS advance notice if:
- debt, combined with all other transactions by the company or any
subsidiaries other than the thrift during the past 12 months, increases
non-thrift liabilities by 5% or more; and non-thrift liabilities, after
the debt transaction, equal 50% or more of the company's consolidated
core capital;
- an asset acquisition or series of such transactions by the company or
non-thrift subsidiary during the past 12 months that involves assets
other than cash, cash equivalents and securities or other obligations
guaranteed by the U.S. Government and exceeds 15% of the company's
consolidated assets; and
- any transaction that, when combined with all other transactions during
the past 12 months, reduces the company's capital by 10% or more.
Any holding company with consolidated subsidiary thrift assets of less than
20% of total assets or consolidated holding company capital of at least 10%
would be exempt from the notice requirement. The OTS could object to or
conditionally approve an activity or transaction if it finds a material risk to
the safety and soundness and stability of the thrift. The review period could be
extended an additional 30 days if necessary.
The OTS proposal also would codify current practices and the factors
relevant to a holding company's need for capital. To determine the need for and
level of an explicit holding company capital requirement, the OTS will look at
overall risk at the thrift and the consolidated entity, their tangible and
equity capital, whether the holding company's debt-to-capital ratio is rising,
what investments or activities are funded by debt, its cash
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flow, how much the holding company relies on dividends from subsidiary thrift to
service debt or fulfill other obligations, earnings volatility and the thrift's
standing in the corporate structure.
Comments for the proposed rule were due by February 9, 2001. See
"-- Regulation of the Bank -- Qualified Thrift Lender Test." The Company cannot
determine whether the proposed rule will be adopted.
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 insured
savings association without giving at least 60 days written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition. In
addition, no company may acquire control of such an institution without prior
OTS approval. These provisions also prohibit, among other things, any director
or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of a savings and loan holding
company, from acquiring control of any savings association not a subsidiary of
the savings and loan holding company, unless the acquisition is approved by the
OTS. For additional restrictions on the acquisition of a unitary thrift holding
company, see "-- Financial Services Modernization Legislation."
Financial Services Modernization Legislation
General. On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization Act"). The
Financial Services Modernization Act repeals the two affiliation provisions of
the Glass-Steagall Act:
- Section 20, which restricted the affiliation of Federal Reserve Member
Banks with firms "engaged principally" in specified securities
activities; and
- Section 32, which restricts officer, director, or employee interlocks
between a member bank and any company or person "primarily engaged" in
specified securities activities.
In addition, the Financial Services Modernization Act also contains
provisions that expressly preempt any state law restricting the establishment of
financial affiliations, primarily related to insurance. 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 Financial Services Modernization Act 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 thrift holding
company. The Financial Institution Modernization Act grandfathers any company
that was a unitary thrift holding company on May 4, 1999 (or became a unitary
thrift 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 thrift holding company also must continue to
control at least one savings association, or a successor institution, that it
controlled on May 4, 1999.
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The Financial Services Modernization Act 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.
The Company and the Bank do not believe that the Financial Services
Modernization Act will have a material adverse affect on the operations of the
Company and the Bank in the near-term. However, to the extent that the act
permits banks, securities firms, and insurance companies to affiliate, the
financial services industry may experience further consolidation. The Financial
Services Modernization Act 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 thrift 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 thrift
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.
Privacy. Under the Financial Services Modernization Act, 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. Federal banking regulators issued final rules on
May 10, 2000. Pursuant to those 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.
The rules were effective November 13, 2000, but compliance is optional
until July 1, 2001. These privacy provisions will affect how consumer
information is transmitted through diversified financial companies and conveyed
to outside vendors. It is not possible at this time to assess the impact of the
privacy provisions on the Company's financial condition or results of
operations.
Safeguarding Confidential Customer Information. In January 2001, the
banking agencies adopted guidelines requiring financial institutions to
establish an information security program to:
- identify and assess the risks that may threaten customer information;
- develop a written plan containing policies and procedures to manage and
control these risks;
- implement and test the plan; and
- adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information, and internal or
external threats to information security.
Each institution may implement a security program appropriate to its size
and complexity and the nature and scope of its operations.
The guidelines outline specific security measures that institutions should
consider in implementing a security program. A financial institution must adopt
those security measures determined to be appropriate. The guidelines require the
board of directors to oversee an institution's efforts to develop, implement,
and maintain an effective information security program and approve written
information security policies and programs. The guidelines are effective July 1,
2001.
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REGULATION OF THE BANK
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 reserves 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 are required to pay assessments to the FDIC at an annual rate of
approximately .0212% of insured 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.
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. In addition, the OTS may require a savings association to maintain
capital above the minimum capital levels.
A savings association with a greater than "normal" level of interest rate
exposure must deduct an interest rate risk ("IRR") component in calculating its
total capital for purposes of determining whether it meets its risk-based
capital requirement. Interest rate exposure is measured, generally, as the
decline in an institution's net portfolio value that would result from a 200
basis point increase or decrease in market interest rates (whichever would
result in a lower net portfolio value), divided by the estimated economic value
of the savings association's assets. The interest rate risk component to be
deducted from total capital is equal to one-half of the difference between an
institution's measured exposure and "normal" IRR exposure (which is defined as
2%), multiplied by the estimated economic value of the institution's assets. In
August 1995, the OTS indefinitely delayed implementation of its IRR regulation.
Based on information voluntarily supplied to the OTS, at December 31, 2000, the
Bank would not have been required to deduct an IRR component in calculating
total risk-based capital had the IRR component of the capital regulations been
in effect.
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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 condition of its holding company,
affiliates, subsidiaries, or other persons, or savings associations with which
it has significant business relationships. The Bank has agreed to maintain
minimum core capital and risk-based capital ratios of 6.5% and 11.0%,
respectively.
As shown below, the Bank's regulatory capital exceeded all minimum
regulatory capital requirements applicable to it as of December 31, 2000.
TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL
------------------ ------------------ -------------------
BALANCE % BALANCE % BALANCE %
(DOLLARS IN THOUSANDS) ---------- ---- ---------- ---- ---------- -----
Stockholders' equity........... $ 140,387 -- $ 140,387 -- $ 140,387 --
Adjustments:
General reserves............. -- -- -- -- 15,632 --
Other(1)..................... -- -- -- -- (4,105) --
---------- ---- ---------- ---- ---------- -----
Regulatory capital............. 140,387 8.01% 140,387 8.01% 151,914 12.23%
Regulatory capital
requirements................. 26,279 1.50 70,078 4.00 99,407 8.00
---------- ---- ---------- ---- ---------- -----
Excess capital................. $ 114,108 6.51% $ 70,309 4.01% $ 52,507 4.23%
========== ==== ========== ==== ========== =====
Adjusted assets(2)............. $1,751,960 $1,751,960 $1,242,588
========== ========== ==========
- ---------------
(1) Includes the portion of non-residential construction and land development
loans that 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.
As a result of a number of federally insured financial institutions
extending their risk selection standards to attract lower credit quality
accounts due to such credits having higher interest rates and fees, in March
1999, the federal banking regulatory agencies jointly issued Interagency
Guidelines on Subprime Lending. In addition, expanded guidelines were issued by
the agencies on January 31, 2001. Subprime lending involves extending credit to
individuals with less than perfect credit histories.
These guidelines provide that if the risks associated with subprime lending
are not properly controlled, the agencies consider subprime lending a high-risk
activity that is unsafe and unsound. Specifically, the 2001 guidelines direct
examiners to expect regulatory capital one and one-half to three times higher
than that typically set aside for prime assets for institutions that:
- have subprime asset concentration of 25% of Tier 1 capital or higher; or
- have subprime portfolios experiencing rapid growth or adverse performance
trends, administered by inexperienced management or having inadequate or
weak controls.
Based upon a review of the portfolio and credit and underwriting policies,
the Bank has concluded that it does not currently engage in subprime lending and
does not have a subprime lending program that would subject it to the higher
capital requirements under the January 2001 guidelines. Although we believe we
do not engage in subprime lending, we cannot determine whether our
interpretation of the guidelines will be validated
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by the OTS after examination and whether, or to what extent, additional capital
requirements will be imposed on us. Any requirement for us to maintain
additional regulatory capital as a result of our activities in subprime lending
could have an adverse affect on our future prospects and operations, and may
restrict our ability to grow. If we are unable to comply with any new capital
requirements imposed upon regulatory examination, we may be subject to the
prompt corrective action regulations of the OTS.
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.
Proposed Capital Requirements for Community Institutions. In November 2000,
the federal bank and thrift regulatory agencies requested public comment on an
advance notice of proposed rulemaking that considers the establishment of a
simplified regulatory capital framework for non-complex institutions.
In the proposal, the agencies suggested criteria that could be used to
determine eligibility for a simplified capital framework, such as the nature of
a bank's activities, its asset size and its risk profile. In the advance notice,
the agencies seek comment on possible minimum regulatory capital requirements
for non-complex institutions, including a simplified risk-based ratio, a simple
leverage ratio, or a leverage ratio modified to incorporate certain off-balance
sheet exposures.
The advance notice solicits public comment on the agencies' preliminary
views. Comments were due on the proposal by February 1, 2001. Given the
preliminary nature of the proposal, it is not possible to predict its impact on
the Bank at this time.
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, 2000, 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
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
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The Bank's actual capital amounts and ratios and the capital amounts and
ratios for the Bank to meet the minimum capital requirements required by the OTS
and to be categorized as "well capitalized" under the PCA Rules are presented in
the table below.
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
----------------- ------------------ -----------------
AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS
(DOLLARS IN THOUSANDS) -------- ------ -------- ------- -------- ------
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%
As of December 31, 1999:
Total capital
(to risk weighted assets)............. $139,815 12.50% $89,468 8.00% $111,835 10.00%
Core capital
(to adjusted tangible assets)......... 127,160 8.05% 63,174 4.00% 78,967 5.00%
Tangible capital
(to adjusted tangible assets)......... 127,160 8.05% 23,690 1.50% n/a n/a
Tier 1 capital
(to risk weighted assets)............. 127,160 11.37% n/a n/a 67,101 6.00%
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, 2000, the Bank's
loans-to-one-borrower limit was $24.6 million based upon the 15% of unimpaired
capital and surplus measurement. At December 31, 2000, the Bank's largest
relationships consisted of one borrower with outstanding commitments of $19.9
million, which consisted of approximately 5 loans, with $9.6 million secured by
commercial real estate in the Bank's lending area and $10.3 million secured by
non-residential collateral. All 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 assets while the Code requires investments of
60% of 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
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association. The FHLB also relies on the QTL test. A savings association will
only enjoy full borrowing privileges if the savings association is a QTL. As of
December 31, 2000, the Bank was in compliance with its QTL requirement 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 association
may not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate; and covered transactions and certain other
transactions between a savings association or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each loan or extension of credit by a
savings association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130% (depending on the type of collateral) of the
amount of the loan or extension of credit.
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. The OTS recently adopted an amendment to these capital
distribution limitations. Under the new rule, 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
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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 institution's failure to comply
with the provisions of CRA could, at a minimum, result in regulatory
restrictions on its activities and the denial of certain applications. In
addition, an institution's failure to comply with the Fair Lending Laws could
result in enforcement actions by the OTS, as well as other federal regulatory
agencies and the Department of Justice.
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, (ii) 0.3% of total assets,
or (iii) 5% of its FHLB advances (borrowings). At December 31, 2000, the Bank
had $20.7 million in FHLB stock, which was in compliance with this requirement.
Liquidity Requirements. Under OTS regulations, a savings association is
required 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.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain noninterest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW, and Super NOW
checking accounts) and non-personal time deposits. The balances maintained to
meet the
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reserve requirements imposed by the Federal Reserve Board may be used to satisfy
the liquidity requirements that are imposed by the OTS. At December 31, 2000,
the Bank was in compliance with these requirements.
OTHER REAL ESTATE LENDING STANDARDS
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 residential 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.
EMPLOYEES
The Company employed 270 full time equivalent persons at December 31, 2000.
A union or collective bargaining group does not represent employees and the
Company considers its employee relations to be satisfactory.
STATISTICAL FINANCIAL DATA
LOAN PORTFOLIO
Loans Receivable
The Company's loan portfolio is almost exclusively secured by real estate,
concentrated in Southern California. The Bank's principal lending activities
consist of single family residential, single family construction and income
property lending. The composition of the net growth in loans, from $1.4 billion
at December 31, 1999 to $1.6 billion at December 31, 2000, includes increases in
net single family residential loans of $208.9 million and net income property
loans of $36.4 million.
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The table below sets forth the composition of the Company's loan portfolio
as of the dates indicated.
DECEMBER 31,
--------------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
------------------- ------------------- ------------------- ------------------ -----------------
BALANCE % BALANCE % BALANCE % BALANCE % BALANCE %
(DOLLARS IN THOUSANDS) ---------- ------ ---------- ------ ---------- ------ --------- ------ -------- ------
Single family
residential............ $ 888,416 49.17% $ 683,250 40.99% $ 576,032 35.88% $ 396,629 41.00% $337,784 45.70%
Income property:
Multi-family(1)........ 253,039 14.00 222,616 13.36 250,876 15.62 225,738 23.33 220,707 29.86
Commercial(1).......... 200,372 11.09 232,938 13.98 222,558 13.86 111,893 11.57 60,388 8.17
Development (2)........ 203,894 11.28 148,092 8.88 78,425 4.88 7,310 0.76 -- --
Single family
construction:
Single family
residential(3)....... 195,983 10.85 274,697 16.48 275,888 17.18 107,989 11.16 56,306 7.62
Tract.................. 3,495 0.19 24,056 1.44 85,942 5.35 68,653 7.10 33,791 4.57
Land(4).................. 46,520 2.57 59,095 3.55 69,581 4.33 39,475 4.08 14,513 1.96
Other.................... 15,390 0.85 22,053 1.32 46,615 2.90 9,698 1.00 15,684 2.12
---------- ------ ---------- ------ ---------- ------ --------- ------ -------- ------
Gross loans
receivable(5).......... 1,807,109 100.00% 1,666,797 100.00% 1,605,917 100.00% 967,385 100.00% 739,173 100.00%
====== ====== ====== ====== ======
Less:
Undisbursed funds...... (171,789) (196,249) (256,096) (108,683) (46,646)
Deferred (fees) and
costs, net(6)........ 2,197 (1,295) (5,919) (7,177) (6,611)
Allowance for estimated
credit losses........ (29,450) (24,285) (17,111) (13,274) (13,515)
---------- ---------- ---------- --------- --------
Net loans receivable..... $1,608,067 $1,444,968 $1,326,791 $ 838,251 $672,401
========== ========== ========== ========= ========
- ---------------
(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.
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The table below sets forth the Company's loan portfolio diversification by
size.
YEAR ENDED DECEMBER 31,
--------------------------------------------
2000 1999
-------------------- --------------------
NO. OF GROSS NO. OF GROSS
LOANS COMMITMENT LOANS COMMITMENT
(DOLLARS IN THOUSANDS) ------ ---------- ------ ----------
Loans in excess of $10.0 million:
Single family residential........................ -- $ -- 1 $ 13,000
Income property:
Multi-family.................................. -- -- -- --
Commercial.................................... 2 22,027 3 32,622
Development................................... 5 59,707 3 33,900
Other............................................ -- -- 1 16,000
-- ---------- -- ----------
7 $ 81,734 8 $ 95,522
== ========== == ==========
Percentage of total gross loans............... 4.52% 5.73%
Loans between $5.0 and $10.0 million:
Single family residential........................ 5 $ 33,073 7 $ 39,364
Income property:
Multi-family.................................. -- -- 1 6,655
Commercial.................................... 8 55,568 9 65,998
Development................................... 13 90,672 11 71,049
Single family construction:
Single family residential..................... 2 14,300 4 24,812
Tract......................................... -- -- 2 11,040
Land............................................. 1 6,501 1 6,501
Other............................................ 1 7,500 3 27,466
-- ---------- -- ----------
30 $ 207,614 38 $ 252,885
== ========== == ==========
Percentage of total gross loans............... 11.49% 15.17%
Loans less than $5.0 million....................... $1,517,761 $1,318,390
---------- ----------
Gross loans receivable........................ $1,807,109 $1,666,797
========== ==========
The table below sets forth the Company's net loan portfolio composition,
excluding net deferred fees and costs, as of the dates indicated.
DECEMBER 31, 2000 DECEMBER 31, 1999
--------------------- ---------------------
BALANCE PERCENT BALANCE PERCENT
(DOLLARS IN THOUSANDS) ---------- ------- ---------- -------
Single family residential................ $ 883,814 54.04% $ 674,917 45.90%
Income property:
Multi-family........................... 251,995 15.41% 222,142 15.11%
Commercial............................. 187,680 11.48% 212,100 14.42%
Development............................ 130,263 7.97% 99,296 6.75%
Single family construction:
Single family residential.............. 127,630 7.80% 198,066 13.47%
Land..................................... 45,450 2.78% 50,161 3.41%
Other.................................... 8,488 0.52% 13,866 0.94%
---------- ------ ---------- ------
Total.......................... $1,635,320 100.00% $1,470,548 100.00%
========== ====== ========== ======
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Single Family Residential Loans
The Bank offers first mortgage loans secured by single family (one-to-four
unit) residential properties located in the Bank's primary lending area of
Southern California. At December 31, 2000, $888.4 million, or 49.17% of the
total gross loan portfolio was secured by single family residential properties
with an average loan size of $0.5 million, compared to $683.3 million, or 40.99%
of the total gross loan portfolio at December 31, 1999.
The Company originates single family residential loans principally through
contact with, and submissions by, independent mortgage brokers. The Company pays
a fee, generally ranging from 0.5% to 2.0% of the loan amount, to mortgage
brokers in connection with its funding of certain loans. The practice and
pricing are common for single family-secured loans originated throughout the
Company's market area.
Income Property Multi-family and Commercial Loans
The Company originates loans secured by multi-family properties and
commercial properties, such as office buildings, retail properties, industrial
properties and various special purpose properties. The Company generates a
majority of its new income property loan opportunities through contact with, and
submissions by, independent mortgage loan brokers. However, a growing proportion
of the Company's new business is derived from existing customer relationships or
through referrals from existing customers. The Company competes for such loans
by providing highly responsive transaction execution, specialized market
knowledge and expertise and a high customer service orientation. Multi-family
and commercial loans accounted for $253.0 million or 14.00% and $200.4 million
or 11.09%, respectively, of the Bank's total gross loan portfolio at December
31, 2000. The average loan size of the income producing properties portfolio was
$3.0 million at December 31, 2000. At December 31, 1999, multi-family and
commercial real estate loans consisted of $222.6 million or 13.36% and $232.9
million or 13.98%, respectively, of the Bank's total gross loan portfolio.
Income Property -- Development Loans
Commencing in 1998, the Company has pursued financing opportunities
involving (1) the acquisition of land and the construction of income-producing
improvements thereon or (2) the acquisition and substantial renovation of
existing, income-producing properties. To date, the Company has focused on loans
for apartment building construction (primarily located in the West Los Angeles
area) and the renovation of existing commercial real estate improvements located
throughout Los Angeles County. At December 31, 2000, income property development
loans accounted for $203.9 million, or 11.28% of the Bank's total gross loan
portfolio compared to $148.1 million, or 8.88% of the Bank's total gross loan
portfolio at December 31, 1999.
Single Family Construction
The Company provides individual home construction financing, primarily to
local builders and, to a much lesser extent, homeowners. Generally, the Company
finances the construction of luxury custom homes throughout the coastal region
of Southern California and elsewhere within the Company's market area. A
majority of the Company's single family construction -- residential loans are
sourced through standing relationships between the Company's loan officers and
local builders and, therefore, do not typically involve mortgage brokers.
The Company's loan commitment generally includes provision for a portion of
the cost of the acquired land and all of the costs of construction (including
financing costs). Generally, the Company's loan commitment covers between 70.0%
and 75.0% 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 Company records its financing commitment.
The Company's single family construction residential loans have initial
terms of 12 to 24 months, with an option for the borrower to extend the loan for
up to six months, subject to the Company's then current evaluation of the status
of construction, costs to and at completion, the as-completed valuation of the
property, and other factors. Single family construction residential homes
accounted for $196.0 million, or 10.85% of the
15
20
total gross loan portfolio at December 31, 2000, with an average loan size of
$1.4 million, compared to $274.7 million, or 16.48% of the total gross loan
portfolio at December 31, 1999.
In 2001, the Company plans to introduce a construction to permanent loan
program targeted at owner-occupied properties.
Single Family Construction -- Tract Loans
In the past, the Company provided financing to small-to-medium-sized
developers of residential subdivisions located throughout Southern California.
Generally, the Company's tract loans finance land acquisition, site development
and home construction.
Except for very small subdivisions (i.e., generally developments involving
10 or fewer homes), the Company generally structured its tract loans such that
it will separately finance land acquisition and site development, and the
individual phased construction of homes. In connection with these multi-phase
developments, the Company does not commit to finance more than one phase of the
development at a time, and fully underwrites future phases at such time as the
borrower makes their financing request. Generally, the Company's tract loans
carried a loan term of 12 months, with built-in options to extend the loan for
up to an additional six months. As finished homes are sold, the Company
generally receives substantially all of the proceeds from sales until its loan
is fully repaid.
At December 31, 2000, tract loans accounted for $3.5 million, or 0.19% of
the Bank's total gross loan portfolio compared to $24.1 million, or 1.44% of the
Bank's total gross loan portfolio at December 31, 1999. 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.
Consumer Lending
In December 2000, the Bank launched a new consumer lending product. This
new product offers automobile, recreational vehicle and boat loans, personal
unsecured loans and personal unsecured lines of credit to its retail customers
through a correspondent lending relationship and receives fee income based upon
originations. This product was introduced to offer a greater range of services
to our customers, which will assist the Bank in achieving greater franchise
value through an expansion of the products and services we offer our retail
customers.
NEW BUSINESS GENERATION
The Company extends credit pursuant to its lending policies covering loan
applications, borrower financial information and legal and corollary agreements
which support the vesting of title to the Company's collateral, title policies,
fire and extended liability coverage casualty insurance, credit reports, and
other documents necessary to support each extension of credit. The real property
collateral that secures the Company's loans is appraised either by an
independent fee appraiser or by one of the Company's staff appraisers. The
Company's staff appraisers and the Company's Chief Appraiser generally review
independent fee appraisals. With few exceptions, all of the principal legal
documents that support each extension of credit are prepared or reviewed by the
Company's in house legal staff or outside attorneys.
16
21
The following table sets forth the approximate composition of the Company's
gross new loan commitments, net of internal refinances, for the periods
indicated, in dollars and as a percentage of total loans originated.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
2000 1999 1998
----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS) AMOUNT % AMOUNT % AMOUNT %
---------------------- -------- ------ -------- ------ -------- ------
Single family residential(1)............ $361,034 47.36% $293,600 42.03% $302,600 31.37%
Income property:
Multi-family(2)....................... 63,366 8.32 21,800 3.12 64,800 6.72
Commercial(3)......................... 66,118 8.68 61,400 8.79 125,900 13.05
Development(4)........................ 116,123 15.24 86,400 12.37 81,200 8.42
Single family construction:
Single family residential(5).......... 121,279 15.92 164,100 23.49 220,400 22.85
Tract(6).............................. -- -- 12,100 1.73 57,100 5.92
Land(7)................................. 34,063 4.47 51,500 7.37 98,500 10.21
Other(8)................................ 49 0.01 7,700 1.10 14,100 1.46
-------- ------ -------- ------ -------- ------
Total......................... $762,032 100.00% $698,600 100.00% $964,600 100.00%
======== ====== ======== ====== ======== ======
- ---------------
(1) Includes unfunded commitments of $0.3 million, $0.4 million and $5.3 million
at December 31, 2000, 1999 and 1998, respectively.
(2) Includes unfunded commitments of $0.5 million at December 31, 2000. There
were no unfunded commitments at December 31, 1999. Includes $1.7 million of
financings provided in connection with sales of previously foreclosed
properties for 1998.
(3) Includes unfunded commitments of $0.9 million, $13.1 million and $16.4
million at December 31, 2000, 1999 and 1998, respectively.
(4) Includes unfunded commitments of $64.9 million, $40.2 million and $17.5
million at December 31, 2000, 1999 and 1998, respectively.
(5) Includes unfunded commitments of $64.8 million, $72.3 million and $109.8
million at December 31, 2000, 1999 and 1998, respectively.
(6) There were no unfunded commitments at December 31, 2000. Includes unfunded
commitments of $2.5 million and $34.7 million at December 31, 1999 and 1998,
respectively.
(7) Includes unfunded commitments of $0.4 million, $4.0 million and $12.9
million at December 31, 2000, 1999 and 1998, respectively.
(8) There were no unfunded commitments at December 31, 2000. Includes unfunded
commitments of $7.5 million and $1.2 million at December 31, 1999 and 1998,
respectively.
17
22
The table below sets forth, by contractual maturity, the Company's loan
portfolio at December 31, 2000. The table below is based on contractual loan
maturities and does not consider amortization and prepayments of loan principal.
MATURING IN:
------------------------------------------------------------
OVER OVER
ONE YEAR FIVE YEARS TOTAL
LESS THAN THROUGH THROUGH OVER LOANS
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS RECEIVABLE
(DOLLARS IN THOUSANDS) --------- ---------- ---------- --------- ----------
Single family residential................... $ 18,164 $ 39,713 $256,223 $574,316 $ 888,416
Income property:
Multi-family.............................. 1,261 52,186 112,801 86,791 253,039
Commercial................................ 18,958 67,370 111,811 2,233 200,372
Development............................... 203,894 -- -- -- 203,894
Single family construction:
Single family residential................. 195,983 -- -- -- 195,983
Tract..................................... 3,495 -- -- -- 3,495
Land........................................ 34,487 8,459 3,353 221 46,520
Other....................................... 9,910 3,261 -- 2,219 15,390
-------- -------- -------- -------- ----------
Gross loans receivable(1)................... $486,152 $170,989 $484,188 $665,780 1,807,109
======== ======== ======== ======== ==========
Less:
Undisbursed funds......................... (171,789)
Deferred (fees) and costs, net............ 2,197
Allowance for estimated credit losses..... (29,450)
----------
Net loans receivable........................ $1,608,067
==========
- ---------------
(1) Gross loans receivable includes the principal balance of loans outstanding
plus outstanding but unfunded loan commitments, predominantly in connection
with construction loans.
ASSET QUALITY
The Company has an asset review and classification system to establish
specific and general allowances for estimated credit losses and to classify
assets and groups of assets. The Company's problem asset classifications are
discussed below.
NONACCRUAL LOANS
As a matter of policy, the Company generally ceases to accrue interest on
any loan with respect to which the loan's contractual payments are more than 90
days past due, as well as loans classified substandard for which interest
payment reserves were established from loan funds rather than borrower funds. In
addition, interest is not recognized on any loan for which management has
determined that collection of the Company's investment in the loan is not
reasonably assured.
CLASSIFIED ASSETS
OTS regulations require insured institutions to classify their assets in
accordance with established policies and procedures. A classified asset is an
asset classified substandard, doubtful or loss. Loans that are not classified
are categorized as pass or special mention. The severity of an asset's
classification is dependent upon, among other things, the institution's risk of
loss, the borrower's performance, the characteristics of the institution's
security, and the local market conditions, among other factors.
The Company automatically classifies as substandard (1) real estate owned
("REO"), (2) loans delinquent 90 or more days, and (3) other loans that have
been adversely classified pursuant to OTS regulations and guidelines
("performing/classified"). Performing loans are classified consistent with the
Company's classification policies.
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23
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).
DECEMBER 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
(DOLLARS IN THOUSANDS) ---------- ---------- ---------- -------- --------
Risk elements:
Nonaccrual loans...................... $ 31,601 $ 44,031 $ 47,688 $ 15,396 $ 28,624
Real estate owned, net................ 2,859 5,587 4,070 9,859 20,140
---------- ---------- ---------- -------- --------
34,460 49,618 51,758 25,255 48,764
Performing loans classified
substandard or lower(1)............ 40,642 25,646 45,397 35,845 45,088
---------- ---------- ---------- -------- --------
Total classified assets............ $ 75,102 $ 75,264 $ 97,155 $ 61,100 $ 93,852
========== ========== ========== ======== ========
Total classified loans............. $ 72,243 $ 69,677 $ 93,085 $ 51,241 $ 73,712
========== ========== ========== ======== ========
Loans restructured and paying in
accordance with modified terms(2)..... $ 14,933 $ 15,394 $ 27,334 $ 25,631 $ 22,446
========== ========== ========== ======== ========
Gross loans before allowance for
estimated credit losses............... $1,637,517 $1,469,253 $1,343,902 $851,525 $685,916
========== ========== ========== ======== ========
Loans receivable, net of specific
reserves and deferred fees............ $1,631,721 $1,468,445 $1,338,718 $847,647 $683,731
========== ========== ========== ======== ========
Delinquent Loans
30 - 89 days.......................... $ 12,407 $ 9,063 $ 37,308 $ 4,435 $ 10,082
90 + days............................. 14,509 14,916 13,832 10,793 16,643
---------- ---------- ---------- -------- --------
Total delinquent loans............. $ 26,916 $ 23,979 $ 51,140 $ 15,228 $ 26,725
========== ========== ========== ======== ========
Allowance for estimated credit losses:
General............................... $ 23,654 $ 23,477 $ 11,927 $ 9,396 $ 11,330
Specific.............................. 5,796 808 5,184 3,878 2,185
---------- ---------- ---------- -------- --------
Total allowance for estimated
credit losses.................... $ 29,450 $ 24,285 $ 17,111 $ 13,274 $ 13,515
========== ========== ========== ======== ========
Total allowance for estimated
credit losses to loans
receivable, net of specific
reserves and deferred fees....... 1.80% 1.65% 1.28% 1.57% 1.98%
========== ========== ========== ======== ========
Total general allowance for
estimated credit losses to loans
receivable, net of specific
reserves and deferred fees....... 1.45% 1.60% 0.89% 1.11% 1.66%
========== ========== ========== ======== ========
Core capital............................ $ 140,387 $ 127,160 $ 108,673 $ 69,906 $ 52,803
========== ========== ========== ======== ========
Risk-based capital...................... $ 151,914 $ 139,815 $ 119,400 $ 78,454 $ 59,560
========== ========== ========== ======== ========
Ratio of classified assets to:
Loans receivable, net of specific
reserves and deferred fees......... 4.60% 5.13% 7.26% 7.21% 13.73%
========== ========== ========== ======== ========
Bank core capital and general
allowance for estimated credit
losses............................. 45.78% 49.96% 80.56% 77.05% 146.34%
========== ========== ========== ======== ========
Core capital.......................... 53.50% 59.19% 89.40% 87.40% 177.74%
========== ========== ========== ======== ========
Risk-based capital.................... 49.44% 53.83% 81.37% 77.88% 157.58%
========== ========== ========== ======== ========
- ---------------
(1) Excludes nonaccrual
(2) Troubled debt restructured loans ("TDRs") not classified and not on
nonaccrual
Nonaccrual loans totaled $31.6 million at December 31, 2000 (or 1.80% of
total assets), compared with nonaccrual loans of $44.0 million (or 2.78% of
total assets) at December 31, 1999. Included in nonaccrual
19
24
loans at December 31, 2000, were five single family residential loans with
balances of $1.0 million or more representing $11.0 million, or 34.91% of total
nonaccrual loans. The average loan to value ("LTV") for these five loans was
67.76%. Nonaccrual loans also consisted of one income property construction loan
with a balance of $11.0 million, or 34.77% of total nonaccrual loans. In
December 2000, the Bank reclassified $5.2 million of the general valuation
allowance to the specific allowance as a result of an internal valuation
analysis performed on this income property development loan secured by a retail
center in Riverside County, California, whose major tenant filed for Chapter 11
bankruptcy protection. As a result, the Bank placed this loan on nonaccrual
status. Subsequent to December 31, 2000, $4.5 million, or 14.26% of total
nonaccrual loans, consisting of one land loan with a balance of $3.4 million and
one single family construction loan with a balance of $1.1 million, paid off.
Other classified loans were $40.6 million at December 31, 2000, compared with
$25.6 million at December 31, 1999. Subsequent to December 31, 2000, there was
one new nonaccrual single family residential loan with a balance of $2.3
million. Delinquent loans totaled $26.9 million at December 31, 2000, compared
with $24.0 million at December 31, 1999.
The table below sets forth information concerning the Company's gross
classified loans, by category, as of December 31, 2000.
DELINQUENT LOANS OTHER
---------------------------- NONACCRUAL PERFORMING
90 + DAYS 30 - 89 DAYS(1) LOANS(2) LOANS TOTAL
(DOLLARS IN THOUSANDS) ---------- --------------- ---------- ---------- -------
Single family residential................ $ 9,682 $4,222 $ 3,665 $ 8,740 $26,309
Income property:
Multi-family........................... -- -- -- -- --
Commercial............................. -- 3,061 -- 10,696 13,757
Development............................ -- -- 10,987 -- 10,987
Single family construction:
Single family residential.............. 879 -- 1,833 7,567 10,279
Tract.................................. -- -- -- 3,464 3,464
Land..................................... 3,930 -- -- 3,499 7,429
Other.................................... 18 -- -- -- 18
------- ------ ------- ------- -------
Gross classified loans................. $14,509 $7,283 $16,485 $33,966 $72,243
======= ====== ======= ======= =======
- ---------------
(1) Includes $0.5 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, management estimates the
revenues expected to be generated from disposal of the Company's collateral or
owned property, less construction and renovation costs (if any), holding costs
and transaction costs. For tract construction and land development, the
resulting projected cash flows are discounted utilizing a market rate of return
to determine their value.
The Company maintains an allowance for estimated credit losses which is not
tied to individual loans or properties ("general allowances"). General
allowances are maintained for each of the Company's principal loan segments, and
supplemented by periodic additions through provisions for credit losses. In
measuring the adequacy of the Company's general allowances, management considers
(1) the Company's historical loss experience for each loan portfolio segment and
in total, (2) the historical migration of loans within each portfolio segment
and in total (i.e., from performing to nonperforming, from nonperforming to
REO),
20
25
(3) observable trends in the performance of each loan portfolio segment, (4)
observable trends in the region's economy and in its real property markets and
(5) guidelines published by the OTS for maintaining general allowances.
In addition to the amount of allowance determined by applying individual
loss factors to the portfolio, the general allowance may also include an
unallocated amount. The unallocated allowance recognizes the model and
estimation risk associated with the allowance formula and specific allowances.
In addition, the unallocated allowance is based upon management's evaluation of
various conditions, the effects of which are not directly measured in the
determination of the formula and specific allowances. The evaluation of the
inherent loss with respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific problem credits or
portfolio segments. The conditions evaluated in connection with the unallocated
allowance include (1) general economic and business conditions affecting our key
lending areas, (2) credit quality trends (including trends in nonperforming
loans expected to result from existing conditions), (3) collateral values, (4)
loan volumes and concentrations, (5) seasoning of the loan portfolio, (6)
specific industry conditions within portfolio segments (7) recent loss
experience in particular segments of the portfolio, (8) duration of the current
business cycle, (9) bank regulatory examination results and (10) findings of our
internal credit examiners. The unallocated reserves are reviewed periodically to
determine whether they are at a level that management believes are adequate.
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit that
management believes indicate the probability that a loss has occurred.
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.
21
26
The table below summarizes the Company's allowance for estimated credit
losses by category for the periods indicated.
DECEMBER 31,
---------------------------------------------------
2000 1999 1998 1997 1996
(DOLLARS IN THOUSANDS) ------- ------- ------- ------- -------
Dollars:
Single family residential.............. $ 8,075 $ 7,095 $ 7,836 $ 6,671 $ 6,476
Income property:
Multi-family........................ 906 646 1,063 2,000 4,786
Commercial.......................... 4,236 6,907 4,334 2,252 1,150
Development......................... 7,877 2,067 354 -- --
Single family construction:
Single family residential........... 4,382 3,946 789 503 168
Tract............................... 693 855 1,092 817 338
Land................................... 1,914 1,470 293 162 167
Other.................................. 260 311 1,082 226 --
Unallocated............................ 1,107 988 268 643 430
------- ------- ------- ------- -------
Total.......................... $29,450 $24,285 $17,111 $13,274 $13,515
======= ======= ======= ======= =======
Percentage of year end allowance:
Single family residential.............. 27.42% 29.22% 45.80% 50.26% 47.92%
Income property:
Multi-family........................ 3.08 2.66 6.21 15.07 35.41
Commercial.......................... 14.38 28.44 25.33 16.97 8.51
Development......................... 26.75 8.51 2.07 -- --
Single family construction:
Single family residential........... 14.88 16.25 4.61 3.79 1.24
Tract............................... 2.35 3.52 6.38 6.15 2.50
Land................................... 6.50 6.05 1.71 1.22 1.24
Other.................................. 0.88 1.28 6.32 1.70 --
Unallocated............................ 3.76 4.07 1.57 4.84 3.18
------- ------- ------- ------- -------
Total.......................... 100.00% 100.00% 100.00% 100.00% 100.00%
======= ======= ======= ======= =======
Percentage of reserves to total gross
loans (1) by category:
Single family residential.............. 0.91% 1.04% 1.36% 1.68% 1.92%
Income property:
Multi-family........................ 0.36 0.29 0.42 0.89 2.17
Commercial.......................... 2.11 2.97 1.95 2.01 1.90
Development......................... 3.86 1.40 0.45 -- --
Single family construction:
Single family residential........... 2.24 1.44 0.29 0.47 0.30
Tract............................... 19.83 3.55 1.27 1.19 1.00
Land................................... 4.11 2.49 0.42 0.41 1.15
Other.................................. 1.69 1.41 2.32 2.33 --
Unallocated............................ n/a n/a n/a n/a n/a
Total.......................... 1.63% 1.46% 1.07% 1.37% 1.83%
- ---------------
(1) Percent of allowance for estimated credit losses to gross loan commitments,
which include the outstanding but undisbursed portion of such commitments.
The change in the percentage of reserves to total loans by category is a
result of different levels of classified assets within each category.
22
27
Unallocated reserves are established based on management's judgment in
order to appropriately reflect the presence of indicators of inherent losses
that are not fully reflected in the historical loss information and analysis
used in the development of allocated reserves.
The table below summarizes the activity of the Company's allowance for
estimated credit losses for the periods indicated.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
2000 1999 1998 1997 1996
(DOLLARS IN THOUSANDS) ---------- ---------- ---------- -------- --------
Average loans outstanding....... $1,547,206 $1,411,697 $1,081,382 $745,197 $671,365
========== ========== ========== ======== ========
Total allowance for estimated
credit losses at beginning of
period........................ $ 24,285 $ 17,111 $ 13,274 $ 13,515 $ 15,192
Provision for credit losses..... 6,000 12,000 7,135 5,137 6,067
Charge-offs:
Single family residential..... (354) (1,910) (1,178) (3,472) (3,103)
Income property:
Multi-family............... -- (186) (1,038) (1,745) (4,641)
Commercial................. (573) (512) (815) -- --
Single family construction:
Single family
residential.............. -- -- (267) -- --
Tract...................... (147) -- -- -- --
Land.......................... -- (1,140) -- (150) --
Other......................... (10) (1,124) -- (11) --
Recoveries:
Single family residential..... -- -- -- -- --
Income property:
Multi-family............... -- -- -- -- --
Commercial................. -- -- -- -- --
Single family construction:
Single family
residential.............. -- -- -- -- --
Tract...................... -- -- -- -- --
Land.......................... -- -- -- -- --
Other......................... 249 46 -- -- --
---------- ---------- ---------- -------- --------
Net charge-offs................. (835) (4,826) (3,298) (5,378) (7,744)
---------- ---------- ---------- -------- --------
Total allowance for estimated
credit losses at end of
period........................ $ 29,450 $ 24,285 $ 17,111 $ 13,274 $ 13,515
========== ========== ========== ======== ========
Ratio of net charge-offs to
average loans outstanding
during the period............. 0.05% 0.34% 0.30% 0.72% 1.15%
Ratio of allowance to average
loans outstanding............. 1.90% 1.72% 1.58% 1.78% 2.01%
REAL ESTATE OWNED
Real estate acquired in satisfaction of loans is transferred to REO at
estimated fair values, less any estimated disposal costs. The difference between
the fair value of the real estate collateral and the loan balance at the time of
transfer is recorded as a loan charge off if fair value is lower. Any subsequent
declines in the fair value of the REO after the date of transfer are recorded
through a write-down of the asset or through the establishment of, or additions
to specific reserves. The Company's investment in REO decreased from $5.6
million to $2.9 million, or 48.83%, from December 31, 1999 to 2000,
respectively.
23
28
The table below summarizes the composition of the Company's portfolio of
real estate owned properties as of the dates indicated.
DECEMBER 31,
--------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ------ ------ ------
Single family residential................................ $2,859 $1,218 $2,509
Income property:
Multi-family........................................... -- -- 213
Commercial............................................. -- -- 1,393
Land..................................................... -- 4,398(1) --
------ ------ ------
Gross investment......................................... 2,859 5,616 4,115
Allowance for estimated losses......................... -- (29) (45)
------ ------ ------
Real estate owned, net................................... $2,859 $5,587 $4,070
====== ====== ======
- ---------------
(1) In December 1999, the Bank acquired 18 lots of a tract development in La
Quinta, California with a carrying value of $4.4 million.
In the preceding table, the Company's gross investment in REO equals loan
principal at foreclosure, plus post-foreclosure capitalized costs, less
cumulative charge-offs.
The table below summarizes the changes in valuation of the REO portfolio
for the periods indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------------
2000 1999 1998 1997 1996
(DOLLARS IN THOUSANDS) ---- ---- ------- -------- -------
Total allowance for estimated losses at
beginning of period........................ $ 29 $ 45 $ 2,563 $ 11,871 $15,725
Provision for estimated losses............. -- 80 60 913 4,933
Charge-offs................................ (29) (96) (2,578) (10,221) (8,787)
---- ---- ------- -------- -------
Total allowance for estimated losses at end
of period.................................. $ -- $ 29 $ 45 $ 2,563 $11,871
==== ==== ======= ======== =======
INVESTMENT SECURITIES
The Company has authority to invest in a variety of investment securities,
including U.S. Government and agency securities, mortgage-backed securities and
corporate securities. However, in recent years the Company's strategy has been
to deploy its assets through loan originations, rather than purchases of
investment securities. As a result, the investment activity has been steadily
decreasing over the last six years, and during 2000 and 1999 there was no
investment activity. Subsequent to the Company's stock offering in the third
quarter of 1998, the Company utilized the $27.6 million of proceeds to purchase
$27.9 million in FNMA discount notes, $5.0 million of which matured in September
1998 and $22.9 million of which matured in December 1998. During 1998, the
Company sold $596,000 in mutual funds. The Company classifies all securities
acquired as available-for-sale under generally accepted accounting principles,
and thus the securities were carried at fair value, with unrealized gains and
losses excluded from income and reported as a separate component of
stockholders' equity, net of taxes.
SOURCES OF FUNDS
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.
24
29
DEPOSITS
At December 31, 2000, the Company operated seven retail-banking locations
with three primary product lines; (1) checking and savings accounts, (2) money
market accounts, and (3) certificates of deposit. Five of these branches are
located in the South Bay area of Los Angeles County, one is located in the San
Fernando Valley area of Los Angeles County and the other is located near the
border of Los Angeles and Ventura Counties. At December 31, 2000, the Company's
retail branches carried average deposit balances of $277.6 million and $131.9
million in the Valley and South Bay regions, respectively, which is
substantially higher than most local banking companies. The Company does not
operate a money desk or otherwise solicit Brokered Deposits.
The Company has several types of deposit accounts principally designed to
attract short term deposits. The table below summarizes the twelve month average
on deposits and the weighted average interest costs incurred thereon during the
periods indicated. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Net Interest Income."
2000 1999 1998
-------------------------------- -------------------------------- ------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT
AMOUNT COST OF TOTAL AMOUNT COST OF TOTAL AMOUNT COST OF TOTAL
(DOLLARS IN THOUSANDS) ---------- -------- -------- ---------- -------- -------- -------- -------- --------
Noninterest checking....... $ 31,174 -- 2.67% $ 24,469 -- 2.32% $ 13,378 -- 1.47%
Checking/NOW............... 39,609 2.46% 3.39 35,105 2.16% 3.33 25,912 2.62% 2.85
Passbook................... 26,658 2.18% 2.28 27,666 3.31% 2.62 73,190 4.04% 8.06
Money market............... 180,815 4.99% 15.46 156,538 4.37% 14.85 22,487 3.19% 2.48
Certificates of
deposit(1)............... 891,037 5.94% 76.20 810,392 5.22% 76.88 772,748 5.60% 85.14
---------- ------- ---------- ------- -------- -------
Total.............. $1,169,293 5.58% 100.00% $1,054,170 4.94% 100.00% $907,715 5.33% 100.00%
========== ======= ========== ======= ======== =======
- ---------------
(1) See "Note 7 -- Deposits" for certificates of deposit with balances
>$100,000.
FHLB ADVANCES
The FHLB system functions as a source of credit to savings institutions
which are members. Advances are secured by the Company's mortgage loans and the
capital stock of the FHLB owned by the Company. Subject to the FHLB's advance
policies and requirements, these advances can be requested for any business
purpose in which the Company is authorized to engage. In granting advances, the
FHLB considers a member's creditworthiness and other relevant factors. At
December 31, 2000, the Company had an approved line of credit with the FHLB for
a maximum advance of up to 35% of total assets ($613.2 million as of December
31, 2000) based on qualifying collateral. At December 31, 2000, the Company had
ten FHLB advances outstanding totaling $384.0 million which had a weighted
averaged interest rate of 5.98% and a weighted average remaining maturity of 4
years and 2 months.
SENIOR NOTES
On December 31, 1997, the Company issued $40.0 million of Senior Notes due
2004 ("1997 Senior Notes") in a private placement (the "1997 Offering"), which
included registration rights. Concurrent with the completion of the 1997
Offering, the Company prepaid all of its 1995 Senior Notes and redeemed all of
its Series A Preferred Stock. The 1997 Senior Notes bear interest payable
semiannually at the stated interest rate of 12.50%. On or after December 31,
2002, the 1997 Senior Notes will be redeemable at any time at the option of the
Company, in whole or in part, at the redemption price of 106.25% for the twelve
month period beginning December 31, 2002, and 103.125% beginning December 31,
2003 and thereafter until maturity.
In November 2000, the Company repurchased $642,000 of its 1997 Senior Notes
at an average price of 96.2% of par value. As of March 23, 2001, the Company
repurchased $2.1 million of its 1997 Senior Notes at an average price of 99.6%
of par value.
25
30
OTHER
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 Company intends to use the proceeds to repurchase some of its
outstanding 12.50% 1997 Senior Notes due 2004 in order to reduce its overall
interest costs. To the extent that the Company is unable to use the full amount
of the proceeds to repurchase 1997 Senior Notes, the capital will be used to
repurchase Common Stock or to fund acquisitions of complementary lines of
business. Some portion of the proceeds may be invested in the Bank to support
future growth. Pending use of the proceeds as described above, the proceeds will
be invested in short term investments.
ITEM 2. PROPERTIES
As of December 31, 2000, the Company had seven leased and two wholly owned
properties. The leased properties included its corporate headquarters, five
branch offices (two of which were ground leases for sites on which the Company
has built branch offices), and one warehouse. All of the properties owned or
leased by the Company are in Southern California.
The following table summarizes the Company's owned and leased properties at
December 31, 2000 and, with respect to leased properties, highlights the
principal terms and net book values of the owned properties and leasehold
improvements. None of the leases contain any unusual terms and are all "net" or
"triple net" leases.
EXPIRATION RENEWAL MONTHLY SQUARE NET
OF TERM OPTIONS RENTAL FEET BOOK VALUE
---------- ----------- -------- ------ ----------
Leased:
El Segundo Corporate............. 11/30/05 One 5-year $104,149 61,190 $579,114
Torrance Branch.................. 12/31/01 One 5-year 18,578 7,343 66,925
Westlake Branch.................. 06/30/10 Two 5-year 14,245 7,700 129,106
Manhattan Beach Branch........... 10/30/10 Four 5-year 4,590 4,590 --
Warehouse........................ 06/30/01 Two 3-year 4,000 10,000 57,834
Tarzana Branch................... 01/31/05 Five 5-year 3,589 3,352 --
Redondo Beach Branch............. 04/30/04 Two 5-year 3,857 1,403 82,853
-------- ------ --------
Total.................... $153,008 95,578 $915,832
======== ====== ========
Owned:
Hawthorne Branch................. 10,000 $170,896
Westchester Branch............... 8,800 367,833
Manhattan Beach Branch (building
only)(1)...................... 4,590 35,804
Tarzana Branch (building
only)(1)...................... 3,352 3,787
------ --------
Total.................... 26,742 $578,320
====== ========
- ---------------
(1) Ground lease only; building and improvements are owned by the Company but
revert to the landlord upon termination of the lease.
The Bank utilizes a client-server computer system with use of various
third-party vendors' software for retail deposit operations, loan servicing,
accounting and loan origination functions. The net book value of the
26
31
Bank's electronic data processing equipment, including personal computers and
software, was $1.1 million at December 31, 2000.
At December 31, 2000, the net book values of the Company's office property,
and furniture, fixtures and equipment, excluding data processing equipment, were
$3.7 million. See Note 6 of the Notes to Consolidated Financial Statements. The
Company believes that all of the above facilities are in good condition and are
adequate for the Company's present operations.
ITEM 3. LEGAL PROCEEDINGS
LITIGATION
The Bank is a defendant in a construction defect case entitled Marine
Village Townhomes Homeowners' Association v. Hawthorne Savings and Loan
Association that was filed in the Superior Court of the State of California,
County of Los Angeles. In this action, Plaintiffs allege, under several theories
of recovery, that the Bank was responsible for construction defects in a
multi-unit condominium complex, and further alleges fraud by the Bank in
connection with the sales of the condominiums. The Bank initially provided a
construction loan to the developer, but took over the completion of a portion of
the projects after the developer defaulted. Plaintiffs are seeking damages of
approximately $3.3 million, plus punitive damages. The Bank has denied that it
is responsible for all of the defects Plaintiffs are alleging, and has made
claims for indemnification against the contractor and subcontractors. The Bank
is also seeking reimbursement from various insurance carriers for defense costs
and indemnification for any amounts the Bank is obligated to pay. No assurances
can be given that the responsible parties will ultimately indemnify the Bank.
Further, there can be no insurance coverage for intentional acts or punitive
damages, if awarded. Although the Bank intends to vigorously defend its position
and to pursue indemnification, there can be no assurances that the Bank will
prevail. In addition, the Bank has incurred substantial legal fees defending the
case. In addition, the inherent uncertainty of jury or judicial verdicts makes
it impossible to determine with certainty the Company's maximum exposure in this
case.
In December 2000, the Bank settled the action entitled Mells v. Hawthorne,
a construction defect case in which the Bank was appealing a $767,000 judgment
against the Bank. The terms of the Settlement Agreement are confidential, and
did not result in a material additional accrual during the fourth quarter. In
conjunction with the settlement, the parties have stipulated to the reversal of
the judgment and dismissal of the action with prejudice.
The Bank was a defendant in a construction defect case entitled Stone Water
Terrace HOA v. Hawthorne Savings and Loan Association, which was filed in the
Superior Court of the State of California, County of Los Angeles. In this
action, Plaintiff alleged, under several theories of recovery, that the Bank was
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 projects after the developer defaulted. The
plaintiff sought damages in an unspecified amount, plus punitive damages. The
Bank denied the allegations in the complaint and sought indemnification against
the responsible parties. On September 18, 2000, the Court entered an order
dismissing the Stonewater Terrace HOA case because Plaintiffs failed to take
certain actions. In March 2001, the Plaintiffs filed a motion seeking to have
the case reinstated. The Bank intends to oppose the motion, but there can be no
assurances that the case will not be reinstated. If the case is reinstated, it
is probable that the Bank will incur substantial legal fees defending this
matter. At the time the case was dismissed, discovery had not yet begun, so the
Bank is not in a position to estimate the extent of any liability. In addition,
the inherent uncertainty of jury or judicial verdicts makes it impossible to
determine with certainty the Company's maximum exposure in this action.
The Bank is involved in a variety of other litigation matters in the
ordinary course of its business, and anticipates that it will become involved in
new litigation matters from time to time in the future. Based on the current
assessment of these other matters, management does not presently believe that
any one of these existing other matters is likely to have material adverse
impact on the Company's financial condition or result of operations. However,
the Company will incur legal and related costs concerning the litigation and may
from time to time determine to settle some or all of the cases, regardless of
management's assessment of the
27
32
Company's legal position. The amount of legal defense costs and settlements in
any period will depend on many factors, including the status of cases (and the
number of cases that are in trial or about to be brought to trial) and the
opposing parties' aggressiveness in pursuing their cases and their perception of
their legal position. Further, the inherent uncertainty of jury or judicial
verdicts makes it impossible to determine with certainty the Company's maximum
cost in any pending litigation. Accordingly, the Company's litigation costs and
expenses may vary materially from period to period, and no assurance can be
given that these costs will not be material in any particular period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth
quarter of 2000.
ITEM 4A. EXECUTIVE OFFICERS
The following table sets forth, as of February 26, 2001 the names and ages
of all executive officers of the Company, indicating their positions and
principal occupation.
NAME AGE POSITION WITH THE COMPANY AND PRIOR EXPERIENCE
---- --- ----------------------------------------------
Simone Lagomarsino............. 39 President and Chief Executive Officer of Hawthorne Financial
Corporation and Hawthorne Savings, F.S.B. since December
1999. Executive Vice President and Chief Financial Officer
of the Company and the Bank from February 1999 through
December 1999. Executive Vice President and Chief Financial
Officer of First Plus Bank from March 1998 to February 1999.
Senior Vice President, Finance of Imperial Financial Group
from March 1997 to March 1998. Senior Vice President and
Chief Financial Officer of Ventura County National Bank from
March 1995 to March 1997. (Ventura County National Bank was
sold to City National Bank in January 1997). Financial
advisor Prudential Securities September 1993 to March 1995.
Karen C. Abajian............... 38 Executive Vice President and Chief Financial Officer of
Hawthorne Financial Corporation and Hawthorne Savings,
F.S.B. since April 2000. Senior Vice President and
Controller of Imperial Bank from May 1993 to March 2000.
David L. Adams................. 47 Senior Vice President and Income Property Group Manager of
Hawthorne Savings, F.S.B. since June 2000. Vice President
and Wholesale Lending Division Manager of Pacific Shore
Funding, Inc. from November 1998 to June 2000. Vice
President and Correspondent Loan Production Division Manager
of Century National Financial Group, Inc. from January 1998
to November 1998. Senior Vice President and Director of
Residential Loan Production of Downey Savings and Loan
Association from 1995 to 1997.
William R. Brown............... 44 Senior Vice President of Hawthorne Savings, F.S.B. since
August 1993. Group manager of single family residential
construction lending since January 2000. Manager of the
Bank's construction servicing group from January 1998
through December 1999. Manager of the Bank's single family
and tract construction lending operations from 1995 through
1998. Manager of Bank's Special Assets division from 1993
through 1995. Vice President, City National Bank, Real
Estate Special Assets group, from January 1993 to August
1993. Senior Vice President, Valley Federal Savings, from
1983 to 1992.
David L. Hardin................ 47 Executive Vice President of Hawthorne Savings, F.S.B. since
September 1993. Executive Vice President and Director,
Retail Banking of Downey Savings from February 1992 to
September 1993. Executive Vice President and Chief Retail
Officer of Valley Federal Savings from November 1990 to
February 1992.
Eileen Lyon.................... 43 Senior Vice President, General Counsel, and Corporate
Secretary of Hawthorne Financial Corporation and Hawthorne
Savings, F.S.B. since February 2000. Partner with Manatt,
Phelps & Phillips, LLP from 1993 to February 2000.
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NAME AGE POSITION WITH THE COMPANY AND PRIOR EXPERIENCE
---- --- ----------------------------------------------
Daniel A. Ruvalcaba............ 49 Executive Vice President and Chief Lending Officer of
Hawthorne Savings, F.S.B. since February 2000. Executive
Vice President and Chief Credit Officer of California
National Bank from 1997 to January 2000. Senior Vice
President of California Federal Bank from 1994 to 1997.
Executive Vice President and Senior Credit Officer of
Travelers Insurance Corporation from 1987 to 1994.
Charles B. Stoneburg........... 58 Executive Vice President of Hawthorne Savings, F.S.B. since
August 1993. President of Semper Enterprises Inc. from
August 1981 to July 1993. Executive Vice President of FiServ
Corporation from September 1972 to August 1981.
29
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET PRICES OF COMMON STOCK
The common stock of the Company ("Common Stock") is traded on the Nasdaq
National Market under the symbol "HTHR". Mellon Investor Services is the
Company's transfer agent and registrar, and is able to respond to inquiries from
shareholders on their website: www.mellon-investor.com. The following table sets
forth the high and low sales prices of the Common Stock as reported by Nasdaq
for the periods indicated below.
YEAR ENDED DECEMBER 31, 2000 HIGH LOW
---------------------------- ---- ---
First quarter............................................... 11 1/2 7 41/64
Second quarter.............................................. 8 3/4 7 3/8
Third quarter............................................... 12 7 3/4
Fourth quarter.............................................. 15 11
YEAR ENDED DECEMBER 31, 1999 HIGH LOW
---------------------------- ---- ---
First quarter............................................... 17 14 3/4
Second quarter.............................................. 16 1/2 13 5/16
Third quarter............................................... 16 3/4 13 1/4
Fourth quarter.............................................. 14 3/4 11 1/16
STOCKHOLDERS
As of March 23, 2001, there were approximately 411 holders of record.
DIVIDENDS
It is the present policy of the Company to retain earnings to provide funds
for use in its business. The Company has not paid cash dividends on the Common
Stock during the past several years and does not anticipate doing so in the
foreseeable future.
As a holding company whose only significant asset is the common stock of
the Bank, the Company's ability to pay dividends on its Common Stock and to
conduct business activities directly or in non-banking subsidiaries depends
significantly on the receipt of dividends or other distributions from the Bank.
Federal banking laws and regulations, including the regulations of the OTS,
limit the Bank's ability to pay dividends to the Company. The Bank generally may
not declare dividends or make any other capital distribution to the Company if,
after the payment of such dividends or other distribution, the Bank would fall
within any of the three undercapitalized categories under the prompt corrective
action standards established by the OTS and the other federal banking agencies.
Another regulation of the OTS also limits the Company's ability to pay dividends
and make other capital distributions in a manner that depends upon the extent to
which it meets regulatory capital requirements. In addition, HOLA generally
requires savings association subsidiary of a savings and loan holding company to
give the OTS at least 30 days advance notice of any proposed dividends to be
made on its guarantee, permanent or other non-withdrawable stock or else the
dividend will be invalid. See "Item 1. Business -- Regulation of the
Bank -- Capital Distribution Limitations." Further, the OTS may prohibit any
dividend or other capital distribution that it determines would constitute an
unsafe or unsound practice. In addition to the regulation of dividends and other
capital distributions, there are various statutory and regulatory limitations on
the extent to which the Bank can finance or otherwise transfer funds to the
Company or any of its non-banking subsidiaries, whether in the form of loans,
extensions of credit, investments or asset purchases. The director of the OTS
may further restrict these transactions in the interest of safety and soundness.
30
35
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below is derived from the audited
consolidated financial statements of the Company and should be read in
conjunction with the Consolidated Financial Statements presented elsewhere
herein.
AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- ---------- -------- --------
Statement of Operations Data:
Interest revenues....................... $ 148,988 $ 132,747 $ 106,992 $ 75,616 $ 65,354
Interest costs.......................... (88,682) (73,626) (61,874) (43,825) (39,960)
---------- ---------- ---------- -------- --------
Net interest income..................... 60,306 59,121 45,118 31,791 25,394
Provision for credit losses............. (6,000) (12,000) (7,135) (5,137) (6,067)
---------- ---------- ---------- -------- --------
Net interest income after provision for
credit losses........................ 54,306 47,121 37,983 26,654 19,327
Noninterest revenues, net............... 8,094 7,820 4,653 3,588 8,588
(Loss)/income from real estate operations,
net.................................. (924) 324 1,909 229 (2,378)
General and administrative expenses..... (34,328) (32,363) (28,802) (22,009) (21,046)
Other non-operating (expense)/ income... (2,196) (4,672) (31) 112 (3,366)(1)
---------- ---------- ---------- -------- --------
Total noninterest expenses...... (36,524) (37,035) (28,833) (21,897) (24,412)
Income before income tax (expense)/ benefit
and extraordinary item............... 24,952 18,230 15,712 8,574 1,125
Income tax (expense)/benefit............ (10,668) (8,030) (4,674) 2,577 6,382
---------- ---------- ---------- -------- --------
Income before extraordinary item........ 14,284 10,200 11,038 11,151 7,507
Extraordinary item...................... -- -- -- (1,534)(2) --
---------- ---------- ---------- -------- --------
Net income.............................. $ 14,284 $ 10,200 $ 11,038 $ 9,617 $ 7,507
========== ========== ========== ======== ========
Net income available for common stock... $ 14,284 $ 10,200 $ 11,038 $ 5,254 $ 5,070
========== ========== ========== ======== ========
Per Share Amounts:
Basic earnings per share before
extraordinary item................... $ 2.69 $ 1.93 $ 2.64 $ 2.35 $ 1.95
Basic earnings per share after
extraordinary item................... 2.69 1.93 2.64 1.82 1.95
Diluted earnings per share before
extraordinary item................... 1.94 1.33 1.65 1.30 1.17
Diluted earnings per share after
extraordinary item................... 1.94 1.33 1.65 1.00 1.17
Diluted book value per share............ 13.91 12.10 10.43 7.67 7.14
Balance Sheet Data at Period End:
Total assets............................ $1,753,395 $1,581,153 $1,412,434 $928,197 $847,195
Cash and cash equivalents............... 99,919 86,722 45,449 51,620 93,978
Investment securities................... -- -- -- 578 38,371
Loans receivable, net................... 1,608,067 1,444,968 1,326,791 838,251 672,401
Real estate owned, net.................. 2,859 5,587 4,070 9,859 20,140
Deposits................................ 1,214,856 1,086,635 1,019,450 799,501 717,809
Senior notes due 2004................... 39,358 40,000 40,000 40,000 --
Senior notes due 2000................... -- -- -- -- 12,307
Other borrowings........................ 384,000 349,000 264,000 40,000 50,000
Stockholders' equity.................... 104,161 92,304 81,424 42,319 43,922
Allowance for estimated credit losses... 29,450 24,285 17,111 13,274 13,515
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AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ---------- ---------- ---------- -------- --------
Asset Quality at Period End:
Nonaccrual loans........................ $ 31,601 $ 44,031 $ 47,688 $ 15,396 $ 28,624
Real estate owned, net.................. 2,859 5,587 4,070 9,859 20,140
---------- ---------- ---------- -------- --------
$ 34,460 $ 49,618 $ 51,758 $ 25,255 $ 48,764
========== ========== ========== ======== ========
Net charge-offs........................... $ 835 $ 4,826 $ 3,298 $ 5,378 $ 7,744
Yields and Costs (for the period):
Interest-earnings assets................ 8.94% 8.68% 9.06% 9.00% 8.43%
Interest-bearing liabilities............ 5.81% 5.21% 5.60% 5.44% 5.29%
Interest rate spread(3)................. 3.13% 3.47% 3.46% 3.56% 3.14%
Net interest margin(4).................. 3.62% 3.87% 3.82% 3.78% 3.28%
Performance Ratios(5):
Return on average assets................ 0.85% 0.66% 0.93% 1.11% 0.93%
Return on average common stockholders'
equity............................... 14.58% 11.66% 18.22% 19.83% 17.75%
Average stockholders' equity to average
assets............................... 5.85% 5.68% 5.09% 5.60% 5.24%
Efficiency ratio(6)..................... 50.19% 48.35% 57.88% 62.19% 77.03%
Bank Capital Ratios at Period End:
Tangible................................ 8.01% 8.05% 7.65% 7.55% 6.27%
Core.................................... 8.01% 8.05% 7.65% 7.55% 6.27%
Tier 1.................................. 11.30% 11.37% 10.10% 10.23% 9.85%
Risk-based.............................. 12.23% 12.50% 11.10% 11.48% 11.11%
Asset Quality Data at Period End:
Total nonaccrual loans to total assets... 1.80% 2.78% 3.38% 1.66% 3.38%
Nonaccrual loans to total gross loans... 1.93% 3.00% 3.55% 1.81% 4.17%
Allowance for estimated credit losses to
gross loans.......................... 1.80% 1.65% 1.27% 1.56% 1.97%
Allowance for estimated credit losses to
nonaccrual loans..................... 93.19% 55.15% 35.88% 86.22% 47.22%
Net charge-offs to average loans........ 0.05% 0.34% 0.30% 0.72% 1.15%
- ---------------
(1) Includes a one-time charge on all deposits insured by the SAIF as of March
31, 1996 to recapitalize the SAIF.
(2) Relates to the accelerated write off of unamortized issue costs and original
issue discount associated with Senior Notes due 2000, which were issued by
the Company in December 1995 and repaid in full in December 1997, with a
portion of the proceeds from the offering of Senior Notes due 2004.
(3) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(4) Net interest income divided by average interest-earning assets.
(5) With the exception of period end ratios, all ratios are based on average
balances for the period.
(6) Represents general and administrative expenses divided by net interest
income before provision for credit losses and noninterest revenues.
32
37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion provides information about the results of
operations, financial condition, liquidity, and asset quality of the Company.
This information is intended to facilitate the understanding and assessment of
significant changes and trends related to the financial condition of the Company
and the results of its operations. This discussion and analysis should be read
in conjunction with the Company's Consolidated Financial Statements and the
accompanying notes presented herein. See "Cautionary Statement Regarding Forward
Looking Statements."
RESULTS OF OPERATIONS
2000 COMPARED WITH 1999
GENERAL
Net income for the year ended December 31, 2000 was $14.3 million, or $1.94
per diluted share, compared with $10.2 million, or $1.33 per diluted share, for
the same period in 1999. This net income resulted in a return on average assets
("ROA") of 0.85%, and a return on average equity ("ROE") of 14.58% for the year
ended December 31, 2000, compared with a ROA of 0.66% and a ROE of 11.66%,
during the same period in 1999. Pre-tax income increased 36.87% for the year
ended December 31, 2000 to $25.0 million in 2000 from $18.2 million generated
during the same period in 1999.
The Company's net interest income before provision for credit losses
increased 2.00% to $60.3 million for the year ended December 31, 2000, compared
with $59.1 million in 1999. The Company's yield on average earning assets was
8.94% for the year ended December 31, 2000, compared with 8.68% during the same
period in 1999. The average cost of interest-bearing liabilities for the Company
increased to 5.81% during the year ended December 31, 2000, compared with 5.21%
during the same period in 1999. The Company's resulting net interest margin for
the year ended December 31, 2000 was 3.62%, compared with 3.87% during the same
period in 1999. 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 while interest-bearing liabilities are pricing off of the higher
short term rates.
Provisions for credit losses totaled $6.0 million in 2000, compared with
$12.0 million in 1999. At December 31, 2000, the ratio of total allowance for
estimated credit losses to gross loans reached 1.80%, compared with 1.65% at
December 31, 1999.
Nonaccrual loans totaled $31.6 million at December 31, 2000 (or 1.80% of
total assets), compared with nonaccrual loans of $44.0 million (or 2.78% of
total assets) at December 31, 1999. Other classified loans were $40.6 million at
December 31, 2000, compared with $25.6 million at December 31, 1999. Delinquent
loans totaled $26.9 million at December 31, 2000, compared with $24.0 million at
December 31, 1999.
Noninterest revenues were $8.1 million in 2000, compared with noninterest
revenues of $7.8 million earned in 1999. Noninterest revenues in 2000 included a
$1.2 million award from the United States Treasury Department's Bank Enterprise
Award program for its community involvement and the financing of affordable
housing and other community projects in under-secured neighborhoods, as
discussed elsewhere herein.
Losses from real estate operations, net, were $0.9 million in 2000,
compared with income of $0.3 million in 1999. The loss from real estate
operations resulted primarily from a $0.5 million write-down and subsequent loss
of $0.3 million on the sale of one property versus net recoveries during 1999.
Total general and administrative expenses ("G&A") were $34.3 million for
the year ended December 31, 2000, a 6.07% increase over the $32.4 million of G&A
incurred during the same period in 1999. The increase in G&A was primarily due
to increases in employee costs and professional fees. The $2.5 million decrease
in other non-operating expenses was primarily due to fewer legal settlements in
2000 compared with 1999.
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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 each of the three
years ended December 31. The interest costs associated with the Company's
issuance of 1997 Senior Notes are included in the table.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------
2000 1999 1998
------------------------------- ------------------------------- -------------------------------
AVERAGE REVENUES/ YIELD/ AVERAGE REVENUES/ YIELD/ AVERAGE REVENUES/ YIELD/
BALANCE COST COST BALANCE COST COST BALANCE COST COST
(DOLLARS IN THOUSANDS) ---------- --------- ------ ---------- --------- ------ ---------- --------- ------
Assets:
Interest-earning assets:
Loans receivable(1)..... $1,547,206 $141,279 9.13% $1,411,697 $126,854 8.99% $1,081,382 $102,213 9.45%
Cash and cash
equivalents........... 98,071 6,233 6.36 99,179 4,911 4.95 81,188 3,698 4.55
Investment securities... -- -- -- -- -- -- 8,801 510 5.79
Investment in capital
stock of Federal Home
Loan Bank............. 20,566 1,476 7.18 18,344 982 5.35 9,862 571 5.79
---------- -------- ---------- -------- ---------- --------
Total
interest-earning
assets............ 1,665,843 148,988 8.94 1,529,220 132,747 8.68 1,181,233 106,992 9.06
-------- -------- --------
Noninterest-earning
assets.................. 9,410 11,005 8,839
---------- ---------- ----------
Total assets........ $1,675,253 $1,540,225 $1,190,072
========== ========== ==========
Liabilities and
Stockholders' Equity:
Interest-bearing
liabilities:
Deposits................ $1,138,119 $ 63,513 5.58 $1,029,701 $ 50,831 4.94 $ 894,337 $ 47,642 5.33
FHLB advances........... 346,983 20,180 5.82 343,205 17,795 5.18 170,060 9,232 5.43
Senior notes............ 39,912 4,989 12.50 40,000 5,000 12.50 40,000 5,000 12.50
---------- -------- ---------- -------- ---------- --------
Total
interest-bearing
liabilities....... 1,525,014 88,682 5.81 1,412,906 73,626 5.21 1,104,397 61,874 5.60
-------- -------- --------
Noninterest-bearing
checking................ 31,174 24,469 13,378
Noninterest-bearing
liabilities............. 21,124 15,337 11,703
---------- ---------- ----------
Stockholders' equity...... 97,941 87,513 60,594
---------- ---------- ----------
Total liabilities
and stockholders'
equity............ $1,675,253 $1,540,225 $1,190,072
========== ========== ==========
Net interest income......... $ 60,306 $ 59,121 $ 45,118
======== ======== ========
Interest rate spread........ 3.13% 3.47% 3.46%
==== ===== ====
Net interest margin......... 3.62% 3.87% 3.82%
==== ===== ====
- ---------------
(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 REO.
The Company recorded net interest income before provision for credit losses
of $60.3 million and $59.1 million for the years ended December 31, 2000 and
1999, respectively, reflecting an increase of 2.00%. Average earning assets were
$1.7 billion for the year ended December 31, 2000, compared with $1.5 billion
during 1999, reflecting an increase of 8.93%. The yield on interest-earning
assets was 8.94% in 2000, compared with 8.68% in 1999. 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 5.81%
during the year ended December 31, 2000, compared with 5.21% during the same
period in 1999. Expressed as a percentage of interest-earning assets, the
Company's resulting net interest margin was 3.62% and 3.87% in 2000 and 1999,
respectively. The compression in the net interest margin is the result of the
inverted yield curve environment in
34
39
which short term rates are higher than long term rates. In turn, adjustable rate
assets are repricing off of the lower, long term rates, while interest-bearing
liabilities are repricing off of the higher, short term rates.
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 December 31, 2000, 89.45% of the Company's net loan portfolio was
adjustable rate, with 83.41% 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 December 31, 2000, 76.11% of the Company's interest-bearing deposits
were comprised of certificate accounts, the majority of which have original
terms averaging twelve months. The remaining, weighted average term to maturity
for the Company's certificate accounts approximated six months at December 31,
2000. 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 December 31, 2000, 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.
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),
35
40
(2) changes in rate (i.e., changes in rate multiplied by old volume) and (3)
changes attributable to both rate and volume.
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
2000 AND 1999 1999 AND 1998
INCREASE (DECREASE) DUE TO CHANGE IN INCREASE (DECREASE) DUE TO CHANGE IN
---------------------------------------- ----------------------------------------
VOLUME AND NET VOLUME AND NET
VOLUME RATE RATE(1) CHANGE VOLUME RATE RATE(1) CHANGE
(DOLLARS IN THOUSANDS) ------- ------- ---------- ------- ------- ------- ---------- -------
Interest-earning assets:
Loans receivable(2).................. $12,177 $ 2,051 $ 197 $14,425 $31,222 $(5,041) $(1,540) $24,641
Cash and cash equivalents............ (55) 1,392 (15) 1,322 819 322 72 1,213
Investment securities................ -- -- -- -- (510) (510) 510 (510)
Investment in capital stock of
Federal Home Loan Bank............. 119 335 40 494 491 (43) (37) 411
------- ------- ----- ------- ------- ------- ------- -------
12,241 3,778 222 16,241 32,022 (5,272) (995) 25,755
------- ------- ----- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits............................. 5,352 6,632 698 12,682 7,211 (3,493) (529) 3,189
FHLB advances........................ 196 2,165 24 2,385 9,399 (414) (422) 8,563
Senior notes......................... (11) -- -- (11) -- -- -- --
------- ------- ----- ------- ------- ------- ------- -------
5,537 8,797 722 15,056 16,610 (3,907) (951) 11,752
------- ------- ----- ------- ------- ------- ------- -------
Change in net interest income.......... $ 6,704 $(5,019) $(500) $ 1,185 $15,412 $(1,365) $ (44) $14,003
======= ======= ===== ======= ======= ======= ======= =======
- ---------------
(1) Calculated by multiplying change in rate by change in volume.
(2) Includes the interest on nonaccrual loans only to the extent that it was
paid and recognized as interest income.
The Company's interest revenues increased by $16.2 million, or 12.23%,
during the year ended December 31, 2000, compared with the same period in 1999.
This increase was primarily attributable to a 9.60% increase in the average
balance of loans outstanding and a 14 basis point increase in the yield on
average loans outstanding, which averaged 9.13% during 2000, compared with 8.99%
in 1999. Average total loans, net of deferred fees, grew to $1.5 billion in
2000, an increase of 9.60% over $1.4 billion in 1999.
Interest costs increased by $15.1 million, or 20.45%, during the ended
December 31, 2000, compared with the same period in 1999. The average balance of
certificates of deposits increased $80.6 million, to $891.0 million and 5.94% in
average cost of funds during the year ended December 31, 2000, compared with
$810.4 million and 5.22% in average cost of funds during the same period in
1999. In addition, the average balance of money market accounts reflected an
increase of $24.3 million, to $180.8 million and 4.99% in average cost of funds
in 2000, compared with $156.5 million and 4.37% in average cost of funds in
1999. The increase in volume and rates on deposits had a negative impact on the
Company's average cost of interest-bearing liabilities.
These changes in interest revenues and interest costs produced an increase
of $1.2 million, or 2.00%, in the Company's net interest income for the year
ended December 31, 2000, compared with the same period during 1999. Expressed as
a percentage of interest-earning assets, the Company's net interest margin
decreased to 3.62% during 2000, compared with the net interest margin of 3.87%
produced during the same period in 1999. 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.
PROVISION FOR ESTIMATED CREDIT LOSSES
Provisions for estimated credit losses were $6.0 million and $12.0 million
for 2000 and 1999, respectively. The Company's ratio of net charge-offs was
0.05% in 2000, an improvement over 0.34% in 1999. Additionally, total classified
assets to Bank core capital and general allowance for estimated credit losses
have decreased to 45.78% in 2000, compared with 49.96% in 1999.
Average loans outstanding during 2000 increased by $135.5 million, or 9.60%
over 1999, while the provision for credit losses decreased by $6.0 million in
2000, or 50.0%, compared to 1999 provisions. The
36
41
Company reported a ratio of the general allowance for estimated credit losses to
loans receivable, net of specific reserves, of 1.45% as of December 31, 2000,
compared with 1.60% as of December 31, 1999.
Although the Company maintains its allowance for estimated credit losses at
a level which it considers to be adequate to provide for potential losses, based
on presently known conditions, there can be no assurance that such losses will
not exceed the estimated amounts, thereby adversely affecting future results of
operations. The calculation of the adequacy of the allowance for estimated
credit losses, and therefore the requisite amount of provision for credit
losses, is based on several factors, including underlying loan collateral
values, delinquency trends and historical loan loss experience, all of which can
change without notice based on market and economic conditions and other factors.
See "Asset Quality" for a more complete discussion of the Company's allowance
for estimated credit losses.
NONINTEREST REVENUES
Noninterest revenues were $8.1 million for the year ended December 31,
2000, an increase of $0.3 million, or 3.50%, from $7.8 million earned in 1999.
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 for the year ended December 31, 2000 included a $1.2
million award from the United States Treasury Department's Bank Enterprise Award
Program for its lending and financial services activities in distressed
communities. The Bank was one of 158 depository institutions that received
awards in 2000. In addition, the Bank's service fees on deposits of $1.0 million
in 2000 increased 106.05% from 1999, primarily due to a new fee schedule rolled
out in July 2000.
REAL ESTATE OPERATIONS
The table below sets forth the costs and revenues attributable to the
Company's REO properties for the periods indicated. The compensatory and legal
costs directly associated with the Company's property management and disposal
operations are included in general and administrative expenses.
YEAR ENDED DECEMBER 31,
------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ----- ----- ------
Expenses associated with real estate operations:
Repairs, maintenance and renovation..................... $(294) $(219) $ (277)
Insurance and property taxes............................ (18) (132) (123)
----- ----- ------
(312) (351) (400)
Net (loss)/recoveries from sales of REO................... (166) 754 2,278
Property operations, net.................................. 30 1 91
Charge-off/provision for estimated losses on REO.......... (476) (80) (60)
----- ----- ------
(Loss)/income from real estate operations, net............ $(924) $ 324 $1,909
===== ===== ======
Net (loss)/income 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.
37
42
During the year ended December 31, 2000, the Company sold 14 properties
generating net cash proceeds of $5.1 million and a net loss of $0.2 million,
compared with sales of 22 properties generating net cash proceeds of $10.4
million and a net recovery of $0.8 million during the year ended December 31,
1999.
NONINTEREST EXPENSES
General and Administrative Expenses
The table below details the Company's general and administrative expenses
for the periods indicated.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
2000 AND 1999 1999 AND 1998
---------------------------- ----------------------------
2000 1999 CHANGE 1999 1998 CHANGE
(DOLLARS IN THOUSANDS) ------- ------- ------ ------- ------- ------
Employee................. $17,391 $14,822 $2,569 $14,822 $14,414 $ 408
Operating................ 6,092 6,393 (301) 6,393 6,177 216
Occupancy................ 3,758 3,889 (131) 3,889 3,404 485
Professional............. 4,255 4,035 220 4,035 1,738 2,297
Technology............... 1,939 1,988 (49) 1,988 2,117 (129)
SAIF premiums and OTS
assessments............ 893 1,236 (343) 1,236 952 284
------- ------- ------ ------- ------- ------
Total.......... $34,328 $32,363 $1,965 $32,363 $28,802 $3,561
======= ======= ====== ======= ======= ======
Total general and administrative expenses were $34.3 million in 2000, a
6.07% increase over the $32.4 million of G&A incurred during the same period in
1999. The increase in G&A expenses was primarily due to increases in employee
costs and professional fees. The increase in employee costs was primarily due to
$1.2 million in higher incentive costs and a decrease of $1.5 million in
deferred costs related to more standardized loan structures and underwriting
procedures. The increase in professional fees was primarily comprised of outside
consultants working on operational projects, partially offset by decreases in
legal fees attributable to ongoing litigation matters previously disclosed as
well as loan documentation and restructurings. See "Item 3 -- Legal
Proceedings."
The Company pays premiums to the SAIF based upon the dollar amount of
deposits it holds and the assessment rate charged by the FDIC, which is based
upon the Company's financial condition, its capital ratios and the rating it
receives in connection with annual regulatory examinations by the OTS.
The increase in G&A expenses 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 year ended December 31, 2000, increased to
50.19% compared with 48.35% during the same period in 1999.
Other Non-Operating Expense
Other non-operating expense totaled $2.2 million for the year ended
December 31, 2000, primarily incurred during the first quarter, of which $2.0
million related to amounts paid, or reserved for payment, in connection with
ongoing litigation and/or satisfaction of judgments against the Company. The
remaining expense was primarily in connection with the early termination of the
Irvine office lease.
INCOME TAXES
The Company recorded an income tax provision of $10.7 million for the year
ended December 31, 2000, compared with $8.0 million during 1999. The Company's
effective tax rate was 42.75% for the year ended December 31, 2000, compared
with 44.05% during the same period in 1999.
38
43
1999 COMPARED WITH 1998
GENERAL
Net income for the year ended December 31, 1999 was $10.2 million, or $1.33
per diluted share, compared with $11.0 million, or $1.65 per diluted share, for
the same period in 1998. This net income resulted in a return on average assets
of 0.66%, and a return on average equity of 11.66%, compared with a ROA of 0.93%
and ROE of 18.22%, during the same period in 1998. Pre-tax income increased
16.03% for the year ended December 31, 1999 to $18.2 million from $15.7 million
generated during the same period in 1998.
The Company's net interest income before provision for credit losses
increased 31.04% to $59.1 million for the year ended December 31, 1999, compared
with $45.1 million in 1998. The Company's yield on average earning assets was
8.68% for the year ended December 31, 1999, compared with 9.06% during the same
period in 1998. The average cost of interest-bearing liabilities for the Company
decreased to 5.21% during the year ended December 31, 1999, compared with 5.60%
during the same period in 1998. The Company's resulting net interest margin for
the year ended December 31, 1999, was 3.87%, compared with 3.82% during the same
period in 1998.
Provisions for credit losses totaled $12.0 million in 1999, compared with
$7.1 million in 1998. This growth in the provision for credit losses was the
result of management's previously announced commitment to increase the Bank's
allowance for estimated credit losses by the end of 1999. This commitment
acknowledged (1) the significant growth in net loans, (2) the introduction
during 1998 and 1999 of new loan products, and (3) the resulting lack of
seasoning of many of the Bank's loans. At December 31, 1999, the ratio of total
allowance for estimated credit losses to gross loans reached 1.65%, compared
with 1.27% at December 31, 1998.
Nonaccrual loans totaled $44.0 million at December 31, 1999 (or 2.78% of
total assets), compared with nonaccrual loans of $47.7 million (or 3.38% of
total assets) at December 31, 1998. Included in nonaccrual loans at December 31,
1999, were five single family residential loans with balances greater than $1.0
million representing $18.0 million, or 40.93% of total nonaccrual loans, and one
commercial loan with a $10.5 million balance, or 23.84% of total nonaccrual
loans, at December 31, 1999. The average LTV for the five single family
residential loans was 73.80%. Other classified loans were $25.6 million at
December 31, 1999, compared with $45.4 million at December 31, 1998. Delinquent
loans totaled $24.0 million at December 31, 1999, compared with $51.1 million at
December 31, 1998.
Noninterest revenues were $7.8 million in 1999, compared with $4.7 million
earned in 1998. The increase in noninterest revenues resulted primarily from a
greater amount of exit and release fees and prepayment penalties in connection
with loans repaid during the period.
Income from real estate operations, net, was $0.3 million for the year
ended December 31, 1999, compared with $1.9 million earned in 1998. The decrease
in income from real estate operations in 1999 was the result of higher net
recoveries in 1998, as discussed elsewhere herein.
Total general and administrative expenses were $32.4 million for the year
ended December 31, 1999, a 12.36% increase over the $28.8 million of G&A
incurred during the same period in 1998. The increase in G&A was primarily due
to increases in professional fees, occupancy expenses attributable to leasehold
improvements at the corporate headquarters and employee costs. The increase in
professional fees was primarily comprised of legal fees attributable to ongoing
litigation matters as well as loan documentation and restructurings. The
remaining professional fees consisted of the Company's independent accountants,
other professional fees related to operational projects and recruiting fees. The
increase in employee costs in 1999 was primarily due to additional personnel
added to the Company's various business and staff support groups.
The Company incurred $4.7 million in other non-operating expenses during
1999, of which $4.3 million related to amounts paid, or reserved for payment, in
connection with ongoing litigation and/or satisfaction of judgments against the
Company, and for severance for the former CEO. During 1998, the Company incurred
minimal non-operating expenses primarily related to losses on the sale of
certain fixed assets.
39
44
NET INTEREST INCOME
The Company recorded net interest income of $59.1 million and $45.1 million
for the years ended December 31, 1999 and 1998, respectively, reflecting an
increase of 31.04%. Average earning assets were $1.5 billion for the year ended
December 31, 1999, compared with $1.2 billion during 1998, reflecting an
increase of 29.46%. The yield on interest-earning assets was 8.68% in 1999,
compared with 9.06% in 1998.
The Company's interest revenues increased by $25.8 million, or 24.07%,
during the year ended December 31, 1999, compared with the same period in 1998.
Average total loans, net of deferred fees, grew to $1.4 billion in 1999, an
increase of 30.55%, which was partially offset by a 46 basis point decrease in
the yield on average loans outstanding, which averaged 8.99% during 1999,
compared with 9.45% during 1998. The primary reason for the decline in the loan
portfolio yield is due to lower yielding loans being added to the loan portfolio
during 1997, 1998 and 1999, reflecting the increased competitive rate pressure
in the marketplace and a change in the portfolio mix. In addition, higher
yielding loans were paying off during 1998 and 1999, adding to the overall
decline in the yield on average earning assets.
The steady growth in loans was funded through core deposit growth and
borrowings from the FHLB. The average cost of interest-bearing liabilities for
the Company decreased to 5.21% during the year ended December 31, 1999, compared
with 5.60% during the same period in 1998. Interest costs increased by $11.8
million, or 18.99%, during the year ended December 31, 1999, compared with the
same period in 1998, primarily due to a 27.93% increase in the average balance
of the Company's interest-bearing liabilities. This increase was partially
offset by a decrease in the weighted average rates incurred on the Company's
deposits and FHLB advances, which together averaged 5.00% for the year ended
December 31, 1999, compared with 5.34% during the same period of 1998. The
average balance of certificates of deposits increased $37.6 million, to $810.4
million and 5.22% in average cost of funds during the year ended December 31,
1999, compared with $772.7 million and 5.60% in average cost of funds during the
same period in 1998. At December 31, 1999, certificates of deposit totaled
$838.1 million, or 77.13% of total deposits, from $833.7 million, or 81.78% of
total deposits at December 31, 1998. This reduced reliance on certificates of
deposit, in conjunction with a decrease in the weighted average rate on deposits
and FHLB advances, had a positive impact on the Company's cost of
interest-bearing liabilities and was achieved by capitalizing on the Bank's
strong community involvement.
Expressed as a percentage of interest-earning assets, the Company's
resulting net interest margin was 3.87% and 3.82% in 1999 and 1998,
respectively. The increase in net interest income was primarily due to
significant growth in earning assets, which was a direct result of the Bank's
continuing successful pursuit of real estate secured financing business.
PROVISION FOR ESTIMATED CREDIT LOSSES
Provisions for estimated credit losses were $12.0 million and $7.1 million
for 1999 and 1998, respectively. The Company's ratio of net charge-offs was
0.34% in 1999, compared with 0.30% in 1998. Additionally, total classified
assets to Bank core capital and general allowance for estimated credit losses
have decreased to 49.96% in 1999, compared with 80.56% in 1998.
The increase of $4.9 million, or 68.19%, in the level of provision for
estimated credit losses in 1999, compared with 1998, reflected management's
intention to increase the ratio of the Company's general valuation reserves to
approximately 1.50% of net loans by the end of 1999, a level deemed by
management to be prudent in view of the significant growth in the Company's loan
portfolio since 1997, the relative lack of seasoning of many of the Company's
loans, and the significant amount of construction loans in the Company's loan
portfolio directed at financing real estate development. The Company achieved a
ratio of the general allowance for estimated credit losses to loans receivable,
net of specific reserves, of 1.60% as of December 31, 1999, compared with 0.89%
in 1998. See "Asset Quality" for a more complete discussion of the Company's
allowance for estimated credit losses.
40
45
NONINTEREST REVENUES
Noninterest revenues were $7.8 million for the year ended December 31,
1999, an increase of $3.2 million, or 68.06%, from $4.7 million earned in 1998.
During the last half of 1998, the sharp drop in market interest rates increased
the volume of prepayments and refinancings during the first half of 1999 to $7.3
million, resulting in a $3.1 million, or 73.84%, increase.
REAL ESTATE OPERATIONS
During the year ended December 31, 1999, the Company sold 22 properties
generating net cash proceeds of $10.4 million and a net recovery of $0.8
million, compared with sales of 102 properties generating net cash proceeds of
$15.2 million and a net recovery of $2.3 million during the same period of 1998.
NONINTEREST EXPENSES
General and Administrative Expenses
General and administrative expenses totaled $32.4 million in 1999, an
increase of 12.36% over the $28.8 million of G&A incurred during the same period
in 1998. Professional fees totaled $4.0 million, which included expenses of $1.6
million related to outside litigation counsel, who represent the Company in a
variety of legal matters due to ongoing litigation as well as loan documentation
and restructurings. The remaining professional fees consisted of the Company's
independent accountants, other professional fees related to operational projects
and recruiting fees. The increase of $0.5 million in occupancy expenses was
attributable to leasehold improvements at the corporate headquarters. The
increase of $0.4 million in employee costs in 1999 was primarily due to
additional personnel added to the Company's various business and staff support
groups. During 1999 and 1998, the Company employed an average of 272 and 251
full-time equivalent individuals, respectively. The corresponding growth in
employee-related expenses, which consist primarily of base salaries, incentive
compensation and the Company's share of benefit expenses, was successfully
leveraged resulting in greater growth in the dollar amount of the Company's net
interest income.
The efficiency ratio for the twelve months ended December 31, 1999, was
48.35% compared with 57.88% during the same period in 1998.
Other Non-Operating Expense
The Company incurred $4.7 million in other non-operating expenses during
1999, primarily during the fourth quarter, of which $4.3 million related to
amounts paid, or reserved for payment, in connection with ongoing litigation
and/or satisfaction of judgments against the Company, and for severance for the
former CEO. During 1998, the Company incurred minimal non-operating expenses
primarily related to losses on sale of certain fixed assets.
INCOME TAXES
The Company recorded an income tax provision of $8.0 million for the year
ended December 31, 1999, compared with $4.7 million during 1998. The Company's
effective tax rate was 44.05% for the year ended December 31, 1999, compared
with 29.75% during the same period in 1998. The Company returned to taxable
status during 1998, following several years in which it realized substantial
income tax benefits from utilization of accumulated operating loss
carry-forwards.
BALANCE SHEET ANALYSIS
The Company's total assets at December 31, 2000 were $1.8 billion, an
increase of $172.2 million, or 10.89%, over December 31, 1999. As of December
31, 2000, asset growth was reflected in all categories of interest-earning
assets, with the exception of FHLB stock. Loan receivables, net, reflected the
largest growth, increasing by $163.1 million over 1999. The steady growth in
loans was funded through core deposit growth and borrowings from the FHLB.
Deposits increased by 11.80% year-over-year to $1.2 billion from $1.1 billion,
with transaction accounts increasing $66.9 million, or 26.92%, to $315.4 million
at December 31, 2000 from
41
46
$248.5 million at December 31, 1999. At December 31, 2000, certificates of
deposit totaled $899.5 million, or 74.04% of total deposits, down from 77.13% of
total deposits, or $838.1 million at December 31, 1999. The cross-sell ratio,
defined as the number of different types of loan and/or deposit products per
household serviced, was 1.51 services per household at December 31, 2000,
compared with 1.32 at December 31, 1999.
STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL
The Company's capital consists of common stockholders' equity, which
amounted to $104.2 million, or 5.94% of total assets at December 31, 2000,
compared with $92.3 million, or 5.84% of total assets at December 31, 1999.
Management is committed to maintaining capital at a level sufficient to
assure shareholders, customers, and regulators that the Company and its Bank
subsidiary are financially sound. The Company and the Bank are subject to
risk-based capital regulations adopted by the federal banking regulators in
January 1990. These guidelines are used to evaluate capital adequacy and are
based on an institution's asset risk profile and off-balance sheet exposures.
According to the regulations, institutions whose Tier 1 and total capital ratios
meet or exceed 6% and 10%, respectively, are deemed "well capitalized".
The table below compares the Company'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
FOR CAPITAL CAPITALIZED
ADEQUACY UNDER PCA
ACTUAL PURPOSES PROVISIONS
---------------- --------------- ----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(DOLLARS IN THOUSANDS) -------- ----- ------- ----- -------- -----
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%
As of December 31, 1999:
Total capital to risk weighted assets... $139,815 12.50% $89,468 8.00% $111,835 10.00%
Core capital to adjusted tangible
assets............................... 127,160 8.05% 63,174 4.00% 78,967 5.00%
Tangible capital to adjusted tangible
assets............................... 127,160 8.05% 23,690 1.50% n/a n/a
Tier 1 capital to risk weighted
assets............................... 127,160 11.37% n/a n/a 67,101 6.00%
The following table summarizes the regulatory capital requirements under
the Home Owners' Loan Act ("HOLA") for the Bank as of December 31, 2000. As
indicated in the table below, the Bank's capital levels exceed all three of the
currently applicable minimum HOLA capital requirements.
TANGIBLE CAPITAL CORE CAPITAL RISK-BASED CAPITAL
------------------ ------------------ -------------------
BALANCE % BALANCE % BALANCE %
(DOLLARS IN THOUSANDS) ---------- ---- ---------- ---- ---------- -----
Stockholders' equity........... $ 140,387 -- $ 140,387 -- $ 140,387 --
Adjustments:
General reserves............. -- -- -- -- 15,632 --
Other(1)..................... -- -- -- -- (4,105) --
---------- ---- ---------- ---- ---------- -----
Regulatory capital............. 140,387 8.01% 140,387 8.01% 151,914 12.23%
Regulatory capital
requirement.................. 26,279 1.50 70,078 4.00 99,407 8.00
---------- ---- ---------- ---- ---------- -----
Excess capital................. $ 114,108 6.51% $ 70,309 4.01% $ 52,507 4.23%
========== ==== ========== ==== ========== =====
Adjusted assets(2)............. $1,751,960 $1,751,960 $1,242,588
========== ========== ==========
- ---------------
(1) Includes the portion of non-residential construction and land development
loans that exceed a loan to value ratio of 80%.
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(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.
CAPITAL RESOURCES AND LIQUIDITY
The Company had $2.1 million cash on hand at December 31, 2000. The Company
is a holding company with no significant business operations outside of the
Bank. Its requisite obligations, which pertain to its debt and operations, are
dependent upon its sole source of funds, which are dividends from the Bank.
The Company's liquidity position refers to the extent to which the
Company's funding sources are sufficient to meet its current and long term cash
requirements. Federal regulations currently require savings associations to
maintain a monthly average daily balance of liquid assets equal to 4% of the
average daily balance of its net withdrawable accounts and short term borrowings
during the preceding calendar quarter. The Bank has liquidity ratios of 6.22%
and 8.76% for December 2000 and 1999, respectively. 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.
The Company's current primary funding resources are deposit accounts,
principal payments on loans, proceeds from sales of REO, advances from the FHLB
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, operating
costs and expenses, and holding and refurbishment costs on REO.
In July 2000, the Company authorized the repurchase of up to an additional
5% of its Common Stock, or approximately 264,000 shares. This is in addition to
the 5% repurchase authorization announced in March 2000, for approximately
277,000 shares. As of February 26, 2001, the Company has repurchased 421,006
shares at an average price of $9.74.
In November 2000, the Company repurchased $642,000 of its 1997 Senior Notes
at an average price of 96.2% of par value. As of February 26, 2001, the Company
repurchased $2.1 million of its 1997 Senior Notes at an average price of 99.6%
of par value. 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 Company intends to use the proceeds to repurchase some of its
outstanding 12.50% 1997 Senior Notes due 2004 in order to reduce its overall
interest costs. To the extent that the Company is unable to use the full amount
of the proceeds to repurchase 1997 Senior Notes, the capital will be used to
repurchase Common Stock or to fund acquisitions of complementary lines of
business. Some portion of the proceeds may be invested in the Bank to support
future growth. Pending use of the proceeds as described above, the proceeds will
be invested in short term investments.
LIQUIDITY
OTS regulations require a savings association to maintain an average daily
balance of liquid assets (including cash and cash equivalents, and certain
marketable securities that are not committed) equal to at least 4% of either (1)
the average daily balance of its net withdrawable accounts and short term
borrowings
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during the preceding calendar quarter, or (2) the amount of its net withdrawable
accounts and short term borrowings at the end of its preceding calendar quarter.
Under FIRREA, this liquidity requirement may be changed from time to time by the
OTS to any amount within the range of 4% to 10% of such accounts and borrowings
depending upon economic conditions and the deposit flows of the member
associations. Monetary penalties may be imposed for failure to meet this
liquidity ratio requirement. The Company's average liquidity for the quarter
ending December 31, 2000, was 8.30%, which exceeds the applicable 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.
INTEREST RATE RISK MANAGEMENT
Interest rate risk ("IRR") and credit risk constitute the two greatest
sources of financial exposure for insured financial institutions. Please refer
to "Item 1 -- Business -- Statistical Financial Data -- Loan Portfolio," for a
thorough discussion of the Company's lending activities. 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 realizes income principally from the differential or spread
between the interest earned on loans, investments, other interest-earning assets
and the interest incurred on deposits and borrowings. The volumes and yields on
loans, deposits and borrowings are affected by market interest rates. As of
December 31, 2000, 89.45% of the Company's loan portfolio was tied to adjustable
rate indices, such as COFI, Prime Rate, CMT, MTA and LIBOR. The majority of the
Company's deposits are time deposits with a stated maturity (generally one year
or less) and a fixed rate of interest. As of December 31, 2000, 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.
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 or
expand significantly 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.
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.
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
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49
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 7A, 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.
Since 1995, the Company has been utilizing interest rate floors to mitigate
the risk of interest margin compression in a decreasing rate environment.
Additionally, on most new income property loans, the Company utilizes interest
rate caps. These are life caps and are usually three points above the rate at
underwriting or at an amount that would still allow for one-to-one debt service
coverage at the maximum rate, thereby reducing the likelihood of borrower
default in a rising rate environment. The risk to the Company associated with
the interest rate floors is that interest rates may decline, and the borrower
may choose to refinance the loan, either with the Company or with another
financial institution, resulting in the Company having to replace the
higher-yielding asset at a lower rate. The risk to the Company associated with
interest rate caps is that interest rates will exceed the maximum rates on such
loans, and while the Company's cost of funds continues to rise, the interest
income derived from these loans will be fixed, resulting in an overall
compression on net interest income.
A traditional, although analytically limited measure, of a financial
institution's IRR is the "static gap." Static gap is the difference between the
amount of assets and liabilities (adjusted for any off-balance positions) which
are expected to mature or reprice within a specific period. Generally, a
positive gap benefits an institution during periods of rising interest rates,
and a negative gap benefits an institution during periods of declining interest
rates. However, because a portion of the indices that the Company's loan
products are priced to may lag changes in market interest rates by three months
or more, the Company's net interest income may not reflect changes in interest
rates immediately.
At December 31, 2000, 76.11% of the Company's interest-bearing deposits
were comprised of certificate accounts, the majority of which have original
terms averaging twelve months. The remaining, weighted average term to maturity
for the Company's certificate accounts approximated six months at December 31,
2000. 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. However, if interest rates
continue to fall, the Company may be unable to match the decrease in its offered
deposit rates in order to mitigate the risk of deposit outflows.
The following table sets forth information concerning repricing
opportunities for the Company's interest-earning assets and interest-bearing
liabilities as of December 31, 2000. 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
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50
period in which they mature. Such assets and liabilities are classified by the
earlier of their maturity or repricing date.
DECEMBER 31, 2000
------------------------------------------------------------------------
OVER THREE OVER SIX OVER ONE
THREE THROUGH THROUGH YEAR OVER
MONTHS SIX TWELVE THROUGH FIVE
OR LESS MONTHS MONTHS FIVE YEARS YEARS TOTAL
(DOLLARS IN THOUSANDS) ---------- ---------- --------- ---------- -------- ----------
Interest-earning assets:
Cash and cash
equivalents(1)............ $ 82,450 $ -- $ -- $ -- $ -- $ 82,450
Investments and FHLB Stock... 20,730 -- -- -- -- 20,730
Loans receivable(2).......... 1,068,468 402,093 31,767 7,087 125,905 1,635,320
---------- -------- --------- --------- -------- ----------
Total
interest-earning
assets............. $1,171,648 $402,093 $ 31,767 $ 7,087 $125,905 $1,738,500
========== ======== ========= ========= ======== ==========
Interest-bearing liabilities:
Deposits
Non-certificates of
deposit(2).............. $ 282,399 $ -- $ -- $ -- $ -- $ 282,399
Certificates of deposit... 260,224 223,033 392,320 23,886 -- 899,463
FHLB advances................ 30,000 125,000 74,000 155,000 -- 384,000
Senior notes................. -- -- -- 39,358 -- 39,358
---------- -------- --------- --------- -------- ----------
Total
interest-bearing
liabilities........ $ 572,623 $348,033 $ 466,320 $ 218,244 $ -- $1,605,220
========== ======== ========= ========= ======== ==========
Interest rate sensitivity
gap.......................... $ 599,025 $ 54,060 $(434,553) $(211,157) $125,905 $ 133,280
Cumulative interest rate
sensitivity gap.............. 599,025 653,085 218,532 7,375 133,280 133,280
As percentage of total
interest-earning assets...... 34.46% 37.57% 12.57% 0.42% 7.67% 7.67%
- ---------------
(1) Excludes noninterest-earning cash balances.
(2) Balances include $31.6 million of nonaccrual loans, and are gross of
deferred fees and cost and allowance for estimated credit losses.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
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 Company, like other
financial institutions, is subject to interest rate risk 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 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
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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 December 31, 2000, based on the Company's internally generated model, it
was estimated that the Company's NPV ratio was 9.51% in the event of a 200 basis
point increase in rates, a decrease of 6.12% from basecase of 10.13%. If rates
were to decrease by 200 basis points, the Company's NPV ratio was estimated at
10.49%, an increase of 3.55% from basecase.
Presented below, as of December 31, 2000, is an analysis of the Company's
IRR as measured in the NPV for instantaneous and sustained parallel shifts of
100, 200, and 300 basis point increments in market interest rates.
NET PORTFOLIO VALUE
---------------------------
CHANGE $ CHANGE FROM CHANGE FROM
IN RATES $ AMOUNT BASECASE RATIO BASECASE
(DOLLARS IN THOUSANDS) -------- -------- ------------- ----- -----------
+300 bp $151,141 $(31,027) 8.64% -149 bp
+200 bp 168,575 (13,594) 9.51% -62 bp
+100 bp 178,702 (3,467) 9.99% -14 bp
0 bp 182,169 10.13%
-100 bp 179,001 (3,167) 9.85% -28 bp
-200 bp 193,920 11,751 10.49% +36 bp
-300 bp 211,368 29,199 11.21% +108 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 unique loan portfolio, the internal model
reflects greater sensitivity in both an increasing and a declining rate
environment.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information regarding Financial Statements and Supplementary Data appears
on pages A-1 through A-39 under the captions "Consolidated Statements of
Financial Condition," "Consolidated Statements of Operations," "Consolidated
Statements of Stockholders' Equity," "Consolidated Statements of Cash Flows" and
"Notes to Consolidated Financial Statements" and is incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except as hereinafter noted, the information concerning directors and
executive officers of the Company is incorporated by reference from the section
entitled "Election of Directors" of the Company's Proxy Statement, which is
filed as Exhibit No. 99 to this Annual Report on Form 10-K. For information
concerning executive officers of the Company, see "Item 4(A). Executive Officers
of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference
from the section entitled "Compensation of Directors and Executive Officers" in
the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual
Report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is incorporated by reference from the sections entitled "Principal
Shareholders" and "Election of Directors" of the Company's Proxy Statement,
which is filed as Exhibit No. 99 to this Annual Report on Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is
incorporated by reference from the section entitled "Certain Transactions" of
the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual
Report on Form 10-K.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:
(1) FINANCIAL STATEMENTS
Independent Auditors' Report
Consolidated Financial Statements
Consolidated Statements of Financial Condition as of December 31,
2000 and 1999.
Consolidated Statements of Income for the years ended December
31, 2000, 1999 and 1998.
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2000, 1999 and 1998.
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998.
Notes to Consolidated Financial Statements for the years ended
December 31, 2000, 1999 and 1998.
(2) FINANCIAL STATEMENT SCHEDULES
Schedules are omitted because they are not applicable or because
the required information is provided in the Consolidated Financial
Statements, including the Notes thereto.
(B) REPORTS ON FORM 8-K
Not applicable.
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(C) EXHIBITS
Exhibits are listed by number corresponding to the Exhibit Table of
Item 601 of Regulation S-K.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1 Certificate of Incorporation of the Company and Amendment of
Certificate of Incorporation of the Company(1)
3.2 Bylaws of the Company(1)
4.1 Specimen certificate of the Company's Common Stock
4.2 Indenture, dated as of December 31, 1997, between the
Company and United States Trust Company of New York, as
Trustee, relating to the Company's 12 1/2% Notes due 2004(2)
4.3 Form of the Company's 12 1/2% Notes due 2004 (included in
Section 2.02 of the Indenture included as Exhibit 4.2)(2)
4.4 Form of Warrants to purchase an aggregate of 2,512,188
shares of Common Stock
4.5 Registration Rights Agreement among the Company and certain
investors
4.6 Unit Purchase Agreement among the Company and the investors
named therein
4.7 Indenture dated as of March 28, 2001 between Hawthorne
Financial Corporation and Wilmington Trust Company, as
Trustee
4.8 Certificate of Trust of HFC Capital Trust I
4.9 Amended and Restated Trust Agreement of HFC Capital Trust I,
among Hawthorne Financial Corporation, Wilmington Trust
Company and the Administrative Trustees named therein dated
as of March 28, 2001
4.10 Capital Securities Certificate of HFC Capital Trust I
4.11 Common Securities Certificate of HFC Capital Trust I
4.12 Capital Securities Guarantee Agreement between Hawthorne
Financial Corporation and Wilmington Trust Company, dated as
of March 28, 2001
4.13 Common Securities Guarantee Agreement between Hawthorne
Financial Corporation and Wilmington Trust Company, dated as
of March 28, 2001
4.14 10.18% Junior Subordinated Deferrable Interest Debentures
due June 8, 2031
10.1 Hawthorne Financial Corporation 1994 Stock Option Plan(3)*
10.2 Hawthorne Financial Corporation 1995 Stock Option Plan(4)
10.3 Lease of corporate headquarters(5)
10.4 Change in Control Employment Agreement between Company and
Simone Lagomarsino(6)*
10.5 Change in Control Employment Agreement(6)*
10.6 Deferred Compensation Plan*
10.7 Deferred Compensation Loan Agreement between Hawthorne and
Karen Abajian*
11.1 Statement on computation of per share earnings(7)
21.1 Subsidiaries of the Registrant, Hawthorne Savings, F.S.B.
23.1 Consent of Deloitte & Touche LLP
99 Proxy Statement for Annual Meeting of Shareholders to be
held May 21, 2001(8)
- ---------------
* Designates management contract, compensatory plan or arrangement.
(1) Incorporated by reference from the Company's Registration Statement on Form
S-8 (No. 33-74800) filed on February 3, 1994.
49
54
(2) Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, as amended on May 11, 1998 and November 3,
1998.
(3) Incorporated by reference from the Company's Registration Statement on Form
S-8 (No. 333-59879) filed on July 24, 1998.
(4) Incorporated by reference from the Company's Registration Statement on Form
S-8 (No. 333-59875) filed on July 24, 1998.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1996.
(6) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2000.
(7) See Note 1 to the Notes to Consolidated Financial Statements included in
Item 8 and listed in Item 14(a) of this Annual Report on Form 10-K.
(8) To be filed within 120 days after the end of the fiscal year ended December
31, 2000.
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SIGNATURES
Pursuant to the requirements of section 13 or 15(d) 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.
DATED: March 30, 2001
HAWTHORNE FINANCIAL CORPORATION
By: /s/ SIMONE LAGOMARSINO
------------------------------------
Simone Lagomarsino
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
SIGNATURE DATE
--------- ----
/s/ SIMONE LAGOMARSINO March 30, 2001
- -----------------------------------------------------------
Simone Lagomarsino
Director, President, and Chief Executive Officer
(Principal Executive Officer)
/s/ KAREN C. ABAJIAN March 30, 2001
- -----------------------------------------------------------
Karen C. Abajian
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ TIMOTHY R. CHRISMAN March 30, 2001
- -----------------------------------------------------------
Timothy R. Chrisman, Chairman of the Board
/s/ MARILYN G. AMATO March 30, 2001
- -----------------------------------------------------------
Marilyn G. Amato, Director
/s/ GARY W. BRUMMETT March 30, 2001
- -----------------------------------------------------------
Gary W. Brummett, Director
/s/ ANTHONY W. LIBERATI March 30, 2001
- -----------------------------------------------------------
Anthony W. Liberati, Director
/s/ HARRY F. RADCLIFFE March 30, 2001
- -----------------------------------------------------------
Harry F. Radcliffe, Director
/s/ HOWARD E. RITT March 30, 2001
- -----------------------------------------------------------
Howard E. Ritt, Director
51
56
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS, INDEPENDENT AUDITORS' REPORT
CONTENTS
PAGE
----
Independent Auditors' Report................................ A-2
Consolidated Financial Statements
Consolidated Statements of Financial Condition............ A-3
Consolidated Statements of Income......................... A-4
Consolidated Statements of Stockholders' Equity........... A-5
Consolidated Statements of Cash Flows..................... A-6
Notes to Consolidated Financial Statements................ A-8
A-1
57
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Hawthorne Financial Corporation
El Segundo, California:
We have audited the accompanying consolidated statements of financial
condition of Hawthorne Financial Corporation and Subsidiary (the "Company") as
of December 31, 2000 and 1999 and the related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2000. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based upon our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial condition of Hawthorne Financial
Corporation and Subsidiary as of December 31, 2000 and 1999, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States of America.
DELOITTE & TOUCHE LLP
Los Angeles, California
February 9, 2001
(March 28, 2001 as to Note 17)
A-2
58
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
------------------------
2000 1999
(DOLLARS IN THOUSANDS) ---------- ----------
Assets:
Cash and cash equivalents................................. $ 99,919 $ 86,722
Loans receivable (net of allowance for estimated credit
losses of $29,450 in 2000 and $24,285 in 1999)......... 1,608,067 1,444,968
Real estate owned, net.................................... 2,859 5,587
Accrued interest receivable............................... 11,040 9,250
Investment in capital stock of Federal Home Loan Bank, at
cost................................................... 20,730 22,236
Office property and equipment at cost, net................ 4,808 5,939
Deferred tax asset, net................................... 2,867 2,203
Other assets.............................................. 3,105 4,248
---------- ----------
Total assets...................................... $1,753,395 $1,581,153
========== ==========
Liabilities and Stockholders' Equity:
Liabilities:
Deposits:
Noninterest-bearing.................................. $ 32,994 $ 28,838
Interest-bearing..................................... 1,181,862 1,057,797
---------- ----------
Total deposits.................................... 1,214,856 1,086,635
FHLB advances.......................................... 384,000 349,000
Senior notes........................................... 39,358 40,000
Accounts payable and other liabilities................. 11,020 13,214
---------- ----------
Total liabilities................................. 1,649,234 1,488,849
Commitments and contingencies (Note 13)
Stockholders' Equity:
Common stock -- $0.01 par value; authorized 20,000,000
shares; issued and outstanding, 5,566,801 shares (2000)
and 5,331,301 shares (1999)............................ 56 53
Capital in excess of par value -- common stock............ 42,095 40,981
Retained earnings......................................... 65,602 51,318
Less:
Treasury stock, at cost -- 391,406 shares (2000) and
5,400 shares (1999)................................... (3,592) (48)
---------- ----------
Total stockholders' equity........................ 104,161 92,304
---------- ----------
Total liabilities and stockholders' equity........ $1,753,395 $1,581,153
========== ==========
See Accompanying Notes to Consolidated Financial Statements
A-3
59
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA) -------- -------- --------
Interest revenues:
Loans.................................................... $141,279 $126,854 $102,213
Investments.............................................. 7,709 5,893 4,779
-------- -------- --------
Total interest revenues.......................... 148,988 132,747 106,992
-------- -------- --------
Interest costs:
Deposits................................................. 63,513 50,831 47,642
FHLB advances............................................ 20,180 17,795 9,232
Senior notes............................................. 4,989 5,000 5,000
-------- -------- --------
Total interest costs............................. 88,682 73,626 61,874
-------- -------- --------
Net interest income........................................ 60,306 59,121 45,118
Provision for credit losses................................ 6,000 12,000 7,135
-------- -------- --------
Net interest income after provision for credit losses.... 54,306 47,121 37,983
Noninterest revenues:
Loan related and other fees.............................. 7,072 7,324 4,213
Deposit fees............................................. 1,022 496 433
Gain on sales of investment securities................... -- -- 7
-------- -------- --------
Total noninterest revenues....................... 8,094 7,820 4,653
(Loss)/income from real estate operations, net............. (924) 324 1,909
Noninterest expenses:
General and administrative expenses:
Employee.............................................. 17,391 14,822 14,414
Operating............................................. 6,092 6,393 6,177
Occupancy............................................. 3,758 3,889 3,404
Professional.......................................... 4,255 4,035 1,738
Technology............................................ 1,939 1,988 2,117
SAIF premiums and OTS assessments..................... 893 1,236 952
-------- -------- --------
Total general and administrative expenses........ 34,328 32,363 28,802
Other non-operating expense:
Legal settlement expenses............................. 2,049 3,539 --
Other................................................. 147 1,133 31
-------- -------- --------
Total noninterest expenses....................... 36,524 37,035 28,833
-------- -------- --------
Income before income taxes................................. 24,952 18,230 15,712
Income tax provision....................................... 10,668 8,030 4,674
-------- -------- --------
Net income................................................. $ 14,284 $ 10,200 $ 11,038
======== ======== ========
Basic earnings per share................................... $ 2.69 $ 1.93 $ 2.64
======== ======== ========
Diluted earnings per share................................. $ 1.94 $ 1.33 $ 1.65
======== ======== ========
Weighted average basic shares outstanding.................. 5,300 5,288 4,176
======== ======== ========
Weighted average diluted shares outstanding................ 7,371 7,697 6,692
======== ======== ========
See Accompanying Notes to Consolidated Financial Statements
A-4
60
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CAPITAL IN
EXCESS OF ACCUMULATED
NUMBER OF PAR VALUE -- OTHER
COMMON COMMON COMMON COMPREHENSIVE
SHARES STOCK STOCK INCOME/(LOSS)
(IN THOUSANDS) --------- ------ ------------ -------------
Balance at January 1, 1998................... 3,091 $31 $12,310 $ 6
Exercised stock options...................... 86 1 436 --
Stock offering proceeds, net................. 2,013 20 27,603 --
Other comprehensive income, net of tax, net
change in unrealized gain (loss) on
securities................................. -- -- (6)
Net income................................... -- -- --
Repayments................................... -- --
Comprehensive Income......................... -- -- --
----- --- ------- ---
Balance at December 31, 1998................. 5,190 52 40,349 --
Exercised stock options...................... 110 1 576 --
Exercised warrants........................... 26 -- 56 --
Net income................................... -- -- --
Other........................................ -- -- --
Repayments................................... -- -- --
Comprehensive Income......................... -- -- --
----- --- ------- ---
Balance at December 31, 1999................. 5,326 53 40,981 --
Exercised stock options...................... 236 3 1,114 --
Treasury stock............................... (387)
Net income................................... -- -- --
Comprehensive Income......................... -- -- --
----- --- ------- ---
Balance at December 31, 2000................. 5,175 $56 $42,095 $--
===== === ======= ===
LOAN TO
EMPLOYEE
STOCK TOTAL
RETAINED TREASURY OWNERSHIP STOCKHOLDERS' COMPREHENSIVE
EARNINGS STOCK PLAN EQUITY INCOME
(IN THOUSANDS) -------- -------- --------- ------------- -------------
Balance at January 1, 1998................... $30,112 $ (48) $(92) $ 42,319
Exercised stock options...................... -- -- -- 437
Stock offering proceeds, net................. -- -- -- 27,623
Other comprehensive income, net of tax, net
change in unrealized gain (loss) on
securities................................. -- -- -- (6) $ (6)
Net income................................... 11,038 -- -- 11,038 11,038
Repayments................................... -- -- 13 13
-------
Comprehensive Income......................... -- -- -- -- $11,032
------- ------- ---- -------- -------
Balance at December 31, 1998................. 41,150 (48) (79) 81,424
Exercised stock options...................... -- -- -- 577
Exercised warrants........................... -- -- -- 56
Net income................................... 10,200 -- -- 10,200 $10,200
Other........................................ (32) -- -- (32)
Repayments................................... -- -- 79 79
-------
Comprehensive Income......................... -- -- -- -- $10,200
------- ------- ---- -------- -------
Balance at December 31, 1999................. 51,318 (48) -- 92,304
Exercised stock options...................... -- -- -- 1,117
Treasury stock............................... (3,544) (3,544)
Net income................................... 14,284 -- -- 14,284 $14,284
-------
Comprehensive Income......................... -- -- -- -- $14,284
------- ------- ---- -------- =======
Balance at December 31, 2000................. $65,602 $(3,592) $ -- $104,161
======= ======= ==== ========
See Accompanying Notes to Consolidated Financial Statements
A-5
61
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................ $ 14,284 $ 10,200 $ 11,038
Adjustments:
Deferred income tax (benefit)/provision............ (664) 619 3,999
Provision for credit losses on loans............... 6,000 12,000 7,135
Provision for estimated losses on real estate
owned............................................ 476 80 60
Net gain on sale of investment securities.......... -- -- (7)
Net loss/(gain) from sale of real estate owned..... 166 (754) (2,278)
Net loss from disposal of other assets............. -- 7 34
Loan fee and discount accretion.................... (2,822) (5,108) (6,396)
Depreciation and amortization...................... 2,778 2,389 1,551
FHLB dividends..................................... (1,476) (961) (571)
Increase in accrued interest receivable............ (1,790) (826) (3,126)
Decrease/(increase) in other assets................ 1,143 563 (453)
(Decrease)/increase in other liabilities........... (1,788) 5,654 1,183
--------- --------- ---------
Net cash provided by operating activities..... 16,307 23,863 12,169
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment securities:
Purchases.......................................... -- -- (27,919)
Maturities......................................... -- -- 27,900
Sales proceeds..................................... -- -- 596
Loans:
New loans funded................................... (488,560) (377,267) (487,097)
Construction disbursements......................... (264,506) (336,806) (354,326)
Payoffs............................................ 551,851 544,156 345,044
Sales proceeds..................................... 14,961 3,000 --
Purchases.......................................... (8,568) (1,155) --
Principal payments................................. 24,355 24,806 121,940
Other, net......................................... 466 7,092 (118,823)
Real estate owned, net:
Sales proceeds..................................... 5,105 10,385 15,184
Capitalized costs.................................. (62) (149) (1,058)
Other, net......................................... -- (30) (2,134)
Purchase of FHLB stock................................ (630) (7,721) (5,770)
Redemption of FHLB stock.............................. 3,612 -- --
Office property & equipment:
Sales proceeds..................................... 51 233 5
Additions.......................................... (1,337) (2,031) (3,904)
--------- --------- ---------
Net cash used in investing activities......... (163,262) (135,487) (490,362)
--------- --------- ---------
See Accompanying Notes to Consolidated Financial Statements
A-6
62
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Deposit activity, net.................................... 128,221 67,185 219,949
Net increase in FHLB advances............................ 35,000 85,000 224,000
Net proceeds from exercise of stock options and
warrants.............................................. 1,117 633 437
Collection of ESOP loan.................................. -- 79 13
Reduction in senior notes................................ (642) -- --
Payments to acquire treasury stock....................... (3,544) -- --
Proceeds from stock offering............................. -- -- 27,623
-------- -------- --------
Net cash provided by financing activities........ 160,152 152,897 472,022
-------- -------- --------
Increase (decrease) in cash and cash equivalents........... 13,197 41,273 (6,171)
Cash and cash equivalents, beginning of year............... 86,722 45,449 51,620
-------- -------- --------
Cash and cash equivalents, end of year..................... $ 99,919 $ 86,722 $ 45,449
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest.............................................. $ 87,204 $ 73,214 $ 61,272
Income taxes, net..................................... 11,050 4,233 3,017
Non-cash investing and financing activities:
Real estate acquired in settlement of loans........... 3,277 13,649 6,387
Loans originated to finance sales of real estate
owned............................................... -- 1,500 2,402
Loans originated to refinance existing bank loans..... 28,229 48,008 44,060
Net change in unrealized gains/(losses) on
available-for-sale securities....................... -- -- (6)
Disposal of other assets.............................. -- -- 39
See Accompanying Notes to Consolidated Financial Statements
A-7
63
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") and general practices within the banking industry. The following is a
summary of significant principles used in the preparation of the accompanying
financial statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary, Hawthorne Savings, F.S.B. ("Bank"). All
significant intercompany transactions and accounts have been eliminated in
consolidation.
NATURE OF OPERATIONS
The Company is principally engaged in the business of attracting deposits
from the general public and using those deposits, together with borrowings and
other funds, to originate residential and income property real estate loans. The
Company's principal sources of revenue are interest earned on mortgage loans and
fees received concerning various deposit account services and miscellaneous loan
processing activities. The Company's principal expenses are interest paid on
deposit accounts and the costs necessary to operate the Company.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities and disclosures of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the period. Actual results could differ from those estimates.
Significant estimates include the allowance for estimated credit losses,
valuation of real estate owned, fair value of stock options and fair values of
financial instruments.
CASH AND CASH EQUIVALENTS
The Bank, in accordance with regulations, must maintain qualifying liquid
assets at an average monthly balance of not less than 4% of the average of all
deposits and other borrowings due in less than one year. Liquid assets consist
primarily of cash, certificates of deposit and overnight investments. 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. In addition, bankers'
acceptances and certain U.S. Government securities, corporate notes and
mortgage-backed securities qualify as liquid assets for regulatory purposes. In
the consolidated statements of financial condition and cash flows, cash and cash
equivalents include cash, amounts due from banks and overnight investments.
INVESTMENT SECURITIES
The Company has authority to invest in a variety of investment securities,
including U.S. Government and agency securities, mortgage-backed securities and
corporate securities. However, in recent years the Company's strategy has been
to deploy its assets through loan originations, rather than purchases of
investment securities. As a result, the investment activity has been steadily
decreasing over the last six years, and during 2000 and 1999 there was no
investment activity. The Company classifies all securities acquired as
available-for-sale under GAAP, and thus the securities are carried at fair
value, with unrealized gains and losses excluded from income and reported as a
separate component of stockholders' equity, net of taxes.
A-8
64
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LOANS RECEIVABLE
Loans are generally carried at principal amounts, less net deferred loan
fees. Net deferred loan fees include deferred unamortized fees, less direct
incremental loan origination costs. The Company defers all loan fees, net of
certain direct costs associated with originating loans, and recognizes these net
deferred fees into interest revenue as a yield adjustment over the term of the
loans using the interest method for permanent loans and the straight-line method
for construction loans. When a loan is paid off, any unamortized net deferred
fees and costs are recognized in interest income.
Interest on loans, including impaired loans, is recognized in revenue as
earned and is accrued only if deemed collectible. When loans are 90 days or more
delinquent, or when collection of interest or principal becomes uncertain, the
loans are placed on nonaccrual status, meaning that the Company stops accruing
interest on such loans and reverses any interest previously accrued but not
collected. A nonaccrual loan may be restored to accrual status when delinquent
principal and interest payments are brought current and future monthly principal
and interest payments are expected to be collected.
The Company considers a loan to be impaired when it is probable that it
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. Once a loan is determined to be impaired, the impairment is
measured based on the present value of the expected future cash flows discounted
at the loan's effective interest rate, except that as a practical expedient, the
impairment is measured by using the loan's observable market price or the fair
value of the collateral if the loan is collateral dependent.
When the measurement of the impaired loan is less than the recorded amount
of the loan, the Company recognizes an impairment is recognized by creating a
valuation allowance with a corresponding charge to the allowance for credit
losses or by adjusting an existing valuation allowance for the impaired loan
with a corresponding charge or credit to the allowance for credit losses.
All loans are classified as held-to-maturity as the Company has the current
intent and ability to hold these loans in its portfolio until maturity.
ALLOWANCE FOR ESTIMATED CREDIT LOSSES
Management establishes specific allowances for estimated losses on
individual loans and REO when it has determined that recovery of the Company's
gross investment is not probable and when the amount of loss can be reasonably
determined. In making this determination, management considers (1) the status of
the asset, (2) the probable future status of the asset, (3) the value of the
asset or underlying collateral and (4) management's intent with respect to the
asset. In quantifying the loss, if any, associated with individual loans and
REO, management utilizes external sources of information (i.e., appraisals,
price opinions from real estate professionals, comparable sales data and
internal estimates). In establishing specific allowances, management estimates
the revenues expected to be generated from disposal of the Company's collateral
or owned property, less construction and renovation costs (if any), holding
costs and transaction costs. For tract construction and land development, the
resulting projected cash flows are discounted utilizing a market rate of return
to determine their value.
The Company maintains an allowance for estimated credit losses, which is
not tied to individual loans or properties ("General Reserves"). General
Reserves are maintained for each of the Company's principal loan segments and
supplemented by periodic additions through provisions for estimated credit
losses. In measuring the adequacy of the Company's General Reserves, management
considers (1) the Company's historical loss experience for each loan portfolio
segment and in total, (2) the historical migration of loans within each
portfolio segment and in total (i.e., from performing to nonperforming, from
nonperforming to REO), (3) observable trends in the performance of each loan
portfolio segment, (4) observable trends in the region's economy and in its real
property markets and (5) guidelines published by the OTS for maintaining General
Reserves.
A-9
65
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
REAL ESTATE OWNED
Properties acquired through foreclosure, or deed in lieu of foreclosure
("real estate owned"), are transferred to REO and carried at the lower of cost
or estimated fair value less the estimated costs to sell the property. The fair
value of the property is based upon a current appraisal. Subsequent to
foreclosure, management periodically performs valuations and the REO property is
carried at the lower of carrying value or fair value, less costs to sell. The
determination of a property's estimated fair value incorporates (1) revenues
projected to be realized from disposal of the property, (2) construction and
renovation costs, (3) marketing and transaction costs and (4) holding costs
(e.g., property taxes, insurance and homeowners' association dues). For
multi-family construction and land developments, these projected cash flows are
discounted utilizing a market rate of return to determine their fair value. In
many instances following foreclosure, these properties require significant time
for the completion of construction and their marketing and eventual sale.
Revenue recognition upon disposition of the property is dependent upon the sale
having met certain criteria relating to the buyer's initial investment in the
property sold.
OFFICE PROPERTY AND EQUIPMENT
Company property and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are computed on a
straight-line basis over the estimated useful lives of the various classes of
assets. The ranges of useful lives for the principal classes of assets are as
follows:
Buildings................................... 20 - 30 years
Computers and related software.............. 3 - 5 years
Facsimiles, copiers and printers............ 3 - 7 years
Furniture and fixtures...................... 7 years
Leasehold improvements...................... Shorter of 5 years or term of lease
Automobiles................................. 3 years
PARENT COMPANY
In connection with the issuance of its 1997 Senior Notes, the Company
capitalized $2.5 million of issuance costs. In 2000, 1999 and 1998, the Company
amortized $361,000 of its 1997 Senior Notes issuance costs which are being
amortized over the life of the debt, which is seven years.
INCOME TAXES
The Company and its subsidiary have historically filed a consolidated
federal income tax return and a combined state franchise tax return on a fiscal
year ending September 30. The Company adopted a December 31 tax year-end for its
consolidated federal income tax return and its combined state franchise tax
returns beginning with the stub period ending December 31, 1998 and continuing
each year thereafter.
Deferred tax assets and liabilities represent the tax effects, calculated
at currently effective tax rates, of future deductible or taxable amounts
attributable to events that have been recognized on a cumulative basis in the
financial statements. If it is more likely than not that any of a deferred tax
asset will not be realized, a valuation allowance is recorded.
STOCK BASED COMPENSATION PLANS
The Company has elected to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure requirements of Statement of Financial
Accounting Standards ("SFAS") No. 123 in the footnotes to its consolidated
financial statements. SFAS No. 123 requires pro forma disclosure of net income
and, if presented, earnings per share, as if the fair-value based method of
accounting defined in this statement had
A-10
66
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
been applied. APB Opinion No. 25 and related interpretations requires accounting
for stock compensation awards based on their intrinsic value as of the grant
date.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets related to those assets to be held and used are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. SFAS No. 121 requires that certain
long-lived assets to be disposed of be reported at the lower of historical cost
or fair value, less cost to sell.
RECENT ACCOUNTING PRONOUNCEMENTS
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 will adopt SFAS No. 133 effective
January 1, 2001. The adoption of SFAS No. 133 will 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 financial statements for periods beginning after December 15,
2000. This statement revises the standards for accounting for securitizations
and other transfers of financial assets and collateral, and requires certain
disclosures. Management does not believe that there will be a material impact on
the financial position or results of operations of the Company from adoption of
this statement.
RECLASSIFICATIONS
Certain amounts in the 1999 and 1998 consolidated financial statements have
been reclassified to conform with 2000.
EARNINGS PER SHARE CALCULATION
The following table sets forth the Company's earnings per share
calculations for the years ended December 31, 2000, 1999 and 1998. In the
following table, (1) "Warrants" refers 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 (see Note
10).
In July 1998, the Company completed an offering of 2,012,500 shares of its
Common Stock (including 262,500 shares issued upon exercise by the underwriters
of their overallotment option) at a price of $15.00 per share, realizing net
proceeds (after offering costs) of approximately $27.6 million. As an additional
result of
A-11
67
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
this offering, the exercise price of the Warrants was reduced to $2.128 per
share and the number of shares of Common Stock purchasable upon the exercise of
the Warrants was increased to 2,512,188.
YEARS ENDED DECEMBER 31,
------------------------------
2000 1999 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA) -------- ------- -------
Average shares outstanding:
Basic..................................................... 5,300 5,288 4,176
Warrants.................................................. 2,486 2,496 2,444
Options(1)................................................ 360 445 587
Less: Treasury stock(2)................................... (775) (532) (515)
-------- ------- -------
Diluted................................................... 7,371 7,697 6,692
======== ======= =======
Net income.................................................. $ 14,284 $10,200 $11,038
======== ======= =======
Basic earnings per share.................................... $ 2.69 $ 1.93 $ 2.64
======== ======= =======
Diluted earnings per share.................................. $ 1.94 $ 1.33 $ 1.65
======== ======= =======
Year end shares outstanding:
Basic..................................................... 5,175 5,326 5,190
Warrants.................................................. 2,486 2,486 2,512
Options(3)................................................ 446 403 527
Less: Treasury stock(2)................................... (619) (584) (510)
-------- ------- -------
Diluted................................................... 7,488 7,631 7,719
======== ======= =======
Basic book value per share.................................. $ 20.13 $ 17.33 $ 15.69
======== ======= =======
Diluted book value per share................................ $ 13.91 $ 12.10 $ 10.43
======== ======= =======
- ---------------
(1) Excludes 225,327 options outstanding for the year ended December 31, 2000
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 pro forma 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 160,000 options outstanding for the month of December 2000 for
which the exercise price exceeded the monthly average market price of the
Company's Common Stock at period-end.
NOTE 2 -- CASH AND CASH EQUIVALENTS
The table below reflects cash and cash equivalents for the dates indicated:
DECEMBER 31,
------------------
2000 1999
(DOLLARS IN THOUSANDS) ------- -------
Cash and due from banks.................................. $19,919 $86,722
Federal funds sold....................................... 80,000 --
------- -------
Total.......................................... $99,919 $86,722
======= =======
NOTE 3 -- INVESTMENT SECURITIES AVAILABLE-FOR-SALE
As of December 31, 2000, the Company did not have any investment securities
available-for-sale. The Company has authority to invest in a variety of
investment securities, including U.S. Government and agency securities,
mortgage-backed securities and corporate securities. However, in recent years
the Company's
A-12
68
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
strategy has been to deploy its assets through loan originations, rather than
purchases of investment securities. As a result, the investment activity has
been steadily decreasing over the last six years, and in both 2000 and 1999
there was no investment activity. The Company classifies all securities acquired
as available-for-sale under GAAP, and thus the securities are carried at fair
value, with unrealized gains and losses excluded from income and reported as a
separate component of stockholders' equity, net of taxes.
The table below reflects comprehensive income, comprised of unrealized
gains arising during the period, net of tax, and reclassification adjustments
for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ----- ----- -----
Unrealized holding gains arising during period, net of tax
expense of $0 in 2000, $0 in 1999 and $2 in 1998.......... $-- $-- $ 1
Less: Reclassification adjustment for gains included in
net income, net of tax expense of $0 in 2000, $0 in
1999 and $4 in 1998.................................... -- -- 7
--- --- ---
Net change in unrealized loss on securities, net of tax
(expense)................................................. $-- $-- $(6)
=== === ===
NOTE 4 -- LOANS RECEIVABLE
The Company's loan portfolio consists almost exclusively of loans secured
by real estate located in Southern California. The table below sets forth the
composition of the Company's loan portfolio as of the dates indicated.
DECEMBER 31,
------------------------
2000 1999
(DOLLARS IN THOUSANDS) ---------- ----------
Single family residential................................... $ 888,416 $ 683,250
Income property:
Multi-family(1)........................................... 253,039 222,616
Commercial(1)............................................. 200,372 232,938
Development(2)............................................ 203,894 148,092
Single family construction:
Single family residential(3).............................. 195,983 274,697
Tract..................................................... 3,495 24,056
Land(4)..................................................... 46,520 59,095
Other....................................................... 15,390 22,053
---------- ----------
Gross loans receivable(5)......................... 1,807,109 1,666,797
Less:
Undisbursed funds......................................... (171,789) (196,249)
Deferred (fees) and costs, net............................ 2,197 (1,295)
Allowance for estimated credit losses..................... (29,450) (24,285)
---------- ----------
Net loans receivable........................................ $1,608,067 $1,444,968
========== ==========
- ---------------
(1) Predominantly term loans secured by improved properties, with respect to
which the properties' cash flows are sufficient to service the Company's
loan.
(2) Predominantly loans to finance the construction of income-producing
improvements. Also includes loans to finance the renovation of existing
improvements.
(3) 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.
A-13
69
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) Gross loans receivable includes the principal balance of loans outstanding,
plus outstanding but unfunded loan commitments, predominantly in connection
with construction loans.
The table below summarizes the maturities for fixed rate loans and the
repricing intervals for adjustable rate loans as of December 31, 2000:
PRINCIPAL BALANCE
-------------------------------------------
FIXED RATE ADJUSTABLE RATE TOTAL
(DOLLARS IN THOUSANDS) ---------- --------------- ----------
Interval:
G 3 months.......................... $ 36,692 $1,201,247 $1,237,939
H 3 to 6 months..................... 1,011 401,151 402,162
H 6 to 12 months.................... 5,979 26,030 32,009
H 1 to 2 years...................... 6,270 -- 6,270
H 2 to 5 years...................... 817 -- 817
H 5 to 10 years..................... 12,447 -- 12,447
H 10 to 20 years.................... 13,623 -- 13,623
More than 20 years.................. 101,842 -- 101,842
-------- ---------- ----------
Gross loans receivable...... $178,681 $1,628,428 $1,807,109
======== ========== ==========
The contractual weighted average interest rates on loans at December 31,
2000 and 1999 were 8.98% and 8.64%, respectively. The table below summarizes
nonaccrual loans for the dates indicated.
DECEMBER 31,
------------------
2000 1999
(DOLLARS IN THOUSANDS) ------- -------
Single family residential................................ $13,954 $22,579
Income property:
Commercial............................................. -- 10,498
Development............................................ 10,987 --
Single family construction:
Single family residential.............................. 2,712 6,847
Tract.................................................. -- 1,945
Land..................................................... 3,930 2,140
Other.................................................... 18 22
------- -------
Total(1)....................................... $31,601 $44,031
======= =======
- ---------------
(1) At December 31, 2000, nonaccrual loans included ten loans, totaling $7.1
million, in bankruptcy. Includes $3.7 million and $18.7 million of TDRs at
December 31, 2000 and 1999, respectively. Excludes $15.1 million and $16.2
million of TDRs that were paying in accordance with their modified terms at
December 31, 2000 and 1999, respectively.
The interest income recognized on loans that were on nonaccrual status at
December 31, 2000, 1999 and 1998 was $1.7 million, $2.3 million and $3.3
million, respectively. If these loans had been performing for the entire year,
the income recognized would have been $3.3 million, $4.5 million and $4.9
million for 2000, 1999 and 1998, respectively.
The table below summarizes the amounts of interest income that would have
been recognized on TDRs had borrowers paid at the original loan interest rate
throughout each of the years below, the interest income that would have been
recognized based upon the modified interest rate, and the interest income that
was included in the consolidated statements of income for the periods indicated.
For this purpose, a TDR is a loan with respect to which (1) the original
interest rate was changed for a defined period of time, (2) the loan's
A-14
70
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
maturity was extended due to borrowers' financial difficulty, and/or (3) the
Company agreed to suspend principal or interest payments for a defined period of
time.
PRINCIPAL ORIGINAL MODIFIED RECOGNIZED
BALANCE INTEREST INTEREST INTEREST
(DOLLARS IN THOUSANDS) --------- -------- -------- ----------
Year ended December 31, 2000:
Permanent loans........................... $18,787 $2,049 $1,804 $1,273
======= ====== ====== ======
Year ended December 31, 1999:
Construction loans........................ $ 5,072 $ 684 $ 681 $ 392
Permanent loans........................... 29,766 3,319 2,842 1,636
------- ------ ------ ------
$34,838 $4,003 $3,523 $2,028
======= ====== ====== ======
Year ended December 31, 1998:
Permanent loans........................... $34,276 $2,873 $2,695 $2,484
======= ====== ====== ======
The table below summarizes the activity within the allowance for estimated
credit losses on loans for the periods indicated.
YEAR ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ------- ------- -------
Balance, beginning of year............................ $24,285 $17,111 $13,274
Provision for credit losses......................... 6,000 12,000 7,135
Charge-offs......................................... (1,084) (4,872) (3,298)
Recoveries.......................................... 249 46 --
------- ------- -------
Balance, end of year.................................. $29,450 $24,285 $17,111
======= ======= =======
Management believes the level of allowance for estimated credit losses on
loans is adequate to absorb losses inherent in the loan portfolio; however,
circumstances might change which could adversely affect the performance of the
loan portfolio resulting in increasing loan losses which cannot be reasonably
predicted at December 31, 2000.
The recorded investment in loans considered to be impaired under SFAS No.
114 as amended by SFAS No. 118, was as follows:
AT OR FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ------- ------- -------
Impaired loans with specific loss reserves............ $11,364 $ 3,991 $41,124
Impaired loans without specific loss reserves......... 26,583 49,615 28,770
Specific loss reserves allocated to impaired loans.... (5,270) (659) (5,177)
------- ------- -------
Total impaired loans, net of specific
reserves.................................. $32,677 $52,947 $64,717
======= ======= =======
Average investment in impaired loans.................. $38,000 $65,500 $60,000
Interest income recognized on impaired loans.......... $ 2,775 $ 3,417 $ 4,879
A-15
71
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The table below reconciles the principal balance of impaired loans and TDRs
for the dates indicated:
DECEMBER 31,
--------------------
2000 1999
(DOLLARS IN THOUSANDS) -------- --------
Total impaired loans........................................ $ 37,947 $ 53,606
Impaired loans 90 days or more delinquent................... (10,042) (11,853)
-------- --------
Performing impaired loans................................. 27,905 41,753
Impaired loans which are not TDRs........................... (12,768) (14,445)
-------- --------
Performing TDRs........................................... 15,137 27,308
TDRs which are 90 days or more delinquent................... 3,650 7,530
-------- --------
Total TDRs........................................ $ 18,787 $ 34,838
======== ========
No additional funds are committed to be advanced in connection with
impaired loans.
LOANS TO EXECUTIVE OFFICERS AND DIRECTORS
In the ordinary course of business, the Company has granted loans to
certain executive officers and directors and the companies with which they are
associated. In management's opinion, such loans and commitments to lend were
made under terms that are consistent with the Company's normal lending policies.
During the year ended December 31, 2000, the Company granted $228,000 in
loans to executive officers and directors. During the year ended December 31,
1998, the Company granted $155,000 in loans to executive officers and directors
and received repayments of $1,000. During 1999, all loans to executive officers
and directors were paid in full.
NOTE 5 -- REAL ESTATE OPERATIONS
Real estate acquired in satisfaction of loans is transferred from loans to
properties at the lower of the carrying values or the estimated fair values,
less any estimated disposal costs. The difference between the fair value of the
real estate collateral and the loan balance at the time of transfer is recorded
as a loan charge-off. Any subsequent declines in the fair value of the
properties after the date of transfer are recorded through a write-down of the
asset.
The table below summarizes real estate owned ("REO") properties for the
dates indicated:
DECEMBER 31,
----------------
2000 1999
(DOLLARS IN THOUSANDS) ------ ------
Single family residential(1)................................ $2,859 $1,218
Land(2)..................................................... -- 4,398
------ ------
Gross investment(3)......................................... 2,859 5,616
Less allowance for estimated losses....................... -- 29
------ ------
Real estate owned, net...................................... $2,859 $5,587
====== ======
- ---------------
(1) As of December 31, 2000, the Company held five properties.
(2) In December 1999, the Bank acquired 18 lots of a tract development in La
Quinta, California with a carrying value of $4.4 million.
(3) Fair value of collateral at foreclosure, plus post-foreclosure capitalized
costs.
A-16
72
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The table below summarizes activity in the allowance for estimated losses
on real estate owned for the periods indicated:
YEARS ENDED DECEMBER 31,
--------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ----- ----- --------
Total allowance for estimated losses at beginning of
period................................................... $ 29 $ 45 $ 2,563
Provision for estimated losses........................... -- 80 60
Charge-offs.............................................. (29) (96) (2,578)
---- ---- -------
Total allowance for estimated losses at end of
period......................................... -- $ 29 $ 45
==== ==== =======
The following table sets forth the costs and revenues attributable to the
Company's REO properties for the periods indicated. The compensatory and legal
costs directly associated with the Company's property management and disposal
operations are included in general and administrative expenses.
YEARS ENDED DECEMBER 31,
------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ----- ----- ------
Expenses associated with real estate operations:
Repairs, maintenance and renovation..................... $(294) $(219) $ (277)
Insurance and property taxes............................ (18) (132) (123)
----- ----- ------
(312) (351) (400)
Net (loss)/recoveries from sales of REO................... (166) 754 2,278
Property operations, net.................................. 30 1 91
Charge-off/provision for estimated losses on REO.......... (476) (80) (60)
----- ----- ------
(Loss)/income from real estate operations, net............ $(924) $ 324 $1,909
===== ===== ======
NOTE 6 -- OFFICE PROPERTY AND EQUIPMENT -- AT COST
The following table summarizes property and equipment for the dates
indicated:
DECEMBER 31,
-------------------
2000 1999
(DOLLARS IN THOUSANDS) -------- --------
Office buildings............................................ $ 1,415 $ 1,421
Furniture and equipment..................................... 6,449 5,927
Computer hardware/software.................................. 3,486 3,200
Leasehold improvements...................................... 3,482 3,054
-------- --------
Total............................................. 14,832 13,602
Less:
Accumulated depreciation and amortization................. (10,214) (7,853)
-------- --------
4,618 5,749
Land........................................................ 190 190
-------- --------
Net............................................... $ 4,808 $ 5,939
======== ========
The Company recognized $2.8 million, $2.3 million and $1.6 million of
depreciation and amortization expense for the years ended December 31, 2000,
1999, and 1998, respectively.
A-17
73
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 -- 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.
DECEMBER 31, 2000 DECEMBER 31, 1999
---------------------------------- ----------------------------------
BALANCE(1) PERCENT WAIR WARM BALANCE(1) PERCENT WAIR WARM
(DOLLARS IN THOUSANDS) ---------- ------- ---- ---- ---------- ------- ---- ----
Transaction accounts:
Noninterest-bearing checking.... $ 32,994 2.71% -- -- $ 28,838 2.66% -- --
Checking/NOW.................... 42,774 3.52% 2.67% -- 40,563 3.73% 2.17% --
Passbook........................ 25,868 2.13% 2.00% -- 23,568 2.17% 1.41% --
Money Market.................... 213,757 17.60% 5.20% -- 155,537 14.31% 4.45% --
---------- ------ ---------- ------
Total transaction
accounts............... 315,393 25.96% 248,506 22.87%
---------- ------ ---------- ------
Certificates of deposit:
7 day maturities................ 20,905 1.72% 4.04% -- 30,631 2.82% 4.08% --
Less than 6 months.............. 11,248 0.93% 4.93% 2 42,082 3.87% 4.78% 2
6 months to 1 year.............. 106,193 8.74% 6.18% 4 147,407 13.57% 5.24% 3
1 year to 2 years............... 744,058 61.25% 6.43% 6 584,488 53.79% 5.46% 8
Greater than 2 years............ 17,059 1.40% 5.35% 14 33,521 3.08% 5.31% 12
---------- ------ ---------- ------
Total certificates of
deposit................ 899,463 74.04% 838,129 77.13%
---------- ------ ---------- ------
Total deposits....... $1,214,856 100.00% 5.71% 6 $1,086,635 100.00% 4.86% 5
========== ====== ========== ======
- ---------------
(1) Deposits in excess of $100,000 were 29.87% of total deposits at December 31,
2000, compared to 23.47% of total deposits at December 31, 1999.
The table below summarizes interest expense on deposits, by type of
account, for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ------- ------- -------
Checking/NOW.......................................... $ 1,006 $ 801 $ 765
Passbook.............................................. 582 918 632
Money Market.......................................... 8,986 6,803 2,957
Certificates of deposit............................... 52,939 42,309 43,288
------- ------- -------
Total....................................... $63,513 $50,831 $47,642
======= ======= =======
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74
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
This table sets forth the remaining maturities of the certificates of
deposit outstanding for the periods indicated:
CERTIFICATES OF DEPOSIT OUTSTANDING AT DECEMBER 31, 2000
-----------------------------------------------------------
OVER THREE
THREE THROUGH OVER SIX
MONTHS SIX THROUGH OVER ONE
OR LESS MONTHS TWELVE MONTHS YEAR TOTAL
(DOLLARS IN THOUSANDS) -------- ---------- ------------- -------- --------
Balances < $100,000
4.00% or less........................... $ 1,533 $ 55 $ 26 $ 4 $ 1,618
4.01% - 5.00%........................... 19,599 2,122 1,396 2,182 25,299
5.01% - 6.00%........................... 69,672 15,634 5,427 6,097 96,830
6.01% - 7.00%........................... 90,468 141,680 265,421 10,860 508,429
7.01% or more........................... -- -- 175 -- 175
-------- -------- -------- ------- --------
181,272 159,491 272,445 19,143 632,351
Balances > $100,000
4.00% or less........................... -- -- -- -- --
4.01% - 5.00%........................... 6,764 337 486 498 8,085
5.01% - 6.00%........................... 33,051 5,911 1,247 1,205 41,414
6.01% - 7.00%........................... 39,137 57,294 117,937 3,040 217,408
7.01% or more........................... -- -- 205 -- 205
-------- -------- -------- ------- --------
78,952 63,542 119,875 4,743 267,112
-------- -------- -------- ------- --------
Total........................... $260,224 $223,033 $392,320 $23,886 $899,463
======== ======== ======== ======= ========
CERTIFICATES OF DEPOSIT OUTSTANDING AT DECEMBER 31, 1999
-----------------------------------------------------------
Balances < $100,000
4.00% or less.......................... $ 1,645 $ 114 $ 74 $ 12 $ 1,845
4.01% - 5.00%.......................... 76,930 43,765 14,758 6,704 142,157
5.01% - 6.00%.......................... 110,906 93,532 123,972 58,904 387,314
6.01% - 7.00%.......................... -- 95 68,582 7,848 76,525
7.01% or more.......................... -- 1 -- -- 1
-------- -------- -------- -------- --------
189,481 137,507 207,386 73,468 607,842
Balances > $100,000
4.00% or less.......................... 1,155 -- -- -- 1,155
4.01% - 5.00%.......................... 26,883 12,065 5,133 1,379 45,460
5.01% - 6.00%.......................... 45,952 36,074 46,553 24,860 153,439
6.01% - 7.00%.......................... 189 421 27,319 2,304 30,233
7.01% or more.......................... -- -- -- -- --
-------- -------- -------- -------- --------
74,179 48,560 79,005 28,543 230,287
-------- -------- -------- -------- --------
Total.......................... $263,660 $186,067 $286,391 $102,011 $838,129
======== ======== ======== ======== ========
NOTE 8 -- 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
A-19
75
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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:
DECEMBER 31,
----------------------------------------------
2000 1999
--------------------- ---------------------
AVERAGE AVERAGE
RATE AT RATE AT
PRINCIPAL YEAR END PRINCIPAL YEAR END
(DOLLARS IN THOUSANDS) --------- -------- --------- --------
Original Term:
12 Months............................... $ 25,000 5.81% $ -- --
24 Months............................... 25,000 6.56% -- --
36 Months............................... 100,000 6.73% -- --
60 Months............................... 135,000 5.92% 300,000 5.30%
120 Months.............................. 99,000 5.19% 49,000 4.36%
-------- --------
Total........................... $384,000 5.98% $349,000 5.16%
======== ========
The following table summarizes information relating to the Company's FHLB
advances for the periods or dates indicated:
YEAR ENDED DECEMBER 31,
------------------------
2000 1999
(DOLLARS IN THOUSANDS) ---------- ----------
Average balance during the year........................ $346,983 $343,205
Average interest rate during the year.................. 5.82% 5.18%
Maximum month-end balance during the year.............. $384,000 $379,000
Loans underlying the agreements at year end............ $751,628 $799,866
NOTE 9 -- INCOME TAXES
The provision for income taxes consists of the following components for the
periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) -------- ------- -------
Current income tax expense:
Federal............................................ $ (9,203) $(7,409) $ (654)
State.............................................. (2,129) (2) (21)
-------- ------- -------
Total current.............................. (11,332) (7,411) (675)
Deferred income tax expense:
Federal............................................ 1,843 1,168 (4,013)
State.............................................. (1,179) (1,787) 14
-------- ------- -------
Total deferred............................. 664 (619) (3,999)
-------- ------- -------
Income tax provision................................. $(10,668) $(8,030) $(4,674)
======== ======= =======
A-20
76
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The table below summarizes the components of the net deferred income tax
assets for the dates indicated:
DECEMBER 31,
--------------------
2000 1999
(DOLLARS IN THOUSANDS) -------- --------
Deferred income tax liabilities:
Loan fees............................................ $ (7,523) $ (6,503)
FHLB stock........................................... (2,390) (2,001)
Depreciation......................................... (438) (962)
Other................................................ (888) (699)
-------- --------
Total........................................ (11,239) (10,165)
Deferred income tax assets:
Bad debts............................................ 10,826 7,317
Federal AMT credit carry-forward..................... -- 30
Other................................................ 3,280 5,021
-------- --------
Total........................................ 14,106 12,368
-------- --------
Deferred tax assets, net............................... $ 2,867 $ 2,203
======== ========
The table below summarizes the differences between the statutory income tax
and the Company's effective tax for the periods indicated:
YEAR ENDED DECEMBER 31,
----------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ------- ------ -------
Federal income tax..................................... $ 8,733 $6,379 $ 5,497
Addition/(reduction) resulting from:
Change in federal valuation allowance................ -- -- (1,084)
California franchise tax, net of federal income
taxes............................................. 1,785 1,163 5
Other................................................ 150 488 256
------- ------ -------
Total........................................ $10,668 $8,030 $ 4,674
======= ====== =======
NOTE 10 -- STOCKHOLDERS' EQUITY
EMPLOYEE BENEFIT PLANS
The Company has an Employee Stock Ownership Plan ("ESOP") that previously
covered substantially all employees over 21 years of age who met minimum service
requirements. As of December 15, 1995, the Company froze the ESOP and all
accounts became fully vested and nonforfeitable. At December 31, 2000, the ESOP
owned 92,223 shares of the Company's common stock.
Effective April 1, 1996, the ESOP was amended to include a 401(k) plan. The
Company makes a matching contribution equal to 100% of the amount each
participant elects to defer up to a maximum of 5% of the participant's
compensation for the calendar quarter. Employees are eligible to participate if
they were employed by the Company on March 1, 1996 or have been employed for 6
months, worked at least 500 hours, and are over 21 years of age. Contributions
under the plan were $416,727, $420,935 and $382,559 for 2000, 1999 and 1998,
respectively.
DEFERRED COMPENSATION PLAN
In October 2000, the Bank adopted a Deferred Compensation Plan ("the Plan")
in order to provide specified benefits to a select group of management and
highly compensated employees. Under the Plan, participants are allowed to defer
up to 100% of their annual salaries and bonuses. The Bank does not currently
A-21
77
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
match participants' deferrals. The balance in each participants' deferred
compensation account earns interest at a rate equal to the interest rate on
10-Year Treasury notes as in effect on the last date of the calendar year
quarter immediately preceding the valuation date, plus 2.50%. The interest
crediting rate was 8.30% for the year ended December 31, 2000. The expense of
funding the deferred compensation plan was minimal for the year ended December
31, 2000.
STOCK OPTION PLANS
The Company has two stock option plans ("Option Plans"), one of which
provides for the issuance of stock options to directors and employees of the
Company and the other of which provides for the issuance of stock options to
employees other than certain executive officers of the Company. At December 31,
2000, the Option Plans provide for the issuance of 1,300,000 maximum aggregate
shares of Company Common Stock upon exercise of options. The exercise price of
any option may not be less than the fair market value of the Common Stock on the
date of grant and the term of any option may not exceed 10 years.
Presented below is a summary of the transactions under the stock option
plans described above for the periods indicated:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------
2000 1999 1998
------------------------- ------------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------- -------------- -------- -------------- ------- --------------
Outstanding, beginning of year...... 787,800 $10.79 882,300 $10.19 721,800 $ 7.03
Granted........................... 301,500 8.51 135,000 14.36 255,000 17.23
Exercised......................... (235,500) 4.74 (110,000) 5.24 (86,500) 5.06
Canceled or expired............... (247,500) 16.72 (119,500) 15.47 (8,000) 5.26
-------- -------- -------
Outstanding, end of year............ 606,300 9.58 787,800 10.79 882,300 10.19
======== ======== =======
Options exercisable, end of year.... 142,300 480,733 580,400
======== ======== =======
The table below summarizes information about stock options outstanding and
exercisable at December 31, 2000.
WEIGHTED AVERAGE
RANGE OF NUMBER REMAINING CONTRACTUAL NUMBER
EXERCISE PRICES OUTSTANDING LIFE (YEARS) EXERCISABLE
- --------------- ----------- --------------------- -----------
$ 4.65......... 57,000 2.92 57,000
5.26........... 69,300 5.00 69,300
7.74 - 9.91.. 320,000 7.32 16,000
13.73.......... 35,000 7.00 --
15.09 - 16.31.. 125,000 6.08 --
------- -------
$ 4.65 - 16.31.. 606,300 6.37 142,300
======= =======
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78
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
If compensation costs for the Option Plans had been determined based on the
fair value at the grant date for awards in 2000, 1999 and 1998 consistent with
the provisions of SFAS No. 123, the Company's net income and net earnings per
share would have been reduced to the pro forma amounts indicated below.
YEARS ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) ------- ------- -------
Net earnings:
As reported......................................... $14,284 $10,200 $11,038
Pro forma........................................... $14,022 $ 8,677 $ 9,371
Basic earnings per share:
As reported......................................... $ 2.69 $ 1.93 $ 2.64
Pro forma........................................... $ 2.65 $ 1.64 $ 2.24
Diluted earnings per share:
As reported......................................... $ 1.94 $ 1.33 $ 1.65
Pro forma........................................... $ 1.90 $ 1.13 $ 1.40
Weighted average fair value at date of grant.......... $ 3.71 $ 6.62 $ 8.33
The fair value of options granted under the Option Plans was estimated on
the date of grant using the Black-Scholes option-pricing model. In 2000, the
following weighted average assumptions were used: no dividend yield, expected
volatility of 56.46%, risk free interest rate of 4.76% and expected lives of 2
to 4 years. In 1999, no dividend yield, expected volatility of 30.55%, risk free
interest rate of 6.76%, and expected lives of 4 to 8 years. In 1998, no dividend
yield, expected volatility of 32.97%, risk free interest rate of 5.25% and
expected lives of 5 to 8 years.
NOTE 11 -- CAPITAL AND DEBT OFFERINGS
On December 31, 1997, the Company sold $40.0 million of 12.50% 1997 Senior
Notes due 2004 ("1997 Senior Notes") in a private placement (the "1997
Offering"), which included registration rights. Interest on the 1997 Senior
Notes is payable semiannually. On or after December 31, 2002, the 1997 Senior
Notes will be redeemable at any time at the option of the Company, in whole or
in part, at the redemption price of 106.25% for the twelve-month period
beginning December 31, 2002, and 103.125% thereafter.
In July 1998, the Company sold 2,012,500 shares of its Common Stock
(including 262,500 shares, issued upon exercise by the underwriters of their
over allotment option) at a price of $15.00 per share, realizing net proceeds
(after offering costs) of approximately $27.6 million. As a result of this
offering, the exercise price of the Warrants was reduced to $2.128 and the
number of shares of Common Stock acquirable upon the exercise of the Warrants
was increased to 2,512,188.
A-23
79
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12 -- REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined) and to average assets (as defined). Management
believes, as of December 31, 2000, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2000 and 1999, the most recent notification from the OTS
categorized the Bank as well capitalized under the regulatory framework for
Prompt Corrective Action ("PCA") Rules. There are no conditions or events since
that notification that management believes have changed the Bank's category. The
following table sets forth the Bank's actual regulatory capital amounts and
ratios and the regulatory capital amounts and ratios for the Bank to meet the
minimum capital requirements required by the OTS and to be categorized as "well
capitalized" under the PCA Rules as of December 31, 2000 and 1999.
TO BE WELL
CAPITALIZED UNDER
PROMPT
FOR CAPITAL CORRECTIVE ACTION
ACTUAL ADEQUACY PURPOSES PROVISIONS
------------------ ----------------- ------------------
AMOUNT RATIOS AMOUNT RATIOS AMOUNT RATIOS
(DOLLARS IN THOUSANDS) -------- ------ ------- ------ -------- ------
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%
As of December 31, 1999:
Total capital
(to risk weighted assets)........ $139,815 12.50% $89,468 8.00% $111,835 10.00%
Core capital
(to adjusted tangible assets).... 127,160 8.05% 63,174 4.00% 78,967 5.00%
Tangible capital
(to adjusted tangible assets).... 127,160 8.05% 23,690 1.50% n/a n/a
Tier 1 capital
(to risk weighted assets)........ 127,160 11.37% n/a n/a 67,101 6.00%
NOTE 13 -- COMMITMENTS AND CONTINGENCIES
LITIGATION
The Bank is a defendant in a construction defect case entitled Marine
Village Townhomes Homeowners' Association v. Hawthorne Savings and Loan
Association that was filed in the Superior Court of the State of
A-24
80
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
California, County of Los Angeles. In this action, Plaintiffs allege, under
several theories of recovery, that the Bank was responsible for construction
defects in a multi-unit condominium complex, and further alleges fraud by the
Bank in connection with the sales of the condominiums. The Bank initially
provided a construction loan to the developer, but took over the completion of a
portion of the projects after the developer defaulted. Plaintiffs are seeking
damages of approximately $3.3 million, plus punitive damages. The Bank has
denied that it is responsible for all of the defects Plaintiffs are alleging,
and has made claims for indemnification against the contractor and
subcontractors. The Bank is also seeking reimbursement from various insurance
carriers for defense costs and indemnification for any amounts the Bank is
obligated to pay. No assurances can be given that the responsible parties will
ultimately indemnify the Bank. Further, there can be no insurance coverage for
intentional acts or punitive damages, if awarded. Although the Bank intends to
vigorously defend its position and to pursue indemnification, there can be no
assurances that the Bank will prevail. In addition, the Bank has incurred
substantial legal fees defending the case. In addition, the inherent uncertainty
of jury or judicial verdicts makes it impossible to determine with certainty the
Company's maximum exposure in these actions.
The Bank was a defendant in a construction defect case entitled Stone Water
Terrace HOA v. Hawthorne Savings and Loan Association, which was filed in the
Superior Court of the State of California, County of Los Angeles. In this
action, Plaintiff alleged, under several theories of recovery, that the Bank was
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 projects after the developer defaulted. The
plaintiff sought damages in an unspecified amount, plus punitive damages. The
Bank denied the allegations in the complaint and sought indemnification against
the responsible parties. On September 18, 2000, the Court entered an order
dismissing the Stonewater Terrace HOA case because Plaintiffs failed to take
certain actions. In March 2001, the Plaintiffs filed a motion seeking to have
the case reinstated. The Bank intends to oppose the motion, but there can be no
assurances that the case will not be reinstated. If the case is reinstated, it
is probable that the Bank will incur substantial legal fees defending this
matter. At the time the case was dismissed, discovery had not yet begun, so the
Bank is not in a position to estimate the extent of any liability. In addition,
the inherent uncertainty of jury or judicial verdicts makes it impossible to
determine with certainty the Company's maximum exposure in this action.
The Bank is involved in a variety of other litigation matters in the
ordinary course of its business, and anticipates that it will become involved in
new litigation matters from time to time in the future. Based on the current
assessment of these other matters, management does not presently believe that
any one of these existing other matters is likely to have a material adverse
impact on the Company's financial condition or results of operations. However,
the Company will incur legal and related costs concerning the litigation and may
from time to time determine to settle some or all of the cases, regardless of
management's assessment of the Company's legal position. The amount of legal
defense costs and settlements in any period will depend on many factors,
including the status of cases (and the number of cases that are in trial or
about to be brought to trial) and the opposing parties' aggressiveness in
pursuing their cases and their perception of their legal position. Further, the
inherent uncertainty of jury or judicial verdicts makes it impossible to
determine with certainty the Company's maximum cost in any pending litigation.
Accordingly, the Company's litigation costs and expenses may vary materially
from period to period, and no assurance can be given that these costs will not
be material in any particular period.
LENDING COMMITMENTS
At December 31, 2000, the Company had commitments to fund the undisbursed
portion of existing construction and land loans of $147.0 million and income
property and estate loans of $4.5 million. The commitments to fund the
undisbursed portion of existing lines of credit, excluding construction and land
lines of credit, totaled $20.3 million.
A-25
81
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LEASES
The Company has entered into agreements to lease certain office facilities
under noncancelable operating leases that expire at various dates to the year
2010. The leases generally provide that the Company pays property taxes,
insurance and other items. Current rental commitments for the remaining terms of
these noncancelable leases as of December 31, 2000 are as follows:
(DOLLARS IN THOUSANDS)
YEAR AMOUNT
---- ------
2001........................................................ $1,896
2002........................................................ 1,733
2003........................................................ 1,750
2004........................................................ 1,735
2005........................................................ 1,543
Thereafter.................................................. 1,250
------
Total............................................. $9,907
======
Lease expense for office facilities was $1.9 million, $1.7 million and $1.4
million for the years ended December 31, 2000, 1999 and 1998, respectively.
NOTE 14 -- ESTIMATED FAIR VALUE INFORMATION
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments." The Company, using
available market information and appropriate valuation methodologies, has
determined the estimated fair value amounts. However, considerable judgment is
required to interpret market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts the Company could realize in a current market exchange. The use of
different market assumptions and or estimation methodologies may have a material
effect on the estimated fair value amounts.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
2000 1999
------------------------ ------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
(DOLLARS IN THOUSANDS) ---------- ---------- ---------- ----------
Assets:
Cash and cash equivalents............... $ 99,919 $ 99,919 $ 86,722 $ 86,722
Loans receivable........................ 1,608,067 1,645,338 1,444,968 1,455,635
Investment in FHLB stock................ 20,730 20,730 22,236 22,236
Accrued interest receivable............. 11,040 11,040 9,250 9,250
Liabilities:
Deposits:
Noninterest-bearing checking......... 32,994 32,994 28,838 28,838
Checking/NOW......................... 42,774 42,774 40,563 40,563
Passbook............................. 25,868 25,868 23,568 23,568
Money market......................... 213,757 213,757 155,537 155,537
Certificates of deposit.............. 899,463 898,640 838,129 836,101
FHLB advances........................... 384,000 389,295 349,000 346,881
Senior notes............................ 39,358 39,752 40,000 38,600
Accrued interest payable................ 1,351 1,351 1,224 1,224
A-26
82
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The methods and assumptions used to estimate the fair value of each class
of financial instruments for which it is practicable to estimate that value are
explained below:
For cash and cash equivalents, the carrying amounts approximate fair values
due to the short term nature of these instruments.
The carrying amount of loans receivable is their contractual amounts
outstanding reduced by net deferred loan origination fees and the allowance for
loan losses (Note 4). Adjustable rate loans consist primarily of loans whose
interest rates float with changes in either a specified bank's reference rate or
current market indices.
The fair value of both adjustable and fixed rate loans was estimated by
discounting the remaining contractual cash flows using the estimated current
rate at which similar loans would be made to borrowers with similar credit risk
characteristics over the same remaining maturities, reduced by net deferred loan
origination fees and the allocable portion of the allowance for the estimated
credit losses. The estimated current rate for discounting purposes was not
adjusted for any change in borrowers' credit risks since the origination of such
loans. Rather, the allocable portion of the allowance for estimated credit
losses is considered to provide for such changes in estimating fair value.
The fair value of nonaccrual loans (Note 4) has been estimated at the
carrying amount of these loans, as it is not practicable to reasonably assess
the credit risk adjustment that would be applied in the market place for such
loans.
For FHLB stock, the carrying amount approximates fair value, as the stock
may be sold back to the FHLB at the carrying value.
The withdrawable amounts for noninterest-bearing checking, checking/NOW,
passbook and money market accounts are considered stated at their estimated fair
value. The fair value of fixed-maturity certificates of deposit is estimated
using the rates currently offered for deposits of similar remaining maturities.
The fair value of FHLB advances is estimated using the rates currently
offered on similar instruments with similar terms.
The fair value of the 1997 Senior Notes in 2000 and 1999 is based on quoted
market price.
Additionally, optional commitments to originate mortgages are excluded from
this presentation because such commitments are typically at market terms, are
typically for adjustable rate loans, and are generally cancelable by borrower
without significant fees or costs upon cancellation.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2000 and 1999. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amounts presented.
A-27
83
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 -- PARENT COMPANY ONLY FINANCIAL STATEMENTS
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31,
--------------------
2000 1999
(DOLLARS IN THOUSANDS) -------- --------
Assets:
Cash at the Bank and cash equivalents..................... $ 2,126 $ 1,259
Loans receivable, net..................................... 228 --
Investment in subsidiary.................................. 140,387 127,160
Other assets.............................................. 1,457 4,716
-------- --------
Total assets...................................... $144,198 $133,135
======== ========
Liabilities and Stockholders' Equity:
Liabilities:
Senior notes........................................... $ 39,358 $ 40,000
Accounts payable and other liabilities................. 679 831
-------- --------
Total liabilities................................. 40,037 40,831
Stockholders' Equity:
Common stock -- $0.01 par value; authorized 20,000,000
shares; issued and outstanding, 5,566,801 shares
(2000) and 5,331,301 shares (1999).................... 56 53
Capital in excess of par value -- common stock......... 42,095 40,981
Retained earnings...................................... 65,602 51,318
Less:
Treasury stock, at cost -- 391,406 shares (2000) and
5,400 shares (1999)................................... (3,592) (48)
-------- --------
Total stockholders' equity........................ 104,161 92,304
-------- --------
Total liabilities and stockholders' equity........ $144,198 $133,135
======== ========
A-28
84
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 -- PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) ------- ------- -------
Interest revenues from investments.......................... $ 38 $ 55 $ 571
Interest costs.............................................. 4,989 5,000 5,000
------- ------- -------
Net interest (loss)......................................... (4,951) (4,945) (4,429)
Noninterest revenues/(expenses), net:
Operating................................................. -- -- 1
Other non-operating....................................... 25 (808) --
Operating costs............................................. (1,137) (939) (1,307)
------- ------- -------
Loss before income taxes and equity in subsidiary........... (6,063) (6,692) (5,735)
Income tax benefit.......................................... 2,620 2,903 --
------- ------- -------
Loss before equity in subsidiary............................ (3,443) (3,789) (5,735)
Equity in earnings of subsidiary............................ 17,727 13,989 16,773
------- ------- -------
Net income.................................................. $14,284 $10,200 $11,038
======= ======= =======
A-29
85
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15 -- PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
(DOLLARS IN THOUSANDS) -------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 14,284 $ 10,200 $ 11,038
Adjustments:
Equity in undistributed earnings of subsidiary........ (17,727) (13,989) (16,773)
Depreciation and amortization......................... 361 361 361
Increase in interest receivable....................... (6) -- --
Decrease/(increase) in other assets................... 2,904 (2,890) (44)
(Decrease)/increase in accounts payable and other
liabilities......................................... (152) (9,390) 10,188
Other................................................. -- (32) --
-------- -------- --------
Net cash (used in)/provided by operating
activities..................................... (336) (15,740) 4,770
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities.................................. -- -- (27,900)
Maturities of securities................................. -- -- 27,900
Net (increase)/decrease in loans receivable.............. (228) 150 (150)
-------- -------- --------
Net cash (used in)/provided by investing
activities..................................... (228) 150 (150)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of stock options and
warrants.............................................. 1,117 633 437
Payments to acquire treasury stock....................... (3,544) -- --
Net collection of ESOP loan.............................. -- 79 13
Cash contribution to subsidiary.......................... -- (7,500) (22,000)
Cash dividends received.................................. 4,500 3,000 --
Reduction in senior notes................................ (642) -- --
Stock offering proceeds, net............................. -- -- 27,623
-------- -------- --------
Net cash provided by/(used in) financing
activities..................................... 1,431 (3,788) 6,073
-------- -------- --------
Net increase/(decrease) in cash and cash equivalents....... 867 (19,378) 10,693
Cash and cash equivalents, beginning of year............... 1,259 20,637 9,944
-------- -------- --------
Cash and cash equivalents, end of year..................... $ 2,126 $ 1,259 $ 20,637
======== ======== ========
Non-cash investing and financing items:
Net change in unrealized loss on available-for-sale
securities............................................ -- -- (6)
A-30
86
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16 -- QUARTERLY INFORMATION (UNAUDITED)
THREE MONTHS ENDED FOR 2000
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
IN THOUSANDS, EXCEPT PER SHARE DATA) -------- ------- ------------ -----------
Interest revenues............................. $34,436 $36,375 $39,190 $38,987
Interest costs................................ 19,691 20,868 23,812 24,311
------- ------- ------- -------
Net interest income......................... 14,745 15,507 15,378 14,676
Provision for credit losses................... 1,500 1,500 1,500 1,500
------- ------- ------- -------
Net interest income after provision for credit
losses...................................... 13,245 14,007 13,878 13,176
Noninterest revenues.......................... 1,760 2,134 2,965 1,235
Loss from real estate operations, net......... (59) (90) (537) (238)
Noninterest expenses:
General and administrative expenses......... 8,099 8,711 8,672 8,846
Other non-operating expense................. 1,828 196 117 55
------- ------- ------- -------
Total noninterest expenses.......... 9,927 8,907 8,789 8,901
------- ------- ------- -------
Income before income taxes.................... 5,019 7,144 7,517 5,272
Income tax provision.......................... 2,115 3,072 3,233 2,248
------- ------- ------- -------
Net income.................................... $ 2,904 $ 4,072 $ 4,284 $ 3,024
======= ======= ======= =======
Basic earnings per share...................... $ 0.53 $ 0.77 $ 0.81 $ 0.58
======= ======= ======= =======
Diluted earning per share..................... $ 0.39 $ 0.57 $ 0.58 $ 0.41
======= ======= ======= =======
THREE MONTHS ENDED FOR 1999
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
(IN THOUSANDS, EXCEPT PER SHARE DATA) -------- ------- ------------ -----------
Interest revenues............................. $32,014 $32,680 $34,531 $33,522
Interest costs................................ 17,544 18,315 18,782 18,985
------- ------- ------- -------
Net interest income......................... 14,470 14,365 15,749 14,537
Provision for credit losses................... 3,000 2,500 3,500 3,000
------- ------- ------- -------
Net interest income after provision for credit
losses...................................... 11,470 11,865 12,249 11,537
Noninterest revenues.......................... 1,970 1,925 2,045 1,880
Income (loss) from real estate operations,
net......................................... 434 (17) 3 (96)
Noninterest expenses:
General and administrative expenses......... 7,798 7,852 7,315 9,398
Other non-operating expense................. 992 8 622 3,050
------- ------- ------- -------
Total noninterest expenses.......... 8,790 7,860 7,937 12,448
------- ------- ------- -------
Income before income taxes.................... 5,084 5,913 6,360 873
Income tax provision.......................... 2,112 2,487 2,686 745
------- ------- ------- -------
Net income.................................... $ 2,972 $ 3,426 $ 3,674 $ 128
======= ======= ======= =======
Basic earnings per share...................... $ 0.57 $ 0.65 $ 0.69 $ 0.02
======= ======= ======= =======
Diluted earning per share..................... $ 0.38 $ 0.44 $ 0.48 $ 0.02
======= ======= ======= =======
NOTE 17 -- SUBSEQUENT EVENT
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
A-31
87
HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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.
Holders of the Capital Securities are entitled to receive cumulative cash
distributions, accumulating from March 28, 2001, the date of original issuance,
and payable semi-annually in arrears on June 8 and December 8 of each year,
commencing June 8, 2001, at an annual rate of 10.18% of the liquidation amount
of $1,000 per Trust Security. The Company has the right under certain
circumstances to defer payments of interest on the Junior Subordinated
Debentures at any time and from time to time for a period not exceeding 10
consecutive semi-annual periods with respect to each deferral period, provided
that no deferral period may end on a day other than an interest payment date or
extend beyond the stated maturity date of the Junior Subordinated Debentures. If
and for so long as interest payments on the Junior Subordinated Debentures are
so deferred, cash distributions on the Trust Securities will also be deferred
and the Company will not be permitted, subject to certain exceptions, to declare
or pay any cash distributions with respect to the Company's capital stock (which
includes common and preferred stock) or to make any payment with respect to debt
securities of the Company that rank equal with or junior to the Junior
Subordinated Debentures.
Upon the repayment on June 8, 2031, the stated maturity date, or prepayment
prior to this date of the Junior Subordinated Debentures, the proceeds from such
repayment or prepayment shall be applied to redeem the Trust Securities upon not
less than 30 nor more than 60 days notice of a date of redemption at the
applicable redemption price. At maturity, the redemption price shall equal the
principal of and accrued and unpaid interest on the Junior Subordinated
Debentures. The Junior Subordinated Debentures will be prepayable prior to the
maturity date at the option of the Company on or after June 8, 2011, in whole or
in part, at a prepayment price equal to 105.09% of the principal amount thereof
on the prepayment date, declining ratably on each June 8 thereafter to 100% on
or after June 8, 2021, plus accrued and unpaid interest thereon to the date of
prepayment.
The Indenture for the Capital Securities includes provisions that restrict
the payment of dividends under certain conditions and changes in ownership of
the Trust. The Indenture also includes provisions relating to the payment of
expenses associated with the issuance of the Capital Securities.
The Company intends to use the proceeds to repurchase some of its
outstanding 12.50% 1997 Senior Notes due 2004 in order to reduce its overall
interest costs. To the extent that the Company is unable to use the full amount
of the proceeds to repurchase 1997 Senior Notes, the capital will be used to
repurchase common stock or to fund acquisitions of complementary lines of
business. Some portion of the proceeds may be invested in the Bank to support
future growth. Pending use of the proceeds as described above, the proceeds will
be invested in short term investments.
A-32