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 March 31, 2003

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

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

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

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 by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Exchange Act. 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 7,684,219 shares of Common Stock, $0.01 par value, per share outstanding as of April 30, 2003.

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	ITEM 1. Financial Statements
		CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
		CONSOLIDATED STATEMENTS OF INCOME
		CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		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 Disclosure About Market Risks
	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
SIGNATURES
Certification
EXHIBIT 99.1

HAWTHORNE FINANCIAL CORPORATION

FORM 10-Q INDEX
For the quarter ended March 31, 2003


		Page

	PART I - FINANCIAL INFORMATION
ITEM 1	Financial Statements
	Consolidated Statements of Financial Condition at March 31, 2003 and December 31, 2002 (unaudited)		1
	Consolidated Statements of Income for the Three Months Ended March 31, 2003 and 2002 (unaudited)		2
	Consolidated Statement of Stockholders' Equity for the Three Months Ended March 31, 2003 (unaudited)		3
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2003 and 2002 (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 Risks		33
ITEM 4	Controls and Procedures		34
	PART II — OTHER INFORMATION
ITEM 1	Legal Proceedings		34
ITEM 2	Changes in Securities		34
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. The Company operates primarily 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 increases to market rates can cause the interest spread to compress 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 primarily 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 also impede the Company’s ability to improve the overall efficiency ratio.

• Government Regulation And Monetary Policy. All forward-looking statements presume a continuation of the existing regulatory environment and United States’ government monetary policies. The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeals of, existing laws may cause results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, primarily through open market operations in United States government securities, the discount rate for member bank borrowings and bank reserve requirements, and a material change in these conditions has had and is likely to continue to have a material impact on the Company’s results.

• Risks Associated with Litigation. We are, and have been involved, from time to time, in various claims, complaints, proceedings and litigation relating to activities arising from the normal course of our operations, including those discussed herein. Further, our business is primarily conducted in California, which is one of the most highly litigious states in the country. If new facts are developed that would change our current assessment of the litigation matters that we are currently involved in, or 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 a 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. Currently, all investment securities of the Bank are classified as available-for-sale.

• Amortization of Intangible Assets/Impairment of Goodwill. The Company acquired First Fidelity Bancorp, Inc. on August 23, 2002, and as a result recorded intangible assets of $1.5 million and $23.0 million for goodwill. See “Business Combinations, Goodwill and Acquired Intangible Assets.” The Company is required to assess goodwill and other intangible assets annually for impairment, or more frequently if impairment indicators arise. If it were deemed that an impairment occurred, the Company would be required to take a charge against earnings to write down the assets.

• Other Risks. From time to time, the Company details other risks with respect to its business and/or financial results in press releases and filings with the SEC. Stockholders are urged to review the risks described in such releases and filings.

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

iii

HAWTHORNE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)


					March 31,			December 31,
(Dollars in thousands)					2003			2002

Assets:
	Cash and cash equivalents				$	17,772		$	21,849
	Investment securities available-for-sale, at fair value					329,255			267,596
	Loans receivable (net of allowance for credit losses of $35,506 in 2003 and $35,309 in 2002)					2,097,835			2,114,255
	Accrued interest receivable					11,652			11,512
	Investment in capital stock of Federal Home Loan Bank, at cost					35,151			34,705
	Office property and equipment at cost, net					5,237			5,106
	Deferred tax asset, net					6,966			10,068
	Goodwill					22,970			22,970
	Intangible assets					1,285			1,388
	Other assets					32,918			5,521

				Total assets	$	2,561,041		$	2,494,970

Liabilities and Stockholders’ Equity:
	Liabilities:
		Deposits:
			Noninterest-bearing		$	43,328		$	39,818
			Interest-bearing:
				Transaction accounts		605,321			597,528
				Certificates of deposit		1,113,790			1,025,464

				Total deposits		1,762,439			1,662,810
		FHLB advances				565,945			600,190
		Capital securities				51,000			51,000
		Accounts payable and other liabilities				15,062			17,904

				Total liabilities		2,394,446			2,331,904

Commitments and Contingencies (Note 4)						—			—
Stockholders’ Equity:
	Common stock — $0.01 par value; authorized 20,000,000 shares; issued, 8,992,402 shares (2003) and 8,576,048 shares (2002)					90			86
	Capital in excess of par value — common stock					81,553			81,087
	Retained earnings					111,870			105,134
	Accumulated other comprehensive income					1,391			1,504
	Less:
				Treasury stock, at cost — 1,311,383 shares (2003) and 1,188,383 shares (2002)		(28,309	)		(24,745	)

				Total stockholders’ equity		166,595			163,066

				Total liabilities and stockholders’ equity	$	2,561,041		$	2,494,970

See Accompanying Notes to Consolidated Financial Statements

HAWTHORNE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)


					Three Months Ended
					March 31,

(In thousands, except per share data)					2003		2002

Interest revenues:
	Loans				$	34,173	$	32,508
	Investments and other securities					2,952		—
	Investment in capital stock of FHLB, fed funds and other					464		861

				Total interest revenues		37,589		33,369

Interest costs:
	Deposits					9,569		9,534
	FHLB advances					5,813		5,152
	Senior notes					—		806
	Capital securities					773		304

				Total interest costs		16,155		15,796

Net interest income						21,434		17,573
Provision for credit losses						300		500

				Net interest income after provision for credit losses		21,134		17,073
Noninterest revenues:
		Loan related and other fees				886		848
		Deposit fees				456		373
		Other				195		72

				Total noninterest revenues		1,537		1,293
Income from real estate operations, net						1		69
Noninterest expenses:
	General and administrative expenses:
			Employee			6,190		5,032
			Operating			2,401		1,503
			Occupancy			1,186		914
			Professional			447		107
			Technology			549		369
			SAIF premiums and OTS assessments			165		136
			Other/legal settlements			226		20

				Total general and administrative expenses		11,164		8,081

Income before income taxes						11,508		10,354
Income tax provision						4,772		4,452

Net income					$	6,736	$	5,902

Basic earnings per share					$	0.89	$	1.10

Diluted earnings per share					$	0.81	$	0.77

Weighted average basic shares outstanding						7,575		5,372

Weighted average diluted shares outstanding						8,340		7,627

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’			Comprehensive
(In thousands)		Shares			Stock		Stock		Earnings		Income/(Loss)			Stock			Equity			Income

Balance at January 1, 2003			7,388		$	86	$	81,087	$	105,134	$	1,504		$	(24,745	)	$	163,066
Exercised stock options			26			—		196		—		—			—			196
Exercised warrants			390			4		16		—		—			—			20
Tax benefit for stock options exercised			—			—		254		—		—			—			254
Treasury stock			(123	)		—		—		—		—			(3,564	)		(3,564	)
Net income			—			—		—		6,736		—			—			6,736		$	6,736
Other comprehensive income (loss), net:
	Unrealized loss on investment securities available-for-sale, net of tax		—			—		—		—		(113	) (1)		—			(113	)		(113	)

Comprehensive income			—			—		—		—		—			—			—		$	6,623

Balance at March 31, 2003			7,681		$	90	$	81,553	$	111,870	$	1,391		$	(28,309	)	$	166,595


(1)		March 31, 2003

Other comprehensive loss, before tax:
	Unrealized net holding loss on available-for-sale investment securities	$	(185	)
	Reclassification adjustment of net loss included in net income		(5	)

Other comprehensive loss, before tax			(190	)
	Tax effect		77

Other comprehensive loss, net of tax		$	(113	)

See Accompanying Notes to Consolidated Financial Statements

HAWTHORNE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)


			Three Months Ended March 31,

(Dollars in thousands)			2003			2002

Cash Flows from Operating Activities:
	Net income		$	6,736		$	5,902
	Adjustments to reconcile net income to cash (used in)/provided by operating activities:
		Deferred income tax provision		3,179			738
		Provision for credit losses on loans		300			500
		Net loss from sales of investments		5			—
		Net gain from sales of loans		(27	)		—

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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, 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 increases to market rates can cause the interest spread to compress 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 primarily 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 also impede the Company’s ability to improve the overall efficiency ratio.

•		Government Regulation And Monetary Policy. All forward-looking statements presume a continuation of the existing regulatory environment and United States’ government monetary policies. The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeals of, existing laws may cause results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, primarily through open market operations in United States government securities, the discount rate for member bank borrowings and bank reserve requirements, and a material change in these conditions has had and is likely to continue to have a material impact on the Company’s results.

•		Risks Associated with Litigation. We are, and have been involved, from time to time, in various claims, complaints, proceedings and litigation relating to activities arising from the normal course of our operations, including those discussed herein. Further, our business is primarily conducted in California, which is one of the most highly litigious states in the country. If new facts are developed that would change our current assessment of the litigation matters that we are currently involved in, or 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 a 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. Currently, all investment securities of the Bank are classified as available-for-sale.

•		Amortization of Intangible Assets/Impairment of Goodwill. The Company acquired First Fidelity Bancorp, Inc. on August 23, 2002, and as a result recorded intangible assets of $1.5 million and $23.0 million for goodwill. See “Business Combinations, Goodwill and Acquired Intangible Assets.” The Company is required to assess goodwill and other intangible assets annually for impairment, or more frequently if impairment indicators arise. If it were deemed that an impairment occurred, the Company would be required to take a charge against earnings to write down the assets.

•		Other Risks. From time to time, the Company details other risks with respect to its business and/or financial results in press releases and filings with the SEC. Stockholders are urged to review the risks described in such releases and filings.