HAWTHORNE FINANCIAL CORP - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q


x		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2002

o		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 (State or Other Jurisdiction of Incorporation or Organization)		95-2085671 (I.R.S. Employer Identification Number)

2381 Rosecrans Avenue, El Segundo, CA (Address of Principal Executive Offices)		90245 (Zip Code)

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock as of the latest practicable date: The Registrant had 7,475,246 shares of Common Stock, $0.01 par value, per share outstanding as of November 8, 2002.

TABLE OF CONTENTS


		CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
		CONSOLIDATED STATEMENTS OF INCOME
		CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
	ITEM 4. Controls and Procedures
PART II — OTHER INFORMATION
	ITEM 1. Legal Proceedings
	ITEM 2. Changes in Securities
	ITEM 3. Defaults upon Senior Securities
	ITEM 4. Submission of Matters to a Vote of Security Holders
	ITEM 5. Other Information
	ITEM 6. Exhibits and Reports on Form 8-K

HAWTHORNE FINANCIAL CORPORATION

FORM 10-Q INDEX
For the quarter ended September 30, 2002


		Page

PART I — FINANCIAL INFORMATION
ITEM 1.	Financial Statements
	Consolidated Statements of Financial Condition at September 30, 2002 and December 31, 2001 (unaudited)		1
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2002 and 2001 (unaudited)		2
	Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2002 (unaudited)		3
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001 (unaudited)		4
	Notes to Unaudited Consolidated Financial Statements		6
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk		34
ITEM 4.	Controls and Procedures		35
PART II — OTHER INFORMATION
ITEM 1.	Legal Proceedings		35
ITEM 2.	Changes in Securities		35
ITEM 3.	Defaults upon Senior Securities		35
ITEM 4.	Submission of Matters to a Vote of Security Holders		35
ITEM 5.	Other Information		35
ITEM 6.	Exhibits and Reports on Form 8-K		35

CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

When used in this Form 10-Q 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 or real estate values in our market may affect our 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 September 30, 2002, 90.67% of the Company’s loan portfolio was tied to adjustable rate indices, such as MTA, Prime, LIBOR, COFI and CMT. Out of these adjustable rate loans, approximately 55.87%, or $1.08 billion, have reached their internal interest rate floors. Therefore, these loans have taken on fixed rate characteristics. The Company’s deposits of $1.4 billion are comprised of 60.85% time deposits with a stated maturity (generally one year or less) and a fixed rate of interest. As of September 30, 2002, 80.23% of the Company’s borrowings from the Federal Home Loan Bank (“FHLB”) are fixed rate, with remaining terms ranging from one to eight years (though such remaining terms are subject to early call provisions). The remaining 19.77% of the borrowings carry an adjustable interest rate, with 87.72% of the adjustable borrowings tied to the Prime Rate, maturing in 2003, and 12.28% tied to one-month LIBOR, maturing in 2003.

     Changes in the market interest rates directly and immediately affect the Company’s interest spread, and therefore profitability. Sharp and significant changes in 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.

     Sharp decreases in interest rates have resulted in increased loan prepayments as borrowers refinance 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, a decreasing interest rate environment could negatively impact the Company’s ability to grow the balance sheet.

•      Credit Quality. We have invested in various assets that contain elements of credit risk. These assets include loans and investment securities, the majority of which are collateralized by mortgage loans. 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. However, such policies and procedures may not prevent unexpected losses that could materially adversely affect the Company’s results.

•      Risk Associated With Merger. The Company acquired First Fidelity Bancorp, Inc. (“First Fidelity”) on August 23, 2002. The Company’s results may be affected if (1) the expected growth opportunities and cost savings from the merger are not fully realized or take longer to realize than expected; or (2) operating costs, customer losses and business disruption, including adverse effects on relationships with employees, are greater than expected.

•      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.

•      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.

HAWTHORNE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)


					September 30,			December 31,
(Dollars in thousands)					2002			2001

Assets:
	Cash and cash equivalents				$	19,892		$	98,583
	Investment securities available for sale, at fair value					208,580			—
	Loans receivable (net of allowance for credit losses of $35,873 in 2002 and $30,602 in 2001)					2,101,080			1,709,283
	Real estate owned					—			1,312
	Accrued interest receivable					11,498			9,677
	Investment in capital stock of Federal Home Loan Bank, at cost					34,275			24,464
	Office property and equipment at cost, net					4,356			4,237
	Deferred tax asset					8,324			4,363
	Goodwill					22,970			—
	Other intangible assets					1,490			—
	Other assets					6,865			4,278

				Total assets	$	2,419,330		$	1,856,197

Liabilities and Stockholders’ Equity:
	Liabilities:
		Deposits:
			Noninterest-bearing		$	36,238		$	35,634
			Interest-bearing:
				Transaction accounts		591,876			338,829
				Certificates of deposit		976,104			825,182

				Total deposits		1,604,218			1,199,645
		FHLB advances				578,058			484,000
		Senior notes				23,078			25,778
		Capital securities				36,000			14,000
		Accounts payable and other liabilities				17,620			12,325

				Total liabilities		2,258,974			1,735,748

Stockholders’ Equity:
	Common stock — $0.01 par value; authorized 20,000,000 shares; issued and outstanding, 8,573,897 shares (2002) and 5,920,266 shares (2001)					85			59
	Capital in excess of par value— common stock					81,083			44,524
	Retained earnings					99,233			82,435
	Accumulated other comprehensive income					1,071			—
	Less:
		Treasury stock, at cost— 1,060,802 shares (2002) and 560,719 shares (2001)				(21,116	)		(6,569	)

				Total stockholders’ equity		160,356			120,449

				Total liabilities and stockholders’ equity	$	2,419,330		$	1,856,197

See Accompanying Notes to Consolidated Financial Statements

HAWTHORNE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)


				Three Months Ended						Nine Months Ended
				September 30,						September 30,

(In thousands, except per share data)				2002			2001			2002			2001

Interest revenues:
	Loans			$	31,496		$	35,663		$	94,389		$	108,417
	Investments and other securities				1,149			—			1,218			—
	Fed funds and other				985			918			2,935			3,644

			Total interest revenues		33,630			36,581			98,542			112,061

Interest costs:
	Deposits				8,975			14,394			27,002			47,841
	FHLB advances				5,610			5,085			15,903			15,698
	Senior notes				801			956			2,412			3,118
	Capital securities				633			228			1,536			465

			Total interest costs		16,019			20,663			46,853			67,122

Net interest income					17,611			15,918			51,689			44,939
Provision for credit losses					100			400			770			2,900

	Net interest income after provision for credit losses				17,511			15,518			50,919			42,039

Noninterest revenues:
	Loan related fees				1,125			827			2,763			2,929
	Deposit fees				408			368			1,144			1,009
	Other fees				208			111			322			371

			Total noninterest revenues		1,741			1,306			4,229			4,309

Income from real estate operations, net					2			47			71			209
Noninterest expenses:
	General and administrative expenses:
		Employee			5,683			4,539			15,415			13,548
		Operating			2,063			1,898			5,082			5,048
		Occupancy			1,027			975			2,882			2,984
		Professional			658			481			1,364			2,376
		Technology			423			498			1,163			1,525
		SAIF premiums and OTS assessments			145			223			413			704
		Other/legal settlements			198			—			218			110

			Total general and administrative expenses		10,197			8,614			26,537			26,295

Income before income taxes and extraordinary item					9,057			8,257			28,682			20,262
Income tax provision					3,321			3,509			11,760			8,637

Income before extraordinary item					5,736			4,748			16,922			11,625
Extraordinary item, related to early extinguishment of debt (net of year-to-date taxes of $94 in 2002 and $194 in 2001)					(125	)		(11	)		(125	)		(266	)

Net income				$	5,611		$	4,737		$	16,797		$	11,359

Basic earnings per share before extraordinary item				$	0.83		$	0.89		$	2.80		$	2.21

Basic earnings per share after extraordinary item				$	0.81		$	0.89		$	2.78		$	2.16

Diluted earnings per share before extraordinary item				$	0.71		$	0.62		$	2.19		$	1.54

Diluted earnings per share after extraordinary item				$	0.69		$	0.62		$	2.18		$	1.50

Weighted average basic shares outstanding					6,910			5,350			6,034			5,269

Weighted average diluted shares outstanding					8,090			7,609			7,712			7,559

See Accompanying Notes to Consolidated Financial Statements

HAWTHORNE FINANCIAL CORPORATION

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)


					Capital in
					Excess of				Accumulated
	Number of				Par Value -				Other					Total
	Common		Common		Common		Retained		Comprehensive		Treasury			Stockholders'
(In thousands)	Shares		Stock		Stock		Earnings		Income/(Loss)		Stock			Equity

Balance at January 1, 2002		5,360	$	59	$	44,524	$	82,435	$	—	$	(6,569	)	$	120,449
Exercised stock options		105		1		1,122

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•		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 September 30, 2002, 90.67% of the Company’s loan portfolio was tied to adjustable rate indices, such as MTA, Prime, LIBOR, COFI and CMT. Out of these adjustable rate loans, approximately 55.87%, or $1.08 billion, have reached their internal interest rate floors. Therefore, these loans have taken on fixed rate characteristics. The Company’s deposits of $1.4 billion are comprised of 60.85% time deposits with a stated maturity (generally one year or less) and a fixed rate of interest. As of September 30, 2002, 80.23% of the Company’s borrowings from the Federal Home Loan Bank (“FHLB”) are fixed rate, with remaining terms ranging from one to eight years (though such remaining terms are subject to early call provisions). The remaining 19.77% of the borrowings carry an adjustable interest rate, with 87.72% of the adjustable borrowings tied to the Prime Rate, maturing in 2003, and 12.28% tied to one-month LIBOR, maturing in 2003.

		Changes in the market interest rates directly and immediately affect the Company’s interest spread, and therefore profitability. Sharp and significant changes in 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.

		Sharp decreases in interest rates have resulted in increased loan prepayments as borrowers refinance 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, a decreasing interest rate environment could negatively impact the Company’s ability to grow the balance sheet.

•		Credit Quality. We have invested in various assets that contain elements of credit risk. These assets include loans and investment securities, the majority of which are collateralized by mortgage loans. 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. However, such policies and procedures may not prevent unexpected losses that could materially adversely affect the Company’s results.

•		Risk Associated With Merger. The Company acquired First Fidelity Bancorp, Inc. (“First Fidelity”) on August 23, 2002. The Company’s results may be affected if (1) the expected growth opportunities and cost savings from the merger are not fully realized or take longer to realize than expected; or (2) operating costs, customer losses and business disruption, including adverse effects on relationships with employees, are greater than expected.

•		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.

•		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.