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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number: 0-1100

Hawthorne Financial Corporation

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

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

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

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No  o

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

      As of June 30, 2003 (the last business day of the most recently completed second fiscal quarter), the aggregate market value of voting and non-voting stock held by nonaffiliates of the registrant was approximately $243,941,536 (based upon the last reported sales price of the Common Stock as reported by the Nasdaq National Market). Shares of Common Stock held by each executive officer, director, and shareholders with beneficial ownership of greater than 10% of the outstanding Common Stock of the registrant and persons or entities known to the registrant to be affiliates of the foregoing have been excluded in that such persons may be deemed to be affiliates. This assumption regarding affiliate status is not necessarily a conclusive determination for other purposes.

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

      The number of shares of Common Stock, par value $0.01 per share, of the Registrant outstanding as of February 27, 2004 was 11,798,471 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 2004 Annual Meeting of Stockholders.

HAWTHORNE FINANCIAL CORPORATION

ANNUAL REPORT ON FORM 10-K

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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:

	•	Announced Merger with Commercial Capital. On January 27, 2004, the Company announced that it had signed a definitive agreement to merge with Commercial Capital Bancorp, Inc. (“Commercial Capital”) that is anticipated to become effective in the second quarter of 2004. Factors associated with the merger that could adversely affect the Company’s results of operations include: 1) the businesses of the Company and Commercial Capital may not be combined successfully, or the combination may take longer to accomplish than expected; 2) the growth opportunities and cost savings from the merger of the Company and Commercial Capital may not be fully realized or may take longer to realize than expected; 3) operating costs and business disruption following the completion of the merger, including adverse effects on relationships with employees, may be greater than expected; 4) we may not obtain governmental approvals of the merger, or adverse regulatory conditions may be imposed in connection with governmental approvals of the merger; 5) the stockholders of either the Company or Commercial Capital may fail to approve the merger.
	•	Economic Conditions. The Company’s results are strongly influenced by general economic conditions in its market area. The Company operates in the coastal counties of Southern California. Accordingly, deterioration in the economic conditions in these counties could have a material adverse impact on the quality of the Company’s loan portfolio and the demand for its products and services. In particular, changes in economic conditions in the real estate industry or real estate values in the Company’s market may affect its borrowers’ ability to perform, and necessitate further provisions for potential loan losses.
	•	Interest Rate Risk. The Company realizes income principally from the differential or spread between the interest earned on loans, investments, and other interest earning assets, and the interest paid on deposits and borrowings. The volumes and yields on loans, investments, deposits, and borrowings are affected by market interest rates.

	Changes in the market level of interest rates directly and immediately affect the Company’s interest spread, and therefore profitability. Sharp and significant changes to market rates can cause the interest spread to shrink in the near term, principally because of the timing differences between the adjustable rate loans and the maturities (and therefore repricing) of the deposits and borrowings.
	Sharp decreases in interest rates have historically resulted in increased loan refinancings to fixed rate products. Due to the fact that the Bank is a variable rate lender and offers fixed rate products on a limited basis, this interest rate environment could continue to negatively impact the Company’s ability to grow the balance sheet and leverage off of the existing expense base. This could impede the Company’s ability to improve the overall efficiency ratio.

	•	Government Regulation And Monetary Policy. All forward-looking statements presume a continuation of the existing regulatory environment and United States’ government monetary policies. The banking industry is subject to extensive federal and state regulations, and significant new laws or

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		changes in, or repeals of, existing laws may cause results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, primarily through open market operations in United States government securities, the discount rate for member bank borrowings and bank reserve requirements, and a material change in these conditions has had and is likely to continue to have a material impact on the Company’s results.
	•	Risks Associated with Litigation. We are, and have been involved, from time to time, in various claims, complaints, proceedings and litigation relating to activities arising from the normal course of our operations, including those discussed herein. Further, our business is primarily conducted in California, which is one of the most highly litigious states in the country. If new facts are developed that would change our current assessment of the litigation matters that we are currently involved in, or if we become subject to significant new litigation, we may incur legal and related costs that could affect our results.
	•	Competition. The financial services business in the Company’s market areas is highly competitive, and is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers. The Company faces competition both in attracting deposits and in making loans. The Company competes for loans principally through the interest rates and loan fees we charge and the efficiency and quality of services we provide. Increasing levels of competition in the banking and financial services businesses may reduce the Company’s market share, cause the interest rates and fees we charge for the Company’s loans and deposit products to fall or impact the Company’s ability to retain loans and/or deposits. This may in turn affect the Company’s net interest income, net interest margin, noninterest income and the Company’s results of operations.
	•	Credit Quality. A significant source of risk arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Company has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying its credit portfolio, but such policies and procedures may not prevent unexpected losses that could materially adversely affect the Company’s results.
	•	Other Initiatives. The Company is continually in the process of evaluating and implementing strategic initiatives designed to enhance its franchise value. The Company’s business performance is highly dependent on successfully executing these initiatives and the Company’s strategic plan. There are no guarantees regarding the Company’s success in implementing these initiatives, or in anticipating changes in the economy and taking advantage of opportunities or fully avoiding risks.
	•	Investment Securities. The securities in the Bank’s investment portfolio (primarily Mortgage Backed Securities) are classified as “available-for-sale.” Changes in the fair value of the investment portfolio result from numerous and often uncontrollable events such as changes in interest rates, prepayment speeds, market perception of risk in the economy and other factors. To the extent that the Bank continues to have both the ability and intent to hold these securities for yield enhancement, changes in the fair value will be included as a component of stockholders’ equity. If the decline in fair value, if any, is deemed to be “other than temporary,” it will be treated as a “permanent impairment” and reflected in earnings. The Bank’s investment securities portfolio is also subject to interest rate risk. Fluctuations in interest rates may cause actual prepayments to vary from the estimated prepayments over the life of the security. This may result in adjustments to the amortization of premiums or accretion of discounts related to these instruments, consequently changing the net yield on such securities. Reinvestment risk is also associated with the cash flows from such securities.
	•	Amortization of Intangible Assets/ Impairment of Goodwill. The Company acquired First Fidelity Bancorp, Inc. (“First Fidelity”) on August 23, 2002, and as a result recorded an intangible assets of $1.5 million and $23.0 million for goodwill. See “Business Combinations, Goodwill and Acquired

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		Intangible Assets.” The Company is required to assess goodwill and other intangible assets annually for impairment, or more frequently if impairment indicators arise. If it were deemed that an impairment occurred, the Company would be required to take a charge against earnings to write down the assets.
	•	Other Risks. From time to time, the Company details other risks with respect to its business and/or financial results in press releases and filings with the SEC. Stockholders are urged to review the risks described in such releases and filings.

      The risks highlighted herein should not be assumed to be the only factors that could affect future performance of the Company. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

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PART I

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. The Bank owns 100% of HS Financial Services Corporation (“HSFSC”), a subsidiary of Hawthorne Savings. The Company also owns 100% of HFC Capital Trust I, HFC Capital Trust II, HFC Capital Trust III and HFC Capital Trust IV, which are statutory business trusts and wholly owned subsidiaries of the Company.

      The Company’s only operating segment is the Bank, which specializes in real estate secured loans throughout the coastal counties of Southern California, which are funded predominately with retail deposits and advances from the Federal Home Loan Bank of San Francisco (“FHLB”). The Bank currently operates 15 full service retail offices located in the coastal counties of Southern California. The Bank concentrates on providing superior customer service as it continues to enhance the products and services offered to its retail customers.

Recent Developments

      Three-For-Two Stock Split. On September 25, 2003, the Company announced that its Board of Directors approved a 3-for-2 stock split to be effected in the form of a 50% stock dividend. The additional shares were distributed to shareholders of record as of October 6, 2003 on October 27, 2003. The effect of the stock split has been recognized and reflected in all share and per share amounts for all periods presented.

      On January 27, 2004, Hawthorne Financial Corporation (“Hawthorne”) entered into an Agreement and Plan of Reorganization (“Agreement”) with Commercial Capital Bancorp (“CCBI”) and CCBI Acquisition Corporation, pursuant to which Hawthorne will be acquired by CCBI. Under the terms of the agreement, which has been unanimously approved by the Boards of Directors of both companies, shareholders of Hawthorne will receive 1.933 shares of CCBI common stock in exchange for each share of Hawthorne stock. The transaction, which is expected to be a reorganization for tax purposes, values each share of Hawthorne common stock at $37.92, based on CCBI’s closing price of $26.15 on January 27, 2004. The value of the transaction and value of each share of Hawthorne common stock on consummation of the merger may be higher or lower depending on the price of CCBI’s common stock on such date. The transaction is expected to close in the summer of 2004, pending shareholder and regulatory approval and satisfaction of other customary conditions. At December 31, 2003, CCBI had $1.72 billion in total assets, $1.05 billion in total loans, $645.6 million in total deposits and $102.0 million in total equity. At December 31, 2003, Hawthorne had $2.67 billion in total assets, $2.15 billion in total loans, $1.72 billion in total deposits and $185.3 million in total equity.

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 by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) concerning reserves required to be maintained against deposits and certain other matters.

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      HSFSC is a California corporation that was incorporated on April 11, 2002, and is a wholly-owned subsidiary of Hawthorne Savings, F.S.B. HSFSC, which commenced operations in July 2002, offers uninsured investments to its customers and engages in limited insurance agent activities. As of September 30, 2003, the securities activities of HSFSC were reorganized and are now being conducted through an unincorporated division of the Bank. HSFSC is a licensed life insurance agent for the purpose of receiving commissions on the sale of fixed rate annuities. Registered representatives of HSFSC sell mutual funds and variable rate annuities in the Bank’s offices through a third party vendor, Duerr Financial Services, a registered broker-dealer. Income to date from this subsidiary has been insignificant.

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

Operations

      The Bank offers a variety of consumer banking products through its network of retail branches, which includes the traditional range of checking and savings accounts, money market accounts and certificates of deposit. The Bank currently has 15 full service retail branches, 9 of which are located in the South Bay region of Los Angeles County. The Bank also has two branches in Orange County, two branches in San Diego County and two branches in the San Fernando Valley, one of which is in Ventura County.

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

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

      The Bank funds its loans and investments predominantly with retail deposits generated through its 15 full service retail branches and FHLB advances. Scheduled payments of loans and investment securities are a reasonably stable source of funds, while prepayments on loans and investment securities and deposit streams are subject to significant fluctuations. During 2002 and 2003, the Bank significantly increased its investment portfolio, which primarily consists of mortgage backed securities (“MBS”) and collateralized mortgage obligations (“CMO”).

Market Area and Competition

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

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

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

      The Bank competes for deposit funds with other Southern California-based financial companies, including banks, savings associations, credit unions and thrift and loans. These companies generally compete with one another based upon price, convenience and service. Though many of the Bank’s competitors offer customers a larger spectrum of products than the Bank, the Company, as part of its strategic plan, continues to enhance the line of products and services offered to retail customers. The Bank’s cross-sell ratio (deposit and loan products per household) was 2.77 at December 31, 2003, compared with 2.44 at December 31, 2002.

Supervision And Regulation

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

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

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

      Activities Restriction Test. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions, provided the Bank satisfies the Qualified Thrift Lender (“QTL”) test or meets the definition of domestic building and loan association pursuant to the Internal Revenue Code of 1986, as amended (the “Code”). The Company presently intends to continue to operate as a unitary thrift savings

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      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.

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

	•	the creation of a five-member oversight board appointed by the Securities & Exchange Commission (“SEC”) that will set standards for accountants and have investigative and disciplinary powers;
	•	the prohibition of accounting firms from providing various types of consulting services to public clients and requiring accounting firms to rotate partners among public client assignments every 5 years;
	•	increased penalties for financial crimes;
	•	expanded disclosure of corporate operations and internal controls, including conflict of interest policies, and certification of financial statements;
	•	enhanced controls on and reporting of insider trading; and
	•	statutory separations between investment bankers and analysts.

      The new legislation and its implementing regulations will result in increased compliance costs, including certain outside professional costs.

      USA Patriot Act of 2001. The USA Patriot Act of 2001 (the “Patriot Act”), significantly expanded the anti-money laundering and financial transparency laws, including:

	•	due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons;
	•	standards for verifying customer identification at account opening;
	•	rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering;

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	•	reports by nonfinancial businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for cash transactions exceeding $10,000; and
	•	the filing of suspicious activities reports involving securities by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.

      Fair and Accurate Credit Transactions Act. In December, 2003, President Bush signed into law the Fair and Accurate Credit Transactions Act (“FACT Act”) which sets new obligations for financial firms to help deter identity theft and give consumers more control of their credit data. It also reauthorizes a federal ban on state laws that interfere with corporate credit granting and marketing practices. The FRB and the Federal Trade Commission (“FTC”) are required to draft regulations to implement the FACT Act. It is not possible at this time to determine the impact of such regulations that are to be drafted; however, the FRB and FTC recently announced that businesses will have until December 1, 2004 to comply with the new initiatives.

      Privacy. Federal banking rules limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. Pursuant to these rules, financial institutions must provide:

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

      These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. The Bank has implemented privacy policies in accordance with the law.

      On December 22, 2003, the SEC issued the advance notice of proposed rulemaking along with the federal banking agencies and other government agencies seeking comment on whether they should consider amending current regulations “to allow or require financial institutions to provide alternative types of privacy notices, such as a short privacy notice, that would be easier for consumers to understand.” The concept release lists more than 40 questions regarding which the agencies seek comment from the public, organized in the following categories: goals of a privacy notice, elements of a privacy notice, language of a privacy notice, format of a privacy notice, mandatory and permissible aspects of a privacy notice, costs and benefits of a short notice, and other categories.

      In recent years, a number of states have implemented their own versions of privacy laws. For example, in 2003, California adopted standards that are tougher than federal law, allowing bank customers the opportunity to bar financial companies from sharing information with their affiliates.

      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

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      Interagency Guidance on Response Programs to Protect Against Identity Theft. On August 12, 2003, the Federal bank and thrift regulatory agencies requested public comment on proposed guidance that would require financial institutions to develop programs to respond to incidents of unauthorized access to customer information, including procedures for notifying customers under certain circumstances. The proposed guidance:

	•	interprets previously issued interagency customer information security guidelines that require financial institutions to implement information security programs designed to protect their customers’ information; and
	•	describes the components of a response program and sets a standard for providing notice to customers affected by unauthorized access to or use of customer information that could result in substantial harm or inconvenience to those customers, thereby reducing the risk of losses due to fraud or identity theft.

      Dividends and Other Transfers of Funds. 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.

      Generally, OTS regulations require a savings association to file an application if:

	•	it is not eligible for expedited treatment of its other applications under OTS regulations;
	•	the total amount of all of 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 2 years;
	•	it would not be at least adequately capitalized, under the prompt corrective action regulations of the OTS following the distribution; or
	•	the 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.

      Alternatively, a savings association must give the OTS notice of a capital distribution if the savings association is not required to file an application, but:

	•	would not be well capitalized under the prompt corrective action regulations of the OTS following the distribution;
	•	the proposed capital distribution would reduce the amount of or retire any part of the savings association’s common or preferred stock or retire any part of debt instruments like notes or debentures included in capital, other than regular payments required under a debt instrument approved by the OTS; or
	•	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, the OTS does not require the savings association to submit an application or give notice when making the proposed capital distribution. The OTS may prohibit a proposed capital distribution that would otherwise be permitted if the OTS determines that the distribution would constitute an unsafe or unsound practice.

      Transactions with Affiliates. The Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, any affiliates, the purchase

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      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. Additionally, savings associations may request OTS permission to make loans in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop residential housing, provided:

	•	the purchase price of each single-family dwelling in the development does not exceed $500,000;
	•	the savings association is in compliance with its fully phased-in capital requirements;
	•	the loans comply with applicable loan-to-value requirements; and
	•	the aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus.

      Notwithstanding the above limitations, a savings association may have total loans and extensions of credit, for any purpose, to one borrower outstanding at one time not to exceed $500,000.

      At December 31, 2003, the Bank’s loans-to-one-borrower limit was $36.0 million based upon the 15% of unimpaired capital and surplus measurement. At December 31, 2003, the Bank’s 2 largest lending relationships had outstanding balances of $20.9 million, which consisted of 10 loans secured by multi-family real estate, and $11.1 million, which consisted of 6 loans with $10.3 million and $0.8 million secured by income property development and multi-family real estate, respectively. These loans were performing in accordance with their terms.

      Qualified Thrift Lender Test. Savings associations must meet a QTL test, which test 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 9 out of every 12 months. Associations that fail to meet the QTL test will generally be prohibited from engaging in any activity not permitted for both a national bank and a savings association. As of December 31, 2003, the Bank was in compliance with its QTL requirement and met the definition of a domestic building and loan association.

      Capital Standards. The federal banking agencies have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk federal banking agencies, to 100% for assets with relatively high credit risk.

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      The risk-based capital ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risk. Under the capital guidelines, a banking organization’s total capital is divided into tiers. “Tier I capital” consists of 1) common equity, 2) qualifying noncumulative perpetual preferred stock, 3) a limited amount of qualifying cumulative perpetual preferred stock and 4) minority interests in the equity accounts of consolidated subsidiaries (including trust-preferred securities), less goodwill and certain other intangible assets. Not more than 25% of qualifying Tier I capital may consist of trust-preferred securities. “Tier II capital” consists of hybrid capital instruments, perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, preferred stock that does not qualify as Tier I capital, a limited amount of the allowance for loan and lease losses and a limited amount of unrealized holding gains on equity securities. “Tier III capital” consists of qualifying unsecured subordinated debt. The sum of Tier II and Tier III capital may not exceed the amount of Tier I capital.

      The guidelines require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the 5 categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.

      Proposed accounting rules regarding special purpose entities (Fin 46) could disqualify trust-preferred securities from Tier 1 capital status. The Company’s trust-preferred securities are recorded on the Holding Company’s books and are therefore not included in the Bank’s Tier 1 capital.

      In addition, federal banking regulators may set capital requirements higher than the minimums described above for financial institutions whose circumstances warrant it. For example, a financial institution experiencing or anticipating significant growth may be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets.

      Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following 5 categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 2003, the Bank exceeded the required ratios for classification as a “well capitalized” institution.

      An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment.

      In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency. Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized — without the express permission of the institution’s primary regulator.

      Safety and Soundness Standards. The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns

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      Premiums for Deposit Insurance. Through the BIF, the FDIC insures our customer deposits up to prescribed limits for each depositor. The amount of FDIC assessments paid by each BIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution’s capitalization risk category and supervisory subgroup category. An institution’s capitalization risk category is based on the FDIC’s determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. An institution’s supervisory subgroup category is based on the FDIC’s assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required.

      FDIC-insured depository institutions pay an assessment rate equal to the rate assessed on deposits insured by the Savings Association Insurance Fund (“SAIF”).

      The assessment rate currently ranges from zero to 27 cents per $100 of domestic deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. Due to continued growth in deposits and some recent bank failures, the BIF is nearing its minimum ratio of 1.25% of insured deposits as mandated by law. If the ratio drops below 1.25%, it is likely the FDIC will be required to assess premiums on all banks. Any increase in assessments or the assessment rate could have a material adverse effect on the company’s earnings, depending on the amount of the increase. Furthermore, the FDIC is authorized to raise insurance premiums under certain circumstances.

      The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. The termination of deposit insurance for the Bank could have a material adverse effect on the company’s earnings.

      All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, commonly referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation. The FICO assessment rates effective for the fourth quarter 2004 were 1.54 cents for each $100 of assessable deposits. The FICO assessments are adjusted quarterly to reflect changes in the assessment bases of the FDIC’s insurance funds and do not vary depending on a depository institution’s capitalization or supervisory evaluations.

      Interstate Banking and Branching. A federal savings association has the ability to establish branches outside its home state. Commercial banks can also branch across state lines, subject to any state law limitations or prohibitions. Competition may increase further as banks branch across state lines and enter new markets.

      Community Reinvestment Act and Fair Lending Developments. We are subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (“CRA”) activities. The CRA generally requires the federal banking agencies to evaluate the

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      A bank’s compliance with its CRA obligations is based on a performance-based evaluation system which bases CRA ratings on an institution’s lending service and investment performance. When a bank applies for approval to acquire another bank, the banking regulators will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. The Bank’s more recent CRA exam resulted in a rating of “outstanding.”

      On February 6, 2004, the federal banking agencies proposed amendments to the CRA regulations that would:

	•	increase the definition of “small institution” from total assets of $250 million to $500 million, without regard to any holding company; and
	•	take into account abusive lending practices by a bank or its affiliates in determining a bank’s CRA rating.

      Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of San Francisco. 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 loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. As an FHLB member, the Bank is required to own capital stock in an FHLB in an amount equal to the greater of:

	•	1% of its aggregate outstanding principal amount of its residential mortgage loans, home purchase contracts and similar obligations at the beginning of each calendar year; or
	•	5% of its FHLB advances or borrowings.

      At December 31, 2003, the Bank was in compliance with this requirement.

      A new capital plan of the FHLB-SF was approved by the Federal Housing Finance Board and will be implemented on April 1, 2004. The new capital plan incorporates a single class of stock with a par value of $100 per share, and may be issued, exchanged, redeemed, and repurchased only at par value. Each member is required to own stock in amount equal to the greater of:

	•	a membership stock requirement with an initial cap of $25 million (100% of “membership asset value” as defined), or
	•	an activity based stock requirement (based on percentage of outstanding advances).

      The new capital stock is redeemable on 5 years’ written notice, subject to certain conditions.

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

      Federal Reserve System. The FRB requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non-personal time deposits. At December 31, 2003, we were in compliance with these requirements.

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      The Company owns all of the outstanding stock of the Bank. The Company’s capital consists of common stockholders’ equity, which at December 31, 2003 amounted to $185.3 million, or 6.9% of the Company’s total assets.

      As of December 31, 2003, the Bank is categorized as “well capitalized” under the regulatory framework for Prompt Corrective Action (“PCA”) Rules. There are no conditions or events subsequent to December 31, 2003, that management believes have changed the Bank’s category. The following table compares the Bank’s actual capital ratios to those required by regulatory agencies to meet the minimum capital requirements required by the OTS and to be categorized as “well capitalized” under the PCA Rules for the periods indicated.

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

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

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Employees

      The Company employed 386 full time equivalent employees at December 31, 2003. A union or collective bargaining group does not represent employees and the Company considers its employee relations to be satisfactory.

Statistical Financial Data

      The Bank’s loan portfolio consists almost exclusively of loans secured by real estate, concentrated primarily in the coastal counties of Southern California. The Bank’s principal lending activities consist of single family residential, construction and income property lending. At December 31, 2003, approximately $2.1 billion, or 94.8% of the Bank’s total loan portfolio, was tied to adjustable rate indices, such as MTA, LIBOR, CMT, Prime and COFI. The Bank’s portfolio of adjustable rate loans includes approximately $435.8 million of loans with an initial fixed rate term of 3 to 5 years prior to transitioning to a semi-annual adjustable rate loan (“hybrid ARMs”). The net loan portfolio grew from $2.1 billion at December 31, 2002, to $2.2 billion at December 31, 2003.

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

(1)	Predominantly term loans secured by improved properties, with respect to which the properties’ cash flows are sufficient to service the Bank’s loan.
(2)	Predominantly loans to finance the construction of income producing properties. Also includes loans to finance the renovation of existing properties.
(3)	Predominantly loans for the construction of individual and custom homes.
(4)	The Bank expects that a majority of these loans will be converted into construction loans, and the land secured loans repaid with the proceeds of these construction loans, within 12 months.
(5)	Gross loans receivable includes the principal balance of loans outstanding, plus outstanding but unfunded loan commitments, predominantly in connection with construction loans.

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

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

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

(1)	Excludes net deferred fees and costs.

      The Bank offers first mortgage loans secured by single family (one-to-four unit) residential (“SFR”) properties located in the Bank’s principal lending area of the coastal counties of Southern California. The Bank originates single family residential loans principally through contact with, and submissions by, approved independent mortgage brokers. The Bank pays a fee, generally ranging from 0.5% to 1.0% of the loan amount, to these mortgage brokers in connection with such loan fundings. The Bank offers primarily adjustable rate mortgage loan products with interest rates that adjust monthly or semi-annually, after an initial introductory period of 1 month, 3 years, or 5 years. These loans generally provide for a prepayment penalty of 6 months interest for the first 1 to 3 years after origination. These adjustable rate products generally provide for floors and overall caps on the increase or decrease in interest rates at an adjustment date and over the term of the loan. A portion of the Bank’s adjustable rate mortgage loans have introductory terms below the fully indexed rates. In underwriting these loans, the Bank qualifies the borrowers based upon the fully indexed rate.

      At December 31, 2003, $864.5 million, or 39.8% of the total loan portfolio was secured by single-family residential properties (88.2% secured by owner-occupied properties), compared with $851.3 million, or 39.8% of the total net loan portfolio at December 31, 2002.

      New loans originated in 2003 had an average loan-to-value of 69%.

      The Bank originates loans secured by multi-family properties and commercial properties, such as office buildings, retail properties, industrial properties and various special purpose properties principally through contact with, and submissions by, approved independent mortgage brokers. The Bank pays a rebate, generally ranging from 0.25% to 1.0% of the loan amount, to these mortgage brokers in connection with such loan fundings. Additionally, in the ordinary course of business, the Bank purchases income property loans consistent with its current underwriting standards.

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

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      New multi-family loans originated in 2003 had an average loan-to-value of 70%. Maturities on these loans are typically 15 years to 30 years with a 30 year amortization period. In addition, the weighted average debt coverage ratio on new multi-family loans originated in 2003 was 1.28.

      The Bank generally originates adjustable rate commercial loans. New commercial loans originated in 2003 had an average loan-to value of 65%. Maturities on commercial loans are typically 10 years with a 25 year amortization period; however, the Bank may make loans with maturities up to 15 years. The weighted average debt coverage ratio on new commercial loans originated in 2003 was 1.31.

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

      During 2003, the Bank continued to emphasize its position as a provider of construction loans predominantly to apartment developers, and to a lesser extent to developers of other types of income property including office buildings, shopping centers and industrial buildings. New loans originated in 2003 had an average loan-to-value of 72%, as stabilized. These loans generally have terms of 18 to 24 months and include extension options, subject to the Bank’s approval. There are generally no prepayment penalties associated with these loans.

      During 2003, the Bank continued to emphasize its strategic niche as a provider of bridge loans to both apartment owners and income property investors. The Bank’s experienced Construction Lending Group closely manages this more complex niche, while providing a valuable source of funding to investors who want to renovate and/or upgrade their properties. New loans originated in 2003 had an average loan-to-value of 74%, as stabilized. These loans generally have terms of 18 to 24 months and include extension options, subject to the Bank’s approval. There are generally no prepayment penalties associated with these loans, however, a 0.5% to 1% exit fee may apply.

      The Bank provides financing for individual speculative home construction and small tracts primarily to local builders. To a lesser extent, the Bank provides owner-occupied construction loans for homeowners. These loans are generated through the Bank’s standing relationships with local builders/developers and approved independent mortgage brokers. These loans are adjustable, have maturities of 1 to 2 years and typically include extension options of up to 6 months, subject to the Bank’s evaluation and approval.

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

      Land loans are originated with the intent to convert the loan into a construction loan and are underwritten on an individual basis. New loans originated in 2003 had an average loan-to-value of 64%. In evaluating the feasibility of originating a land loan, the Bank considers the anticipated use of the land, such as the location and the market environment, as well as the repayment ability of the borrower and/or guarantor(s), as

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      Financing construction loans typically involve a greater degree of credit risk than long term financing on improved owner occupied property. The Bank’s ability to mitigate the risk of loss is primarily dependent upon the accuracy of the initial estimate of the property value upon completion of development or construction compared to the estimated cost of the project. If this was inaccurate, the Bank may be confronted with a completed project having a value that is insufficient to ensure full repayment of the Bank’s loan. This development and construction risk is partially mitigated by evaluation of anticipated market demand, assessment of both the borrower’s and developer’s ability to undertake construction, monitoring the progress of construction, equity in the project and secondary support (such as payment guarantees), as necessary.

      During 2001, the Bank launched an overdraft protection program for its checking account customers. At December 31, 2003, and December 31, 2002, the outstanding overdraft protection lines totaled $0.5 million and $0.7 million, respectively.

New Business Generation

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

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

(1)	Includes unfunded commitments of $0.2 million, $0.2 million and $0.8 million at December 31, 2003, 2002 and 2001, respectively.
(2)	Includes unfunded commitments of $0.1 million, $0.7 million and $0.3 million at December 31, 2003 2002 and 2001, respectively.
(3)	There were no unfunded commitments at December 31, 2003. Includes unfunded commitments of $1.3 million and $1.5 million at December 31, 2002 and 2001, respectively.

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(4)	Includes unfunded commitments of $48.2 million, $29.0 million and $38.4 million at December 31, 2003, 2002 and 2001, respectively.
(5)	Includes unfunded commitments of $66.2 million, $30.8 million and $44.9 million at December 31, 2003, 2002 and 2001, respectively.
(6)	Includes unfunded commitments of $0.9 million at December 31, 2003. There were no unfunded commitments at December 31, 2002. Includes unfunded commitments of $2.0 million at December 31, 2001.
(7)	There were no unfunded commitments at December 31, 2003. Includes unfunded commitments of $2.9 million at December 31, 2002. There were no unfunded commitments at December 31, 2001.

      The table below summarizes the maturities for fixed rate loans and the repricing intervals for adjustable rate loans as of December 31, 2003.