Hawthorne Financial Corp., Hawthorne, Calif, recently took some bold steps to deal with its asset-quality problems, showing that Southern California's real estate woes continue to inflict pain on the region's smaller financial institutions.

Many bankers there have said that the region's real estate problems are at or near their peak. Hawthorne's recent moves, however, show how long the road to recovery could be.

"A lot of the smaller Southern California financial institutions are just going to have to rely on things turning around in their economy," said Phil Colaco, an analyst with SNL Securities in Charlotte, Va. "Either that or look for a merger from the east or the north."

Scott Braly, Hawthorne's chief executive, did not return phone calls requesting comment.

In a scenario that's been played out at literally dozens of community banks and thrifts in Southern California in the last year, Mr. Braly was hired in July and promptly swept away much of the thrift's old management and revamped its internal controls.

A Big Residential Player

Hawthorne for more than 30 years was run by Vernon Herbst until last March, when he retired after several years of wrangling with Office of Thrift Supervision regulators. Mr. Herbst built Hawthorne into a big player in residential construction financing in western Los Angeles County.

When he was hired, Mr. Braly said he would attack nonperforming assets first, and Hawthorne's performance in the first quarter under him bears that out.

The company lost $10.5 million in the third quarter, reflecting, it said in a statement, "the magnitude of, and credit losses associated with, nonperforming assets." The company's $922 million-asset Hawthorne Savings and Loan Association has a whopping $176 million in nonperforming assets, or 19% of total assets. Hawthorne has one of the highest nonperforming ratio's in California.

Loan-Loss Provisions Shrink

The thrift took $8.8 million in provisions for loan losses during the quarter, compared to $54.5 million a year ago. The company pointed out that last year's provisions were taken at the direction of the OTS, but this year they were taken independently.

Hawthorne's 1993 nine month-loss was $9.9 million, bringing the total loss over the last 21 months to $32 million. Luckily, however, Hawthorne is enjoying the fruits of its years of conservative capital building. It's core capital and risk-based capital ratios stand at 6.3% and 10.7%, respectively.

SNL's Mr. Colaco said Hawthorne is going to need the capital.

"A 20% nonperforming asset ratio is tough to come back from," he said.

For instance, Hawthorne in the third quarter took a $2.7 million hit on its real estate operations, including $2 million it had to pay in back property taxes when it took over properties from troubled borrowers.

Hawthorne also wrote off $2.5 million in goodwill on its books from branch acquisitions over the years.

Finally, Hawthorne's net interest margin was squeezed considerably in the third quarter, a condition that is not expected to improve soon.

Mr. Braly has instituted a new policy putting all loans one or more payment past due on nonaccrual. In the past, Hawthorne walted until three payments were late before putting loans on nonaccrual status.

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