<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934 [NO FEE REQUIRED]

                   For the fiscal year ended December 31, 1996

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from                to

                         Commission File Number: 0-1100

                         HAWTHORNE FINANCIAL CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                 DELAWARE                                     95-2085671
      (STATE OR OTHER JURISDICTION OF                     (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                    IDENTIFICATION NO.)

      2381 ROSECRANS AVENUE, 2ND FLOOR                    
           EL SEGUNDO, CALIFORNIA                               90245
    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                  (ZIP CODE)


       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 725-5000
           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
       
                                      None

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                     COMMON STOCK, PAR VALUE $0.01 PER SHARE
                                (TITLE OF CLASS)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                    YES   X     NO
                                         ---        ---

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

         The aggregate market value of the voting stock held by non-affiliates
of the Registrant, based on the closing stock price of such stock as of February
28, 1997 as reported by the National Association of Securities Dealers, was
$26,169,583.

         The number of shares of Common Stock, par value $0.01 per share, of the
Registrant outstanding as of February 28, 1997 was 2,623,275 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 Annual Meeting of Stockholders to be held on
May 21, 1997.





<PAGE>   2


                         HAWTHORNE FINANCIAL CORPORATION
                            ANNUAL REPORT ON FORM 10K

<TABLE>
<CAPTION>
                                                                                                              PAGE

                                                      PART I.
<S>               <C>                                                                                         <C> 
ITEM 1.           Business.....................................................................................2
                       General.................................................................................2
                       Business Overview.......................................................................3
                       New Business Generation.................................................................4
                       Financing Criteria and Standards........................................................9
                       Regulation.............................................................................11
                       Taxation...............................................................................18
ITEM 2.           Properties..................................................................................20
ITEM 3.           Legal Proceedings...........................................................................21
ITEM 4.           Submission of Matters to a Vote of Security Holders.........................................22
ITEM 4A.          Executive Officers..........................................................................22


                                                     PART II.
ITEM 5.           Market for Registrant's Common Stock and Related Stockholder Matters........................23
ITEM 6.           Selected Financial Data.....................................................................24
ITEM 7.           Management's Discussion and Analysis of Financial Condition and Results of Operations.......25
                       Operating Results......................................................................25
                       Financial Condition, Capital Resources & Liquidity and Asset Quality...................33
                       Interest Rate Risk Management..........................................................54
ITEM 8.           Financial Statements and Supplementary Data.................................................55
ITEM 9.           Changes in and Disagreements with Accountants on Accounting and Financial
                  Disclosure..................................................................................55


                                                     PART III.
ITEM 10.          Directors and Executive Officers of the Registrant..........................................56
ITEM 11.          Executive Compensation......................................................................56
ITEM 12.          Security Ownership of Certain Beneficial Owners and Management..............................56
ITEM 13.          Certain Relationships and Related Transactions..............................................56


                                                     PART IV.
ITEM 14.          Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................57
</TABLE>


FORWARD LOOKING STATEMENTS

         When used in this Form 10-K or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder 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, and to advise readers that various risks and uncertainties, including
regional and national economic conditions, changes in levels of market interest
rates, credit risks of lending activities, and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected. The risks highlighted herein should not be assumed to
be the only things that could affect future performance of the Company.


         The Company does not undertake, and specifically disclaims any
obligation, to publicly release the result of any revisions which 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.



<PAGE>   3



                                   P A R T   I.


ITEM 1.        BUSINESS

GENERAL

HAWTHORNE FINANCIAL CORPORATION

         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's six full service retail offices are located in Southern
California. Hawthorne Savings had 201 employees as of January 31, 1997. The
Company's executive offices are located at 2381 Rosecrans Avenue, El Segundo,
California 90245, and its telephone number is (310) 725-5000.

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 ("FHLB") of San Francisco, which is a
member bank of the Federal Home Loan Bank System. The Bank's deposit accounts
are insured up to the $100,000 maximum amount currently allowable under federal
laws by the Savings Association Insurance Fund ("SAIF"), which is a separate
insurance fund administered by the Federal Deposit Insurance Corporation
("FDIC"). The Bank is subject to examination and regulation by the Office of
Thrift Supervision ("OTS") and the FDIC. Hawthorne Savings is further subject to
regulations of the Board of Governors of the Federal Reserve System ("FRB")
concerning reserves required to be maintained against deposits and certain other
matters.

         Hawthorne Savings is principally engaged in the business of attracting
deposits from the general public and using those deposits, together with
borrowings and other funds, to originate residential and income property real
estate loans. The Bank's principal sources of revenue are interest earned on
mortgage loans and investment securities, and fees received in connection with
various deposit account services and miscellaneous loan processing activities.
The Bank's principal expenses are interest paid on deposit accounts and the
costs necessary to operate the Bank.

         The operations of a savings institution are significantly influenced by
the real estate market, general economic conditions and the related monetary and
fiscal policies of the FRB and policies of financial institution regulatory
authorities, including the FRB, the OTS and the FDIC. Deposit flows and costs of
funds are influenced by the general interest rate environment and rates of
return on competing investments. Demand for mortgage, construction and other
types of loans is affected by market interest rates for such financing, the
volume of sales and supply of housing, the availability of funds and the
regulatory environment. The value of real estate securing loans is also directly
affected by real estate market and general economic conditions, which may change
materially over time.

         The Bank's operating results depend primarily on (i) the margin
("spread") between the yield from its interest-earning assets, principally loans
and investment securities, and the cost of its interest-bearing liabilities,
principally deposits, (ii) the size and relative amounts of its interest-earning
assets and its interest-bearing liabilities, and (iii) the quality of its
assets.

         At December 31, 1996, Hawthorne Savings met and exceeded all three
regulatory capital requirements, based upon rules currently in effect, with core
capital to total assets of 6.27%, core capital to risk- weighted assets of
9.85%, and total capital to risk-weighted assets of 11.11%. Based on the
foregoing, the Bank exceeded the regulatory capital requirements to qualify as a
"well capitalized" institution under applicable laws and regulations.





                                        2


<PAGE>   4

BUSINESS OVERVIEW

         The Company has historically operated exclusively in Southern
California. Prior to 1990, the Southern California economy experienced an
extended period of significant growth fueled primarily by the real estate
development, aerospace and defense industries. The expanding economy encouraged
significant in-migration into California and, coupled with favorable federal
income tax policies through 1986, created strong demand for housing and led to
significant development of virtually all types of real estate. Throughout this
period, the Company was actively engaged in financing the construction of
residential properties, principally for-sale housing developments, individual
homes and apartment buildings. As a matter of business strategy, the Company
utilized its construction financing activities as its principal source of
permanent loans, by converting its construction loans to permanent loans and by
providing permanent financing to purchasers of units within tract developments,
the construction of which the Company financed. Virtually all of the loans with
respect to which borrowers defaulted during the 1990s were originated by the
Company during the period 1986 through 1990, a period during which the market
value of real estate generally increased substantially.

         Commencing in 1990, the Southern California economy entered a period of
severe economic recession which was characterized by, among other things, high
unemployment, declining business and real estate activity, declining real estate
values and a withdrawal of the capital which had fueled the sharp rise in real
estate activity and values during the period 1986 through 1990. During this
recessionary period, the demand for virtually all types of real estate slackened
because of declining market values, the unavailability of mortgage credit for
certain types of real estate, most notably construction developments and
permanent financing secured by income-producing properties, and the flight of
equity capital which had supported the high level of property transactions
during the 1980s. By historically focusing a substantial portion of its lending
activities on construction financing, which involved a small number of
affiliated developers with little or no financial resources of their own, the
Company was affected more significantly than its peers when the Southern
California economy entered recession. As a result, the Company experienced
enormous credit losses during the period 1992 through 1996, which led to
significant net losses and a severe deterioration in the Bank's capital.

         For the five years ended December 31, 1996, the Company reported
cumulative net losses of $61.4 million, with annual losses of $22.1 million
(1992), $29.6 million (1993), $3.0 million (1994), and $14.2 million (1995) and
net earnings of $7.5 million (1996). These results included cumulative
provisions for credit losses on loans and foreclosed properties of $120.3
million, with annual provisions of $54.6 million (1992), $29.4 million (1993),
$5.3 million (1994), $20.0 million (1995), and $11.0 million (1996).

         Beginning in 1992, the Company and the Bank came under intense scrutiny
from regulators as the deterioration in local real estate values resulted in a
significant number of the Company's borrowers defaulting on their loans. In June
1993, the Board of Directors of the Company and the Bank recruited Scott A.
Braly as President and Chief Executive Officer of both companies. Mr. Braly
recruited a number of experienced individuals to completely restructure the
Company and to aggressively manage the Company's growing portfolio of foreclosed
properties and troubled loans. During the period 1992 through 1996, the Company
foreclosed on its real estate collateral securing approximately $270 million of
loan principal, invested approximately $50 million following foreclosure,
principally to complete unfinished tract developments, and sold properties
representing approximately $258 million of this accumulated investment (before
credit losses). Approximately $32 million of foreclosed properties (before
credit loss reserves) remained unsold at the end of 1996. During this period,
the Company's credit losses on loans and properties were approximately $120
million, representing the sum of actual losses realized from property sales and
provisions to establish reserves for unsold properties and loans. In response to
the increasing level of credit losses and the staffing needs to monitor the
Company's problem assets, the Company significantly curtailed its loan
origination activities during 1993 and 1994.

         During the first quarter of 1995, continuing credit losses required the
Company to substantially increase its specific and general reserves, which
rendered it "undercapitalized" according to the "prompt corrective action"
regulations issued by the OTS under the Federal Deposit Insurance Corporation
Improvement Act ("FDICIA"). In June 1995, the OTS issued a Prompt Corrective
Action ("PCA") Directive to the Bank, ordering the Bank to submit a capital
restoration plan to the OTS, which plan was approved in June 1995, and
required the Bank to increase its qualifying Tier 1 capital by $15 million to
$20 million by December 15, 1995.

         In December 1995, the Company successfully completed the sale of $27
million of "investment units" in a private placement. The investment units
consist of equal amounts of senior notes and a new class of preferred stock,
together with warrants to purchase common stock of the Company. The Company
contributed $19 million of the



                                       3

<PAGE>   5

net proceeds of the private placement as qualifying Tier 1 capital into the Bank
upon completion of the private placement. With the infusion of capital into the
Bank, the OTS terminated the PCA and released the Bank from its capital plan.

         Based upon published economic data, the severe economic downturn
throughout Southern California began abating during 1995 and has continued to
evidence improvement through the end of 1996. As the overall economy has
improved, the real estate-based segments of the economy have similarly improved,
measured by several factors, including (1) a rising number of property sales,
(2) a declining percentage of real estate transactions represented by foreclosed
or otherwise distressed real estate, (3) an increasing availability of mortgage
credit for virtually all property types, and (4) an increasing amount of equity
capital deployed in the acquisition of real estate. There can be no assurance
that these trends will continue, however. The economies and real estate markets
in Southern California will continue to be significant determinants of the
quality of the Company's assets in future periods and, thus, its results of
operations.

         The Company continues to make progress in reducing its portfolios of
nonperforming assets, with the investment in gross nonperforming assets
declining from $118.2 million and $151.2 million at December 31, 1992 and 1993,
respectively, to $80.7 million, $49.2 million and $36.8 million at December 31,
1994, 1995 and 1996, respectively. This substantial and continuing decline in
nonperforming assets, coupled with the Company's successful reentry into
selected real estate financing markets, returned it to profitability during the
fourth quarter of 1995 and for the year ended December 31, 1996, during which
the Company reported net earnings of $0.5 million and $7.5 million,
respectively. See NEW BUSINESS GENERATION and ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.


NEW BUSINESS GENERATION

LENDING

         The Company's principal lending area encompasses Los Angeles and Orange
counties, with ancillary markets including the rest of Southern California.

         Financial companies intensely compete for mortgage financings
throughout the Company's Southern California markets. Generally, the Company
competes with both in-market and out-of-market financial companies for loans,
including banks, savings institutions and thrift and loans (in-market
competitors), and regional banks, brokerages and specialty funds and investment
entities (out-of-market). These companies generally compete successfully based
upon their ability and willingness to originate loans at the lowest prices
generally available in the marketplace, with the ultimate intention of
securitizing such loans and selling them into the secondary mortgage markets. As
discussed elsewhere herein, the Company generally focuses upon those segments of
the mortgage financing markets in which price is only one of several factors
considered by borrowers in their financing decisions. The Company originates and
processes its loans from a central location, rather than through its retail
branch network. Loans are generally obtained through a network of mortgage
brokers rather than via a captive sales force.

         The Company's current loan origination activities, which focus upon
financings secured by expensive homes, income-producing real estate and
residential construction, are governed by established policies and practices
appropriate to the risks inherent in the financing of specialty real estate. The
Company's primary competitive advantages - effective and efficient transaction
execution and a willingness to tailor the terms and conditions of individual
transactions to optimize the borrower's and the Company's objectives - have led
the Company to tailor its organization, resources and loan policies accordingly.

         To maximize penetration of its targeted mortgage financing markets, the
Company has established independent groups which maintain responsibility for
each of the Company's primary lending businesses. Each of these groups is
separately resourced with a full complement of sales and credit professionals,
each of whom independently report to the Chief Executive Officer. Each of these
business groups is supported by the appraisal, quality management and servicing
groups, which in turn report separately to the Chief Executive Officer.
Management believes that this operating template has permitted the Company to
maintain a relatively flat organizational structure and to maximize
responsiveness to customers and opportunities, without sacrificing internal
controls and credit quality.

         Since the middle of 1996, competition in the Company's market segments
has expanded significantly, in large part due to (1) measurable improvements in
the level of positive economic activity throughout Southern California, (2)



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<PAGE>   6

a noticeable increase in the level of non-distressed real estate activity
encompassing virtually all property types, and (3) the availability and
deployment of large pools of capital directed at real estate investment and
financing, emanating from both in-market and out-of-market sources. These
recently visible competitive forces have begun to place downward pressure on the
price of all forms of real estate financing and have moderately liberalized the
terms under which credit is extended. Because of these market forces, the
Company expects that the yields on loans originated in the future will be
somewhat lower than those obtained during 1995 and 1996, assuming no change in
the general level of market interest rates and realization of the Company's
internal loan production objectives.

         The table below summarizes the Company's loan origination activity for
1995 and 1996. By comparison, the Company originated $49.9 million and $44.9
million of new loans in 1993 and 1994, respectively.

<TABLE>
<CAPTION>
                                              FOR THE YEAR ENDED   FOR THE YEAR ENDED
                                              DECEMBER 31, 1996    DECEMBER 31, 1995
                                              -------------------  ------------------
      TYPE OF SECURITY                          AMOUNT     %         AMOUNT        %
------------------------------------------    ---------   -----    --------      ----
<S>                                           <C>         <C>      <C>        <C>
Single family homes (1-4 units)
    Estate (1)                                 $ 72,500     21.8%   $ 53,700     27.2%
    Conventional                                 27,400      8.2      11,400      5.8

Multifamily (5 or more units) (2)                70,700     21.3      66,100     33.5
Commercial                                       46,000     13.8      31,700     16.1
Construction and land (commitments) (3)          98,000     29.6      34,500     17.4
Other                                            17,700      5.3

                                               --------    -----    --------    -----
                                               $332,300    100.0%   $197,400    100.0%
                                               ========    =====    ========    =====
</TABLE>
------------------------


         (1)      Generally defined as individual loans with principal balances
                  of more than $1.0 million originated after 1994. This amount
                  includes unfunded commitments under lines of credit of $2.8
                  million and $5.2 million at December 31, 1996 and 1995,
                  respectively.

         (2)      Includes $16.2 million and $13.8 million of financings
                  provided in connection with sales of previously foreclosed
                  properties for the years ended December 31, 1996 and December
                  31, 1995, respectively.

         (3)      Includes unfunded commitments of $45.5 million at December 31,
                  1996 and $14.9 million at December 31, 1995.

ESTATE FINANCING

         Since 1994, the Company has provided a variety of financings secured by
very expensive homes in Southern California, including homes located in the
communities of Bel-Air, Beverly Hills, Malibu, Newport Beach, Santa Barbara and
La Jolla. Generally, the Company's loans refinance the borrower's existing
mortgage debt, rather than financing the borrower's purchase of a home. The
Company generates virtually all of its new financing opportunities of this type,
which it refers to as "Estate Financing", through contact with, and submissions
by, independent mortgage brokers.

         The Company seeks financing opportunities which involve a wide range of
property types, from large, conventional homes located within mature areas to
very large, multiple acre, one-of-a kind estates. The Company's financings also
encompass a wide range of borrower profiles, from borrowers with the
demonstrated and documented capacity to service the Company's loan to borrowers
with no evident source of recurring cash flow. Loans which meet the highest
standards of collateral quality and borrower capacity and creditworthiness (Tier
1 loans) are similar to conventional home loans except for their size, and
generally have higher loan to value ratios and the most favorable pricing to the
borrower. Loans with respect to which the borrower's resources are limited or
cannot be reliably measured, or with respect to which the Company's collateral
possesses such unique characteristics, including size, amenity, or location, so
as to make its valuation difficult to precisely measure (Tier 3 loans) have the
lowest loan to value ratios and the highest pricing to the borrower. Loans which
fall in between these two sets of parameters (Tier 2 loans) involve advances and
pricing which are tailored to the particular attributes of the property, the
borrower and the reasons underlying the borrower's loan request. To date, a
substantial majority of the Company's Estate loans have been comprised of Tier 2
loans.


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<PAGE>   7

         The Company has been able to charge premium prices in connection with
many of its Estate loans because most of its competitors place internal limits
on the dollar amount of individual financings (without reference to the
underlying attributes of the collateral and the borrower) and because most
lenders are hesitant to extend credit to individuals whose capacity to service
the loan cannot be reliably measured or where the borrower's credit profile is
marred by prior credit problems, the absence of a credit history or other
factors. As suggested above, the Company compensates for the existence of one or
more of these attributes by limiting the advance it will make against its
estimate of the value of the collateral. The Company has also been successful in
attracting business where the borrower requires flexibility in structuring the
terms of the loan, where efficient and timely execution are of paramount
importance, or both. As with all of its financing businesses, the Company's flat
organization structure, small size and portfolio retention strategies all
contribute to its success in attracting new business and in receiving a return
believed by management to be commensurate with the risk assumed and value added
to completing the transaction.

         Since 1994, the Company has originated $126.2 million of Estate loans.
The average per loan size of these loans approximates $2.4 million and the
average loan-to-value ratio is approximately 50%. At December 31, 1996, Estate
loan principal of $107.9 million was outstanding. The average interest rate and
effective yield (which incorporates loan and other fees to be earned over the
contractual life of the loan) on outstanding loan principal at December 31, 1996
was 10.11% and 10.27%, respectively.

CONVENTIONAL HOME FINANCING

         In addition to its other, higher-yielding financing businesses, the
Company also provides conventional permanent financing secured by single family
homes. The Company conducts this business both from its local retail banking
offices and from its corporate offices. This business is the most competitive
and least profitable of all of the Company's financing businesses. The Company
lacks the size and scale of operations to profitably penetrate this business,
especially in view of the significant capacity already in the marketplace in the
form of very large banking and non-banking companies whose principal business is
to originate conventional single-family-secured loans, many for resale in
secondary mortgage markets. The Company is organized to provide a modest volume
of this business each year, generally concentrated in and around its local
retail banking offices.

MULTI-FAMILY AND COMMERCIAL FINANCING

         The Company provides financing to owners and purchasers of apartment
buildings and various types of non-residential properties, such as retail
centers, office buildings, and industrial buildings. The Company generates new
financing opportunities through contact with, and submissions to it by,
independent mortgage loan brokers. The Company is often able to charge premium
prices for its financings because significant opportunities exist in the
marketplace to provide financing which requires tailored terms and conditions,
efficient response and execution, and specialized real estate expertise. These
attributes derive from the Company's smaller size and flat organizational
structure, its strategy to hold all new originations in portfolio, and the real
estate experience of most of its people.

         Since early 1995, the Company has focused upon establishing its
presence in the income property financing business throughout Southern
California by building relationships with a growing network of mortgage brokers
and, to a lesser extent, through repeat business with borrowers. Excluding
internal financings of foreclosed property sales ($30.0 million), the Company
has originated $184.5 million of loan commitments secured by multi-family
residential and commercial real estate since 1994. The average per loan size of
these loans approximated $2.1 million. At December 31, 1996, there were $116.7
million of multi-family residential and commercial real estate loans
outstanding, which amount is net of repayments, sales and undisbursed funds. The
average interest rate and effective yield (which incorporates loan and other
fees) of outstanding loan principal at December 31, 1996 was 9.79% and 10.09%,
respectively. A majority of the Company's cumulative volume of new commitments
involved permanent financings, with the remainder covering a variety of
transaction types, including short-term bridge loans and loans with a
substantial property renovation component.

         The financing of income properties is subject to the risk that the cash
flows being generated by the Company's collateral, as reported by the borrower,
will decline following the funding of the loan, either because of general
economic conditions or because the Company's borrower poorly manages the
property, which could cause the borrower to default on their loan (because the
cash flows from the property are no longer sufficient to cover the

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<PAGE>   8

payments required by the Company's loan). The Company mitigates this risk by (1)
requiring its borrowers to demonstrate their commitment to the property through
a substantial cash equity investment therein, (2) carefully evaluating the
historical and current operations of the property, (3) investigating the rental
markets within the areas surrounding its collateral in order to validate the
revenue and expense assumptions which contribute to the Company's assessment of
the properties' current and potential cash flows, and (4) evaluating the
operating experience of the borrower with similar properties.

CONSTRUCTION FINANCING

         The Company conducts two separate construction financing businesses,
each of which is separately targeted and resourced.

         The Tract Financing group commenced operation during the fourth quarter
of 1995 and provides construction financing to small-to-medium-sized builders of
single-family residential developments in Southern California. In this business,
the Company believes its competitive advantage is focused upon its efficient
response and execution and, more often than not, a pre-existing relationship
with the borrower or particular knowledge of the specific submarket and/or
product type. The Company solicits new business directly with builders and,
occasionally, through independent mortgage brokers. Most financial institutions
of the Company's size or larger now provide development financing and,
therefore, this business is quite competitive. Since 1994, the Company has
extended $49.0 million of tract construction loan commitments covering 13
separate developments. At December 31, 1996, $15.1 million was outstanding with
respect to such commitments, which amount is net of undisbursed funds and
repayments. These commitments generally have an interest rate which is based on
a designated prime rate plus 1.0% to 2.0%, calculated on disbursed balances, and
a loan fee of like amount calculated on the entire commitment amount. With
respect to certain transactions, the Company is scheduled to receive a release
or exit fee as completed units are sold and the Company's loan is repaid. The
average commitment term approximates 18 months. The effective yield to the
Company from these commitments is a function of the Company's stated pricing and
the average funded balance against the commitment.

         The Single Family Residence ("SFR") Financing group provides individual
home construction financing to local builders and homeowners. To date, this
group has focused almost exclusively on providing construction financing in the
beach cities of the South Bay area of Los Angeles County, with occasional
financing outside the Company's principal market area. Virtually all of the
Company's business to date has been generated through pre-existing relationships
between the Company's loan officers and local builders. Since 1994, the Company
has extended a total of $83.5 million of financing commitments related to the
construction of 122 individual residential units. At December 31, 1996, $34.4
million was outstanding with respect to such commitments, which amount is net of
repayments and undisbursed funds. These commitments generally have an interest
rate which is based on a designated prime rate plus 1.0% to 2.0%, calculated on
disbursed balances, and a loan fee of like amount calculated on the entire
commitment amount. The average commitment term approximates 12 months. The
effective yield to the Company from these commitments is a function of the
Company's stated pricing and the average funded balance against the commitment.

         Construction financing presents the Company with the risk that the
actual cost of development will substantially exceed original estimates (because
the original estimates were flawed or because of post-funding approval issues
by the local municipality that has purview over the project), or that the price
of the finished homes will not meet pre-development expectations (because the
original assessment was flawed or because of changes in real estate values
generally). The Company compensates for these risks by (1) generally limiting
its advance to a percentage of expected development costs, and requiring the
borrower to fund the difference, (2) carefully evaluating the line item costs to
complete the development, utilizing its resident loan officers and staff (or,
where appropriate, third parties), (3) carefully evaluating the product type to
be built and the demand for the finished homes by reference to recent sales of
comparable homes, and (4) the development experience of, and the success or
failure of, the Company's borrower with similar projects.

         The Company very rarely converts these construction financings to
Estate or conventional financings because the permanent loan sizes would fall
beneath targets for the Estate group and the Company seeks to limit its
conventional new financing volume within any development concentration.




                                       7


<PAGE>   9

OTHER

         Occasionally, the Company provides financing to borrowers in which its
security is in the form of a promissory note rather than a fee interest in real
estate. Such financings generally provide potential compensation to the Company
well in excess of the yields which are typically obtained from the Company's
predominant lending activities. During 1996, the Company provided commitments
totaling $17.7 million in six separate transactions which were secured by
promissory notes. With respect to one transaction involving a commitment of $6.5
million, the promissory note security was, in turn, secured by real estate. With
respect to two transactions involving aggregate commitments of $4.5 million the
Company's loans were secured by pools of nonperforming loans which, in turn,
were collateralized by residential real estate. The remaining three loans were
secured by promissory notes which, in turn, were not collateralized by specific
assets of the borrower. At December 31, 1996, $14.7 million was outstanding
against these commitments. During the first quarter of 1997, one loan, with a
disbursed balance of $6.6 million, was repaid by the borrower in full prior to
the loan's maturity.

DEPOSITS

         The Company operates six retail banking locations, a decrease from the
twenty-one offices operated by the Company in mid-1993. Four of these branches
are located in the South Bay area of Los Angeles County. The Company's retail
branches average nearly $120.0 million in retail deposit accounts, which is
substantially higher than most local banking companies. The Company does not
operate a money desk or otherwise solicit brokered deposits.

         The Company solicits deposits from the general public throughout its
service area. Generally, the Company competes for deposit funds with other
Southern California-based financial companies, including banks, savings
institutions and thrift and loans. These companies generally compete with one
another based upon price, convenience and service.

         Because the Company does not have a critical mass of retail banking
facilities, and because its smaller size does not afford it the economies of
scale to advertise its basic products to the extent of its principal
competitors, the Company generally competes on price and, to a lesser extent, on
service and convenience. Historically, these limitations have been moderated by
the loyalty afforded by, and the resistance to change of, the Company's primary
customer constituency, individuals over 55 years of age.

COMPETITION

         The Company experiences substantial competition both in attracting and
retaining deposits and in making loans. Its most direct competition for deposits
historically has come from other thrift institutions, commercial banks and
credit unions doing business in its market areas in Southern California. In
addition, as with all banking organizations, the Company has experienced
increasing competition from nonbanking sources. For example, the Company also
competes for funds with full service and discount broker-dealers and with other
investment alternatives, such as mutual funds and corporate and governmental
debt securities. The Company's competition for loans comes principally from
other thrift institutions, commercial banks, mortgage banking companies,
consumer finance companies, insurance companies and other institutional lenders.
A number of institutions with which the Company competes for deposits and loans
have significantly greater assets, capital and other resources than the Company.
In addition, many of the Company's competitors are not subject to the same
extensive federal regulations that govern savings and loan holding companies
such as the Company and federally-chartered and federally-insured savings
institutions such as the Bank. As a result, many of the Company's competitors
have advantages over the Company in conducting certain businesses and providing
certain services.






                                        8


<PAGE>   10

FINANCING CRITERIA AND STANDARDS

PHILOSOPHY

         As described in the preceding section, the Company provides financing
in a number of tightly-defined market segments, which are distinguished by
property type, borrower profile or loan size and transaction attributes. In all
instances, the Company extends credit in situations in which it expects to be
repaid from the liquidation of its collateral prior to the maturity of its loan,
or in which it reasonably expects that its loan can be refinanced with another
lender prior to the loan's maturity. The Company does not extend credit with the
expectation that borrowers will default on their obligations, resulting in a
restructuring of the loan or foreclosure of the Company's collateral. Because of
the types of credit extended by the Company, the terms of each loan are often
individually tailored to satisfy the Company's credit standards and the
borrower's financing needs. This means that the Company's loans may contain
provisions, such as prepaid interest for the term of the loan or a line of
credit facility, that fall outside the normal scope of mortgage financing
offered by the Company's competitors. In all instances, the Company places its
primary reliance upon the quantitative and qualitative attributes of the
collateral which will secure the Company's loan. In situations in which the
borrower's ability to service the Company's loan cannot be reliably measured, or
where the borrower's credit history is marred in the manner set forth above, the
Company adjusts downward the advance it will make, to the extent it decides to
extend credit at all.

LOAN LIMITS

         As described under NEW BUSINESS GENERATION, the Company seeks to
originate relatively few, relatively high-dollar balance loans within each of
its lending businesses (with the exception of the Company's conventional home
financing group). Accordingly, the Company's internal "house limit," applicable
to individual transactions or to multiple loans with affiliated borrowers (as
defined in applicable federal regulations), is higher than for many other
regulated financial companies. As of December 31, 1996, the Company's "house
limit" was $6.0 million, or approximately 11% of the Bank's core capital and 14%
of the Company's stockholders' equity. Loans in excess of $0.5 million and up to
and including the house limit may be, and are, approved by the Chief Executive
Officer, without prefunding review and approval by the Board of Directors of the
Company or the Bank. Loan requests in excess of $6.0 million and up to the
Bank's legal lending limit ($9.6 million at December 31, 1996) require approval
of the Credit Committee of the Board of Directors prior to funding. A majority
of the Credit Committee consists of nonmanagement directors of the Company and
the Bank.

         For the two years ended December 31, 1996, the Company originated 23
loans involving $139.6 million of loan commitments, with respect to which the
Company's legally binding loan commitment in connection with individual
transactions or involving multiple loans to affiliated borrowers exceeded $6
million. Through December 31, 1996, aggregate commitments of $11.2 million had
been extinguished through repayments by borrowers prior to the maturity of the
commitment, and aggregate commitments of $18.5 million had been sold to another
financial institution. At December 31, 1996, $93.1 million was outstanding
against these cumulative commitments, which amount is net of repayments, sales
and undisbursed funds. Subsequent to December 31, 1996, an additional $17.2
million of aggregate commitments were extinguished through repayments by
borrowers prior to the maturity of the commitment.

LENDING CRITERIA

         The Company has adopted a detailed lending policy which governs all
aspects of the Company's lending operations, including loan administration, loan
approval authorities, loan underwriting criteria, general lending restrictions
and policies and portfolio management. Although the Company's financing
businesses generally do not lend themselves to detailed requirements, the
lending policy does establish broad parameters and criteria which assist
management in evaluating and structuring loans. For example, under the Company's
loan policy, the maximum ratio of the value of the security property to the loan
amount ("loan-to-value ratio") may not exceed 80% in the case of a construction
loan and 85% in the case of a permanent multi-family residential and commercial
real estate loan. The Company's lending policy also contains, among other
things, various loan concentration targets by type of loan, geographic location
of the security property, loan size and occupancy status.

         For each loan that it funds, the Company requires, among other things,
a completed loan application, supporting financial information from the
borrower, legal and corollary agreements which support the vesting of title, a
title insurance policy, fire and extended liability coverage casualty insurance,
credit reports, contemporary loan documents and other required documents. Though
the Company may require flood insurance pursuant to



                                       9


<PAGE>   11

federal regulations and state laws, the Company does not require earthquake
insurance coverage. The lack of earthquake insurance coverage derives from a
combination of competitive pressure (i.e., the Bank's competitors do not require
such coverage as a condition of extending credit), the cost of such coverage, if
it is even available, and management's assessment that its collateral base is
sufficiently diverse geographically as to substantially moderate the risk of a
material, adverse result should a major earthquake again hit a section of
Southern California. The collateral for the Bank's loan is appraised either by
an approved independent fee appraiser or by one of the Bank's staff appraisers.
All fee appraisals are reviewed by the Bank's Chief Appraiser.

         The loans originated by the Company since 1994 have been almost
exclusively secured by a first lien priority on real estate. Commencing in 1997,
the Company expects to more actively seek financing opportunities, principally
involving the financing of income-producing properties, with respect to which
the Company would act as the primary or lead lender in acquiring and negotiating
the terms and conditions of the loan with the borrower, and would place a
portion of the loan with another financial institution while retaining a
separate subordinated lien priority (i.e., a second trust deed) or a
subordinated interest in the total loan ("mezzanine loans"). Generally,
management expects that mezzanine loans would be considered only in those
instances in which (1) the total loan request exceeds the Company's house
lending limit and (2) the loan request, absent size constraints, otherwise
satisfies the Company's objectives for credit quality and yield. The Company
expects that the volume of mezzanine loans would constitute less than 10% of
total loan volume during 1997 and 1998.

ESTATE FINANCING

         As with its other principal financing businesses, the Company tailors
the terms and pricing of its Estate financings on a transaction-by-transaction
basis. Accordingly, the Company offers a variety of terms and conditions,
including fixed and adjustable-rate pricing, tied to various indices; payments
which are interest-only or payments which include the amortization of loan
principal; varying adjustment frequencies for adjustable-rate loans; varying
interest rate and payment floors and caps; and either on a partial or full
amortizing basis; and varying maturity and extension options. As described
elsewhere herein, the Company provides advances to borrowers which, on average,
have produced a loan-to-value ratio of approximately 50% for financings
completed to date. Though the Company will, as a matter of policy, advance up to
80% of the value of the Company's collateral, very few of the Company's
financings have involved advances for more than 70% of the value of the
Company's collateral. Management determines the value of the proposed collateral
by reference to current appraisals and by detailed property inspections by the
Company's senior management. The Company will provide financing for individual
transactions in an amount up to, but not in excess of, the Company's legal
lending limit for loans-to-one borrower.

MULTI-FAMILY AND COMMERCIAL FINANCING

         Management underwrites the proposed collateral which will secure income
property financings by reference to the historical, current and projected
operation of the property. In evaluating income-producing properties, management
requires that borrowers provide, at a minimum, current rent rolls, recent
operating statements and pro forma operating statements. As appropriate, the
Company's lending personnel adjust reported results to accommodate lease
expirations (from non-residential properties), tenant turnover, necessary
capital improvements and other relevant factors. Generally, the adjusted
property cash flows are expected to produce a debt coverage ratio ("DCR") of not
less than 140% for non-residential properties and 120% for apartment buildings,
utilizing the fully-adjusted interest rate at funding to measure pro forma debt
service (i.e., the Company does not offer "teaser" or discount introductory
interest rates). Utilizing current market capitalization rates, the Company's
targeted DCR's generally produce loan-to-value ratios between 65% and 75%. As a
matter of policy, the Company will not advance more than 80% of the appraisal
value of its principal collateral. Where material capital improvements are
necessary to cure deferred maintenance on the property, the Company may, and
has, held back the necessary funds from the initial funding of the loan, which
amounts are payable to the borrower only after the agreed-upon work has been
completed. As circumstances warrant, the Company may include minimum thresholds
for maintenance of a DCR by the borrower and working capital reserves. The
Company will provide financing for individual transactions in an amount up to,
but not in excess of, the Bank's legal lending limit for loans-to-one borrower.




                                       10

<PAGE>   12

CONSTRUCTION FINANCING

         For tract development financings, management underwrites each proposed
development by reference to the borrower's quantified plan, including costs to
and at completion by line item, and sales and marketing projections, and by
utilizing, where appropriate, third party sources to validate the compatibility
of the proposed development and product to be built within the immediate
marketplace. The Company also reviews the borrower's previous experience with
construction projects in general, and with the particular product type being
proposed. The Company maintains an internal staff of professionals experienced
in residential and non-residential development in Southern California. In
addition to underwriting proposed developments, these individuals manage the
Company's post-origination disbursement and inspection process, which is
uniformly based upon validated voucher submissions from builders. Generally, the
Company will advance between 75% and 90% of the cost of the proposed development
(land basis plus development costs), with the borrower being required to provide
the remaining funds. Depending upon the particular transaction, this range of
advance generally translates into loan-to-value ratios of between 65% to 80%.
The Company will provide financing for individual transactions in an amount up
to, but not in excess of, the Bank's legal lending limit for loans-to-one
borrower.

         For individual home construction, management underwrites each proposed
transaction in a manner similar to that employed in the underwriting of tract
developments. Because the Company has, to date, concentrated its individual home
construction activities within its immediate local market in the South Bay area
of Los Angeles County, management believes that it generally possesses the
market knowledge necessary to evaluate each proposal. Post-origination
disbursements and inspections are managed in the same fashion as for all of the
Company's tract financing activities. Because these transactions solely involve
the construction of individual homes, the Company's loans-to-one borrower limit
is not a constraint. As with tract financing, the Company will provide between
75% to 90% of the construction funds, which generally translates into
loan-to-value ratios of between 65% to 80%.

PORTFOLIO MANAGEMENT

         Within each of its principal lending groups, the Company employs one or
more professionals whose responsibilities include (1) performing periodic
reviews of individual loans subsequent to their funding, including assessing the
borrower's compliance with applicable loan covenants, the current condition and
approximate valuation of the Company's collateral, the borrower's recent
performance, and changes (if any) to the ownership of the Company's collateral,
(2) assessing, via generally available data from independent sources, market
trends affecting the Company's loan collateral, including transaction volumes
and pricing, and (3) pursuing and negotiating loan restructurings, which to
date have generally been limited to loans made prior to 1995.

         As described more fully elsewhere herein (see CLASSIFIED ASSETS), the
Company has an established asset review process and asset classification system.
This process is administered by the Company's Finance group, and utilizes
information acquired and accumulated by portfolio managers and others in
establishing loan-specific and portfolio reserves and in classifying individual
assets and groups of similar assets. The results of classifications, and the
appropriateness of valuation allowances, are reported to the Company's Audit
Committee. Through December 31, 1996, the Company had completed one or more
individual asset reviews covering virtually all of its loans, except for loans
secured by single family homes originated prior to 1995, with respect to which
individual loan reviews had been performed on approximately 60% of the related
principal balance.


REGULATION

GENERAL

         The Company is registered with the OTS as a savings and loan holding
company and is subject to regulation and examination as such by the OTS. The
Company is a member of the FHLB and its deposits are insured by the FDIC. The
Company is subject to examination and regulation by the OTS under the Home
Owners' Loan Act ("HOLA") and the FDIC under the Federal Deposit Insurance Act
("FDIA") with respect to most of its business activities, including, among
others, lending activities, capital standards, general investment authority,
deposit-taking and borrowing authority, mergers and other business combinations,
establishment of branch offices, and permitted subsidiary investment and
activities. The effect of the statutes, regulations and other pronouncements and
policies which govern the operations and activities of the Company and the Bank
can be significant, cannot be predicted with a high degree of certainty and can
change over time. Moreover, such statutes, regulations and other



                                       11

<PAGE>   13

pronouncements and policies are intended to protect depositors and the insurance
funds administered by the FDIC, and not stockholders or holders of indebtedness
which is not insured by the FDIC.

         The following sections should be read in conjunction with MANAGEMENT'S
DISCUSSION and NOTES L, M, and N of the NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS. The description of the statutes and regulations applicable to the
Company and the Bank set forth below and elsewhere herein do not purport to be
complete descriptions of such statutes and regulations and their effects on the
Company and the Bank. Such descriptions also do not purport to identify every
statute and regulation that may apply to the Company or the Bank.

SAVINGS AND LOAN HOLDING COMPANY REGULATION

         General. The Company is registered as a savings and loan holding
company under the HOLA and is subject to OTS regulation, examination,
supervision and reporting requirements.

        Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings institution. However, if the savings institution subsidiary of such a
holding company fails to meet a qualified thrift lender ("QTL") test, then such
unitary holding company also shall become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings institution requalifies as a QTL within one year thereafter, shall
register as, and become subject to the restrictions applicable to, a bank
holding company. See SAVINGS INSTITUTION REGULATION Qualified Thrift Lender
Test.

        If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution shall commence
or continue for a limited period of time after becoming a multiple savings and
loan holding company or subsidiary thereof any business activity, upon prior
notice to, and no objection by the OTS, other than: (i) furnishing or performing
management services for a subsidiary savings institution; (ii) conducting an
insurance agency or escrow business; (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution; (iv) holding
or managing properties used or occupied by a subsidiary savings institution; (v)
acting as trustee under deeds of trust; (vi) those activities authorized by
regulation as of March 5, 1987 to be engaged in by multiple savings and loan
holding companies; or (vii) unless the Director of the OTS by regulation
prohibits or limits such activities for savings and loan holding companies,
those activities authorized by the Federal Reserve Board as permissible for bank
holding companies. Those activities described in (vii) above also must be
approved by the Director of the OTS prior to being engaged in by a multiple
savings and loan holding company.

        Restrictions on Acquisitions. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS, (i) control of any other savings
institution or savings and loan holding company or substantially all the assets
thereof or (ii) more than 5% of the voting shares of a savings institution or
holding company thereof which is not a subsidiary. Except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
institution, other than a subsidiary savings institution, or of any other
savings and loan holding company.

         Federal Securities Laws. The Company's common stock is registered with
the Securities and Exchange Commission under Section 12(g) of the Securities
Exchange Act of 1934, as amended ("Exchange Act"). The Company is subject to the
information, proxy solicitation, insider trading restrictions and other
requirements of the Exchange Act.

SAVINGS INSTITUTION REGULATION

         Qualified Thrift Lender Test. Any savings institution that does not
meet a QTL test set forth in the HOLA and complementary regulations must either
convert to a national bank charter or be subject to restrictions specified in
the OTS regulations. Any such savings institution that does not become a bank
will be: (i) prohibited from making any new investment or engaging in activities
that would not be permissible for national banks; (ii) prohibited from
establishing any new branch office in a location that would not be permissible
for a national bank in




                                       12

<PAGE>   14

the institution's home state; (iii) ineligible to obtain new advances from any
FHLB; and (iv) subject to limitations on the payment of dividends comparable to
the statutory and regulatory dividend restrictions applicable to national banks.
Also, beginning three years after the date on which the savings institution
ceases to be a QTL, the savings institution would be prohibited from retaining
any investment or engaging in any activity not permissible for a national bank
and would be required to repay any outstanding advances to any FHLB. A savings
institution may requalify as a QTL if it thereafter complies with the QTL test.

         Under recent legislation and applicable regulations, any savings
institution is a QTL if (i) it qualifies as a domestic building and loan
association under Section 7701(a)(19) of the Internal Revenue Code of 1986, as
amended ("Code") (which generally requires that at least 60% of the
institution's assets constitute housing-related and other qualifying assets), or
(ii) at least 65% of the institution's "portfolio assets" (as defined) consist
of certain housing and consumer-related assets on a monthly average basis in at
least nine out of every 12 months. At December 31, 1996, the Company was in
compliance with the QTL test.

         Enforcement and Termination of Deposit Insurance. The OTS' enforcement
authority over savings institutions and their holding companies includes, among
other things, the ability to assess civil money penalties, to issue cease and
desist orders, to initiate removal and prohibition orders against officers,
directors, and certain other persons, and to appoint a conservator or receiver
for savings institutions under appropriate circumstances. In general, these
enforcement actions may be initiated for violations of laws and regulations,
violations of cease and desist orders and "unsafe or unsound" conditions or
practices, which are not limited to cases of inadequate capital.

         The FDIC has authority to recommend that the OTS take any authorized
enforcement action with respect to any federally insured savings institution. If
the OTS does not take the recommended action or provide an acceptable plan for
addressing the FDIC's concerns within 60 days after the receipt of the
recommendation from the FDIC, the FDIC may take such action if the FDIC Board of
Directors determines that the institution is in an unsafe or unsound condition
or that failure to take such action will result in the continuation of unsafe or
unsound practices in conducting the business of the institution. The FDIC may
also take action prior to the expiration of the 60-day time period in exigent
circumstances after notifying the OTS.

         The FDIC may terminate the deposit insurance of any insured depository
if the FDIC determines, after a hearing, that the institution has engaged or is
engaging in unsafe or unsound practices which, as with the OTS' enforcement
authority, are not limited to cases of capital inadequacy, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation or order or any condition imposed in writing by the FDIC. In
addition, FDIC regulations provide that any insured institution that falls below
a 2% minimum leverage ratio (see below) will be subject to FDIC deposit
insurance termination proceedings unless it has submitted, and is in compliance
with, a capital plan with its primary federal regulator and the FDIC. The FDIC
may also suspend deposit insurance temporarily during the hearing process if the
institution has no tangible capital. The FDIC is additionally authorized by
statute to appoint itself as conservator or receiver of an insured institution
(in addition to the powers of the institution's primary federal regulatory
authority) in cases, among others and upon compliance with certain procedures,
of unsafe or unsound conditions or practices or willful violations of cease and
desist orders.

         Transactions with Affiliates. Under federal law, all transactions
between and among a savings association and its affiliates, which include
holding companies, are subject to Sections 23A and 23B of the Federal Reserve
Act. Generally, these requirements limit these transactions to a percentage of
the savings association's capital and require all of them to be on terms at
least as favorable to the association as transactions with non-affiliates. In
addition, a savings association may not lend to any affiliate engaged in
non-banking activities not permissible for a bank holding company or acquire
shares of any affiliate not a subsidiary. The OTS is authorized to impose
additional restrictions on transactions with affiliates if necessary to protect
the safety and soundness of a savings association. The OTS regulations also set
forth various reporting requirements relating to transactions with affiliates.

        Extensions of credit by a savings association to executive officers,
directors and principal shareholders are subject to Section 22(h) of the Federal
Reserve Act, which, among other things, generally prohibits loans to any such
individual where the aggregate amount exceeds an amount equal to 15% of an
institution's unimpaired capital and surplus, plus an additional 10% of
unimpaired capital and surplus in the case of loans that are fully secured by
readily marketable collateral.




                                       13


<PAGE>   15


         FHLB System. As a member of the FHLB system, the Bank is required to
own capital stock in its regional FHLB, the FHLB of San Francisco, in a minimum
amount determined at the end of each year based on the greater of (i) 1.00% of
the aggregate principal amount of its unpaid residential mortgage loans, home
purchase contracts and similar obligations, (ii) 5.00% of its outstanding
borrowings from the FHLB of San Francisco, or (iii) 0.3% of its total assets.
The Company was in compliance with this requirement, with an investment of $6.8
million in FHLB stock, at December 31, 1996. The FHLB of San Francisco serves as
a reserve or central bank for the member institutions within its assigned
region, the Eleventh FHLB District. It makes advances to members in accordance
with policies and procedures established by the Federal Housing Finance Board
and the Board of Directors of the FHLB of San Francisco.

         Federal Reserve System. The Federal Reserve Board requires all
depository institutions to maintain reserves against their transaction accounts
(primarily NOW and Super NOW checking accounts) and non-personal time deposits.
At December 31, 1996, the Company was in compliance with its reserve
requirements.

         Deposit Insurance. The FDIC administers two separate deposit insurance
funds. The Bank Insurance Fund ("BIF") generally insures the deposits of
commercial banks, and the Savings Association Insurance Fund ("SAIF") generally
insures the deposits of savings institutions.

        Under FDIC regulations, institutions are assigned to one of three
capital groups for insurance premium purposes - "well capitalized," "adequately
capitalized" and "undercapitalized" - which are defined in the same manner as
the regulations establishing the prompt corrective action system under Section
38 of the FDIA, as discussed under Prompt Corrective Action Rules below. These
three groups are then divided into subgroups which are based on supervisory
evaluations by the institution's primary federal regulator, resulting in nine
assessment classifications. Effective January 1, 1997, assessment rates for
SAIF-insured institutions range from 0% of insured deposits for well-capitalized
institutions with minor supervisory concerns to .27% of insured deposits for
undercapitalized institutions with substantial supervisory concerns. In
addition, an additional assessment of 6.4 basis points and 1.3 basis points will
be added to the regular SAIF-assessment and to the regular BIF-assessment,
respectively, until December 31, 1999 in order to cover Financing Corporation
debt service payments.

        Both the SAIF and the BIF are required by law to attain and thereafter
maintain a reserve ratio of 1.25% of insured deposits. The BIF has achieved the
required reserve ratio, and as a result, the FDIC reduced the average deposit
insurance premium paid by BIF-insured banks to a level substantially below the
average premium previously paid by savings institutions. Banking legislation was
enacted September 30, 1996 to eliminate the premium differential between
SAIF-insured institutions and BIF-insured institutions. The legislation provided
that all insured depository institutions with SAIF-assessable deposits as of
March 31, 1995 pay a special one-time assessment to recapitalize the SAIF.
Pursuant to this legislation, the FDIC promulgated a rule that established the
special assessment necessary to recapitalize the SAIF at 65.7 basis points of
SAIF-assessable deposits held by affected institutions as of March 31, 1995.
Based upon its level of SAIF deposits as of March 31, 1995, the Company paid a
special assessment of $3.8 million. The assessment was accrued in the quarter
ended September 30, 1996.

        Another component of the SAIF recapitalization plan provides for the
merger of the SAIF and the BIF on January 1, 1999, provided that no insured
depository institution is a savings association on that date. If legislation is
enacted which requires the Bank to convert to a bank charter, the Company would
become a bank holding company subject to the more restrictive activity limits
imposed on bank holding companies unless special grandfather provisions are
included in such legislation. The Company does not believe that its activities
would be materially affected in the event that it was required to become a bank
holding company.

         Liquidity. Federal regulations currently require a savings institution
to maintain a monthly average daily balance of liquid assets (including cash,
certain time deposits, bankers' acceptances and specified United States
Government, state or federal agency obligations) equal to at least 5.00% of the
average daily balance of its net withdrawable accounts and short-term borrowings
during the preceding calendar month. This liquidity requirement may be changed
from time to time by the OTS to any amount within the range of 4.00% to 10.00%
of such accounts and borrowings depending upon economic conditions and the
deposit flows of member institutions. Federal regulations also require each
member institution to maintain a monthly average daily balance of short-term
liquid assets (generally those having maturities of 12 months or less) equal to
at least 1.00% of the average daily balance of its net withdrawable accounts and
short-term borrowings during the preceding calendar month. Monetary penalties
may be imposed for failure to meet these liquidity ratio requirements. The
Company's liquidity and short-term liquidity ratios for the calculation period
ended December 31, 1996, were 11.05% and 6.49%, respectively, which exceeded the
applicable requirements.


                                       14

<PAGE>   16

         Community Reinvestment Act. Under the Community Reinvestment Act
("CRA") a savings institution has a continuing and affirmative obligation
consistent with its safe and sound operation to help meet the credit needs of
its entire community, including low and moderate income neighborhoods. The CRA
also requires the OTS to assess an institution's performance in meeting the
credit needs of its delineated communities, as part of its examination of the
institution, and to take such assessments into consideration in reviewing
applications with respect to branches, mergers and other business combinations,
and savings and loan holding company acquisitions. An unsatisfactory CRA rating
may be the basis for denying such an application and community groups have
successfully protested applications on CRA grounds. The OTS assigns CRA ratings
of "outstanding", "satisfactory", "needs to improve" or "substantial
noncompliance". The Bank was rated "satisfactory" in April 1996.

         Regulatory Capital Requirements. HOLA and the capital regulations of
the OTS promulgated thereunder ("Capital Regulations") impose three capital
requirements on savings institutions, including a "core capital requirement", a
"tangible capital requirement" and a "risk-based capital requirement".

         Under the core capital requirement, a savings institution must maintain
"core capital" of not less than 3.0% of adjusted total assets. "Core Capital"
generally includes common stockholders' equity, noncumulative perpetual
preferred stock, including any related surplus, and minority interests in the
equity accounts of fully consolidated subsidiaries. The amount of an
institution's core capital is, in general, calculated in accordance with
generally accepted accounting principles ("GAAP"), but with certain exceptions.
Among other exceptions, adjustments to an institution's GAAP equity accounts
that are required pursuant to FASB 115 to reflect changes in market value of
certain securities held by the institution that are categorized as
"available-for-sale" are not to be included in the calculation of core capital
for regulatory capital purposes. Intangible assets (not including purchased
mortgage servicing rights, certain mortgage servicing rights with respect to
originated loans and purchased credit card relationships) must be deducted from
core capital. With certain exceptions, equity investments, including equity
investments in real estate, and that portion of land loans and nonresidential
construction loans in excess of an 80% loan-to-value ratio, must also be
deducted from capital. Core capital may include purchased mortgage servicing
rights, certain mortgage servicing rights with respect to originated loans and
purchased credit card relationships, subject to certain limitations.

         Under the tangible capital requirements a savings institution must
maintain "tangible capital" in an amount not less than 1.5% of adjusted total
assets. "Tangible capital" means core capital less any intangible assets
(including supervisory goodwill), plus purchased mortgage servicing rights, and
certain mortgage servicing rights with respect to originated loans, subject to
certain limitations.

         Under the risk-based capital requirement, a savings institution must
maintain "total capital" equal to 8.0% of risk-weighted assets. "Total capital"
consists of core capital and supplementary capital. Supplementary capital
includes, among other things, certain types of preferred stock and subordinated
debt and, subject to certain limitations, loans and lease general reserves up to
1.25% of risk-weighted assets. At December 31, 1996, $6.8 million of the Bank's
general reserves was included in supplementary capital. A savings institution's
supplementary capital may be used to satisfy the risk-based capital requirements
only to the extent of that institution's core capital. Risk-weighted assets are
the assets of the institution (including certain off-balance sheet items,
including letters of credit, and loans or other assets sold with subordination
or recourse arrangements) adjusted to reflect the degree of credit risk deemed
to be associated with such assets, ranging from 0% for low-risk assets such as
U. S. Treasury securities and GNMA securities to 100% for various types of loans
and other assets deemed to be higher risk. Single family mortgage loans having
loan-to-value ratios not exceeding 80% and meeting certain additional criteria,
as well as certain multi-family residential property loans, qualify for a 50%
risk-weighted treatment.

         The risk-based capital rules of the OTS, FDIC and other federal banking
agencies provide that an institution must hold capital in excess of regulatory
minimums to the extent that examiners find either (1) significant exposure to
concentration of credit risk such as risks from higher interest rates,
prepayments, significant off-balance sheet items (especially standby letters of
credit) or risks arising from nontraditional activities or (2) that the
institution is not adequately managing these risks. For this purpose, however,
the agencies have stated that, in view of the statutory requirements relating to
permitted lending and investment activities of savings institutions, the general
concentration by such institutions in real estate lending activities would not,
by itself, be deemed to constitute an exposure to concentration of credit risk
that would require greater capital levels.

        The following table summarizes the regulatory capital requirements under
HOLA for the Bank at December 31, 1996. As indicated in the table, the Bank's
capital levels exceed all three of the currently applicable minimum HOLA capital
requirements (dollars are in thousands).



                                       15

<PAGE>   17
<TABLE>
<CAPTION>
                                             TANGIBLE CAPITAL (2)         CORE CAPITAL (2)          RISK-BASED CAPITAL
                                            ----------------------      ----------------------    ----------------------- 
                                             BALANCE        %            Balance        %         BALANCE           %
                                            ---------    ---------      ---------    ---------    ---------     --------- 

<S>                                         <C>          <C>            <C>          <C>         <C>            <C>      
Stockholders' equity                        $  53,490                   $  53,490                 $  53,490
Adjustments
    General valuation
        allowances                                                                                    6,757
    Unrealized losses                             113                        113                        113
    Disallowed deferred tax asset                (800)                      (800)                      (800)
                                            ---------    ---------      ---------    ---------    ---------     --------- 
Regulatory capital                             52,803         6.27%        52,803         6.27%      59,560         11.11%
Required minimum                               12,634         1.50         25,267        3.00        42,879          8.00
                                            ---------    ---------      ---------    ---------    ---------     --------- 
Excess capital                              $  40,169         4.77%     $  27,536        3.27%    $  16,681          3.11%
                                            =========    =========      =========    =========    =========     ========= 
Adjusted assets(1)                          $ 842,122                   $ 842,122                 $ 535,986
                                            =========                   =========                 =========     
</TABLE>

------------------

         (1)      The term "adjusted assets" refers to the term "adjusted total
                  assets" as defined in 12 C.F.R. Section 567.1 (a) for purposes
                  of tangible and core capital requirements, and for purposes of
                  the risk-based capital requirements, refers to the term
                  "risk-weighted assets" as defined in 12 C.F.R. Section
                  567.5(d). 

         (2)      The tangible and core capital ratios were 5.8% at December 31,
                  1995.

         In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk is
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating its risk-based capital. As a result, such an
institution is required to maintain additional capital in order to comply with
the risk-based capital requirement. The final rule was originally to be
effective as of January 1, 1994; however, its effectiveness has been delayed
several times. In August 1995, the OTS issued Thrift Bulletin No. 67, which
allows eligible institutions to request adjustment to their interest rate risk
component as calculated by the OTS, or to request to use their own models to
calculate their interest rate component. The OTS also indicated that it will
continue to delay the effectiveness of its interest rate risk rule requiring
institutions with above normal interest rate risk exposure to adjust their
regulatory capital requirement until new procedures are implemented and
evaluated.

         Prompt Corrective Action Rules. Under federal law, each federal banking
agency has implemented a system of prompt corrective action for institutions
which it regulates. Under OTS regulations ("PCA Rules"), an institution shall be
deemed to be (i) "well-capitalized" if it has total risk-based capital of 10.0%
or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier 1
leverage capital ratio of 5.0% or more and is not subject to any order or final
capital directive to meet and maintain a specific capital level for any capital
measure; (ii) "adequately capitalized" if it has a total risk-based capital
ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a
Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances)
and does not meet the definition of "well capitalized," (iii) "undercapitalized"
if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1
risk-based capital ratio that is less than 4.0% or a Tier 1 leverage capital
ratio that is less than 4.0% (3.0% under certain circumstances), (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a
Tier 1 leverage capital ratio that is less than 3.0%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. Federal law authorizes the OTS to reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category (except that the
OTS may not reclassify a significantly undercapitalized institution as
critically undercapitalized).

         As of December 31, 1996 and 1995, the most recent notification from the
OTS categorized the Company as well capitalized under the regulatory framework
for prompt corrective action. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual capital amounts and ratios and the capital amounts and ratios
required in order for an institution to be well capitalized and adequately
capitalized are presented in the table below.




                                       16

<PAGE>   18

<TABLE>
<CAPTION>
                                                                     TO BE CATEGORIZED AS        TO BE CATEGORIZED AS
                                                                    ADEQUATELY CAPITALIZED         WELL CAPITALIZED
                                                                   UNDER PROMPT CORRECTIVE     UNDER PROMPT CORRECTIVE
                                              ACTUAL                  ACTION PROVISIONS           ACTION PROVISIONS
                                      ----------------------       -----------------------     ----------------------
                                      AMOUNT          Ratios       Amount           Ratios     Amount          Ratios
                                      ------          ------       ------           ------     ------          ------
<S>                                  <C>               <C>        <C>               <C>       <C>               <C>   
AS OF DECEMBER 31, 1996
    Total Capital
    (to Risk Weighted Assets)        $59,560           11.11%     $42,879           8.00%     $53,599           10.00%
     Tier 1 Capital
    (to Risk Weighted Assets)         52,803            9.85%      21,439           4.00%      32,159            6.00%
     Tier 1 Capital
    (to Average Assets)               52,803            6.55%      32,269           4.00%      40,336            5.00%

AS OF DECEMBER 31, 1995
    Total Capital
    (to Risk Weighted Assets)        $49,448           10.27%     $38,508           8.00%     $48,135           10.00%
     Tier 1 Capital
    (to Risk Weighted Assets)         43,360            9.01%      19,254           4.00%      28,881            6.00%
     Tier 1 Capital
    (to Average Assets)               43,360            5.96%      29,079           4.00%      36,349            5.00%
</TABLE>


         Under the PCA Rules, an institution that is deemed to be
undercapitalized must submit a capital restoration plan and is subject to
mandatory restrictions on capital distributions (including cash dividends) and
management fees, increased supervisory monitoring by the OTS, growth
restrictions, restrictions on certain expansion proposals and capital
restoration plan submission requirements. If an institution is deemed to be
significantly undercapitalized, all of the foregoing mandatory restrictions
apply, as well as a restriction on compensation paid to senior executive
officers. Furthermore, the OTS must take one or more of the following actions:
(i) require the institution to sell shares (including voting shares) or
obligations; (ii) require the institution to be acquired or merge (if one or
more grounds for the appointment of a conservator or receiver exists); (iii)
implement various restrictions on transactions with affiliates; (iv) restrict
interest rates on deposits; (v) impose further asset growth restrictions or
asset reductions; (vi) require the institution or subsidiary to alter, reduce,
or terminate activities considered risky; (vii) order a new election of
directors; (viii) dismiss directors and/or officers who have held office more
than 180 days before the institution became undercapitalized; (ix) require the
hiring of qualified executives; (x) prohibit correspondent bank deposits; (xi)
require the institution to divest or liquidate a subsidiary in danger of
insolvency or a controlling company to divest any affiliate that poses a
significant risk, or is likely to cause a significant dissipation of assets or
earnings; (xii) require a controlling company to divest the institution if it
improves the institution's financial prospects; or (xiii) require any other
action the OTS determines fulfills the purposes of the PCA Rules.

         The OTS may also impose on significantly undercapitalized institutions
one or more of the mandatory restrictions applicable to critically
undercapitalized institutions. The restrictions require prior regulatory
approval for any material transaction, to extend credit on a highly leveraged
transaction, to adopt charter or bylaws amendments, to make material accounting
changes, to engage in covered transactions with affiliates, to pay excessive
compensation, or to pay higher interest on new or renewing liabilities. A
critically undercapitalized institution may not, beginning 60 days after
becoming critically undercapitalized, make any principal or interest payments on
subordinated debt not outstanding on July 15, 1991. The OTS is required, not
later than 90 days after a savings institution becomes critically
undercapitalized to either (i) appoint a conservator or receiver or (ii) take
such other actions it determines would better achieve the purpose of the PCA
Rules. In any event, the OTS is required to appoint a receiver within 270 days
after the institution becomes critically undercapitalized unless (i) with the
concurrence of the FDIC, the OTS determines the institution has a positive net
worth, has been in substantial compliance with an approved capital restoration
plan, is profitable or has an upward trend in earnings which the OTS finds is
substantial, and is reducing the ratio of nonperforming loans to total loans and
(ii) the Director of the OTS and the Chairman of the FDIC both certify that the
institution is viable and not expected to fail.

         Dividends and Other Capital Distributions. OTS regulations impose
limitations on "capital distributions" by savings institutions. Distributions
are defined to include, among other things, cash dividends and payments for the
repurchase or retirement of shares. The OTS retains the authority to prohibit
any capital distribution otherwise authorized under the regulation if the OTS
determines that the capital distribution would constitute an unsafe or unsound
practice. The regulation also states that the capital distribution limitations
apply to direct and indirect distributions to affiliates, including those
occurring in connection with corporation reorganizations.




                                       17

<PAGE>   19

         A savings institution that meets its capital requirements may make
capital distributions without prior OTS approval during a calendar year of up to
the greater of (i) 100% of its net income during the calendar year, plus the
amount that would reduce by not more than one-half its "surplus capital ratio"
at the beginning of the calendar year (the amount by which the institution's
actual capital exceeded its fully phased-in capital requirements at that date)
or (ii) 75% of its net income over the most recent four-quarter period. An
institution that does not meet its minimum regulatory capital requirements
immediately prior to or on a pro forma basis after giving effect to a proposed
capital distribution is not authorized to make any capital distributions unless
it received prior written approval from the OTS or the distributions are in
accordance with the express terms of an approved capital plan.

         Savings institutions generally are required to provide 30 days' advance
notice of any proposed dividend. Any dividend declared within the notice period,
or without giving the prescribed notice, is invalid.

         On December 5, 1994, the OTS published a notice of proposed rulemaking
to amend its capital distribution regulation. Under the proposal, savings
institutions would be permitted to only make capital distributions that would
not result in their capital being reduced below the level required to remain
"adequately capitalized" as defined in the PCA Rules. The Bank would continue to
be required to provide notice to the OTS of its intent to make a capital
distribution.

         Loans to One Borrower Limitation. With certain limited exceptions, the
maximum amount that a savings institution may lend to one borrower (including
certain entities related to such borrower) is an amount equal to 15% of the
institution's unimpaired capital and unimpaired surplus, plus an additional 10%
for loans fully secured by readily marketable collateral. Real estate is not
included within the definition of readily marketable collateral for this
purpose. Pursuant to the current regulation, the maximum amount which the Bank
could have loaned to any one borrower (and related entities) under the general
OTS loans to one borrower limit was $9.6 million as of December 31, 1996.

         Other Lending Standards. The OTS and the other federal banking agencies
have jointly adopted uniform rules on real estate lending and related
Interagency Guidelines for Real Estate Lending Policies. The uniform rules
require that institutions 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 individual institutions'
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 Guidelines
state 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.


TAXATION

FEDERAL

        The Company and the Bank currently file, and expect to continue to file,
a consolidated federal income tax return based on a fiscal year ended September
30. Consolidated returns have the effect of eliminating inter-company
transactions, including dividends, from the computation of taxable income.

        For taxable years beginning prior to January 1, 1996, a savings
institution such as the Company that met certain definitional tests relating to
the composition of its assets and the sources of its income (a "qualifying
savings institution") was permitted to establish reserves for bad debts and to
claim annual tax deductions for additions to such reserves. A qualifying savings
institution was permitted to make annual additions to such reserves based on the
institution's loss experience under the "experience method". Alternatively, a
qualifying savings institution could elect, on an annual basis, to use the
"percentage of taxable income" method to compute its addition to its bad debt
reserve on qualifying real property loans (generally, loans secured by an
interest in improved real estate). The percentage of taxable income method
permitted the institution to deduct a specified percentage (8%) of its taxable
income before such deduction, regardless of the institution's actual bad debt
experience, subject to certain limitations. In fiscal 1996, 1995 and 1994, the
Company utilized the experience method because that method produced a greater
deduction than the percentage method.



                                       18

<PAGE>   20

         On August 20, 1996, President Clinton signed the Small Business Job
Protection Act (the "Act") into law. One provision of the Act repealed the
reserve method of accounting for bad debts for savings institutions effective
for taxable years beginning after 1995 and provided for recapture of a portion
of the reserves existing at the close of the last taxable year beginning before
January 1, 1996. For its tax years beginning on or after January 1, 1996, a
savings institution will be required to account for its bad debts under the
specific charge-off method. Under this method, deductions may be claimed only as
and to the extent that loans become wholly or partially worthless. A savings
institution will be required to recapture its "applicable excess reserves,"
which are its federal tax bad debt reserves in excess of the base year reserve
amount, which are generally the balance of reserves as of December 31, 1987. The
Company does not have applicable excess reserves and thus will not be subject to
the recapture provisions. The base year reserves will continue to be subject to
recapture if: (1) the Company fails to qualify as a "bank" for federal income
tax purposes, (2) certain distributions are made with respect to the stock of
the Company, (3) the bad debt reserves are used for any purpose other than to
absorb bad debt losses or (4) there is a change in federal tax law. The
enactment of this legislation is expected to have no material impact on the
Company's operations or financial position.

        In accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," a deferred tax liability has not been recognized
for the tax bad debt base year reserves of the Company. At December 31, 1996,
the amount of those reserves was approximately $25.5 million. This reserve could
be recognized in the future under the conditions described in the preceding
paragraph.

         Corporations, including qualifying savings institutions, are subject to
an alternative minimum tax in addition to the regular corporate income tax. This
20% tax is computed based on the Company's taxable income (with certain
adjustments), as increased by its tax preference items and applies only if this
tax is larger than its regular tax. The adjustments include an addition to
taxable income of an amount equal to 75% of the excess of the Company's
"adjusted current earnings" over its regular taxable income. The tax preference
items common to savings institutions include the excess, if any, of its annual
tax bad debt deduction over the deduction that would have been available under
the experience method. The Company did not incur a minimum tax liability in 1996
(as computed for federal income tax purposes).

         For additional information regarding taxation, see NOTE I of the NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS.

STATE

         The California franchise tax applicable to the Company is a
variable-rate tax. This rate is computed under a formula that results in a rate
higher than the rate applicable to nonfinancial corporations because it includes
an amount "in lieu" of local personal property and business license taxes paid
by such corporations (but not paid by banks or financial institutions such as
the Company). For the taxable years 1995 and 1996, the maximum rate was set at
approximately 11%. Under California regulations, financial corporations are
permitted to claim bad debt deductions using a reserve method, with the reserve
level being determined by past experience or current facts and circumstances.




                                       19

<PAGE>   21

ITEM 2.        PROPERTIES.

         As of December 31, 1996, the Company had seven leased facilities and
owned the land and improvements of two branch offices. The leased facilities
included its corporate headquarters, four branch offices (with respect to which
the Company leased only the land), a loan production office and a warehouse. All
of the properties owned or leased by the Company are in Southern California.

         The principal terms and the net book values of leasehold improvements
relating to premises leased by the Company are detailed below. None of the
leases contain any unusual terms and all are "net" or "triple net" leases.

<TABLE>
<CAPTION>
                             Expiration    Renewals      Monthly     Square    Net Book Value
Facility                      of Term      Options       Rental       Feet     of Leaseholds
--------                      -------      -------       ------       ----     -------------
 
<S>                           <C>          <C>           <C>         <C>        <C>       
El Segundo Corporate          11/30/00     One 5-yr      $40,092     42,202     $1,050,855

Torrance Branch               12/31/01     One 5-yr       16,529      7,343        227,646

Westlake Branch               03/31/00     None           11,828      7,600         28,696

Manhattan Beach Branch        10/31/10     Four 5-yr       4,590      4,590         55,808

Tarzana Branch                01/31/00     Five 5-yr       3,283      3,352        121,226

Warehouse                     09/30/99     One 2-yr        2,916      6,480

Irvine Production Office      04/30/97     One 6 month     1,500

                                                         -------                ----------
                                                         $80,738                $1,484,231
                                                         =======                ==========
</TABLE>

         At December 31, 1996, the net book values of the Company's office real
property and improvements owned, leasehold interests, and furniture, fixtures
and equipment were $0.8 million, $1.5 million and $2.4 million, respectively.
See NOTE F of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. The Company
believes that all of the above facilities are in good condition and are adequate
for the Company's present operations.


         The Company remains obligated on the lease of a discontinued branch
until July 31, 2001. A lease obligation reserve of $0.5 million was established
with respect to this lease in September 1994.

         In February 1996, the Company sold its Oceanside facility (land and
building) for $2.9 million. In December 1995, a valuation allowance of $0.8
million was established to reduce the Company's carrying value for this facility
to its fair market value.

         In June 1996, the Company sold its Vista and Rancho Bernardo facilities
(land and building), with a carrying value of $1.5 million, for $1.8 million.

         The Company's lease on its Irvine loan production office expires on
April 30, 1997. The Company intends to exercise its option to extend the lease
for six months.





                                       20


<PAGE>   22

ITEM 3.        LEGAL PROCEEDINGS.

         On September 6, 1996, the Company and the Bank were named as defendants
in a class action lawsuit entitled Stanley D. Mosler and Eileen C. Mosler vs.
Hawthorne Savings and Loan Association, Hawthorne Financial Corporation, et.
al., filed in the Superior Court of the State of California as Case No. BC154729
(the "Action"). The plaintiffs had previously filed an individual action
alleging the same matters contained in the class action complaint. The
individual action is scheduled for trial in July 1997. Plaintiffs contend they
were entitled to a notice of availability of foreclosure counseling, which they
allege they did not receive, before the Bank foreclosed. Plaintiffs contend that
the alleged failure to provide counseling notices and the underbidding by the
Bank of the loan amount at foreclosure resulted in damages to the purported
class in an amount in excess of $40 million. The Company has been named and
alleged to have liability based upon its relationship as trustee on the Deed of
Trust securing the Bank's loans. The Company and the Bank filed responsive
pleadings to the Action alleging that the complaint is defective on its face and
that the plaintiffs are not proper representatives of the purported class. The
court granted the Company and Bank's motion and dismissed the plaintiffs' case.
The plaintiffs have appealed.

         The Bank has been named as a defendant in an action entitled Takaki vs.
Hawthorne Savings and Loan Association, filed in the Superior Court of the State
of California, Los Angeles, as Case No. YC021815. The plaintiffs were owners of
real property which they sold in 1991 to a third party. The Bank provided escrow
services in connection with the transaction. A substantial portion of the
consideration paid to the plaintiffs took the form of a deed of trust secured by
another property then owned by an affiliate of the purchaser. The value of the
collateral securing this deed of trust ultimately proved to be inadequate. The
plaintiffs allege that the Bank knew, or should have known, that the security
for the plaintiffs' loan was inadequate and should have so advised them. The
Bank disputes the plaintiffs' allegations and believes that the law in
California is unambiguous that there is no duty which attaches to escrow
providers to advise the parties to an escrow. Trial is scheduled for April 1997.
The plaintiffs have claimed damages in excess of $5 million.

         The Company is involved in a variety of other litigation matters which,
for the most part, arise out of matters and events which were alleged to have
occurred prior to 1994. Many of these lawsuits either allege construction
defects or allege improper servicing of the loan. In the opinion of management,
none of these cases will have a material adverse effect on the Bank's or the
Company's financial condition or operations.








                                       21


<PAGE>   23



ITEM 4.        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         No matters were submitted to a vote of stockholders during the last
quarter of 1996.


ITEM 4A.       EXECUTIVE OFFICERS.

The executive officers of the Company are as follows:


<TABLE>
<CAPTION>
    NAME                 AGE        POSITION WITH THE COMPANY AND PRIOR BUSINESS EXPERIENCE

<S>                     <C>         <C>                                                            
Scott A. Braly            43        President and Chief Executive Officer of Hawthorne Financial and
                                    Hawthorne Savings since July 1993.  Director of Citadel Holding Corporation
                                    and Fidelity Federal Bank from April 1992 to July 1993.  President and Chief
                                    Executive Officer of Valley Federal Savings and Loan Association from April
                                    1990 to April 1992.  Chief Financial Officer of Valley Federal Savings and
                                    Loan Association from June 1989 to November 1990.  Chief Financial Officer
                                    of Bel-Air Savings from May 1985 to May 1989.

Norman A. Morales          36       Executive Vice President and Chief Financial Officer of Hawthorne Financial
                                    and Hawthorne Savings since February 1995.  Executive Vice President and
                                    Chief Financial Officer of SC Bancorp and Southern California Bank from July
                                    1987 to January 1995.

James D. Sage              58       Senior Vice President, Corporate Secretary and General Counsel of Hawthorne
                                    Financial and Hawthorne Savings since August 1993. Special Litigation
                                    Consultant to Great Western Bank from September 1990 to November 1993.
                                    General Counsel of Great Western Bank from September 1982 to September 1990.

</TABLE>

         The above officers serve at the discretion of the Board of Directors.






                                       22


<PAGE>   24
                                   P A R T   II.


ITEM 5.        MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
               MATTERS.

         (A)  MARKET PRICES OF STOCK

         The common stock, par value $0.01 per share, of the Company is traded
on the Nasdaq National Market. The following table sets forth the high and low
sales prices as reported by the Nasdaq for the common stock of the Company for
the periods indicated.

<TABLE>
<CAPTION>
       YEAR ENDED
    DECEMBER 31, 1996               HIGH                       LOW
-------------------------         --------                   --------
<S>                               <C>                     <C>     
First quarter                     $  5 5/8                $     4 3/8
Second quarter                       9                          4 7/8
Third quarter                        9 1/4                      6 3/4
Fourth quarter                       8 1/8                      6 5/8
</TABLE>


<TABLE>
<CAPTION>
        YEAR ENDED
    DECEMBER 31, 1995                HIGH                        LOW
-------------------------          --------                   --------

<S>                              <C>                         <C>  
First quarter                    $    5 1/2                  $   4
Second quarter                        5 1/4                      2 1/4
Third quarter                         3 3/4                      2 1/4
Fourth quarter                        5 3/4                      3 3/4
</TABLE>


         (B)  STOCKHOLDERS

     At the close of business on February 28, 1997, the Company had 2,623,275
shares of common stock outstanding and 519 holders of record of the common stock
of the Company.

         (C)  PER SHARE CASH DIVIDENDS DATA

     The Company has suspended indefinitely the payment of dividends on its
common stock, effective the third quarter 1993.



                                       23

<PAGE>   25

ITEM 6.        SELECTED FINANCIAL DATA.

         The selected consolidated financial data presented below at and for
each of the years in the five-year period ended December 31, 1996 are derived
from the consolidated financial statements of the Company which have been
audited by Deloitte & Touche LLP, independent certified public accountants.

<TABLE>
<CAPTION>
                                                        AT OR FOR THE YEAR ENDED DECEMBER 31,
                                       -----------------------------------------------------------------
                                         1996          1995           1994          1993          1992
                                       ---------     ---------     ---------     ---------     ---------
<S>                                    <C>           <C>           <C>           <C>           <C>      
BALANCE SHEET DATA
Total assets                           $ 847,195     $ 753,583     $ 743,793     $ 881,641     $ 991,308
Cash and investments                     132,349        76,808        61,979       108,899       140,216
Mortgage-backed securities                                            57,395        28,891         5,397
Loans receivable, net                    672,401       617,328       537,020       623,450       765,420
Real estate owned, net                    20,140        37,905        62,613        72,234        29,922
Deposits                                 717,809       698,008       649,382       829,809       909,657
Senior notes                              12,307        12,006           --             --            --
Other borrowings                          50,000           --         47,141            --            --
Stockholders' equity                      43,922        38,966        40,827        43,949        72,616
STATEMENT OF OPERATIONS DATA
Net interest income                       25,394        16,508        19,128        22,106        32,819
Provision for estimated loan losses       (7,489)      (14,895)       (5,298)      (21,867)      (51,242)
Noninterest revenues                       1,927         1,311         1,973         3,295         3,631
Noninterest expenses                     (21,046)      (20,339)      (23,912)      (21,162)      (18,578)
Real estate operations, net                 (956)         (436)        2,433       (26,684)      (12,828)       
Net gain (loss) from disposition
  of deposits and premises                 6,413          (117)        2,835        (4,066)           --
Net earnings (loss)                        7,507       (14,217)       (2,963)      (29,610)      (22,144)
Net earnings (loss) per share (1)           1.11         (5.52)        (1.14)       (11.39)        (8.52)
YIELDS AND COSTS (FOR THE PERIOD)
Interest-earning assets                     8.43%         7.62%         6.63%         6.44%         7.97%
Interest-bearing liabilities                5.29%         5.01%         3.91%         4.12%         4.99%
Interest rate spread                        3.14%         2.61%         2.72%         2.32%         2.98%
Net interest margin (2)                     3.28%         2.47%         2.56%         2.42%         3.31%
CAPITAL RATIOS (END OF PERIOD)
Tangible                                    6.27%         5.80%         5.15%         4.61%         6.55%
Core                                        6.27%         5.80%         5.15%         4.61%         6.55%
Risk-based                                 11.11%        10.27%         9.36%         8.18%        10.10%
ASSET QUALITY DATA(3)
Gross nonperforming assets                 36,783        49,203        80,716       151,183       118,200
Nonperforming assets to total assets        4.34%         6.53%        10.85%        17.15%        11.92%
OTHER RATIOS
Return on average assets                    0.93%        (1.96)%       (0.36)%       (3.09)%       (2.15)%
Return on average common equity            17.75%       (47.57)%       (6.99)%      (50.80)%      (24.24)%
Average stockholders' equity
  to average assets                         5.24%         4.11%         5.12%         6.08%         8.87%
Dividend payout ratio(4)                    N/A           N/A           N/A           N/A           N/A
</TABLE>

-----------------------

         (1)      Calculated using the modified Treasury method for the full
                  year ended December 31, 1996. All other periods calculated
                  using actual shares outstanding.

         (2)      Net interest income divided by average interest-earning
                  assets.

         (3)      Nonperforming assets consists of loans delinquent 90 days or
                  more and properties acquired through foreclosure, net of
                  applicable writedowns and reserves.

         (4)      Cash dividends of $0.7 million and $2.6 million were paid in
                  1993 and 1992, respectively.




                                       24


<PAGE>   26

ITEM 7.        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 
               AND RESULTS OF OPERATIONS.

OPERATING RESULTS

OVERVIEW

         For 1996, the Company reported net earnings of $7.5 million, or $1.11
per share, as compared with a net loss of $14.2 million, or $5.52 per share for
1995. The per share amount for 1996 is based on 5.1 million shares outstanding,
as calculated using the modified Treasury method, while the per share amount for
1995 is based on 2.6 million actual shares outstanding.

         The Company's performance for 1996 marks its first full year of
operations following the successful completion of the sale of $27 million in
"investment units" by the Company in a private placement in December 1995.
During the course of the year, several key strategic initiatives were
implemented in order to enhance the Company's ability to generate asset and
earnings growth during 1997 and beyond. During 1996, (1) loan originations in
excess of $330 million were generated at an average interest rate approaching
10%, (2) the Company's three-branch deposit network in San Diego was sold at a
sizable premium, (3) completed sales of foreclosed properties continued to
substantially reduce the Company's property portfolio, (4) nearly $130 million
of loans were sold at a slight premium, including nearly $43 million of recent
originations secured by commercial properties and apartment buildings, and (5)
substantive restructurings of most of the Company's remaining, large assets
originated during the 1980s were completed. These achievements led directly to
improved core and net earnings, and improved asset quality.

         The Bank maintained core and risk-based regulatory capital ratios of
6.3% and 11.1%, respectively, at December 31, 1996, which exceed the regulatory
minimums which define a "well capitalized" institution. These capital ratios
represent an increase from the levels reported at year end 1995 following the
recapitalization of the Company and the Bank, which were 5.8% and 10.3%, for
core and risk-based ratios, respectively.

         During 1996, the Company's core operating results continued to show
significant improvement when compared to recent periods. In 1996, the Company's
net interest income was $25.4 million, compared to $16.5 million in 1995 and
$19.1 million in 1994. For 1996, earnings from core operations (net interest
income and noninterest revenues less operating costs, before loan loss
provisions, real estate operations and non-recurring items) totaled $6.3
million, as compared to a loss of $2.5 million for 1995 and a loss of $2.8
million for 1994. The improved core results lowered the Company's efficiency
ratio to 77% during 1996, from 114% during 1995 and 113% in 1994.

         In 1996, noninterest revenues totaled $1.9 million, as compared to $1.3
million for 1995 and $2.0 million for 1994. These amounts are exclusive of gains
on sales of assets or other non-recurring revenues.

         For 1996, total operating costs were $21.0 million, as compared with
total operating costs of $20.3 million in 1995 and $23.9 million in 1994. During
the last half of 1996, the Company significantly enhanced its resources
dedicated to new loan origination, credit evaluation and management, and loan
portfolio management, in order to meet the growing demand for the Company's
distinctive mortgage products. These enhancements will be more fully reflected
in the Company's operating costs during 1997. Operating costs for 1996 do not
include expense associated with real estate operations and the $3.8 million
charge for the FDIC SAIF special assessment which was incurred in the third
quarter of 1996 and is reported under other revenues and costs.

         For 1996, the Company recorded loan loss provisions of $7.5 million, as
compared to $14.9 million during 1995 and $5.3 million for 1994. Though a
majority of the 1996 loan provisions, and virtually all of the 1995 loan
provisions, related to loans originated prior to 1995, a growing level of
provisions were recorded during 1995 and 1996 to establish initial general
valuation allowances for the Company's post-1994 loans. Through December 31,
1996, none of the loans originated by the Company since 1994 had resulted in the
foreclosure of the Company's collateral.

         The Company continues to be burdened with relatively poor asset
quality, almost exclusively related to loans made prior to 1994. Since 1993, the
Company has resolved the vast majority of its asset quality problems, through
foreclosure and liquidation of its collateral and through substantive loan
restructurings (which generally involved a comprehensive restructuring of the
Company's loans with selected borrowers). A substantial majority of the total
credit loss provisions recorded during 1996 reflect the financial cost resulting
from the restructuring of a small number of large loans and multiple loans with
individual borrowers originated prior to 1993, and the revaluation of the
Company's significant remaining foreclosed housing development.





                                       25

<PAGE>   27

         The Company believes that the consistent and sustained pattern of
reduced credit loss provisions (loan loss provisions and post-foreclosure
valuation adjustments on real estate owned), which have declined from $55
million in 1992, to $35 million for 1993 and 1994, to $20 million in 1995 and to
$11 million during 1996, accurately reflects the diminishing adverse influence
of the Company's pre-1995 loan portfolio on the Company's operating results. At
December 31, 1996, loans originated prior to 1995 had declined to approximately
50% of the Company's total loan portfolio, and this portfolio had declined in
dollar terms by approximately 40% from its level at the end of 1994.

         During 1996, the Company's real estate operations, which involve the
renovation, operation and disposal of foreclosed properties, produced a net cost
of $1.0 million, compared to a net cost of $0.4 million for 1995 and a net
recovery of $2.4 million for 1994. For 1996, provisions for estimated losses on
real estate owned totaled $3.5 million, compared to $5.1 million in 1995, and
are included in the net cost of real estate operations. No such provisions were
made in 1994.

         Other revenues and costs are comprised of non-recurring activities to
the Company's operations. For the year, the Company incurred a $3.8 million
after-tax charge from the special FDIC SAIF assessment, and realized a net gain
of $6.4 million from the sale of its San Diego retail branch franchise.

         During 1996, the Company sold $129.5 million of performing loans in
five separate transactions. These sales involved $82.4 million, $33.0 million
and $14.1 million of loans secured by single family homes, apartment buildings
and commercial properties, respectively. Approximately $43.0 million of the
loans sold were originated during 1995 and 1996 and were secured by
income-producing properties. In the aggregate, these transactions resulted in
net gains of $0.4 million. During 1995, the Company sold $19.2 million of loans
in a single transaction, which resulted in a negligible net gain. No loans were
sold during 1994.

         For 1996, the Company recorded an income tax benefit of $6.4 million,
$4.2 million of which was attributable to the creation of a deferred tax asset
and $2.1 million of which was attributable to the receipt of a Federal income
tax refund resulting from amendments to certain of the Company's prior years'
tax returns.

         At December 31, 1996, gross nonperforming assets totaled $36.8 million,
or 4.3% of total assets. These nonperforming assets were comprised of loans
delinquent 90 days or more ($16.7 million), and net real estate owned ($20.1
million). By comparison, nonperforming assets totaled $49.2 million (6.5% of
total assets) at December 31, 1995, and $80.7 million (10.9% of total assets) at
the end of 1994.

         During 1996, the collateral securing $21.5 million of loan principal
was foreclosed upon. The collateral securing $38.3 million and $85.7 million of
loan principal was foreclosed upon during 1995 and 1994, respectively.
Consistent with this decline in new property acquisition, the volume of property
sales, measured by net sales proceeds, also declined from 1994 to 1996. For the
years ended December 31, 1996, 1995, and 1994, net proceeds from property
sales (including internal financings) were $44.8 million, $57.1 million and
$89.0 million, respectively.

         The Company expects that virtually all of its current portfolio of
foreclosed properties will be liquidated in the ordinary course of business over
the next 12 months. The completion of the Company's single-largest foreclosed
development project, in addition to two other smaller completed projects now in
final liquidation, marks the last of over 40 failed projects with origins from
the late 1980s and early 1990s. These failed development projects have accounted
for the largest component of the Company's credit losses over the past four
years.

         As previously reported, the Company issued an aggregate of $27.0
million of high-cost Senior Notes and Cumulative Perpetual Preferred Stock, and
issued Warrants to purchase the Company's Common Stock, in connection with the
recapitalization of the Bank in December 1995. For 1996, interest expense on the
$13.5 million (par amount) of Senior Notes was $1.9 million, and accrued but
unpaid dividends on the $13.5 million (par amount) of Cumulative Perpetual
Preferred Stock were $2.4 million.





                                       26


<PAGE>   28
INTEREST MARGIN

         The Company's interest rate spread is the difference between the yield
earned on loans and investment securities and the cost of deposits and
borrowings, before adjustment for the difference between interest-earning assets
and liabilities. The Company's net interest margin is its net interest income
divided by its average interest-earning assets. These percentage measures are
affected by several factors, including (1) the level of, and the relationship
between, the dollar amount of interest-earning assets and interest-bearing
liabilities, (2) the relationship between repricing or maturity of the Company's
adjustable-rate and fixed-rate loans and short-term investment securities and
its deposits and borrowings, and (3) the magnitude of the Company's
nonperforming assets.

         The table below sets forth the Company's average balance sheet, and the
related effective yields and costs on average interest-earning assets and
interest-bearing liabilities, for each of the three years ended December 31,
1996 (dollars are in thousands). In the table, interest revenues are net of
interest associated with nonaccrual loans.

<TABLE>
<CAPTION>
                                                           1996                                1995                    
                                             --------------------------------    -----------------------------------   
                                              AVERAGE    Revenues/    Yield/      Average    Revenues/       Yield/    
                                              BALANCE      Costs       Cost     Balance(1)     Costs          Cost     
                                             --------    --------    --------   ----------   ---------      --------   
<S>                                            <C>          <C>          <C>       <C>          <C>             <C>    
ASSETS
Interest-earning assets
    Loans                                    $671,365    $ 59,722        8.90%   $578,766    $ 45,386           7.84%  
    Cash and cash equivalents                  65,094       3,425        5.26%     21,128       1,446           6.84%  
    Investment securities                      32,014       1,814        5.67%     11,727         626           5.34%  
    Investment in capital                                                                                              
        stock of Federal Home Loan Bank         6,577         393        5.98%      6,473         327           5.05%  
    Mortgage-backed securities                   --          --            --      50,777       3,209           6.32%  
                                             --------    --------                --------    --------          
        Total interest-earning assets         775,050      65,354        8.43%    668,871      50,994           7.62%  
Noninterest-earning assets                     31,675    --------       -----      56,118    --------        -------   
                                             --------                            --------                              
Total assets                                 $806,725                            $724,989                              
                                             ========                            ========

LIABILITIES AND STOCKHOLDERS' EQUITY      
Interest-bearing liabilities                                                                                           
    Deposits                                 $701,836      35,568        5.07%   $675,329      33,593           4.97%  
    Borrowings                                 41,138       2,471        6.01%     12,153         801           6.59%  
    Senior notes                               12,150       1,921       15.81%        625          92          14.72%  
                                             --------    --------                --------    --------
        Total interest-bearing liabilities    755,124      39,960        5.29%    688,107      34,486           5.01%  
                                             --------    --------    --------    --------    --------       --------
Other liabilities                               9,310                               6,997                              
                                            
Stockholders' equity                           42,291                              29,885 
                                             --------                            --------
Total liabilities & stockholders' equity     $806,725                            $724,989                              
                                             ========                            ========
Net interest income                                      $ 25,394                            $ 16,508                  
                                                         ========                            ========
Interest rate spread                                                     3.14%                                  2.61%  
                                                                     ========                               ========
Net interest margin                                                      3.28%                                  2.47%  
                                                                     ========                               ========
</TABLE>

<TABLE>
<CAPTION>
                                                          1994
                                            ----------------------------------
                                            Average    Revenues/        Yield/
                                           balance(1)    Costs           Cost
                                           ----------  ---------        ------
<S>                                         <C>         <C>             <C>  
ASSETS
Interest-earning assets
    Loans                                   $604,410   $ 42,085           6.96%
    Cash and cash equivalents                 39,370      1,695           4.31%
    Investment securities                     51,089      2,485           4.86%
    Investment in capital                   
        stock of Federal Home Loan Bank        6,983        343           4.91%
    Mortgage-backed securities                45,810      2,963           6.47%
                                            --------   --------       
        Total interest-earning assets        747,662     49,571           6.63%
Noninterest-earning assets                    79,524   --------       --------    
                                            --------                            
Total assets                                $827,186 
                                            ========
LIABILITIES AND STOCKHOLDERS' EQUITY        
Interest-bearing liabilities                
    Deposits                                $763,302     29,694           3.89%
    Borrowings                                14,333        749           5.23%
    Senior notes                                  --         --            --
                                            --------   --------
        Total interest-bearing liabilities   777,635     30,443           3.91%
                                             -------   --------       --------
Other liabilities                              7,163                              
                                            
Stockholders' equity                          42,388                      
                                            --------
Total liabilities & stockholders' equity    $827,186                              
                                            ========                                            
Net interest income                                    $ 19,128                   
                                                       ========
Interest rate spread                                                      2.72%
                                                                      ========
Net interest margin                                                       2.56%
                                                                      ========
</TABLE>
__________________
(1)  Amounts for 1994 and 1995 represent monthly averages.


                                       27
<PAGE>   29



         The table below summarizes the components of the changes in the
Company's interest revenues and costs for 1996 and 1995, as compared with the
preceding year (dollars are in thousands).



<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                                      1996 AND 1995
                                         -----------------------------------------------------------------------
                                               INCREASE (DECREASE) DUE TO CHANGE IN
                                         ----------------------------------------------------                   
                                                                                 RATE AND              NET       
                                              VOLUME             RATE            VOLUME(1)            CHANGE     
                                         ----------------   --------------    ---------------    --------------- 
<S>                                      <C>                <C>               <C>                 <C>        
INTEREST REVENUES
Loans(2)                                       $   7,243          $ 6,117        $       976           $ 14,336  
Cash and cash equivalents                          3,009             (334)              (696)             1,979  
Investment securities                              1,083               38                 67              1,188  
Investment in capital stock of
  Federal Home Loan Bank                               5               60                  1                 66  
Mortgage-backed securities                        (3,209)               -                  -             (3,209) 
                                         ----------------   --------------    ---------------    --------------- 
                                                   8,131            5,881                348             14,360  
                                         ----------------   --------------    ---------------    --------------- 
INTEREST COSTS
Deposits                                           1,319              630                 26              1,975 
Borrowings                                         1,910              (66)              (174)             1,670  
Senior notes                                       1,697                7                125              1,829  
                                         ----------------   --------------    ---------------    --------------- 
                                                   4,926              571                (23)             5,474  
                                         ----------------   --------------    ---------------    --------------- 
NET INTEREST INCOME                            $   3,205          $ 5,310        $       371          $   8,886  
                                         ================   ==============    ===============    =============== 
</TABLE>


<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                                        1995 AND 1994
                                           -----------------------------------------------------------------------
                                                 INCREASE (DECREASE) DUE TO CHANGE IN
                                           ---------------------------------------------------- 
                                                                                   RATE AND              NET
                                                VOLUME             RATE            VOLUME(1)           CHANGE
                                           ---------------    --------------   ----------------   ----------------
<S>                                        <C>                <C>              <C>                <C>     
INTEREST REVENUES
Loans(2)                                        $ (1,771)           $ 5,295        $     (223)           $  3,301
Cash and cash equivalents                           (785)               999              (463)               (249)
Investment securities                             (1,915)               242              (186)             (1,859)
Investment in capital stock of
  Federal Home Loan Bank
                                                     (25)                10                (1)                (16)
Mortgage-backed securities                           321                (68)               (7)                246
                                           ---------------    --------------   ----------------   ----------------
                                                  (4,175)             6,478              (880)              1,423
                                           ---------------    --------------   ----------------   ----------------
INTEREST COSTS
Deposits                                          (3,422)             8,275              (954)              3,899
Borrowings                                          (116)               196               (28)                 52
Senior notes                                           -                  -                92                  92
                                           ---------------    --------------   ----------------   ----------------
                                                  (3,538)             8,471              (890)              4,043
                                           ---------------    --------------   ----------------   ----------------
NET INTEREST INCOME                             $   (637)           $(1,993)       $       10           $  (2,620)
                                           ===============    ==============   ================   ================
</TABLE>


         (1)      Calculated by multiplying change in rate by change in volume.
         (2)      Interest on loans is net of interest on nonaccrual loans.



                                       28

<PAGE>   30

         The Company's net interest margin increased by 81 and 72 basis points
during 1996 as compared with 1995 and 1994, respectively. This substantial
improvement resulted from (1) the continued disposal of properties and the
contribution of capital to the Bank by the Company in late 1995, which
contributed to a turnaround in the difference between the amount of the
Company's interest-earning assets and interest-bearing liabilities, which was a
positive $19.9 million during 1996, as compared to a negative $19.2 million
during 1995 and a negative $30.0 million during 1994, (2) the magnitude of the
Company's loan originations since 1994, at average interest rates well in excess
of the interest rates attributable to the Company's remaining pre-1995 loans,
(3) the relatively modest rise in the Company's interest costs during 1996 as
compared to 1995, which generally reflects the stability of market interest
rates since mid-1995, and (4) the substantial repricing during 1996 of the
Company's pre-1995 adjustable-rate loans, a majority of which are priced off of
the 11th District Cost of Funds Index ("DCOFI") with repricing intervals of
six and twelve months, at levels which are more reflective of current market
interest rates and the Company's deposit costs.

         As described elsewhere herein, the Company commenced operation of
several new financing businesses early in 1995, each targeted on a narrow
segment of the real estate finance markets in Southern California and designed
to produce meaningful new loan volume with yields substantially higher than the
Company's pre-1995 loan portfolio while maintaining credit quality. During 1996
and 1995, the Company originated an aggregate $529.7 million of new permanent
loans and construction commitments. At December 31, 1996, $352.9 million of net
loan principal (after deducting undisbursed loans funds and net of sales and
repayments) was outstanding, with a weighted average interest rate (excluding
loan and other fees) of 9.72%. Most of the loans originated during 1995 and 1996
are adjustable-rate and utilize a variety of indices, including the 11th DCOFI,
a designated prime rate and the One-Year Constant Maturity Treasury Index
("CMT").

PROVISIONS FOR POSSIBLE CREDIT LOSSES ON LOANS

         The Company recorded loan loss provisions of $7.5 million, $14.9
million and $5.3 million for the years ended December 31, 1996, 1995, and 1994,
respectively. The provisions for 1996 and 1995 were substantially attributable
to losses related to the Company's pre-1995 loan portfolio, though a growing
proportion of the Company's loan loss provisions during this period represent
general valuation allowances ("GVAs") attributable to the Company's post-1994
loan originations. At December 31, 1996, the Company maintained total loan
reserves of $13.5 million, of which $11.3 million were GVAs. See Credit Losses.

NONINTEREST REVENUES

         The table below details the Company's noninterest revenues for the
periods indicated (dollars are in thousands).

<TABLE>
<CAPTION>
                                        1996               1995               1994
                                   --------------     ---------------    --------------
<S>                                <C>                <C>               <C>      
Other loan and escrow fees              $  1,223           $     515         $     691
Deposit account fees                         464                 582               560
Other revenues                               240                 214               722
                                   --------------     ---------------    --------------
                                        $  1,927            $  1,311          $  1,973
                                   ==============     ===============    ==============
</TABLE>


         Other loan and escrow fees include servicing charges, escrow fees, late
charges, prepayment penalties and non-refundable commitment and extension fees.
In late 1993, the Company substantially terminated its new loan origination and
escrow activities. The Company did not commence originating new loans again
until the last half of 1994, and then did so only moderately until the second
quarter of 1995, when its new financing activities began to produce significant
volumes. New loan volume was $49.9 million in 1993 and $44.9 million in 1994,
rising to $197.4 million in 1995 and $332.3 million in 1996, resulting in an
overall increase in other loan and escrow fees. During 1995 and 1996, the
Company sold one and three branches, respectively, which resulted in lower
deposit account fees. During the 1994 first quarter, the Company received, and
recorded as other revenue, payments of $0.4 million from the Resolution Trust
Corporation resulting from a rent subsidy agreement entered into as part of a
branch office purchase by the Company in the mid-1980s.



                                       29
<PAGE>   31
NONINTEREST EXPENSES

         The table below details the Company's operating costs for periods
indicated (dollars are in thousands).

<TABLE>
<CAPTION>
                                                     1996                 1995                1994
                                                ---------------     ----------------     ---------------
<S>                                             <C>                 <C>                  <C>     
Employee                                             $   9,800             $ 10,118            $ 10,740
Occupancy                                                2,890                2,841               2,780
Operating                                                4,565                3,539               5,002
Professional                                             1,615                1,579               2,816
SAIF insurance premium and OTS assessment                2,152                2,213               2,557
Goodwill amortization                                       24                   49                  16
                                                ---------------     ----------------     ---------------
                                                      $ 21,046             $ 20,339            $ 23,911
                                                ===============     ================     ===============
</TABLE>

EMPLOYEE COSTS

         Since June 1993, the Company has hired, and currently retains the
service of, a staff of senior and middle managers to effect the Company's
strategic and operational initiatives, including management and staff which have
responsibility for the Company's financing activities, retail banking operations
and corporate staff and administrative functions. Management also substantially
restructured the Company's retail branch network, reducing from 21 to 6 the
number of branch offices operated by the Company. These actions, largely
accomplished by late 1994, have resulted in almost no change in the number of
employees (210 in June 1993 and 200 at December 31, 1996) but a significant
change in the composition of the employee base. This change in composition has
resulted in an increase in the Company's base compensation from an annualized
rate of $5.2 million in June 1993 to $8.8 million at the end of 1996. During
1994, management initiated a Company-wide incentive compensation program for all
employees. Under this program, cash bonuses could be, and were, earned for
achievement of the Company's principal strategic and recurring operating
initiatives. For each of the three years ended December 31, 1996, cash incentive
compensation totaled $1.0 million, $1.8 million, and $1.4 million, respectively.
The reduction in incentive compensation expense from 1995 to 1996 was due in
part to the granting of stock options to certain managers in lieu of cash
incentive compensation. See NOTE K of the NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS.

         During 1994, the Company restructured its employee benefit programs to
provide for comparable or improved coverage to employees at reduced costs and to
require certain employees (based upon salary level) to pay all or a portion of
the premium cost of Company-sponsored programs. During 1994, the Company froze
benefits associated with its defined benefit pension plan and ceased
contributions to the Company's Employee Stock Ownership Plan.

OCCUPANCY COSTS

         Since mid-1993, the Company has sold the deposits previously serviced
by 15 branch banking offices and in connection therewith sold or terminated the
lease obligations associated with 14 facilities (the Company retains the lease
obligation with respect to one facility). Despite the sale of branch facilities
or termination of leases on such facilities, the Company has experienced an
overall increase in occupancy costs of about 10% since 1993 primarily due (1) to
the relocation of the Company's corporate offices from two separate owned
facilities into a new leased facility which required significant tenant
improvements and purchase of furnishings and (2) the renovation of all of the
Company's remaining branch facilities.

OPERATING COSTS

         Operating costs principally include (1) data processing service charges
from outside vendors, (2) premiums for corporate liability insurance, (3) the
cost of corporate telecommunications and supplies, (4) the cost of advertising
and promotion, (5) transaction service charges from outside vendors and (6) the
amortization of prepaid offerings costs arising from the 1995 recapitalization
of the Company. During 1994, the Company incurred approximately $0.7 million of
nonrecurring costs in connection with several initiatives, including a third
party review of all of the Company's loan files. In September 1994, the Company
sold six retail banking offices and the related deposits, the full-year
impact of which was not reflected until 1995. During 1996, the Company
significantly expanded its community outreach and marketing activities, which
contributed to an increase in operating costs of approximately $0.5 million in
1996 as compared with 1995. During 1996, 


                                       30
<PAGE>   32
the Company amortized approximately $0.2 million of issue costs which had their
genesis with the December 1995 sale of investment units.

PROFESSIONAL COSTS

         Professional fees are paid to outside lawyers, who represent the
Company in a variety of legal matters, the Company's independent accountants,
and to various other vendors that provide employee search and miscellaneous
consulting services to the Company. Since 1992, the Company has incurred very
high legal costs due to the magnitude of its foreclosure and related actions
against borrowers. The decline in these costs from the level experienced in 1994
generally reflects decreases in the Company's nonperforming assets.

SAIF PREMIUMS

         The Company pays premiums to the SAIF based upon the dollar amount of
deposits it holds and the assessment rate charged by the FDIC, which is based
upon the Company's financial condition, its capital ratios and the rating it
receives in connection with annual regulatory examinations by the OTS. Because
of the Company's improved financial condition, the assessment rate charged by
the FDIC has decreased from $0.31 per $100 of deposits in 1994, 1995, and the
first half of 1996 to $0.29 per $100 of deposits in the last half of 1996. As a
result of the special FDIC SAIF assessment paid in 1996, the Company has already
seen a reduction in its assessment rate to $0.24. Continuing improvement in the
financial condition of the Company, as determined by the Company's regulators,
may result in additional assessment reductions.

REAL ESTATE OPERATIONS

         The table below details the revenues and costs associated with the
Company's foreclosed properties for the periods indicated (dollars are in
thousands).

<TABLE>
<CAPTION>
                                                   1996             1995              1994
                                              --------------   ---------------   ---------------
<S>                                                <C>              <C>               <C>      
EXPENSES ASSOCIATED WITH REAL ESTATE OWNED
    Property taxes                                 $  (135)         $    (35)         $ (1,965)
    Repairs, maintenance and renovation               (160)             (475)             (361)
    Insurance                                         (258)             (132)             (329)
                                              --------------   ---------------   ---------------
                                                      (553)             (642)           (2,655)

NET RECOVERIES FROM SALE OF PROPERTIES                1,769             2,467             2,980

PROPERTY OPERATIONS, NET                              1,339             2,839             2,108

PROVISION FOR ESTIMATED LOSSES ON
  REAL ESTATE OWNED                                 (3,511)           (5,100)
                                              --------------   ---------------   ---------------
                                                   $  (956)          $  (436)          $  2,433
                                              ==============   ===============   ===============
</TABLE>

         The decline in expenses associated with foreclosed properties generally
mirrors the decline in the Company's property portfolio since mid-1993. The
large expenditure for property taxes during 1994 was attributable to the volume
of foreclosures during this period and the significant amounts of delinquent
property taxes attached to these properties. Beginning in early 1995, the
Company began to advance delinquent property taxes prior to foreclosure of the
Company's collateral, in order to reduce the penalties associated with
nonpayment, the cost of which is generally reflected in the Company's credit
loss reserves. With respect to foreclosed apartment buildings, which constituted
approximately 10.0%, 35.0% and 25.0% of the Company's property portfolio at
December 31, 1996, 1995, and 1994, respectively, all holding costs, including
property taxes and depreciation, are included with property operations. With
respect to foreclosed construction developments, which constituted approximately
50.0%, 30.0% and 40.0% of the Company's property portfolio at December 31, 1996,
1995, and 1994, respectively, all holding costs, including property taxes, are
included in the basis of the Company's investment.

         Net recoveries from property sales represent the difference between the
proceeds received from property disposal and the carrying value of such
properties upon disposal.



                                       31
<PAGE>   33

         Property operations include the net cash flows generated from
operation of the Company's foreclosed apartment buildings. During the period
September 1993 through September 1995, the Company operated a growing portfolio
of foreclosed apartment buildings with a combination of in-house professionals
and contracted property management companies. Until the third quarter of 1995,
such buildings were not being marketed for sale, but rather were being operated
for the Company's own account. During this period, the Company funded the
required physical improvements to each building and took the steps necessary to
bring the operation of each building to a stabilized level. Commencing during
the third quarter of 1995, management began marketing for sale the Company's
accumulated portfolio of owned apartment buildings, believing that it had
maximized the operating performance of its portfolio and that general market
conditions had improved substantially from the periods during which the
buildings were originally acquired through foreclosure. Since the third quarter
of 1995 and through the end of 1996, the Company had sold substantially all of
its foreclosed apartment buildings acquired during September 1993 through
September 1995.

         During 1995 and 1996, the Company recorded additional provisions for
estimated losses in connection with two large residential developments. At
December 31, 1996, construction of the homes related to one of these
developments had been completed and all but two homes had been sold. With
respect to the other development, construction had commenced at December 31,
1996 with respect to the last 18 units of a total of 100 units to be
constructed, and all but two production units completed at that date had been
sold. See REAL ESTATE OWNED.

GAIN ON SALE OF LOANS

         During 1995, the Company sold $19.2 million of loans for a nominal
gain. During 1996, the Company sold $129.5 million of loans for a gain of $0.4
million. The majority of the loans sold during 1996 consisted of seasoned loans
secured primarily by single family homes, with approximately $43 million of
total sales represented by loans originated subsequent to 1994 and secured by
income-producing properties.

GAIN ON SALE OF SECURITIES

         During 1996, the Company sold $35 million in U.S. Treasury Securities
for a net gain of $0.2 million. These securities were designated as
available-for-sale and were sold primarily to augment the Bank's capital ratios.
The Company reinvested the proceeds from these sales in U.S. Treasury securities
with weighted average maturities similar to that of the sold securities
(approximately two years).

DISPOSITION OF DEPOSITS AND PREMISES

         In June 1996, the Company sold its three San Diego branches and their
approximately $186.6 million in deposits. This sale resulted in a net gain to
the Company of $6.4 million.

OTHER REVENUES (EXPENSES)

         During the third quarter of 1996, the Company incurred a $3.8 million
charge due to the special FDIC SAIF assessment. Subsequently, the Company's
annual assessment rate was reduced from $0.29 to $0.24, beginning in January
1997. See DEPOSIT INSURANCE.

INCOME TAXES

        The Company recorded an income tax benefit of $6.4 million in 1996 and
income tax expense of $0.6 million and $0.1 million in 1995 and 1994,
respectively. The $6.4 million of income tax benefit in 1996 was attributable to
the creation of a $4.2 million deferred tax asset as a result of the reduction
in the valuation allowance against deferred tax assets and $2.1 million
resulting from a net refund of federal income taxes paid by the Company in prior
years.

        At December 31, 1995, the Company had approximately $35.5 million of
accumulated income tax benefits, consisting primarily of net operating loss
carryforwards and future tax deductions which had not been recognized for
financial statement purposes and are available to be utilized to shield future
earnings from income taxes, both for financial reporting and income tax
reporting purposes. The recognition of these accumulated income tax benefits is
subject to limitations for generally accepted accounting principles and for
regulatory capital purposes. The primary factor affecting the timing and
magnitude of recognition of these accumulated income tax benefits is the current
and future profitability of the Company. Additionally, no more than 10% of the
Bank's regulatory capital can be represented by a deferred tax asset created
pursuant to anticipated future utilization of an institution's income tax
benefits. During 1996, the Company utilized approximately $18.1 million of its
accumulated income tax benefits, which is reflected in the Company's 1996
results as an income tax benefit and a deferred tax asset of $6.4 million and
$4.2 million, respectively. At December 31, 1996, the Company had remaining
income tax benefits of $17.4 million, which are available to be utilized during
1997 and beyond, subject to the Company's continuing ability to generate
earnings. Should the Company cease to be profitable, or should the Company
record substantial operating losses in the future, all or a portion of the
deferred tax asset established to date may need to be reversed. Management
believes that the Company's income tax accounting practices fully comport with
generally accepted accounting principles and have been and are appropriate in
the circumstances.



                                       32
<PAGE>   34

FINANCIAL CONDITION, CAPITAL RESOURCES & LIQUIDITY AND ASSET QUALITY

         The table below sets forth the Company's consolidated assets,
liabilities and stockholders' equity and the percentage distribution of these
items at the dates indicated (dollars are in thousands).

<TABLE>
<CAPTION>
                                                                             DECEMBER 31,
                                                    ------------------------------------------------------------
                                                                1996                            1995
                                                    ------------------------------  ----------------------------
                                                      Balance           Percent         Balance        Percent
                                                    --------------  --------------  --------------  ------------
<S>                                                    <C>          <C>              <C>            <C> 
ASSETS
Cash and cash equivalents                              $   93,978            11.1%     $   14,015          1.9%
Investment securities available for sale                   38,371             4.5          62,793           8.3
Loans receivable, net (1)                                 672,401            79.4         617,328          81.9
Real estate owned                                          20,140             2.4          37,905           5.0
Other assets (2)                                           22,305             2.6          21,542           2.9
                                                    --------------  --------------  --------------  ------------
Total assets                                            $ 847,195          100.0%       $ 753,583        100.0%
                                                    ==============  ==============  ==============  ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
    Deposits                                            $ 717,809           84.7%       $ 698,008         92.6%
    Short-term borrowings                                  50,000             5.9
    Accounts payable and other liabilities                 23,157             2.7           4,603           0.6
    Senior debt                                            12,307             1.5          12,006           1.6
                                                    --------------  --------------  --------------  ------------
                                                          803,273            94.8         714,617          94.8
Stockholders' equity                                       43,922             5.2          38,966           5.2
                                                    --------------  --------------  --------------  ------------
Total liabilities and stockholders' equity              $ 847,195          100.0%       $ 753,583        100.0%
                                                    ==============  ==============  ==============  ============
</TABLE>

         (1)      Includes non-accrual loans of $28.6 million and $21.7 million
                  for 1996 and 1995, respectively. See CLASSIFIED ASSETS below.

         (2)      Includes fixed assets, accrued interest receivable, FHLB stock
                  and other assets.

TOTAL ASSETS

         Total assets increased by $93.6 million from year end 1995 to year end
1996. This increase was primarily due to a net increase in cash and cash
equivalents of $80.0 million and loans receivable of $55.1 million, which were
partially offset by decreases in investment securities and real estate owned of
$24.4 million and $17.8 million, respectively.

CASH AND CASH EQUIVALENTS

         Cash and cash equivalents consist of cash on hand, deposits at
correspondent banks and Federal funds sold. The Company maintains balances at
correspondent banks and the FHLB to cover daily inclearings, wire activities and
other charges. Cash and cash equivalents at year end 1996 were $94.0 million, an
increase of $80.0 million, from $14.0 million at year end 1995. At year end
1996, the Company concluded two loan sales of approximately $76 million which
produced the high levels of cash and cash equivalents. The funds were
subsequently redeployed in investment securities and new loan originations.

INVESTMENT SECURITIES

         Investment securities consist of securities classified as
held-to-maturity and available-for-sale, and mortgage-backed securities.
Investment securities decreased by $24.4 million from year end 1995 to year end
1996. At year end 1995, the Company had $62.8 million in investment securities
classified as available-for-sale. During 1995, the Company 



                                       33
<PAGE>   35

initiated measures to reduce the interest rate risk exposure inherent in the
balance sheet. These measures included the liquidation of certain fixed rate
assets, both loans and investment securities, in the first and second quarters
of 1995. In December 1995, the Company, consistent with guidance issued in
November 1995 by the Financial Accounting Standards Board ("FASB"), reclassified
all of its mortgage-backed securities from held-to-maturity to
available-for-sale. These securities were then liquidated prior to year end. All
securities held in portfolio as of year end 1994 were converted to cash during
1995 by amortization of principal on mortgage-backed securities or by
liquidation. These cash proceeds were partially utilized to fund loan growth,
and when available, reinvested in short-term Fed funds or U.S. Treasury
obligations. See NOTE C of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Subsequent to December 31, 1996, the Company's Board of Directors granted to
management the authority to purchase up to $200 million of investment securities
during 1997. The interest margin projected to be generated by these securities
purchases will supplement the Company's overall interest margin with no
incremental credit risk borne by the Company. The Board's approval contemplated
that the investment securities to be purchased would have expected durations of
between three and seven years, would be financed with short term repurchase
agreements utilizing the purchased investment securities as collateral, and
would be hedged so as to substantially, though not entirely, mitigate the
Company's interest rate risk. During the first quarter of 1997, the Company
purchased $40 million of U.S. Government and agency securities pursuant to this
strategy. Future purchases of investment securities pursuant to this strategy
are dependent upon, among other things, the availability of excess capital not
otherwise deployed in the Company's lending businesses and the general level and
volatility of market interest rates. There can be no assurance that management
of the Company will elect to implement this program to the extent authorized in
the near term or at all.

LOAN PORTFOLIO

         The Company principally invests the proceeds generated from customer
deposit accounts in mortgage loans secured by residential and, to a much lesser
extent, non-residential real estate.




                                       34
<PAGE>   36
         The following two tables below set forth the composition of the
Company's loan portfolio, and the percentage composition by type of security,
delineated by the year of origination and in total, as of the dates indicated
(dollars are in thousands).
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                       ----------------------------------------------------------------
                                                   1996                                1995
                                       -------------------------------   ------------------------------
                                            BALANCE        PERCENT            BALANCE        PERCENT   
                                       -------------------------------   ------------------------------
<S>                                    <C>                <C>            <C>               <C> 
PERMANENT LOANS
Single family (1-4 units)
    Estate                                 $107,891          14.6%           $ 51,142          7.8%
    Conventional                            170,038          23.0             247,955         37.7 
    Project concentrations (1)               61,268           8.3              70,748         10.8 
Multi-family (five or more units)           220,707          29.6             219,015         33.4 
Commercial real estate                       60,388           8.2              31,258          4.8 
Land                                         14,513           2.0               5,579          0.9 
RESIDENTIAL CONSTRUCTION (2)                                                                       
    Single family                            56,306           7.6              21,987          3.4 
    Tract development                        33,791           4.6               6,800          1.0 
OTHER                                        15,684           2.1               1,459          0.2 
                                           --------         -----            --------        -----  
GROSS LOANS RECEIVABLE                      740,586         100.0%            655,943        100.0%
                                                            =====                            =====  

LESS
Participants' share                          (1,413)                           (2,219) 
Undisbursed loan funds                      (46,646)                          (15,208) 
Deferred loan fees and
   credits, net                              (6,611)                           (5,996) 
Allowance for estimated losses              (13,515)                          (15,192) 
                                           --------                         --------- 
NET LOANS RECEIVABLE                       $672,401                          $617,328 
                                           ========                         ========= 
</TABLE>

<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                       -----------------------------------------------------------------
                                                     1994                             1993
                                       ------------------------------   ------------------------------- 
                                            BALANCE        PERCENT           BALANCE         PERCENT    
                                       ------------------------------   ----------------- ------------- 
<S>                                    <C>                <C>            <C>               <C>
PERMANENT LOANS
Single family (1-4 units)
    Estate                                 $    -             -  %           $    -            -  % 
    Conventional                            299,246          52.4             340,803         49.9  
    Project concentrations (1)               76,074          13.3              85,807         12.6
Multi-family (five or more units)           172,641          30.2             193,468         28.4  
Commercial real estate                        7,757           1.4               7,630          1.1
Land                                          3,797           0.7              22,179          3.3
RESIDENTIAL CONSTRUCTION (2)
    Single family                             3,270           0.6               6,603          1.0 
    Tract development                         6,000           1.1              22,925          3.4 
OTHER                                         1,654           0.3               2,013          0.3 
                                           --------         -----             -------        -----      
GROSS LOANS RECEIVABLE                      570,439         100.0%            681,428        100.0% 
                                                            =====                            =====      

LESS
Participants' share                          (3,072)                           (3,098) 
Undisbursed loan funds                       (2,795)                             (966)
                                                      
Deferred loan fees and
   credits, net                              (6,091)                           (7,285) 
Allowance for estimated losses              (21,461)                          (46,629) 
                                           --------                          --------    
NET LOANS RECEIVABLE                       $537,020                          $623,450 
                                           ========                          ========
</TABLE>

<TABLE>
<CAPTION>
                                                DECEMBER 31,
                                       ------------------------------
                                                   1992
                                       ------------------------------
                                            BALANCE        PERCENT
                                       ------------------------------
<S>                                    <C>                <C>
PERMANENT LOANS
Single family (1-4 units)
    Estate                                 $     -            - %
    Conventional                            500,748         59.4
    Project concentrations (1)       
Multi-family (five or more units)           207,024         24.6
Commercial real estate                        3,332          0.4
Land                                         35,957          4.3
RESIDENTIAL CONSTRUCTION (2)                 87,274         10.4
    Single family                                -            -
    Tract development                            -            -
OTHER                                         7,535          0.9
                                           --------        -----   
GROSS LOANS RECEIVABLE                      841,870        100.0%
                                                           =====   
LESS
Participants' share                          (4,250)
Undisbursed loan funds                       (9,750)
Deferred loan fees and
   credits, net                              (9,484)
Allowance for estimated losses              (52,966)
                                           --------   
NET LOANS RECEIVABLE                       $765,420
                                           ========   
</TABLE>

         (1)      The Company did not separately identify project concentrations
                  prior to 1993.

         (2)      The Company did not separately identify tract developments
                  prior to 1993.



                                       35
<PAGE>   37

         The Company's loan portfolio contains no loans to foreign governments,
foreign enterprises, foreign operations of domestic companies, nor any
concentration to borrowers engaged in the same or similar industries that exceed
10 percent of total loans.

         The table below sets forth information concerning the Company's gross
loan portfolio at December 31, 1996 (dollars are in thousands).

<TABLE>
<CAPTION>
                                                       PRINCIPAL           NUMBER            AVERAGE
                                                        BALANCE           OF LOANS         LOAN AMOUNT
                                                       ---------          --------         -----------
<S>                                                    <C>                 <C>              <C>
ORIGINATED PRIOR TO 1995
    PERMANENT LOANS
        Single family (1-4 units)
            Estate                                     $       -               -            $     -  
            Conventional                                 139,600             935                149  
            Project concentrations                        59,779             383                156  
        Multi-family (five or more units)                131,496             266                494  
        Commercial real estate                             7,638              14                546  
        Land                                               1,951               7                279  
    OTHER                                                    959              57                 17  
                                                       ---------           -----                     
                                                         341,423           1,662                205  
                                                       ---------           -----                     
ORIGINATED AFTER 1994                                                                                
    PERMANENT LOANS                                                                                  
        Single family (1-4 units)                                                                    
            Estate                                       107,891              45              2,398  
            Conventional                                  30,438             202                151  
            Project concentrations                         1,489              23                 65  
        Multi-family (five or more units)                 89,211             114                783  
        Commercial real estate                            52,750              24              2,198  
        Land                                              12,562              14                897  
    RESIDENTIAL CONSTRUCTION                                                                         
        Single family                                     56,306              68                828  
        Tract                                             33,791               8              4,224  
    OTHER                                                 14,725               6              2,454  
                                                       ---------           -----                     
                                                         399,163             504                792  
                                                       ---------           -----                     
GROSS LOANS RECEIVABLE                                 $ 740,586           2,166                342  
                                                       =========           =====      
</TABLE>

Estate Financings

         During 1995 and 1996, the Company originated $126.2 million of Estate
loans, with respect to which $107.9 million was outstanding at December 31, 1996
(net of unfunded commitments and repayments). See ITEM 1, NEW BUSINESS
GENERATION - LENDING. At year end 1996, two Estate loans with aggregate unpaid
principal of $1.8 million were nonperforming and an additional Estate loan for
$1.0 million was delinquent one payment. See CLASSIFIED ASSETS- Nonaccrual
Loans". Through December 31, 1996, the Company had not foreclosed upon the
collateral securing any of its Estate loans.

Conventional Home Financings

         The Company's conventional single family loan portfolio is exclusively
secured by single family homes located within the Company's Southern California
lending markets. Except as described below, the Company's single family loans
originated prior to 1995 have performed better than its other real
estate-secured loans originated prior to 1995 (e.g., project concentrations,
apartments, residential construction, and land). Similarly, the Company's
recovery rate from the disposition of foreclosed homes has exceeded the recovery
rates achieved from the disposition of other foreclosed real estate. At December
31, 1996, no conventional single-family residential loans originated after 1994
were in default.



                                       36
<PAGE>   38

         Management believes that the performance of the Company's pre-1995
single family loan portfolio will continue to mirror the general economic
environment within its lending markets. However, management believes that the
future default and foreclosure rates of this portfolio will continue to exceed
that of its local competitors, principally because (1) of the Company's previous
underwriting practices, (2) an unusually large percentage of the loans within
this portfolio had their genesis during 1988-1992 when housing prices generally
were higher than their current levels, and (3) a relatively large percentage of
the portfolio is concentrated in non-owner occupied single family homes.

Project Concentrations

         Prior to 1995, the Company made permanent loans, amortizing over, and
maturing at the end of, thirty years, to a large number of purchasers of
individual units from developers in for-sale housing developments with respect
to which the Company financed construction. A majority of these permanent
"takeout" loans were originated during the period 1988 through 1992 and were
made on terms that fell outside the parameters normally associated with
conventional single family home loans.

         At December 31, 1996, the Company's portfolio of project concentration
loans was $61.3 million, a decrease from $76.1 million at December 31, 1994.
Virtually all of this reduction was attributable to borrower defaults and
foreclosure by the Company of its collateral.

         Because most of these loans were made on favorable terms to foster
sales of units in developments in which unit sales were sluggish, and because
the current retail value of units in many developments has declined
significantly when compared with the purchase price paid by the Company's
borrowers, the performance of this portfolio has been extremely poor. Management
expects that the performance of this portfolio will continue to be quite poor,
principally because the underlying risk factors which have given rise to the
historically poor performance - poorly-qualified borrowers and significant
declines in the value of the Company's collateral - are not expected to change
in the near-term.

Multi-family Financings

         At December 31, 1996, the Company maintained a portfolio of loans
secured by five or more units of $220.7 million, approximately 60% of which was
originated prior to 1995. Management estimates that over 50% of the Company's
remaining permanent apartment loan portfolio originated prior to 1995 had its
genesis with construction financing provided by the Company to the original
developer/borrower. Many such properties were subsequently sold by the developer
and the Company's loan was assumed and remains outstanding.

         During 1995 and 1996, the Company originated $136.8 million of loans
secured by apartment buildings, of which $30.0 million was made to purchasers of
foreclosed apartment buildings sold by the Company during 1995 and 1996.
Generally, these real estate owned-related financings were made on terms
requiring, among other things, a substantial cash investment by the purchaser.
The remaining $106.8 million of post-1994 apartment-secured financings are
generally secured by buildings with 50 or more units, with respect to which the
Company had no prior financing involvement. Loan principal of approximately
$89.2 million was outstanding against such commitments at December 31, 1996,
which amount is net of sales, repayments and unfunded commitments.

         Management expects that the performance of the Company's pre-1995
apartment-secured loan portfolio will continue to be uneven. This expectation
derives from management's view that (1) the underlying economics of its
collateral are not expected to improve materially in the near-term (i.e., rent
and occupancy levels are expected to remain largely static), (2) a large number
of the Company's borrowers are not experienced operators of apartment buildings
and most lack the financial resources to compete effectively with better
capitalized operators, and (3) the cash flows currently being generated by a
sizable portion of the Company's collateral generally are either insufficient,
or barely sufficient, to service the Company's loan in an interest rate
environment which is near cyclical lows.

Commercial Real Estate Financings

         During 1995 and 1996, the Company originated $77.7 million of loans
secured by commercial real estate. At December 31, 1996, approximately $60.4
million of commercial real estate-secured loans were outstanding, which amount
is net of sales and repayments, and virtually all of which was originated since
1994. None of the Company's post-1994 loans was in default at December 31, 1996,
and at such date the Company had not foreclosed upon its collateral with respect
to any loan originated since 1994.



                                       37
<PAGE>   39

Construction Financings

         As described elsewhere herein, the Company's principal business through
1992 was to provide construction loans for tracts of for-sale housing in
Southern California, principally in the South Bay area of Los Angeles County.
Subsequent to mid-1993, the Company foreclosed upon virtually all of the units
securing construction loans made by the Company during the years 1989 through
1992. At December 31, 1996, the Company had no construction loans remaining
from this period.

         The Company originated a total of $132.5 million of commitments for the
construction of individual homes ($83.5 million) and small tracts of for-sale
housing ($49.0 million). This activity is managed by real-estate professionals
and the Company's current customers include experienced developers, none of whom
had previously done business with the Company.

Loan Maturities

         The table below sets forth, by contractual maturity, the Company's real
estate loan portfolio at December 31, 1996 (dollars are in thousands). The table
is based on contractual loan maturities and does not consider amortization and
prepayment of loan principal. As a result, the table does not reflect the actual
nor expected repayment maturities of loans.

<TABLE>
<CAPTION>
                                                                                 MATURING IN
                                                                -------------------------------------------------------------------
                                                                                OVER           OVER
                                                                               ONE YEAR      FIVE YEARS                     TOTAL
                                                                  ONE YEAR     THROUGH        THROUGH        OVER           LOANS
                                                                  OR LESS     FIVE YEARS     TEN YEARS     TEN YEARS     RECEIVABLE
                                                                -----------   -----------   -----------   -----------   -----------
<S>                                                             <C>           <C>           <C>           <C>           <C>        
ORIGINATED PRIOR TO 1995
    PERMANENT LOANS
        Single family (1-4 units)
            Estate                                              $        --   $        --   $        --   $        --   $        --
            Conventional                                                 36         1,278         4,397       133,889       139,600
            Project concentrations                                      467           167           182        58,963        59,779
        Multi-family (5 or more units)                                3,782         5,264        33,597        88,853       131,496
        Commercial real estate                                                                      863         6,775         7,638
        Land                                                          1,150                                       801         1,951
    RESIDENTIAL CONSTRUCTION
        Single family
        Tract development
    OTHER COLLATERALIZED LOANS                                          875            84                                       959
                                                                -----------   -----------   -----------   -----------   -----------
                                                                      6,310         6,793        39,039       289,281       341,423
                                                                -----------   -----------   -----------   -----------   -----------
ORIGINATED AFTER 1994
    PERMANENT LOANS
        Single family (1-4 units)
            Estate                                                    9,569        49,700        42,941         5,681       107,891
            Conventional                                                               95         1,605        28,738        30,438
            Project concentrations                                                    133                       1,356         1,489
        Multi-family (5 or more units)                                9,203         7,078        72,930                      89,211
        Commercial real estate                                        6,000        35,278        10,541           931        52,750
        Land                                                          7,308         5,254                                    12,562
    RESIDENTIAL CONSTRUCTION
        Single family                                                51,656         4,650                                    56,306
        Tract development                                            24,991         8,800                                    33,791
    OTHER                                                             3,979        10,746                                    14,725
                                                                -----------   -----------   -----------   -----------   -----------
                                                                    112,706       121,734       128,017        36,706       399,163
                                                                -----------   -----------   -----------   -----------   -----------
                                                                $   119,016   $   128,527   $   167,056   $   325,987       740,586
                                                                ===========   ===========   ===========   ===========
LESS
Participants' share                                                                                                          (1,413)
Undisbursed funds                                                                                                           (46,646)
Deferred loan fees and credits, net                                                                                          (6,611)
Allowance for estimated losses                                                                                              (13,515)
                                                                                                                        -----------
NET LOANS RECEIVABLE                                                                                                    $   672,401
                                                                                                                        ===========
</TABLE>



                                       38

<PAGE>   40

         As illustrated in the preceding table and as described elsewhere
herein, the Company's post-1994 loans have been made on terms which generally
include shorter final maturities than loans made previously. With respect to
Estate and multifamily residential loans made subsequent to 1994 and with
respect to which maturities are scheduled within five-to-ten years from the
funding of the loan, a majority of such loans carry final maturities of seven
years from the funding of the loan.

         The table below sets forth, by interest rate, the Company's fixed rate
and interest-rate sensitive real estate loans at December 31, 1996. The table is
based on contractual loan maturities and does not consider amortization and
prepayment of loan principal (dollars are in thousands).

<TABLE>
<CAPTION>
                                                                      MATURING IN
                                       -------------------------------------------------------------------------
                                                                OVER               OVER
                                                              ONE YEAR          FIVE YEARS                              TOTAL
                                           LESS THAN           THROUGH            THROUGH             OVER              LOANS
                                           ONE YEAR          FIVE YEARS          TEN YEARS         TEN YEARS          RECEIVABLE
                                       -----------------  -----------------  -----------------  ----------------   ----------------
<S>                                    <C>                <C>                 <C>                 <C>              <C>     
FIXED INTEREST RATES                          $  13,612          $  44,447         $    6,558          $108,138           $172,755
VARIABLE INTEREST RATES
    11th DCOFI                                    4,218             32,009            118,468           216,324            371,019
    Prime rate                                   96,995             45,872             15,614                              158,481
    1 year CMT                                    4,191              6,199             26,416                               36,806
    Other                                                                                                 1,525              1,525
                                       -----------------  -----------------  -----------------  ----------------   ----------------
    Total variable interest rates               105,404             84,080            160,498           217,849            567,831
                                       -----------------  -----------------  -----------------  ----------------   ----------------
TOTAL                                          $119,016           $128,527           $167,056          $325,987            740,586
                                       =================  =================  =================  ================
LESS
    Participants' share                                                                                                    (1,413)
    Undisbursed funds                                                                                                     (46,646)
    Deferred loan fees and
        credits, net                                                                                                       (6,611)
    Allowance for estimated losses                                                                                        (13,515)
                                                                                                                   ----------------
NET LOANS RECEIVABLE                                                                                                      $672,401
                                                                                                                   ================
</TABLE>

CLASSIFIED ASSETS

         For the purpose of the following discussion, "Classified Assets" are
defined as (1) properties acquired through foreclosure less applicable
writedowns and reserves, plus (2) nonperforming loans delinquent three or more
payments, plus (3) loans delinquent one or more payments, plus (4) performing
loans classified Loss, Doubtful and Substandard pursuant to OTS regulations and
guidelines.

         As described elsewhere herein, the Company was an active construction
lender for many years. A majority of the construction loans made during the
period 1987 through 1991 and which did not result in foreclosure of the
Company's collateral were internally refinanced with new permanent loans. With
respect to apartment buildings and individual single family homes, the Company
generally converted the fully-disbursed construction loan into a permanent loan,
amortizing over and due in thirty years. With respect to for-sale housing
developments where the Company financed their construction, the Company
typically made permanent loans to purchasers of individual units from the
developer (project concentrations). During this period, the Company also
financed numerous other for-sale housing developments with respect to which it
did not make any permanent loans following construction.

         Generally, the risk profile associated with the types of loans made
prior to 1995 by the Company (i.e., construction loans, project concentration
loans and apartment loans) is greater than for other types of mortgage finance,
such as owner-occupied single family home loans acquired through purchase
transactions. Further, many of the concentration loans were made on terms
outside the parameters normally associated with conventional financing
(including having loan-to-value ratios greater than 80%, below-market interest
rates and subordinate financing provided by the developer). The recent and
current character of the Company's asset quality is a function of both broad and
market-specific economic factors, compounded by (1) the Company's underwriting
standards during the years in which the Company's Classified Assets were
originated, (2) prior management's aggressiveness in providing permanent


                                       39

<PAGE>   41

financing to purchasers of individual units in Company-financed construction
developments, and (3) the generally poor quality of, and internal
inconsistencies within, the underlying loan documentation supporting individual
transactions. See ITEM 1. NEW BUSINESS GENERATION for a discussion of the
Company's lending activities subsequent to 1994.

         The table below sets forth certain information regarding the Company's
investment in Classified Assets as of the dates indicated (dollars are in
thousands).

<TABLE>
<CAPTION>
                                                                           DECEMBER 31,
                                                   ------------------------------------------------------------------
                                                      1996          1995          1994          1993          1992
                                                   ----------    ----------    ----------    ----------    ----------
<S>                                                <C>           <C>           <C>           <C>           <C>       
PROPERTIES, NET OF RESERVES                        $   20,140    $   37,905    $   62,613    $   72,234    $   29,922
NONPERFORMING LOANS (1)                                16,643        11,298        18,103        78,949        88,278
                                                   ----------    ----------    ----------    ----------    ----------
GROSS NONPERFORMING ASSETS                             36,783        49,203        80,716       151,183       118,200
OTHER DELINQUENT LOANS (30-89 DAYS)                    10,082         8,811        17,747        31,057        74,194
PERFORMING LOANS CLASSIFIED LOSS,
  DOUBTFUL AND SUBSTANDARD (6)                         46,987        58,649        67,309        61,673        42,487
                                                   ----------    ----------    ----------    ----------    ----------
GROSS CLASSIFIED ASSETS                            $   93,852    $  116,663    $  165,772    $  243,913    $  234,881
                                                   ==========    ==========    ==========    ==========    ==========
GROSS CLASSIFIED LOANS (2) (3) (4)                 $   73,712    $   78,758    $  103,159    $  171,679    $  204,959
                                                   ==========    ==========    ==========    ==========    ==========
LOANS RECEIVABLE (5)                               $  685,916    $  632,520    $  558,481    $  670,079    $  818,387
                                                   ==========    ==========    ==========    ==========    ==========
RESERVES ON LOANS
      Specific                                     $    2,185    $    3,426    $    8,578    $   23,294    $   18,883
      General                                          11,330        11,766        12,883        23,335        34,083
                                                   ----------    ----------    ----------    ----------    ----------
                                                   $   13,515    $   15,192    $   21,461    $   46,629    $   52,966
                                                   ==========    ==========    ==========    ==========    ==========

TOTAL RESERVES TO LOANS RECEIVABLE                       1.97%         2.40%         3.84%         6.96%         6.47%
TOTAL RESERVES TO CLASSIFIED LOANS                      18.33%        19.29%        20.80%        27.16%        25.84%
TOTAL RESERVES TO NONPERFORMING LOANS                   81.21%       134.47%       118.55%        59.06%        60.00%
GROSS NONPERFORMING ASSETS TO TOTAL ASSETS               4.34%         6.53%        10.85%        17.15%        11.92%
</TABLE>
________________

         (1)      Loans three or more payments past due.

         (2)      Gross classified assets, exclusive of properties.

         (3)      At December 31, 1996, included $49.3 million of loans 
                  originated prior to 1995.

         (4)      Includes $16.7 million, $7.3 million, $3.8 million, and $37.1
                  million of troubled debt restructurings ("TDRs") at December
                  31, 1996, 1995, 1994 and 1993, respectively. It was not
                  practicable to determine the classification of TDRs at
                  December 31, 1992.

         (5)      Net loans, exclusive of allowance for estimated loan losses.

         (6)      At December 31, 1996 and 1995, respectively, includes $1.9
                  million and $1.6 million of performing loans on nonaccrual
                  status.

         OTS regulations require that savings institutions utilize an internal
asset classification system as a means of reporting problem and potential
problem assets for regulatory supervision purposes. The Company has incorporated
the OTS' internal classifications as a part of its credit monitoring system. The
Company currently designates its assets Pass, Special Mention, Substandard,
Doubtful or Loss. A loan is considered in default of its terms and conditions
upon the failure of a borrower to make a scheduled payment of principal and
interest. The Company's internal asset classification policy requires that the
Company's investment in foreclosed properties and nonaccrual loans be classified
Substandard, Doubtful or Loss. A brief description of these categories follows.

         An asset classified as Pass is considered of sufficient quality to
preclude designation as Special Mention or an adverse classification. Pass
assets generally are protected by the current net worth or paying capacity of
the obligor or by the value of the asset or underlying collateral.

         An asset designated Special Mention does not currently expose an
institution to a sufficient degree of risk to warrant an adverse classification.
However, it does possess credit deficiencies or potential weaknesses deserving
of management's close attention. If uncorrected, such weaknesses or deficiencies
may expose the institution to an increased risk of loss in the future.



                                       40
<PAGE>   42

         An asset classified Substandard is inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Assets so classified have a well-defined weakness or
weaknesses. They are characterized by the distinct possibility that the
institution will sustain some loss if the deficiencies are not corrected.

         Assets classified as Doubtful have all the weaknesses inherent in those
classified Substandard. In addition, these weaknesses make collection or
liquidation in full, on the basis of currently existing facts, conditions and
values, highly questionable or improbable. The Company views the Doubtful
classification as a temporary category. The Company will generally classify
assets as Doubtful when inadequate data is available or when such uncertainty
exists as to preclude a Substandard classification. Therefore, the Company will
normally tend to have a minimal amount of assets classified in this category.

         Assets classified as Loss are considered uncollectible and of such
little value that their continuance as assets without establishment of a
specific reserve is not warranted. A Loss classification does not mean that an
asset has absolutely no recovery or salvage value; rather it means that it is
not practical or desirable to defer establishing a specific reserve for the
asset even though partial recovery may be effected in the future. The Company
will generally classify as Loss the portion of assets identified as exceeding
the asset's fair market value, and a specific reserve is established for such
excess.

         The Company designates a loan as impaired when it becomes a troubled
debt restructuring, 90 days delinquent or it is deemed probable that all
principal and interest will not be collected. Income is recognized on impaired
loans while the loan is performing.

         The table below shows the Company's gross classified loan portfolio as
of December 31, 1996 (dollars are in thousands).

<TABLE>
<CAPTION>
                                                            CLASSIFIED LOANS
                                      --------------------------------------------------------
                                            NON-                 OTHER           PERFORMING
                                        PERFORMING (1)      DELINQUENCIES (2)       LOANS          TOTAL (3)
                                      ------------------   ------------------   --------------   --------------
<S>                                   <C>                  <C>                  <C>              <C>           
Single family (1-4 units)
    Estate                            $            1,806   $            1,017   $        2,169   $        4,992
    Conventional                                   3,380                3,052            6,768           13,200
    Project concentrations                         5,937                1,682            6,008           13,627
Multi-family (5 or more units)                     5,076                4,331           23,778           33,185
Commercial real estate                                                                   6,546            6,546
Land                                                 431                                                    431
Residential construction
    Single family                                                                                              
    Tract development                                                                    1,718            1,718
Other Collateralized Loans                            13                                                     13
                                      ------------------   ------------------   --------------   --------------
Gross Loans Receivable                $           16,643   $           10,082   $       46,987   $       73,712
                                      ==================   ==================   ==============   ==============
</TABLE>
________________

         (1)      Loan principal delinquent 90 days or more.

         (2)      Loan principal delinquent 30 to 89 days.

         (3)      Of the Company's $73.7 million of classified loans at December
                  31, 1996, $49.3 million, or 67%, related to pre-1995 lending
                  activities.

Nonaccrual Loans

         The Company recognizes revenue principally on the accrual basis of
accounting. In recording interest revenues from loans, the Company generally
adheres to a policy of not accruing interest for loans where payment of
principal and interest are delinquent for a period of 30 days or more. The
Company's policy is to assign nonaccrual status to a loan where either (i)
principal or interest payments are delinquent in excess of 30 days or (ii) the
full collection of interest or principal becomes uncertain, regardless of the
length of delinquency status. When a loan reaches "nonaccrual" status, any
interest accrued thereon is reversed and charged against current period
earnings. With respect to loans on nonaccrual status at December 31, 1996, the
Company recognized $1.9 million of interest revenue (representing cash payments
by borrowers prior to their default) and deferred recognition of $0.9 million of
interest revenue (representing uncollected interest payments) during 1996.



                                       41
<PAGE>   43

         At December 31, 1996, approximately $16.6 million of loan principal was
delinquent three or more payments. The discussion below highlights the more
significant individual loans which comprise this aggregate.

         o        One loan with unpaid principal of $3.2 million and secured by
                  a 248 unit apartment building - (1) this loan was originated
                  in July 1995, (2) title was transferred by the Company's
                  borrower in February 1996 without the Company's consent (as
                  required under its loan agreements), (3) the new owners
                  defaulted on their obligation in September 1996, (4) a
                  receiver was appointed in October 1996, (5) the Company
                  advanced approximately $0.5 million during the receivership
                  period to renovate a majority of the units and to
                  substantially release the building, and (6) the Company
                  completed its foreclosure action in February 1997. At March
                  31, 1997, the property was in escrow to be sold for $4.0
                  million in an all-cash transaction, the proceeds from which
                  would produce a modest gain from disposal and result in no
                  economic loss to the Company. In connection with the sale, the
                  Company had received nonrefundable deposits of $0.8 million
                  from the purchaser.

         o        One loan with an unpaid principal balance of $3.1 million and
                  secured by the remaining 53 unsold units in a 182 unit
                  entry-level condominium project. The Company financed the
                  construction of this project in 1991 and 129 units have been
                  sold since 1992. In late 1995, sales of units substantially
                  ceased and the borrowers ceased making their payments to the
                  Company in mid-1996. The Company expects to foreclose upon its
                  collateral during the first half of 1997.

         o        Two Estate loans, each with unpaid principal of $0.9 million
                  and secured by the borrower's personal residence. These loans
                  were originated in early 1995 and the borrowers each defaulted
                  in mid-1996. The Company expects to complete its foreclosure
                  actions, or for the borrower(s) to reinstate their loan(s),
                  during 1997. In the event the Company acquires title,
                  liquidation of the home(s) would be expected in the ordinary
                  course of business.

Restructured Loans

         Prior to September 1993, the Company's previous management followed a
practice of aggressively modifying loans, based upon verbal or, in some cases
written, requests from borrowers. Consistent with the orientation of the
Company's past lending activities, a majority of modifications prior to mid-1993
were associated with acquisition and development loans. Many of these loans were
modified in order to avoid borrower defaults or, in the case of loans already in
default, to prolong the period prior to foreclosure. In many instances, a single
loan, or groups of loans, were modified more than once. Modifications effected
by the Company generally took the form of (1) reducing the interest rate of the
loan to a market interest rate, (2) extending the maturity date of the loan,
generally for acquisition and development loans, or (3) both.

         Commencing in September 1993, new management imposed new parameters to
govern the future restructuring of the Company's loans. Generally, the Company
requires a borrower to submit a written request outlining the borrower's
proposal and to provide the Company with current financial and related
information about the borrower and the Company's collateral. In making its
evaluation, the Company considers whether the proposed modification would
improve the Company's economic position relative to recovery of all or a
substantial portion of its investment in the loan.

         In 1996, the Company recognized interest revenue of $3.1 million on
troubled debt restructured loans. The Company would have recognized interest
revenue of $3.8 million had the borrowers paid according to the original
contractual terms on such loans.

        During 1994, 1995 and 1996, one or more terms of 72 loans, involving
loan principal of $39.1 million outstanding at December 31, 1996, were modified.
The extent of these modifications defined these loans as troubled debt
restructurings ("TDRs") under generally accepted accounting principles. At
December 31, 1996, $35.3 million of these loans were performing in accordance
with their modified terms and $3.8 million were not performing and payments were
delinquent. At December 31, 1996, $16.7 million of total TDRs were included in
the Company's gross classified loans. Generally, the Company classifies TDRs as
substandard for a period of at least six months following a loan's
restructuring, after which time the loan's classification is based upon the
Company's classification policies.  See Classified Assets.  The more significant
TDRs are summarized below.



                                       42
<PAGE>   44

         o        The remaining 30 performing loans within the Company's largest
                  project concentration were modified during 1995, involving
                  principal at the time of the initial restructuring of $7.6
                  million, wherein the Company agreed to forgive loan principal
                  ratably over 24 months in an amount sufficient to equalize the
                  amount of each of the Company's loans and the current value of
                  the Company's collateral, and to provide the funds necessary
                  to repay the then existing subordinate lienholder (who was the
                  original seller of units in the project) at a fraction of the
                  face amount of such liens. Through December 31, 1996, the
                  Company had forgiven $0.7 million of loan principal and was
                  obligated to forgive an additional $0.1 million of loan
                  principal. At December 31, 1996, the remaining principal
                  balance of these loans was $6.5 million, 26 of the 30
                  restructured loans were performing and had performed without
                  incident since their restructuring, and none of the performing
                  loans were classified.

         o        During 1996, the Company restructured the terms of 16
                  apartment-secured loans with a single borrower, involving loan
                  principal at the restructuring date of $11.0 million which had
                  been originated variously through 1989. The restructuring
                  occasioned (1) debt forgiveness of $0.5 million by the
                  Company, (2) a reallocation of the Company's aggregate loan
                  principal among the 16 properties securing such loans so as to
                  produce individual loan-to-value ratios of 75% or less based
                  upon updated property valuations at the time of the
                  restructure, and (3) an adjustment to the interest rates on
                  the loans, such that the loans carry substantially market
                  interest rates following the restructuring. The borrower has
                  performed without incident since the loans were restructured
                  in early 1996. Accordingly, these loans, which represented
                  outstanding principal of $10.5 million at December 31, 1996,
                  were not classified.

         o        During 1994, 1995 and 1996, the Company modified the terms of
                  17 loans secured by apartment buildings, involving principal
                  at the various restructuring dates of $14.8 million, with
                  different borrowers, wherein the Company forgave a portion of
                  the principal balance of its loans, in exchange for
                  corresponding principal payments from the borrowers. In some
                  instances, the interest rate on the loans was adjusted to
                  levels approximating then market interest rates and payments
                  were reamortized over 30 years. At December 31, 1996, these
                  loans represented outstanding principal of $12.3 million and
                  each was performing. Approximately $8.0 million of such loan
                  principal was classified at December 31, 1996.

         o        During 1994, 1995 and 1996, the Company advanced a total of
                  $0.9 million relating to five loans, involving principal of
                  $4.4 million and different borrowers, for delinquent property
                  taxes, renovation to it's collateral and delinquent payments.
                  At December 31, 1996, two of these loans, totaling $0.7
                  million, were over 90 days delinquent, and two loans, totaling
                  $2.8 million, were performing and classified.

         o        During 1996, the Company agreed to contingently modify the
                  terms of one loan, with an original commitment amount of $5.3
                  million and originally secured by an 81 unit condominium
                  conversion. At December 31, 1996, this loan had an outstanding
                  balance of $1.8 million, remained secured by the 37 unsold
                  units within the complex, was on nonaccrual status, and was
                  classified Substandard. The Company has agreed to forgive up
                  to $0.3 million of accrued but unpaid interest and fees if the
                  borrower repays the Company's loan on or before December 31,
                  1997.

         o        The terms of one loan, with unpaid principal of $3.1 million,
                  have been modified several times. See Nonaccrual Loans.

CREDIT LOSSES

         Credit losses are inherent in the business of originating and retaining
real estate loans. The Company performs periodic reviews of any asset that has
been identified as having potential excess credit risk. The Company maintains
special departments with responsibility for resolving problem loans and selling
properties. Valuation allowances for estimated potential future losses are
established on a specific and general basis for loans and properties. Specific
reserves for individual nonperforming assets are determined by the excess of the
Company's gross investment over the fair value of the collateral or property.
General reserves are provided for losses inherent in the loan and property
portfolios which have yet to be specifically identified. General reserves are
based upon management's judgment of a number of factors including estimated
migration of loans, collateral deficiency, composition of the loan and property



                                       43
<PAGE>   45

portfolios, loan delinquency experience patterns, loan classifications, and
prevailing and forecasted economic conditions.

         During the five years ended December 31, 1996, the Company recorded
cumulative provisions for estimated credit losses of $120.3 million, which
amount includes loan and property credit loss provisions. Approximately $25.4
million of such cumulative provisions represent reserves established with
respect to loans and properties at December 31, 1996. The table below sets forth
the source of these cumulative credit losses by property type.

<TABLE>
<CAPTION>
                                                          CUMULATIVE
                                                          PROVISIONS
            PROPERTY TYPE                                 1992-1996
---------------------------------------                ----------------
<S>                                                        <C>        
Construction-related                                       $    42,000
Apartments (5 or more units)                                    32,000
Land                                                            17,000
Single family
    Project concentrations                                      16,000
    Other                                                       10,700
Commercial                                                       2,600 
                                                       ----------------
                                                            $  120,300 
                                                       ================
</TABLE>

         As described elsewhere herein, (1) the Company's sole remaining
pre-1995 construction-related loan defaulted in 1996 and was nonperforming at
December 31, 1996, (2) the Company's portfolio of foreclosed apartment buildings
(all of which previously secured pre-1995 loans), which peaked at over 70
buildings in the third quarter of 1995, had been substantially liquidated by the
end of 1996, (3) the Company's investment in project concentration loans and
properties had been reduced to $68.4 million at December 31, 1996, from its peak
of $96.5 million in 1994, (4) the Company's remaining portfolio of pre-1995
land loans and properties approximated $4.5 million at December 31, 1996, none
of which were individually significant and all of which were performing at that
date, and (5) the Company's portfolio of commercial real estate-secured loans
originated prior to 1995 approximated $7.6 million at December 31, 1996, which
amount includes two loans with outstanding principal of $1.1 million at December
31, 1996 (which were made by the Company in 1994 in connection with the sale of
the Company's then corporate offices), and which were performing at that date.

         The table below sets forth the general and specific credit losses for
the Company's loan and property portfolios as of December 31, 1996 (dollars are
in thousands).

<TABLE>
<CAPTION>
                                                                LOANS
                                                 ------------------------------------
                                                   PERFORMING        DELINQUENT (1)       PROPERTIES           TOTAL
                                                 ---------------   ------------------   ---------------   ---------------
<S>                                               <C>               <C>                    <C>               <C>     
AMOUNTS
Specific reserves                                    $      523        $       1,662          $ 11,172          $ 13,357
General reserves                                          8,433                2,897               699            12,029
                                                 ---------------   ------------------   ---------------   ---------------
Total reserves for estimated losses                   $   8,956        $       4,559          $ 11,871          $ 25,386
                                                 ===============   ==================   ===============   ===============
PERCENTAGES
% of total reserves to gross investment                    1.4%                17.1%             37.1%              3.6%
% of general reserves to gross investment                  1.3%                10.8%              2.2%              1.7%
</TABLE>
________________

         (1)      Delinquent loans are loans one or more payments past due.



                                       44

<PAGE>   46

         The table below summarizes the activity in the Company's reserves for
the periods indicated (dollars are in thousands).

<TABLE>
<CAPTION>
                                                                      FOR THE YEAR ENDED DECEMBER 31,
                                                --------------------------------------------------------------------------
                                                   1996            1995            1994            1993           1992
                                                -----------     -----------     -----------     -----------    -----------
<S>                                             <C>             <C>             <C>             <C>            <C>        
LOANS
Average loans outstanding                       $   671,365     $   578,766     $   604,410     $   756,023    $   845,925
                                                ===========     ===========     ===========     ===========    ===========
Reserve balance at beginning of period          $    15,192     $    21,461     $    46,629     $    52,966    $    10,813
Provision for estimated losses                        7,489          14,850           5,298          10,747         42,153
Charge-offs:
    Permanent loans
        Single family (1-4 units)                    (3,103)         (2,849)           (380)             --             --
        Multi-family (five or more units)            (4,641)         (3,595)           (339)             --             --
        Commercial real estate                           --             (70)             --              --             --
        Land                                             --             (48)             --              --             --
    Residential construction
      (tract development)                                --            (134)             --              --             --
Recoveries                                               --              --              --              72             --
                                                -----------     -----------     -----------     -----------    -----------
Net charge-offs                                      (7,744)         (6,696)           (719)             72             --
Transfer to property and other reserves              (1,422)        (14,423)        (29,747)        (17,156)            --
                                                -----------     -----------     -----------     -----------    -----------
Balance at end of period                        $    13,515     $    15,192     $    21,461     $    46,629    $    52,966
                                                ===========     ===========     ===========     ===========    ===========
Ratio of net charge-offs to average loans
  outstanding during the period                        1.15%           1.16%           0.12%         -0.01%           0.00%

PROPERTIES
Reserve balance at beginning of period          $    15,725     $    32,609     $    39,457     $    15,173    $     2,709
Provision for estimated losses                        3,511           5,100              --          18,662         12,464
Transfers from loan reserves                          1,422          13,873          29,747          17,156             --
Charge-offs                                          (8,787)        (35,857)        (36,595)        (11,267)            --
Recoveries                                               --              --              --            (267)            --
                                                -----------     -----------     -----------     -----------    -----------
Balance at end of period                        $    11,871     $    15,725     $    32,609     $    39,457    $    15,173
                                                ===========     ===========     ===========     ===========    ===========
</TABLE>


         Because the Company's loan and property portfolios are not homogenous,
but rather consist of discreet segments with different collateral and borrower
risk characteristics, management separately measures reserve adequacy, and
establishes and maintains reserves for credit losses, for each identifiable
segment of its property and loan portfolios. The table and discussion below
summarize credit loss reserves and the Company's approach to measuring credit
risk for each of its property and loan portfolios at the date indicated (dollars
are in thousands).

<TABLE>
<CAPTION>
                                                                     DECEMBER 31, 1996
                                                --------------------------------------------------------
                                                                   % OF                        % OF
                                                   LOANS        ASSET TYPE     PROPERTIES    ASSET TYPE
                                                -----------     -----------   -----------    -----------
<S>                                                <C>            <C>          <C>              <C>  
PERMANENT
    Single family residences (1-4 units)
        Estate                                     $   279         0.3%          $    --          --%
        Conventional                                 1,702         1.0               343         12.9
        Project concentrations                       4,495         7.3             2,233         31.4
    Multi-family (five or more units)                5,216         2.4               547         17.0
    Commercial real estate                           1,150         1.9               106         30.6
    Land                                               167         1.2             1,242         49.3
CONSTRUCTION
    Single family                                      168         0.3                --           --
    Tract development                                  338         1.0           $ 7,400         45.8
                                                   -------                       -------
                                                   $13,515         1.8%          $11,871         37.1%
                                                   =======                       =======
</TABLE>



                                       45
<PAGE>   47

         The discussion below summarizes the Company's approach to establishing
and maintaining reserves for each of its principal loan subportfolios. With
respect to its pre-1995 loan subportfolios, the magnitude of the Company's loan
delinquencies, foreclosures and property liquidations since 1993 have provided
management with significant and relevant empirical data about migration trends,
post-foreclosure costs, marketing timeframes and ultimate recoveries from
property disposal. In addition, management has performed one or more
loan-specific reviews of virtually every loan within the Company's pre-1995 loan
portfolios, including obtaining or calculating the current estimated value of
the Company's collateral. This information is utilized by management in
measuring the reserve adequacy of each of the Company's primary subportfolios.
With respect to each of these subportfolios, the Company generally maintains
GVAs which approximate 200% of the potential annual credit losses which would
result from applying relevant historical migration and loss factors to the
remaining performing loans within each subportfolio. These migration and loss
factors are updated periodically for recent activity and their application in
the future could result in increases or decreases to GVAs allocated to each
subportfolio should the Company's migration and loss experience change.

Conventional

         For performing loans, general reserves are established based upon
estimated portfolio migration and estimated loss content (i.e., the estimated
collateral deficiency determined by reference to current market indicators of
the properties' liquidation value). These factors are distinguished by the
classification of the loan. For delinquent loans and for owned homes, general
and specific reserves are established, or charge-offs recorded, based upon the
current fair market value of the property, less selling and renovation costs, by
reference to appraisals or other indicators of the properties' current value
believed by management to be reliable, or the Company's actual loss experience
from selling foreclosed homes since 1993.

Project Concentrations

         As described elsewhere herein, management has identified numerous
project concentrations involving takeout loans made by the Company to facilitate
sales within residential tract developments, the construction of which was
financed by the Company. For performing loans within a concentration, management
establishes general reserves in an amount equal to the estimated collateral
deficiency observable by reference to closed unit sales during the past two
years (generally, sales of foreclosed units by the Company) for the number of
performing loans expected to default in the future and result in foreclosure of
the Company's collateral. For delinquent loans and foreclosed units, the
Company's actual sales experience during the past two years is utilized to
establish specific reserves or to charge-off estimated losses.

Multi-family

         As described elsewhere herein, management has performed one or more
asset reviews for virtually its entire pre-1995 apartment-secured loan portfolio
(i.e., loans secured by buildings with five or more units). In addition, the
Company has foreclosed upon and sold (during 1995 and 1996) a large number of
buildings with the same characteristics (location, size, age, unit mix) as those
of the Company's remaining loan collateral. The estimated valuations derived
from the foregoing are utilized to establish loss factors, by loan
classification, which are coupled with the portfolio's estimated migration to
establish general reserves for performing loans. For nonperforming loans and for
owned buildings, specific reserves are established and, where appropriate,
charge-offs are recorded, for the estimated loss expected from foreclosure (in
the case of nonperforming loans) and disposition of the building, by reference
to the properties' cash flows and the application of current market investor
return and financing factors, less transaction and renovation costs.

Construction

         At December 31, 1996, the Company had investments in three foreclosed
residential tract developments. Reserves had been established, or charge-offs
had been recorded, through December 31, 1996, based upon revenues and costs to
and at completion. With respect to one of these developments, construction was
complete at the end of 1996 and most of the completed units had been sold. With
respect to one other development, construction was approximately 70% complete
and all of the available units in the project had been sold. With respect to the
last development, construction was substantially complete at December 31, 1996
but no units had yet been sold. The Company currently expects to liquidate all
of these units throughout the course of 1997.



                                       46

<PAGE>   48
Post-1994 Originations

         The Company originated $529.7 million of permanent loans and
construction loan commitments during 1995 and 1996. At December 31, 1996, $6.8
million of loan principal originated since 1994 was one or more payments
delinquent as to scheduled principal and interest payments, or 1.3% of
cumulative loan commitments. Based upon appraisals completed at the various
origination dates, the average loan-to-value ratio associated with these
delinquent loans is 79%. Through December 31, 1996, the Company had not
foreclosed upon the collateral securing any of its post-1994 loan originations.
However, during the first quarter of 1997, the Company acquired one property
through foreclosure which secured a $3.2 million loan. Shortly following its
acquisition, the Company agreed to sell the property for an amount which would
result in no economic loss to the Company. At March 31, 1997, the Company had
received nonrefundable deposits from the purchaser totaling $0.8 million. See
Nonaccrual Loans. Also during the first quarter of 1997, the Company sold one
loan originated since 1994, with a principal balance of $3.2 million and secured
by an office building, which became delinquent during the quarter. In connection
with this sale, the Bank received consideration equal to its unpaid principal
balance plus all arrearages and out-of-pocket costs. Accordingly, the sale
resulted in no economic loss to the Company.

         Because the loans originated by the Company since 1994 have been
outstanding for a limited period of time, and because no realized losses have
been incurred through December 31, 1996 with respect to this portfolio, the
Company does not utilize the same experiential migration and loss factors which
are the basis for establishing GVAs for its pre-1995 loans. Until this portfolio
of loans gains further seasoning, management has established, and will continued
to establish, GVAs based upon broad estimates of potential adverse migration and
the costs attendant to foreclosure, renovation (if applicable), marketing and
disposition.

         General reserves are established for each of the business lines, and
loan principal outstanding, based on on-going valuation assessments of the
Company's collateral, expected migration of loans by respective classification
status, and other general factors which may have an impact on the expected
collectability of loan principal outstanding.

         Permanent loan financings typically have interim borrower reporting
requirements, and have other financial measurement covenants, which management
assesses in its periodic asset reviews, classifications, and establishment of
general reserves. Establishment of general reserves related to the post-1994
loan portfolio will be evaluated on a continual basis given the nature of the
Company's business lines.

REAL ESTATE OWNED

         Real estate acquired in satisfaction of loans is transferred from loans
to properties at estimated fair values, less any estimated disposal costs. The
difference between the fair value of the real estate collateral and the loan
balance at the time of transfer is recorded as a loan charge-off. Any subsequent
declines in the fair value of the properties after the date of transfer are
recorded through the establishment of, or additions to, specific reserves.
Recoveries and losses from the disposition of properties are also included in
Real Estate Operations.

         The table below summarizes the composition of the Company's property
portfolio at the dates indicated (dollars are in thousands).

<TABLE>
<CAPTION>
                                                         1996           1995
                                                     -----------    -----------
<S>                                                  <C>            <C>        
SINGLE FAMILY RESIDENCES
    Conventional                                     $     2,660    $     8,815
    Project concentrations                                 7,117          6,419
MULTI-FAMILY (FIVE OR MORE UNITS)                          3,215         18,877
CONSTRUCTION (TRACT DEVELOPMENTS)                         16,156         15,414
LAND                                                       2,517          3,759
COMMERCIAL                                                   346            346
                                                     -----------    -----------
GROSS INVESTMENT(1)                                       32,011         53,630
ALLOWANCE FOR ESTIMATED LOSSES                           (11,871)       (15,725)
                                                     -----------    -----------
NET INVESTMENT                                       $    20,140    $    37,905
                                                     ===========    ===========
</TABLE>
------------------

(1)      Loan principal at foreclosure, plus post-foreclosure capitalized 
         costs, less cumulative charge-offs.



                                       47
<PAGE>   49

         The following summarizes the Company's significant investments in
individual properties and the carrying value of the Company's investment at
December 31, 1996.

Conventional

         At December 31, 1996, the Company owned 14 homes with a gross
investment of $2.7 million (net of charge-offs) and a net carrying value of $2.4
million (net of charge-offs and specific valuation allowances). These homes are
expected to be liquidated in the ordinary course of business during 1997 without
the incurrence of significant additional losses.

Project Concentrations

         At December 31, 1996, the Company owned 78 units within project
concentrations, with a gross investment of $7.1 million (net of charge-offs) and
a carrying value of $5.1 million (net of charge-offs and specific valuation
allowances). Approximately $3.3 million of the Company's carrying value in
project concentration properties at December 31, 1996 consisted of 64 units in
two projects, which are described below.

         o        Daisy ($1.9 million) - Represents the Company's investment in
                  37 entry-level condominiums, which are part of a larger 60
                  unit condominium project located in Huntington Park,
                  California. At December 31, 1996, the Company also had
                  outstanding loan principal of $1.7 million secured by an
                  additional 19 units within this project. The remaining four
                  units secure loans from other financial institutions. The
                  Company financed the construction of this complex in 1989 and
                  provided original concessionary first trust deed financing for
                  the individual purchase of 56 of the 60 units therein in 1991
                  and 1992. The Company's loans approximated 85% of the stated
                  purchase price of the units and the developer provided most of
                  the remaining financing necessary to close individual unit
                  sales, with little or no cash brought to bear by the
                  purchasers. During 1996, the Company ceased marketing
                  foreclosed units for sale because of an absence of demand for
                  such units. Concurrently, the Company began renting its units
                  with the intention of operating them, and all subsequently
                  acquired units, as rentals indefinitely into the future. At
                  December 31, 1996, substantially all of the Company's units
                  had been rented. Credit losses have been recorded on this
                  investment (both foreclosed properties and loans) based upon
                  valuation of the entire complex as a rental apartment
                  building, rather than as for-sale condominiums. Through
                  December 31, 1996, the Company had recorded cumulative credit
                  losses of $2.5 million covering its aggregate exposure,
                  allocated between loans and properties so as to produce
                  individual unit carrying values consistent with operation of
                  the complex as a rental property.

         o        Cerise Avenue ($1.4 million) - In August 1996, the Company
                  foreclosed upon the remaining 27 unsold units within a 43 unit
                  condominium complex located in Hawthorne, California. The 16
                  units not acquired through foreclosure were sold by the
                  original developer during 1995 and 1996. These units sales
                  were not financed by the Company. Subsequent to foreclosure,
                  the Company has spent approximately $0.4 million to bring the
                  unsold units to a marketable condition. Retail sales of the
                  remaining units commenced in early 1997 and sellout is
                  expected by the end of 1997. Through December 31, 1996, the
                  Company had recorded cumulative credit losses of $0.7 million
                  covering the Company's foreclosed property investment. No
                  significant additional losses are expected through the sellout
                  of these units.

         The remainder of the Company's investment in real estate owned related
to project concentrations at December 31, 1996 is expected to be liquidated in
the ordinary course of business during 1997 without the incurrence of additional
credit losses.

Multi-family (5 or more units)

         At December 31, 1996, the Company owned 11 apartment buildings with a
gross investment of $3.2 million (net of charge-offs) and a carrying value of
$2.7 million (net of charge-offs and specific valuation allowances). These
buildings are expected to be liquidated in the ordinary course of business
during 1997 without the incurrence of significant additional losses.



                                       48
<PAGE>   50

Construction (tract development)

         At December 31, 1996, the Company retained investments in three
multiple-unit, for-sale housing developments, with a gross investment of $16.2
million (net of charge-offs) and a carrying value of $9.0 million (net of
charge-offs and specific valuation allowances). With respect to one of these
developments, two homes remained unsold at year end 1996, representing $0.5
million of the Company's carrying value. The other two developments, and the
Company's investments therein at December 31, 1996, are further described below.

         o        Belcourt ($5.3 million) - Represents the Company's investment
                  in a 40 unit condominium development in Los Angeles County,
                  California. In April 1994, the Company foreclosed upon
                  approximately 2.2 acres of land which secured a $1.5 million
                  loan. In February 1996, the Company commenced development of
                  40 condominium units on the site. Construction was completed
                  in December 1996 and retail sales of individual units
                  commenced in early 1997. At December 31, 1996, there were no
                  material costs to complete and sellout of the project is
                  expected by the end of 1997. The Company will not finance
                  individual unit sales. Through the end of 1996, the Company
                  had invested a total of $6.1 million (including its original
                  loan) in this development and had recorded cumulative credit
                  losses of $0.8 million. No significant additional losses are
                  expected through the final liquidation of the Company's
                  investment.

         o        Marbella ($3.2 million) - represents the Company's remaining
                  investment in a 100 unit, luxury condominium development
                  located in a golf course-oriented, master-planned development
                  in Orange County, California. Since the Company's foreclosure
                  in May 1993, at which time the Company's investment
                  approximated $19.0 million and was represented by 42 partially
                  completed units, the Company has invested approximately $17.6
                  million to (1) complete, market and sell 76 units, (2)
                  complete six model units, and (3) commence construction of the
                  final 18 units. The remaining cost prospectively from December
                  31, 1996 to complete and to market the remaining units is
                  estimated to be $5.1 million, which amount has been considered
                  in the carrying value of the Company's investment at December
                  31, 1996. Construction is expected to be completed, and the
                  finished units sold, by the end of 1997. To date, the Company
                  has not financed, nor does it anticipate financing, unit
                  sales. Through December 31, 1996, the Company had recorded
                  credit losses of approximately $14.3 million related to this
                  development. Based upon current estimates to and at
                  completion, no additional loss from this development is
                  anticipated.

Land

         At December 31, 1996, the Company owned four land parcels acquired
through foreclosure during 1993 and 1994 with a gross investment of $2.5 million
(net of charge-offs) and a carrying value of $1.3 million (net of charge-offs
and specific valuation allowances). The Company's investment in two of these
parcels has been completely charged off. The other two parcels consist of (i)
160 acres of undeveloped land in Santa Clarita, California with a carrying value
of $0.8 million, which the Company anticipates will be sold in 1997 without
significant additional losses, and (ii) land in Hermosa Beach, California with a
carrying value of $0.5 million, which has tentatively been approved for the
construction of luxury homes and, upon receipt of final approvals, will either
be sold or developed by the Company.

         Although the Company expects to sell during 1997 a substantial amount
of the real estate owned held by it at December 31, 1996 without significant
additional losses, there can be no assurance that this will be the case. Sales
of real estate generally are subject to market and economic conditions,
including the real estate markets in which the properties are located and the
level of prevailing interest rates, and other factors beyond the control of
management of the Company, which could cause substantial inter-period variations
in the results of such activities.

LIABILITIES

GENERAL

         The Company derives funds principally from deposits and, to a far
lesser extent, from short-term reverse repurchase agreements and borrowings from
the FHLB. In addition, funds are generated from loan repayments and payoffs,
sales of investment securities, and, since late 1993, from sales of foreclosed
properties. Historically, the Company has not accessed the capital markets for
other types of debt instruments, and has had nominal activity in selling
seasoned, single family mortgage loans which are no longer a significant
component to the Company's operations.



                                       49
<PAGE>   51

DEPOSITS

         The Company has several types of deposit accounts principally designed
to attract short-term deposits. The following table sets forth the distribution
of average deposits and the weighted average interest rates paid thereon during
the periods indicated (dollars are in thousands). See NOTE G of the NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS.

<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                               -------------------------------------------------------------------------------
                                               1996                                       1995
                               -------------------------------------    --------------------------------------
                                             WEIGHTED                                 WEIGHTED                
                                             AVERAGE        PERCENT                   AVERAGE        PERCENT 
                                             INTEREST         OF                      INTEREST          OF    
                                AMOUNT(1)      RATE          TOTAL      AMOUNT(1)       RATE           TOTAL   
                               ----------  -----------    ----------    ----------   ----------    -----------
<S>                            <C>            <C>            <C>         <C>           <C>             <C> 
Checking/NOW                   $ 28,032        0.8%          4.0%        $ 29,431       1.6%            4.3%
Passbook                         26,500        1.9           3.8           29,831       0.7             4.4
Money market deposits            26,254        1.4           3.7           51,920       2.0             7.7
Certificates of deposit         621,050        5.6          88.5          564,147       5.7            83.6
                               --------                    ------        --------                     ------
  Total                        $701,836        5.1%        100.0%        $675,329       5.0%          100.0%
                               ========                    ======        ========                     ======
</TABLE>

<TABLE>
<CAPTION>
                                             DECEMBER 31,
                               --------------------------------------
                                                1994
                               --------------------------------------
                                              WEIGHTED
                                              AVERAGE       PERCENT 
                                              INTEREST        OF    
                                AMOUNT(1)       RATE         TOTAL   
                               ----------   ----------   ------------
<S>                              <C>            <C>          <C> 
Checking/NOW                     $ 38,462       0.5%          5.0%
Passbook                           35,978       3.8           4.7
Money market deposits             110,324       1.9          14.5
Certificates of deposit           578,538       4.5          75.8
                                 --------                   -----
  Total                          $763,302       3.9%        100.0%
                                 ========                   ======
</TABLE>
----------------
(1) Amounts represent monthly averages.


                                       50
<PAGE>   52


         The table below sets forth the maturities of the Company's certificates
of deposit outstanding at the dates indicated (dollars are in thousands).


<TABLE>
<CAPTION>
                                                             DECEMBER 31, 1996
                               ------------------------------------------------------------------------------
                                                   OVER            OVER
                                               THREE MONTHS     SIX MONTHS
                               THREE MONTHS       THROUGH         THROUGH          OVER
                                  OR LESS       SIX MONTHS       ONE YEAR        ONE YEAR          TOTAL
                               --------------  --------------  --------------  --------------  --------------
<S>                            <C>             <C>             <C>              <C>             <C>       
BALANCES LESS
  THAN $100,000
    3.00% or less                 $    2,345        $      -        $      -      $        4      $    2,349
    3.01% - 4.00%                        236             104                                             340
    4.01% - 5.00%                     54,800           4,556           3,239          17,127          79,722
    5.01% - 6.00%                    108,271          91,529          93,528          52,373         345,701
    6.01% - 7.00%                      9,760           6,464          40,078          22,706          79,008
    7.01% or more                        234                                             100             334
                               --------------  --------------  --------------  --------------  --------------
                                     175,646         102,653         136,845          92,310         507,454
BALANCES GREATER
  THAN OR EQUAL
   TO $100,000
    3.00% or less                        104                                                             104
    3.01% - 4.00%
    4.01% - 5.00%                     12,609                             160           5,934          18,703
    5.01% - 6.00%                     29,449          25,322          30,697          11,224          96,692
    6.01% - 7.00%                      3,554           2,060          13,373           5,010          23,997
    7.01% or more                                        200                             100             300
                               --------------  --------------  --------------  --------------  --------------
                                      45,716          27,582          44,230          22,268         139,796
                               --------------  --------------  --------------  --------------  --------------

TOTAL                             $  221,362      $  130,235      $  181,075      $  114,578      $  647,250
                               ==============  ==============  ==============  ==============  ==============
</TABLE>


<TABLE>
<CAPTION>
                                                              DECEMBER 31, 1995
                               ------------------------------------------------------------------------------
                                                   OVER            OVER
                                               THREE MONTHS     SIX MONTHS
                               THREE MONTHS       THROUGH         THROUGH          OVER
                                  OR LESS       SIX MONTHS       ONE YEAR        ONE YEAR          TOTAL
                               --------------  --------------  --------------  --------------  --------------
<S>                            <C>             <C>             <C>             <C>             <C>
BALANCES LESS
  THAN  $100,000
    3.00% or less                 $      545      $        2        $      -        $      -      $      547
    3.01% - 4.00%                      5,702           1,636             276              27           7,641
    4.01% - 5.00%                     64,714          16,518          25,675           2,639         109,546
    5.01% - 6.00%                     56,392          53,349         116,277          27,994         254,012
    6.01% - 7.00%                     43,515          12,807          10,977          26,312          93,611
    7.01% or more                        466           1,536           4,643           1,137           7,782
                               --------------  --------------  --------------  --------------  --------------
                                     171,334          85,848         157,848          58,109         473,139
BALANCES GREATER
  THAN OR EQUAL
   TO $100,000
    3.00% or less                        101                                                             101
    3.01% - 4.00%                        108             338                                             446
    4.01% - 5.00%                     13,800           2,666           5,660           1,286          23,412
    5.01% - 6.00%                     12,549          16,975          31,331           6,640          67,495
    6.01% - 7.00%                     15,112           5,292           5,743           8,296          34,443
    7.01% or more                      1,020           1,191           1,672             630           4,513
                               --------------  --------------  --------------  --------------  --------------
                                      42,690          26,462          44,406          16,852         130,410
                               --------------  --------------  --------------  --------------  --------------

TOTAL                             $  214,024      $  112,310      $  202,254      $   74,961      $  603,549
                               ==============  ==============  ==============  ==============  ==============
</TABLE>



                                       51
<PAGE>   53

BORROWINGS


         The Company considers advances from the FHLB system its primary source
of borrowings. The FHLB system functions as a source of credit to savings
institutions which are members of a Federal Home Loan Bank System. See
REGULATION-Federal Home Loan Bank System. The Company may apply for advances
from the FHLB secured by the capital stock of the FHLB owned by the Company and
certain of the Company's mortgages and other assets (principally obligations
issued or guaranteed by the U.S. Government or agencies thereof). Advances can
be requested for any business purpose in which the Company is authorized to
engage. In granting advances, the FHLB considers a member's credit worthiness
and other relevant factors. At December 31, 1996, the Company had an approved
line of credit (collateralized by specific mortgage collateral) with the FHLB
for $200.0 million at terms of up to two years. The Company had outstanding at
year-end 1996 borrowings from the FHLB of $50.0 million at a weighted average
interest rate of 6.12% which mature in June 1997.

         In early 1997, the FHLB approved an increase in the Company's line of
credit to up to 35% of total assets, collateralized by a combination of mortgage
and investment securities collateral with terms up to ten years. With
anticipated future loan fundings and investment purchases, the Company expects
to actively utilize the available line.

         To further supplement its funding needs, the Company may enter into
reverse repurchase agreements, in which it sells securities with an agreement to
repurchase the same securities at a specific future date (overnight to 90 days).
The Company enters into such transactions only with dealers determined by
management to be financially strong and who are recognized as primary dealers in
U.S. Treasury securities by the Federal Reserve Board. The Company had no such
borrowings in 1996. See NOTE H of the NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS.

ACCOUNTS PAYABLE AND OTHER LIABILITIES

         Accounts payable and other liabilities totaled $23.2 million and $4.6
million at December 31, 1996 and 1995, respectively. At year end 1996, the
Company had recorded a liability of approximately $15.0 million relating to the
repurchase of certain loans sold in December. After year end, the Company agreed
to repurchase these loans and has included them in total loans receivable in the
Company's consolidated balance sheets. This amount represents the cash to be
paid for the loans repurchased. Final settlement of this amount was made in
February 1997.

SENIOR NOTES

         At December 31, 1996 and 1995, the Company had outstanding $12.3
million and $12.0 million, respectively, in Senior Notes due 2000, which were
issued in December 1995. The increase in senior notes from 1995 to 1996
represents $0.3 million of amortization on the OID recorded upon the issuance of
these senior notes, which have an aggregate principal amount of $13.5 million,
and is recorded as additional interest expense in the Company's statements of
operations. Total interest expense on senior notes recorded during 1996 was $1.9
million.

STOCKHOLDERS' EQUITY

         Total stockholders' equity at December 31, 1996 and 1995 was $43.9
million and $39.0 million, respectively. The increase in equity of $4.9 million
in 1996 over 1995 was due to consolidated net earnings of $7.5 million, which
were offset in part by accrued but unpaid dividends of $2.4 million on the
Cumulative Perpetual Preferred Stock issued by the Company in December 1995.



                                       52
<PAGE>   54

LIQUIDITY

         The table below summarizes the principal cash flows which gave rise to
the change in the size of the Company's balance sheet during the past three
years (dollars are in thousands).

<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31,
                                                   --------------------------------------------
                                                       1996           1995            1994
                                                   -------------   ------------   -------------
<S>                                                <C>             <C>             <C>     
BEGINNING CASH AND EQUIVALENTS                         $ 14,015       $ 18,063        $ 42,901

ASSET CASH FLOWS
Net cash flows attributable to
  Foreclosed properties(1)(2)                            14,655         25,967          54,344
  Securities(3)                                          24,687         39,007          (6,742)
  Sales of loans                                        130,413         19,282               -
  Loan principal payments and payoffs                    93,953         44,254          67,080
  Cash flows from other assets(4)                       (10,965)         2,221          23,854
                                                   -------------   ------------   -------------
                                                        252,743        130,731         138,536

New loans, net of undisbursed funds(2)                 (266,590)      (160,035)        (27,769)
                                                   -------------   ------------   -------------
Net asset cash flows                                    (13,847)       (29,304)        110,767
                                                   -------------   ------------   -------------

LIABILITY CASH FLOWS
Deposits
  Net sales of deposits                                (178,884)       (16,807)       (183,260)
  Other changes, net                                    204,972         65,698           6,107
Net short-term borrowings                                50,000        (47,141)         47,141
Cash flows from other liabilities                        14,616         (1,840)         (1,687)
                                                   -------------   ------------   -------------
Net liability cash flows                                 90,704            (90)       (131,699)
                                                   -------------   ------------   -------------

EQUITY CASH FLOWS
Net proceeds from capital offering                            -         25,843               -
Cash flows from operations                                3,106           (497)         (3,906)
                                                   -------------   ------------   -------------
Net equity cash flows                                     3,106         25,346          (3,906)
                                                   -------------   ------------   -------------
Total liability and equity cash flows                    93,810         25,256        (135,605)
                                                   -------------   ------------   -------------
NET CASH FLOWS                                           79,963         (4,048)        (24,838)
                                                   -------------   ------------   -------------
ENDING CASH AND EQUIVALENTS                            $ 93,978       $ 14,015        $ 18,063
                                                   =============   ============   =============
</TABLE>
------------------
         (1)      Proceeds from sales of properties, less post-foreclosure
                  capitalized costs.

         (2)      New loan cash flows and the net proceeds from sales of
                  properties exclude the financed portion of property sales
                  where the Company financed the sale. For the three years ended
                  December 31, 1996, the Company provided $18.2 million, $16.0
                  million, and $13.4 million, respectively, of financing in
                  connection with sales of foreclosed properties, which amounts
                  principally related to sales of apartment buildings. 

         (3)      Includes sales and purchases of investment securities.

         (4)      Includes fixed assets, FHLB stock, income tax receivable,
                  other loan related disbursements and other assets.



                                       53
<PAGE>   55

INTEREST RATE RISK MANAGEMENT

         The objective of interest rate risk management is to stabilize the
Company's net interest income ("NII") while limiting the change in its net
portfolio value ("NPV") from interest rate fluctuations. The Company seeks to
achieve this objective by matching its interest sensitive assets and
liabilities, and maintaining the maturity and repricing of these assets and
liabilities at appropriate levels given the interest rate environment. When the
amount of rate sensitive liabilities exceeds rate sensitive assets within
specified periods, the NII generally will be negatively impacted by a rising
rate environment during such periods. The speed and velocity of the repricing of
assets and liabilities will also contribute to the effects on NII.

         The Company utilizes two methods for measuring interest rate risk. Gap
analysis is the first method, with a focus on measuring absolute dollar amounts
subject to repricing within certain periods of time, particularly the one-year
maturity horizon.

         In addition to utilizing gap analysis in measuring interest rate risk,
the Company performs periodic interest rate simulations. These simulations
provide the Company with an estimate of both the dollar amount and percentage
change in NII under various interest rate scenarios. All assets and liabilities
are subjected to tests of up to 400 basis points in increases and decreases in
interest rates. Under each interest rate scenario, the Company projects its net
interest income and the NPV of its current balance sheet. From these results,
the Company can then develop alternatives to dealing with the tolerance
thresholds.

         During 1995, the Company initiated certain measures to reduce interest
rate risk exposure embedded within the balance sheet. These measures included
the sale of approximately $110 million in fixed rate assets and the purchase of
a $450 million interest rate cap on the liability base subject to reprice within
a six-month period. During 1996, the Company continued to reduce interest rate
risk exposure by making additional fixed rate loan sales of approximately $35.0
million and sales of single family 11th DCOFI-indexed loans amounting to
approximately $45.0 million. The Company also was successful in extending the
duration of its liability base from six to seven months during the course of
1996.

         A principal mechanism used by the Company in the past for interest rate
risk management was the origination of ARMs tied to the 11th DCOFI. The basic
premise was that the Company's actual cost of funds would parallel the 11th
DCOFI and, as such, the interest rate spread would generate the desired
operating results. Adjustable rate mortgage loans ("ARMS") comprised almost all
of the Company's loan originations during 1996. ARMs represented approximately
75% of the Company's loan portfolio at December 31, 1996 and 1995, respectively.
The Company currently originates loans tied to multiple indices including
London Interbank Offered Rate ("LIBOR"), CMT, prime, and 11th DCOFI.

         ARMs tied to 11th DCOFI are slower in responding to current interest
rate environments than other types of variable rate loans because the index is a
compilation of the average rates paid by member institutions of the 11th
District of the FHLB. This index typically lags market rate changes in both
directions. If interest rates on deposit accounts increase due to market
conditions and competition, it may be anticipated that the Company will, absent
offsetting factors, experience a decline in its net interest margin. A
contributing factor would be the lag in upward pricing of the ARMs tied to the
11th DCOFI. However, the lag inherent in the 11th DCOFI will also cause the ARMs
to remain at a higher rate for a longer period after interest rates on deposits
begin to decline. The 11th DCOFI lag during a falling interest rate environment
should benefit, in the short-term, the Company's Net Interest Margin, but the
actual dynamics of prepayments and the fact that ARMs reprice at various
intervals may alter this expected benefit.

         Since 1995, the Company has been utilizing interest rate floors to
mitigate the risk of interest margin compression on its new loans in a
decreasing interest rate environment. Typically, these floors represent the rate
at underwriting. Additionally, on most new income property loans, the Company
utilizes interest rate caps. These caps are life caps and are usually five
points above the rate at underwriting or at an amount that would still allow for
one-to-one debt service coverage at the maximum rate, thereby reducing the
likelihood of borrower default in a rising interest rate environment. The risk
to the Company that is associated with the interest rate caps is that interest
rates will exceed the maximum loan rates on such loan, and while the Company's
cost of funds continues to rise, the interest income derived from these loans
will be fixed, resulting in an overall compression on net interest income.



                                       54

<PAGE>   56

         The following sets forth information concerning sensitivity of the
Company's interest-earning assets and interest-bearing liabilities as of
December 31, 1996 (dollars in thousands). Such assets and liabilities are
classified by the earlier of maturity or repricing date.

<TABLE>
<CAPTION>
                                                            OVER THREE      OVER SIX      OVER ONE
                                                THREE        THROUGH         THROUGH        YEAR           OVER
                                                MONTHS         SIX            TWELVE       THROUGH         FIVE
                                               OR LESS        MONTHS          MONTHS      FIVE YEARS       YEARS           TOTAL
                                             -----------    -----------    -----------    -----------    -----------    -----------
<S>                                          <C>            <C>            <C>            <C>            <C>            <C>        
INTEREST-EARNING ASSETS
    Cash and cash equivalents(1)             $    12,586    $        --    $       100    $        --    $        --    $    12,686
    Investments and FHLB stock                     6,788            796            802         36,773             --         45,159
    Loans(2)                                     286,882        191,094         55,409         44,447        114,695        692,527
                                             -----------    -----------    -----------    -----------    -----------    -----------
        Total interest-earning assets        $   306,256    $   191,890    $    56,311    $    81,220    $   114,695    $   750,372
                                             ===========    ===========    ===========    ===========    ===========    ===========
INTEREST-BEARING LIABILITIES
    Deposits
        Demand                               $    70,559    $        --    $        --    $        --    $        --    $    70,559
        CDs                                      221,362        130,235        181,075        114,578             --        647,250
    FHLB advances                                     --         50,000             --             --             --         50,000
    Senior Notes                                      --             --             --         12,307             --         12,307
                                             -----------    -----------    -----------    -----------    -----------    -----------
        Total interest-bearing liabilities   $   291,921    $   180,235    $   181,075    $   126,885    $        --    $   780,116
                                             ===========    ===========    ===========    ===========    ===========    ===========

        Interest rate sensitivity gap        $    14,335    $    11,655    $  (124,764)   $   (45,665)   $   114,695    $   (29,744)
        Cumulative interest rate
          sensitivity gap                         14,335         25,990        (98,774)      (144,439)       (29,744)       (29,744)
        Cumulative interest rate
          sensitivity gap as a percentage
          of total interest-earning assets           4.7%          13.5%       -175.4%        -177.8%         -25.9%          -4.0%
---------------

(1) Cash and cash equivalents do not include $81.3 million of non-interest
    earning cash, a substantial portion of which was invested in loans and
    securities subsequent to December 31, 1996.

(2) Balances include nonaccrual loans of $28.6 million at December 31, 1996.
</TABLE>

REGULATORY CAPITAL REQUIREMENTS

         Federally-insured savings institutions such as the Bank are required to
maintain minimum levels of regulatory capital. The OTS also is authorized to
impose capital requirements in excess of these standards on individual savings
institutions on a case-by-case basis. At December 31, 1996, the Bank was in
compliance with all applicable regulatory capital requirements and qualified as
a "well-capitalized" institution under applicable laws and regulations. For
information relating to the Bank's compliance with these requirements, see ITEM
1. BUSINESS - REGULATION - SAVINGS INSTITUTION REGULATION - Regulatory Capital
Requirements.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         See Index included in Item 14 below and the Financial Statements which
begin on the first page following the Signature Page.


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
         FINANCIAL DISCLOSURE.

         Not Applicable



                                       55
<PAGE>   57

                                  P A R T III.


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The information required in ITEM 10 is hereby incorporated by reference
to the Company's definitive Proxy Statement to be filed with the Securities and
Exchange Commission for the 1997 Annual Meeting of Stockholders ("Proxy
Statement") under the captions "NOMINATION AND ELECTION OF DIRECTORS" and
"COMPENSATION OF EXECUTIVE OFFICERS DURING 1996."


ITEM 11. EXECUTIVE COMPENSATION.

         The information required in ITEM 11 is hereby incorporated by reference
to the Proxy Statement under the captions "COMPENSATION OF EXECUTIVE OFFICERS
DURING 1996" and "REPORT ON EXECUTIVE COMPENSATION."


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The information required in ITEM 12 is hereby incorporated by reference
to the Proxy Statement under the caption "SECURITY OWNERSHIP OF PRINCIPAL
STOCKHOLDERS AND MANAGEMENT; AFFILIATE TRANSACTIONS."


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         The information required in ITEM 13 is hereby incorporated by reference
to the Proxy Statement under the caption "SECURITY OWNERSHIP OF PRINCIPAL
STOCKHOLDERS AND MANAGEMENT; AFFILIATE TRANSACTIONS."



                                       56
<PAGE>   58

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

     (A) The following documents are filed as part of this report:

           (1)    Financial Statements.

                  INDEPENDENT AUDITORS' REPORT

                  CONSOLIDATED FINANCIAL STATEMENTS

                           Consolidated Statements of Financial Condition as of
                           December 31, 1996 and 1995.

                           Consolidated Statements of Operations for the years
                           ended December 31, 1996, 1995 and 1994.

                           Consolidated Statements of Stockholders' Equity for
                           the years ended December 31, 1996, 1995 and 1994.

                           Consolidated Statements of Cash Flows for the years
                           ended December 31, 1996, 1995 and 1994.

                           Notes to Consolidated Financial Statements for the
                           years ended December 31, 1996, 1995 and 1994.

                  MANAGEMENT'S ASSERTION REPORT

                  INDEPENDENT ACCOUNTANTS' REPORT

           (2)    Financial Statement Schedules.

                  Schedules are omitted because the conditions requiring their
                  filing are not applicable or because the required information
                  is provided in the Consolidated Financial Statements,
                  including the Notes thereto.

           (3)    Exhibits.

                  EXHIBIT NO.       DESCRIPTION OF DOCUMENT

                     (3.1)          Certificate of Incorporation and Bylaws. The
                                    Company's Certificate of Incorporation and
                                    Bylaws are attached as Exhibits 4(a) and
                                    4(b) to the Company's Registration Statement
                                    on Form S-8 (Registration No. 33-74800)
                                    filed on February 3, 1994.

                     (3.2)          Amendment of Certificate of Incorporation.
                                    Filed as Exhibit 3 to the Company's
                                    Quarterly Report on Form 10-Q for the
                                    quarter ended September 30, 1995.

                     (3.3)          Certificate of Designations and Preferences
                                    of the Cumulative Preferred Stock, Series A.
                                    Filed with Form 8-K dated February 7, 1996.

                     (4.1)          Specimen Stock Certificate for the Company's
                                    Common Stock. Filed as Exhibit 4 to the
                                    Company's Annual Report on Form 10-K for the
                                    year ended December 31, 1985.

                     (4.2)          Form of Senior Notes due 2000. Filed as an
                                    exhibit to the Form 8-K dated February 7,
                                    1996.


                                       57
<PAGE>   59

                  EXHIBIT NO.       DESCRIPTION OF DOCUMENT

                     (10.1)         Stock Option Plan. Filed as an exhibit to
                                    the Form S-8 (Registration No. 33-74800)
                                    dated February 3, 1994 and updated filing on
                                    Form S-8 (Registration No. 333-23587) dated
                                    March 19, 1997.

                     (10.2)         Employment Agreement between the Company and
                                    Scott Braly. Filed as Exhibit 10 to the
                                    Company's Annual Report on Form 10-K for the
                                    year ended December 31, 1993.

                     (10.3)         Lease of corporate headquarters.

                     (10.4)         Unit Purchase Agreement between the Company
                                    and the investors named therein. Filed as an
                                    exhibit to the Form 8-K dated February 7,
                                    1996.

                     (10.5)         Form of Warrant to purchase 2.4 million
                                    shares of common stock. Filed as an exhibit
                                    to the Form 8-K dated February 7, 1996.

                     (10.6)         Registration Rights Agreement between the
                                    Company and certain investors as named
                                    therein. Filed as an exhibit to the Form 8-K
                                    dated February 7, 1996.

                     (11.1)         Statement re: Computation of Per Share
                                    Earnings (see Note A of the Notes to
                                    Consolidated Financial Statements).

                     (21.1)         Subsidiaries of the Registrant. Filed as
                                    Exhibit 22 to the Company's Annual Report on
                                    Form 10-K for the year ended December 31,
                                    1994.

                     (23.1)         Independent Auditors' Consent.

                     (27.1)         Financial Data Schedules.


     (B)   Reports on Form 8-K

           No current reports on Form 8-K were filed for the three months ended
December 31, 1996.



                                       58
<PAGE>   60

SIGNATURES

Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


DATED:     APRIL 14, 1997        HAWTHORNE FINANCIAL CORPORATION


                                 BY:    /S/  SCOTT A. BRALY
                                        ---------------------------------------
                                             SCOTT A. BRALY, PRESIDENT
                                             AND CHIEF EXECUTIVE OFFICER


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE                                                             DATE
---------                                                             ----

<S>                                                               <C>
/S/  SCOTT A. BRALY                                              April 14, 1997
-----------------------------------------------------
SCOTT A. BRALY, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)


/S/  NORMAN A. MORALES                                           April 14, 1997
-----------------------------------------------------
NORMAN A. MORALES, EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)


/S/  MARILYN G. AMATO                                            April 14, 1997
-----------------------------------------------------
MARILYN G. AMATO, DIRECTOR


/S/  TIMOTHY R. CHRISMAN                                         April 14, 1997
-----------------------------------------------------
TIMOTHY R. CHRISMAN, CHAIRMAN OF THE BOARD


/S/  R. MICHAEL HALL                                             April 14, 1997
-----------------------------------------------------
R. MICHAEL HALL, DIRECTOR


/S/  CHARLES S. JACOBS                                           April 14, 1997
-----------------------------------------------------
CHARLES S. JACOBS, DIRECTOR


/S/  ANTHONY W. LIBERATI                                         April 14, 1997
-----------------------------------------------------
ANTHONY W. LIBERATI, DIRECTOR


/S/  HARRY F. RADCLIFFE                                          April 14, 1997
-----------------------------------------------------
HARRY F. RADCLIFFE, DIRECTOR


/S/  HOWARD E. RITT                                              April 14, 1997
-----------------------------------------------------
HOWARD E. RITT, DIRECTOR


/S/  ROBERT C. TROOST                                            April 14, 1997
-----------------------------------------------------
ROBERT C. TROOST, DIRECTOR
</TABLE>


                                       59
<PAGE>   61
              FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                        AS OF DECEMBER 31, 1996 AND 1995

                       THREE YEARS ENDED DECEMBER 31, 1996



                                      F-1
<PAGE>   62

                                 C O N T E N T S


<TABLE>
<CAPTION>
                                                                    PAGE
                                                                    ----
<S>                                                                 <C>
INDEPENDENT AUDITORS' REPORT                                        F-3

CONSOLIDATED FINANCIAL STATEMENTS

     CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION                 F-4

     CONSOLIDATED STATEMENTS OF OPERATIONS                          F-6

     CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY                F-7

     CONSOLIDATED STATEMENTS OF CASH FLOWS                          F-8

     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                     F-10

MANAGEMENT'S ASSERTION REPORT                                       F-44

INDEPENDENT ACCOUNTANTS' REPORT                                     F-46
</TABLE>



                                      F-2
<PAGE>   63

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders
Hawthorne Financial Corporation
El Segundo, California:


      We have audited the accompanying consolidated statements of financial
condition of Hawthorne Financial Corporation and Subsidiary (the "Company") as
of December 31, 1996 and 1995 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1996. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based upon our audits.

      We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

      In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial condition of Hawthorne Financial
Corporation and Subsidiary as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.

DELOITTE & TOUCHE LLP


January 31, 1997
Los Angeles,  California


                                      F-3
<PAGE>   64

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

                           (DOLLARS ARE IN THOUSANDS)

ASSETS

<TABLE>
<CAPTION>
                                                                                             DECEMBER 31,
                                                                                   ---------------------------------
                                                                                        1996              1995
                                                                                   ---------------   ---------------
<S>                                                                                <C>               <C>
Cash and cash equivalents (NOTE B)                                                      $  93,978         $  14,015

Investment securities-available-for-sale, at market (NOTE C)                               38,371            62,793

Loans receivable (net of allowance for
    estimated credit losses of $13,515 in 1996
    and $15,192 in 1995) (NOTE D)                                                         672,401           617,328

Real estate owned (net of allowance for
    estimated losses of $11,871 in 1996
    and $15,725 in 1995) (NOTE E)                                                          20,140            37,905

Accrued interest receivable                                                                 4,781             3,583

Investment in capital stock of Federal
    Home Loan Bank - at cost                                                                6,788             6,312

Office property and equipment - at cost,
    net (NOTE F)                                                                            4,729             9,597

Deferred tax asset, net (NOTE I)                                                            4,243

Other assets                                                                                1,764             2,050
                                                                                   ---------------   ---------------
                                                                                        $ 847,195         $ 753,583
                                                                                   ===============   ===============
</TABLE>


     The accompanying notes are an integral part of these statements.



                                      F-4
<PAGE>   65

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

           CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED

                  (DOLLARS ARE IN THOUSANDS EXCEPT PAR VALUES)

LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                              DECEMBER 31,
                                                                                        -------------------------
                                                                                           1996          1995
                                                                                        -----------   -----------
<S>                                                                                      <C>           <C> 
Liabilities
    Deposits (NOTE G)                                                                    $ 717,809     $ 698,008
    Short-term borrowings (NOTE H)                                                          50,000
    Accounts payable and other liabilities                                                  23,157         4,603
    Senior notes (NOTE L)                                                                   12,307        12,006
                                                                                        -----------   -----------
                                                                                           803,273       714,617
Commitments and contingencies (NOTE P)

Stockholders' equity (NOTES L and M)
    Preferred stock - $0.01 par value; authorized 10,000,000 shares
        Cumulative preferred stock, series A: liquidation preference,
          $50 per share; authorized, 270 shares; outstanding, 270 shares Common
    stock - $0.01 par value; authorized, 20,000,000 shares;
        issued and outstanding, 2,604,675 shares                                                26            26
    Capital in excess of par value - cumulative preferred stock, series A                   11,592        11,592
    Capital in excess of par value - common stock                                            7,745         7,745
    Unrealized gain (loss) on available-for-sale securities                                   (132)            6
    Retained earnings                                                                       24,858        19,788
                                                                                        -----------   -----------
                                                                                            44,089        39,157

 Less
    Treasury stock, at cost - 5,400 shares                                                     (48)          (48)
    Loan to Employee Stock Ownership Plan (NOTE K)                                            (119)         (143)
                                                                                        -----------   -----------
                                                                                            43,922        38,966
                                                                                        -----------   -----------
                                                                                         $ 847,195     $ 753,583
                                                                                        ===========   ===========
</TABLE>


     The accompanying notes are an integral part of these statements.



                                      F-5
<PAGE>   66

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS

                (DOLLARS ARE IN THOUSANDS, EXCEPT PER SHARE DATA)



<TABLE>
<CAPTION>
                                                                               YEARS ENDED DECEMBER 31,
                                                                   --------------------------------------------------
                                                                       1996              1995              1994
                                                                   --------------   ---------------   ---------------
<S>                                                                   <C>               <C>               <C>       
Interest revenues
    Loans (NOTE D)                                                    $   62,152        $   47,778        $   47,751
    Investments                                                            5,632             2,399             4,523
    Mortgage-backed securities                                                               3,209             2,963
                                                                   --------------   ---------------   ---------------
                                                                          67,784            53,386            55,237
                                                                   --------------   ---------------   ---------------
Interest costs
    Deposits (NOTE G)                                                     35,568            33,593            29,694
    Borrowings (NOTE H)                                                    2,471               801               749
    Senior notes                                                           1,921                92
                                                                   --------------   ---------------   ---------------
                                                                          39,960            34,486            30,443
                                                                   --------------   ---------------   ---------------
Net interest income before contractual interest
  on nonaccrual loans                                                     27,824            18,900            24,794

Contractual interest due on nonaccrual loans (NOTE A)                     (2,430)           (2,392)           (5,666)
                                                                   --------------   ---------------   ---------------
Net interest income                                                       25,394            16,508            19,128
Provision for credit losses (NOTE D)                                       7,489            14,895             5,298
                                                                   --------------   ---------------   ---------------
Net interest income after provision for
   credit losses                                                          17,905             1,613            13,830

Noninterest revenues                                                       1,927             1,311             1,973
Noninterest expenses
    Employee                                                               9,800            10,118            10,740
    Occupancy                                                              2,890             2,841             2,780
    Operating                                                              4,565             3,539             5,002
    Professional                                                           1,615             1,579             2,816
    SAIF premium and OTS assessment                                        2,152             2,213             2,557
    Goodwill amortization (NOTE A)                                            24                49                16
                                                                   --------------   ---------------   ---------------
                                                                          21,046            20,339            23,911
                                                                   --------------   ---------------   ---------------
Real estate operations (NOTE E)                                             (956)             (436)            2,433
Gain on sale of loans                                                        437                68
Gain on sale of securities                                                   248             2,954
Disposition of deposits and premises (NOTE J)                              6,413              (117)            2,835
Other revenues (expenses), net                                            (3,803)            1,346
                                                                   --------------   ---------------   ---------------
Net earnings (loss) before income taxes                                    1,125           (13,600)           (2,840)
Income tax benefit (expense) (NOTE I)                                      6,382              (617)             (123)
                                                                   --------------   ---------------   ---------------
Net earnings (loss)                                                   $    7,507        $  (14,217)       $   (2,963)
                                                                   ==============   ===============   ===============
Net earnings (loss) available for Common                              $    5,704        $  (14,341)       $   (2,963)
                                                                   ==============   ===============   ===============
Net earnings (loss) per share (NOTE A)                                $    1.11         $    (5.52)       $    (1.14)
                                                                   ==============   ===============   ===============
Weighted average shares                                                    5,141             2,599             2,599
                                                                   ==============   ===============   ===============
</TABLE>


     The accompanying notes are an integral part of these statements.



                                      F-6
<PAGE>   67

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                           (DOLLARS ARE IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                              CAPITAL IN
                                                                              CAPITAL IN       EXCESS OF       UNREALIZED
                                                             CUMULATIVE        EXCESS OF      PAR VALUE-       GAIN (LOSS)
                                                              PREFERRED       PAR VALUE-       PREFERRED      ON MARKETABLE
                                               COMMON          STOCK,           COMMON          STOCK,           EQUITY
                                                STOCK         SERIES A           STOCK         SERIES A        SECURITIES
                                           --------------- ---------------  --------------- ---------------  --------------
<S>                                        <C>             <C>               <C>             <C>             <C>
 BALANCE AT DECEMBER 31, 1993                 $     2,605                      $     2,921                     $     1,573
 UNREALIZED GAINS (LOSSES)                                                                                            (180)
 NET EARNINGS (LOSS)
 REPAYMENTS
                                           --------------- ---------------  --------------- ---------------  --------------
 BALANCE AT DECEMBER 31, 1994                       2,605                            2,921                           1,393
 CHANGE IN PAR VALUE OF COMMON
   STOCK                                           (2,579)                           2,579
 ISSUANCE OF PREFERRED STOCK                                                                        12,760
 ISSUANCE OF WARRANTS                                                                2,245
 OFFERING COSTS                                                                                     (1,168)
 UNREALIZED GAINS (LOSSES)                                                                                          (1,387)
 NET EARNINGS (LOSS)
 ACCRUED DIVIDENDS ON PREFERRED
   STOCK
 REPAYMENTS
                                           --------------- ---------------  --------------- ---------------  --------------
 BALANCE AT DECEMBER 31, 1995                          26                            7,745          11,592               6
 UNREALIZED GAINS (LOSSES)                                                                                            (138)
 NET EARNINGS (LOSS)
 ACCRUED DIVIDENDS ON PREFERRED
   STOCK
 REPAYMENTS
                                           --------------- ---------------  --------------- ---------------  --------------
 BALANCE AT DECEMBER 31, 1996                 $        26     $                $     7,745     $    11,592     $      (132)
                                           --------------- ---------------  --------------- ---------------  --------------
</TABLE>



<TABLE>
<CAPTION>
                                                                               LOANS TO
                                                                               EMPLOYEE
                                                                                 STOCK           TOTAL
                                              RETAINED        TREASURY         OWNERSHIP      STOCKHOLDERS'
                                              EARNINGS          STOCK            PLAN           EQUITY
                                           --------------- ---------------  --------------- ---------------
<S>                                        <C>             <C>              <C>             <C>        
 BALANCE AT DECEMBER 31, 1993                 $    37,085     $       (48)     $      (187)    $    43,949
 UNREALIZED GAINS (LOSSES)                                                                            (180)
 NET EARNINGS (LOSS)                               (2,963)                                          (2,963)
 REPAYMENTS                                                                             21              21
                                           --------------- ---------------  --------------- ---------------
 BALANCE AT DECEMBER 31, 1994                      34,122             (48)            (166)         40,827
 CHANGE IN PAR VALUE OF COMMON
   STOCK
 ISSUANCE OF PREFERRED STOCK                                                                        12,760
 ISSUANCE OF WARRANTS                                                                                2,245
 OFFERING COSTS                                                                                     (1,168)
 UNREALIZED GAINS (LOSSES)                                                                          (1,387)
 NET EARNINGS (LOSS)                              (14,217)                                         (14,217)
 ACCRUED DIVIDENDS ON PREFERRED
   STOCK                                             (117)                                            (117)
 REPAYMENTS                                                                             23              23
                                           --------------- ---------------  --------------- ---------------
 BALANCE AT DECEMBER 31, 1995                      19,788             (48)            (143)         38,966
 UNREALIZED GAINS (LOSSES)                                                                            (138)
 NET EARNINGS (LOSS)                                7,507                                            7,507
 ACCRUED DIVIDENDS ON PREFERRED
   STOCK                                           (2,437)                                          (2,437)
 REPAYMENTS                                                                             24              24
                                           --------------- ---------------  --------------- ---------------
 BALANCE AT DECEMBER 31, 1996                 $    24,858     $       (48)     $      (119)    $    43,922
                                           --------------- ---------------  --------------- ---------------
</TABLE>


     The accompanying notes are an integral part of these statements.




                                      F-7
<PAGE>   68
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                           (DOLLARS ARE IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                           YEARS ENDED DECEMBER 31,
                                                                  -------------------------------------------
                                                                      1996           1995            1994
                                                                  -------------   ------------    -----------
<S>                                                                   <C>            <C>             <C>     
NET CASH FROM OPERATING ACTIVITIES
    Net earnings (loss)                                               $  7,507       $(14,217)       $(2,963)
    Adjustments
        Provision (benefit) for income taxes                            (4,257)
        Provision for estimated credit losses                            7,489         14,895          5,298
        Provision for estimated credit losses
          on real estate owned                                           3,511          5,100
        Net gain on sale of branches                                    (6,413)           117         (2,835)
        Net gain on sale of securities                                    (248)        (2,954)
        Net gain on sale of real estate owned                           (1,769)        (2,467)        (2,980)
        Net gain from sale of other assets                                (462)           (68)
        Loan fee and discount accretion                                 (3,537)        (2,061)          (834)
        Depreciation and amortization                                    1,654          1,441            717
        FHLB dividends                                                    (393)          (332)          (325)
        Goodwill amortization                                               24             49             16
        Decrease (increase) in:
            Accrued interest receivable                                 (1,275)           (41)            27
            Income tax assets                                                           2,630         22,767
            Other assets                                                  (485)        (1,018)          (653)
        Increase (decrease) in other liabilities                        14,616         (1,840)        (1,687)
        Other, net                                                        (219)            81
                                                                  -------------   ------------    -----------
        Net cash provided by operating activities                       15,743           (685)        16,548
                                                                  -------------   ------------    -----------

NET CASH FLOWS FROM INVESTING ACTIVITIES
    Investment securities
        Purchases                                                     (139,779)       (62,792)       (25,237)
        Maturities                                                     129,576                        47,000
        Sales proceeds                                                  34,857         44,333
    Mortgage-backed securities
        Purchases                                                                                    (34,855)
        Principal amortization                                              33          7,007          6,350
        Sales proceeds                                                                 50,459
    Loans
        New loans funded                                              (204,914)      (143,236)       (24,677)
        Construction disbursements                                     (61,676)       (16,799)        (3,092)
        Payoffs                                                         72,897         27,760         52,178
        Sales proceeds                                                 130,413         19,282
        Principal amortization                                          21,056         16,494         14,902
        Other, net                                                     (13,137)           503
    Real estate
        Sale proceeds                                                   26,674         41,176         75,612
        Capitalized costs                                              (12,015)       (15,209)       (21,485)
        Other, net                                                          (4)                          217
    Redemption of FHLB stock                                                            1,015            802
    Office property and equipment
        Sales proceeds                                                   4,566            795          5,782
        Additions                                                         (441)        (1,767)        (4,892)
                                                                  -------------   ------------    -----------
        Net cash (used) provided by investing activities               (11,894)       (30,979)        88,605
                                                                  -------------   ------------    -----------
</TABLE>


     The accompanying notes are an integral part of these statements.



                                       F-8

<PAGE>   69

              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

              CONSOLIDATED STATEMENTS OF CASH FLOWS-CONTINUED

                           (DOLLARS ARE IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                    YEARS ENDED DECEMBER 31,
                                                                           -------------------------------------------
                                                                              1996           1995            1994
                                                                           ------------  -------------    ------------
<S>                                                                        <C>           <C>               <C>      
NET CASH FLOWS FROM FINANCING ACTIVITIES
    Payment for sale of deposits                                              (178,884)       (16,807)       (183,260)
    Net change in deposits                                                     204,973         65,698           6,107
    Net change in borrowings                                                    50,000        (47,141)         47,141
    Collection of ESOP loan                                                         25             23              21
    Increase in senior notes                                                                   12,006
    Net proceeds from issuance of preferred stock                                              11,592
    Net proceeds from issuance of warrants                                                      2,245
                                                                           ------------  -------------    ------------
        Net cash provided (used) by financing activities                        76,114         27,616        (129,991)
                                                                           ------------  -------------    ------------
INCREASE (DECREASE) IN CASH
    AND CASH EQUIVALENTS                                                        79,963         (4,048)        (24,838)
CASH AND CASH EQUIVALENTS
    AT BEGINNING OF YEAR                                                        14,015         18,063          42,901
                                                                           ------------  -------------    ------------
CASH AND CASH EQUIVALENTS
    AT END OF YEAR                                                            $ 93,978       $ 14,015        $ 18,063
                                                                           ============  =============    ============
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
    Cash paid during the year for
        Interest                                                              $ 39,672       $ 34,815        $ 30,164
        Income taxes                                                               175

    Non-cash investing and financing activities
        Real estate acquired in settlement of loans                             21,486         38,275          85,703
        Loans originated to finance sales of real estate owned                  18,141         15,996          13,411
        Net change in unrealized losses on
            available-for-sale securities                                         (113)        (1,393)           (180)

    Transfer of held-to-maturity securities to available-for-sale                              30,168

    Loan activity
        Total commitments and permanent fundings                              $332,325       $197,376        $ 45,004
        Less:
            Change in undisbursed funds on construction
              commitments                                                      (31,914)       (16,095)         (3,824)
            Loans originated to finance property sales                         (18,141)       (15,996)        (13,411)
            Undisbursed portion of new lines of credit                         (15,680)        (5,250)
                                                                           ============  =============    ============
        Net construction disbursements and loans funded                       $266,590       $160,035        $ 27,769
                                                                           ============  =============    ============
</TABLE>


     The accompanying notes are an integral part of these statements.



                                      F-9
<PAGE>   70

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE A - SUMMARY OF ACCOUNTING POLICIES

A summary of the significant accounting policies applied in the preparation of
the accompanying consolidated financial statements are set forth in the sections
which follow.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include accounts of Hawthorne Financial
Corporation ("Company") and its wholly-owned subsidiary, Hawthorne Savings,
F.S.B. ("Bank"). All material intercompany transactions and accounts have been
eliminated.

NATURE OF OPERATIONS

Hawthorne Savings is principally engaged in the business of attracting deposits
from the general public and using those deposits, together with borrowings and
other funds, to originate residential and income property real estate loans. The
Bank's principal sources of revenue are interest earned on mortgage loans and
investment securities, and fees received in connection with various deposit
account services and miscellaneous loan processing activities. The Bank's
principal expenses are interest paid on deposit accounts and the costs necessary
to operate the Bank.

CASH AND CASH EQUIVALENTS

The Bank, in accordance with regulations, must maintain qualifying liquid assets
at an average monthly balance of not less than 5% of the average of all deposit
accounts and other borrowings due in less than one year, and short-term
qualifying liquid assets at an average monthly balance of not less than 1% of
the average of all deposit accounts and other borrowings due in less than one
year. Liquid assets consists primarily of cash, certificates of deposit and
overnight investments. In addition, bankers' acceptances, and certain U.S.
Government securities, corporate notes and mortgage-backed securities are liquid
assets for regulatory purposes.

In the consolidated statements of cash flows, cash and cash equivalents include
cash, amounts due from banks, interest-bearing deposits, certificates of deposit
and overnight investments.

INVESTMENT SECURITIES

The Company classifies debt and equity securities upon acquisition into one of
three categories: held-to-maturity, available-for-sale, or trading. Debt
securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized
cost. Debt and equity securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities
and reported at fair value, with unrealized gains and losses included in
earnings. Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale securities
and reported at fair value, with unrealized gains and losses excluded from
earnings and reported in a separate component of stockholders' equity. At
December 31, 1996 and 1995, all debt investment securities are classified as
available-for-sale.

In November 1995, the Financial Accounting Standards Board ("FASB") issued a
"Guide to Implementation of Statement 115 on Accounting for Certain Investments
in Debt and Equity Securities: Questions and Answers" (the "Guide"). The Guide
allowed for a onetime assessment of the classification of all securities and, in
connection with such assessment, permitted the reclassification of securities
from the held-to-maturity classification to the available-for-sale as of a
single date no later than December 31, 1995, without calling into question
management's intent to hold to maturity the remaining securities classified as
held-to-maturity. On December 8, 1995, the Bank transferred 



                                      F-10
<PAGE>   71
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


$48,287,000 of securities from held-to-maturity to available-for-sale for the
purposes of subsequently selling the securities and improving the Bank's
risk-based capital ratio. The Bank sold the securities in December 1995, which
resulted in a realized loss of $9,643.

LOANS RECEIVABLE

The Company defers all loan fees, net of certain direct costs associated with
originating loans, and amortizes these net deferred fees into interest revenue
as a yield adjustment over the lives of the loans using the interest method for
permanent loans and the straight-line method for construction loans. When a loan
is paid off, any unamortized net deferred fees are recognized in interest
income.

Interest on loans is recognized in revenue as earned and is accrued only if
deemed collectible. Loans one or more payments delinquent are placed on
nonaccrual status, meaning that the Company stops accruing interest on such
loans and reverses any interest previously accrued but not collected. A
nonaccrual loan may be restored to accrual status when delinquent principal and
interest payments are brought current and future monthly principal and interest
payments are expected to be collected.

All loans are classified as held-to-maturity as the Company has the current
intent and ability to hold these loans in portfolio until maturity.

REAL ESTATE OWNED

Properties acquired through foreclosure, or deed in lieu of foreclosure ("real
estate owned"), are carried at the lower of cost or estimated fair value of the
property. Subsequent declines in fair value, if any, are accounted for through
the establishment of a specific reserve on the property. The determination of a
property's estimated fair value incorporates (1) revenues projected to be
realized from disposal of the property, less (2) construction and renovation
costs, (3) marketing and transaction costs and (4) holding costs (e.g., property
taxes, insurance and homeowners' association dues). For multiple-unit
residential construction and land developments, these projected cash flows are
discounted utilizing a market rate of return to determine their fair value.

LOAN IMPAIRMENT

On January 1, 1995 the Company adopted SFAS No. 114, "Accounting by Creditors
for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors
for Impairment of a Loan-Income Recognition and Disclosures." This statement
amends SFAS No. 5, "Accounting for Contingencies" and SFAS No. 15, "Accounting
by Debtors and Creditors for Troubled Debt Restructurings." This statement
prescribes that a loan is impaired when it is probable that the creditor will be
unable to collect all contractual principal and interest payments under the
terms of the loan agreement. This statement generally requires impaired loans to
be measured based on the present value of expected future cash flows discounted
at the loan's effective interest rate or, as an expedient, at the loan's
observable market price or the fair value of the collateral if the loan is
collateral-dependent. Creditors may select the measurement method on a loan by
loan basis, except that collateral dependent loans must be measured at the
estimated fair value of the collateral less estimated selling costs if
foreclosure is probable. The Company has chosen to measure impairment based on
the fair value of the underlying collateral. The statement also prescribes
measuring impairment of a restructured loan by discounting the total expected
future cash flows at the loan's effective rate of interest in the original loan
agreement. The effect of initially adopting this statement was not material to
the results of operations or the financial position of the Company.



                                      F-11
<PAGE>   72

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


ALLOWANCE FOR ESTIMATED CREDIT AND REAL ESTATE LOSSES

Management establishes specific reserves for losses on individual real estate
loans and properties when it has determined that recovery of the Company's gross
investment is not likely and when the amount of loss can be reasonably
determined. In making this determination, management considers (1) the current
status of the asset, (2) the probable future status of the asset, (3) the value
of the asset or underlying collateral, and (4) management's intent with respect
to the asset. In quantifying the loss, if any, associated with individual loans
and properties, management utilizes external sources of information (i.e.,
appraisals, price opinions from real estate professionals, comparable sales data
and internal estimates). In establishing specific reserves, management estimates
the revenues expected to be generated from disposal of the Company's collateral
or owned property, less construction and renovation costs (if any), holding
costs and transaction costs. For multiple-unit residential construction and land
developments, the resulting projected net cash flows are discounted utilizing a
market rate of return to determine their fair value.

Management establishes general reserves against the Company's portfolio of real
estate loans and properties. Generally, such reserves are established for each
segment of the Company's loan and property portfolios, including loans secured
by, and properties represented by, single family homes, multi-family dwellings,
commercial properties, residential construction developments and land parcels.
In establishing general reserves, management incorporates (1) the recovery rate
for similar properties previously sold by the Company, (2) valuations of groups
of similar assets, (3) the probability of future adverse events (i.e.,
performing loans which become nonperforming, loans in default which proceed
through to foreclosure) and (4) guidelines published by the Office of Thrift
Supervision ("OTS").

When a specific reserve has been established for a particular loan and the
collateral for that loan is subsequently foreclosed upon, the loan is
transferred to real estate owned at the estimated fair value of the underlying
collateral. The net carrying value of the property following foreclosure is,
therefore, the estimated fair value of the property, net of any specific
reserves which may be established after foreclosure due to a subsequent decline
in fair value. In many instances following foreclosure, these properties require
significant time for the completion of construction and their marketing and
eventual sale. During this period, estimates of future revenues and costs can,
and do, vary, requiring changes in the amount of specific reserves allocated to
individual properties.

For multiple-unit, for-sale housing developments, the actual loss incurred from
the sale of individual units is charged against previously established specific
reserves when all of the foreclosed units within the project have been sold. For
individual assets, the actual loss is charged against previously established
specific reserves when the property is sold.

Based upon periodic analysis of future recoverability, changes in specific
reserves established for the Company's property portfolio are charged to real
estate operations.

DEPRECIATION AND AMORTIZATION

Depreciation is provided in amounts sufficient to relate the cost of depreciable
assets to operations over their estimated service lives, on a straight-line
basis. Buildings are depreciated over their estimated useful lives ranging from
twenty to thirty years on a straight-line basis. Leasehold improvements are
amortized over the lives of their respective leases or the service lives of the
improvements, whichever is shorter. Original issuance costs of $1.2 million, as
of December 1995, associated with the Senior Notes have been capitalized and are
being amortized over the life of the debt, which is five years.



                                      F-12
<PAGE>   73
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


INCOME TAXES

The Company and its subsidiary file a consolidated federal income tax return and
a combined state franchise tax return on a fiscal year ending September 30.

Deferred tax assets and liabilities represent the tax effects, calculated at
currently effective tax rates, of future deductible or taxable amounts
attributable to events that have been recognized on a cumulative basis in the
financial statements.

INTEREST RATE CAPS

Premiums paid for purchased interest rate cap agreements are amortized to
interest expense over the term of the caps. Unamortized premiums are included in
other assets in the statement of financial position. Amounts receivable under
cap agreements are accrued as a reduction of interest expense. The Company was a
party to one interest rate cap agreement with a notional amount of $450.0
million at December 31, 1995 that expired in March 1996.

EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED

In 1994, the Company recorded excess of cost over fair value of $244,000 as
goodwill resulting from the acquisition of one branch facility. The amount was
being amortized over five years. However the facility was sold in 1996, at which
time the remaining balance was offset against the gain on sale.

STOCK BASED COMPENSATION PLANS

The Company applies APB Opinion No. 25 and related Interpretations in accounting
for its plans. In 1995, the FASB issued SFAS No. 123, "Accounting for
Stock-Based Compensation", which encourages companies to account for stock
compensation awards based on the fair value at the date the awards are granted.
This statement does not require the application of the fair value method and
allows the continuance of the current accounting method, which requires
accounting for stock compensation awards based on their intrinsic value as of
the grant date. However, SFAS No. 123 requires pro forma disclosure of net
income and, if presented, earnings per share, as if the fair value based method
of accounting defined in this statement had been applied. See NOTE K.

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Significant estimates include
estimates of the allowance for loan losses, valuation of real estate owned, fair
value of stock options and fair values of financial instruments.

IMPAIRMENT OF LONG-LIVED ASSETS

On January 1, 1996, the Bank adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of."
This statement requires that long-lived assets, certain identifiable
intangibles, and goodwill related to those assets to be held and used or
disposed of be reviewed for impairment based on the fair value of the assets.
Furthermore, this statement requires that certain long-lived assets and
identifiable intangibles to be disposed of be reported at the lower of
historical cost or fair value less cost to sell. The adoption of SFAS No. 121
did not have a material impact on operations in 1996.



                                      F-13
<PAGE>   74
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


RECENT ACCOUNTING PRONOUNCEMENTS

In June 1996, the Financial Accounting Standards Board issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." This statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishment of liabilities,
and is applied prospectively to financial statements for fiscal years beginning
after December 31, 1996. In 1996, the FASB also issued SFAS No. 127, "Deferral
of the Effective Date of Certain Provisions of FASB Statement No. 125," which
defers for one year the effective date of certain provisions within SFAS No.
125. The Company does not believe that adoption of SFAS Nos. 125 and 127 will
have a material impact on its operations and financial position.

RECLASSIFICATIONS

Certain amounts in the 1995 and 1994 consolidated financial statements have been
reclassified to conform with classifications in 1996.

EARNINGS PER SHARE CALCULATION

The table below sets forth the Company's earnings per share calculations for the
years ended December 31, 1996, 1995 and 1994. The Modified Treasury Stock Method
was the method used for 1996 as prescribed under Generally Accepted Accounting
Principles ("GAAP"). All other calculations shown for 1996, using alternate
methods, are for informational purposes only. In the table below, (1) Warrants
refers to the warrants issued by the Company in December 1995, which have an
exercise price of $2.25 per share and can be exercised beginning three years
from the issue date and for a period of ten years from the issue date, and (2)
Preferred Stock refers to the Cumulative Perpetual Preferred Stock issued by the
Company in December 1995, which carries an annual dividend equal to 18% of the
face amount of the Preferred Stock, permits dividends thereon to be paid, under
certain circumstances, in equivalent value of the Company's common stock and has
an initial dividend payment in June 1997.

<TABLE>
<CAPTION>
                                                                        YEARS ENDED DECEMBER 31,
                                                  ---------------------------------------------------------------------
                                                                    1996                          1995         1994
                                                  -----------------------------------------    ------------  ----------
                                                   MODIFIED
                                                   TREASURY                ACTUAL SHARES,
                                                    STOCK       ACTUAL        WARRANTS,          ACTUAL       ACTUAL
                                                    METHOD      SHARES       AND OPTIONS         SHARES       SHARES
                                                  -----------  ----------  ----------------    ------------  ----------
<S>                                                <C>         <C>         <C>                 <C>            <C>  
SHARES OUTSTANDING
   Common                                              2,599       2,599             2,599           2,599       2,599
   Warrants                                            2,376           -             2,376               -           -
   Options                                               686           -               686               -           -
   Less Treasury shares                                 (520)          -                 -               -           -
                                                  -----------  ----------  ----------------    ------------  ----------
   Total                                               5,141       2,599             5,661           2,599       2,599
                                                  ===========  ==========  ================    ============  ==========
STOCKHOLDERS' EQUITY
   Common                                            $32,330     $32,330      $     32,330        $ 27,374     $40,827
   Warrants                                            5,346           -             5,346               -           -
   Options                                             3,482           -             3,482               -           -
   Less Treasury shares (2)                           (3,595)          -                 -               -           -
                                                  -----------  ----------  ----------------    ------------  ----------
   Total                                             $37,563     $32,330      $     41,158        $ 27,374     $40,827
                                                  ===========  ==========  ================    ============  ==========
NET EARNINGS (LOSS)
   Net earnings for the period                       $ 7,507                                      $(14,217)    $(2,963)
   Partial reduction in interest expense (1)             627
   Preferred stock dividends                          (2,430)                                         (124)
                                                  -----------                                  ------------  ----------
   Adjusted earnings available
     for Common                                      $ 5,704                                      $(14,341)    $(2,963)
                                                  ===========                                  ============  ==========
BOOK VALUE PER SHARE                                 $  7.31     $ 12.44      $       7.27        $  10.53     $ 15.71
                                                  ===========  ==========  ================    ============  ==========
EARNINGS PER SHARE                                   $  1.11     $  1.95      $       0.89        $  (5.52)    $ (1.14)
                                                  ===========  ==========  ================    ============  ==========
</TABLE>
---------------------
(1)  Under the Modified Treasury Stock Method, it is assumed that the Company
     will use proceeds from the proforma exercise of the Warrants and Options to
     acquire 20% of the actual shares currently outstanding (Treasury shares)
     and use any remaining assumed proceeds to reduce the outstanding balance of
     the Company's Senior Notes.

(2)  Treasury shares were assumed to be repurchased at the average closing stock
     price for the period.


                                      F-14
<PAGE>   75
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)

NOTE B - CASH AND CASH EQUIVALENTS

Cash and cash equivalents at December 31 consist of the following:

                                            1996           1995
                                        ------------   -----------
Cash                                        $82,578       $ 8,015
Certificates of deposit                         100         1,200
Federal funds sold                           11,300         4,800
                                        ------------   -----------
                                            $93,978       $14,015
                                        ============   ===========


Included in cash at December 31, 1996 is $0.2 million which is restricted
- see NOTE L.

NOTE C - INVESTMENT SECURITIES - AVAILABLE FOR SALE

The cost basis and estimated fair value of investment securities
available-for-sale at December 31 are summarized as follows:

<TABLE>
<CAPTION>
                                                 1996
                       --------------------------------------------------------
                                            GROSS UNREALIZED         ESTIMATED 
                         AMORTIZED     --------------------------       FAIR      
                           COST           GAINS        LOSSES          VALUE
                       --------------  ------------  ------------   -----------
<S>                        <C>              <C>         <C>            <C>    
U.S. Government            $  38,503        $    -      $    132       $38,371
                       --------------  ------------  ------------   -----------
                           $  38,503        $    -      $    132       $38,371
                       ==============  ============  ============   ===========
</TABLE>

<TABLE>
<CAPTION>
                                              1995
                           --------------------------------------------
                                         GROSS UNREALIZED    ESTIMATED  
                            AMORTIZED   ------------------     FAIR       
                              COST      GAINS     LOSSES       VALUE
                           -----------  -------   --------  -----------
<S>                           <C>          <C>       <C>       <C>    
U.S. Government               $62,787      $11       $  5      $62,793
                           -----------  -------   --------  -----------
                              $62,787      $11       $  5      $62,793
                           ===========  =======   ========  ===========
</TABLE>

Within the available-for-sale amounts at year end 1996 and 1995 are restricted
U.S. Government securities purchased with proceeds from the recapitalization of
the Company in December 1995. See NOTE L. These proceeds represent prefunded
interest expense associated with the Senior Notes and had both a cost basis and
fair value of $3.2 million and $4.9 million at December 31, 1996 and 1995,
respectively.



                                      F-15
<PAGE>   76
                HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                 (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The cost basis and estimated fair value of investment securities
available-for-sale at December 31, 1996 are summarized by contractual maturity
as follows:

<TABLE>
<CAPTION>
                                                        ESTIMATED
                                                          FAIR
                                           COST BASIS     VALUE          YIELD
                                           ----------   ----------    ----------
<S>                                        <C>          <C>           <C>  
Due in less than one year                  $    1,605   $    1,598          5.23%
Due in one year through five years             36,898       36,773          5.61%
                                           ----------   ----------    ----------
                                           $   38,503   $   38,371          5.59%
                                           ==========   ==========    ==========
</TABLE>

NOTE D - LOANS RECEIVABLE

Loans receivable at December 31 are summarized as follows:

<TABLE>
<CAPTION>
                                                        1996             1995
                                                    --------------   --------------
<S>                                                  <C>              <C>         
REAL ESTATE LOANS
    PERMANENT
        Single family (1-4 units)
            Estate                                   $    107,891     $     51,142
            Conventional                                  170,038          247,955
            Project concentrations                         61,268           70,748
        Multi-family (five or more units)                 220,707          219,015
        Commercial real estate                             60,388           31,258
        Land                                               14,513            5,579
    RESIDENTIAL CONSTRUCTION
        Single family (1-4)                                56,306           21,987
        Tract development                                  33,791            6,800
OTHER                                                      15,684            1,459
                                                     -------------   --------------
GROSS LOANS RECEIVABLE                                    740,586          655,943

LESS
Participants' share                                        (1,413)          (2,219)
Undisbursed funds                                         (46,646)         (15,208)
Deferred fees and credits, net                             (6,611)          (5,996)
Allowance for estimated credit losses                     (13,515)         (15,192)
                                                     -------------   --------------
NET LOANS RECEIVABLE                                 $    672,401     $    617,328
                                                     =============   ==============
</TABLE>



                                      F-16
<PAGE>   77
                HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                 (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The table below summarizes the maturities for fixed-rate loans and the repricing
intervals for adjustable-rate loans as of December 31, 1996:

<TABLE>
<CAPTION>
                                      PRINCIPAL BALANCE
                         --------------------------------------------
                            FIXED         ADJUSTABLE
INTERVAL                    RATE             RATE           TOTAL
                         ------------    -------------   ------------
<S>                      <C>             <C>             <C>        
1 to 3 months            $     3,010     $    331,931    $   334,941
*3 to 6 months                   351          190,743        191,094
*6 to 12 months               10,252           45,157         55,409
*1 to 2 years                 22,302                          22,302
*2 to 5 years                 22,145                          22,145
*5 to 10 years                 6,558                           6,558
*10 to 20 years               23,491                          23,491
More than 20 years            84,646                          84,646
                         ------------    -------------   ------------
                         $   172,755     $    567,831    $   740,586
                         ============    =============   ============
</TABLE>

* Greater than

The contractual weighted average interest rates on loans at December 31, 1996
and 1995 were 8.75% and 8.25%, respectively.

The table below summarizes nonaccrual loans at December 31 by type of
collateral:

<TABLE>
<CAPTION>
                                                  1996           1995
                                              -------------   ------------
<S>                                           <C>            <C>         
PERMANENT
    Single family (1-4 units)
        Estate                                $      2,824   $      1,300
        Conventional                                 6,432         10,005
        Project concentrations                       7,752          4,140
    Multifamily (5 or more units)                   11,172          4,516
    Land                                               432          1,748
OTHER COLLATERALIZED LOANS                              12
                                              -------------   ------------
                                              $     28,624   $     21,709
                                              =============   ============
</TABLE>

Nonaccrual loans were $28.6 million, $21.7 million and $39.4 million at December
31, 1996, 1995 and 1994, respectively. The interest income recognized for 1996,
1995, and 1994 was $1.9 million, $1.0 million, $1.5 million, respectively. If
these loans had been performing for the entire year the income recognized would
have been $2.8 million, $1.5 million and $2.9 million for 1996, 1995 and 1994,
respectively.



                                      F-17
<PAGE>   78
                HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                 (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The table below summarizes the amounts of interest revenue that would have been
recognized on troubled debt restructurings had borrowers paid at the original
loan interest rate throughout each of the years below, the interest revenue that
would have been recognized based upon the modified interest rate, and the
interest revenue that was included in the consolidated statements of operations
for the periods indicated. For this purpose, troubled debt restructurings
include loans with respect to which (1) the original interest rate was changed
for a defined period of time, (2) the loan's maturity was extended, or (3)
principal or interest payments were suspended for a defined period of time.

<TABLE>
<CAPTION>
                                         PRINCIPAL       ORIGINAL     MODIFIED      RECOGNIZED
                                          BALANCE        INTEREST     INTEREST       INTEREST
                                        ------------    -----------  -----------   --------------
<S>                                     <C>             <C>          <C>            <C>
YEAR ENDED DECEMBER 31, 1996
Construction loans                      $       389     $       43   $       43     $         18
Permanent loans                              38,695          3,716        3,511            3,088
                                        ------------    -----------  -----------   --------------
                                        $    39,084     $    3,759   $    3,554     $      3,106
                                        ============    ===========  ===========   ==============
YEAR ENDED DECEMBER 31, 1995
Permanent loans                         $    24,029     $    1,929   $    1,707     $      1,707
                                        ------------    -----------  -----------   --------------
                                        $    24,029     $    1,929   $    1,707     $      1,707
                                        ============    ===========  ===========   ==============
YEAR ENDED DECEMBER 31, 1994
Construction loans                      $       824     $      113   $       64     $         64
Permanent loans                               9,404            933          633              626
                                        ------------    -----------  -----------   --------------
                                        $    10,228     $    1,046   $      697     $        690
                                        ============    ===========  ===========   ==============
</TABLE>

The table below summarizes the activity within the allowance for estimated
credit losses on loans for the years ended December 31:

<TABLE>
<CAPTION>
                                                         1996          1995          1994
                                                      ----------    ----------     ---------
<S>                                                   <C>           <C>            <C>       
Balance at beginning of year                          $   15,192    $   21,461     $   46,629
Provision for credit losses                                7,489        14,895          5,298
Charge-offs                                               (7,744)       (6,741)          (719)
Transfers to allowance for real estate losses
  and other losses                                        (1,422)      (14,423)       (29,747)
                                                      ----------    ----------     ----------
                                                      $   13,515    $   15,192     $   21,461
                                                      ==========    ==========     ==========
</TABLE>

The Bank is a federally-chartered savings bank engaged in attracting deposits
from the general public and using those deposits, together with borrowings and
other funds, to originate residential real estate loans in areas near its six
branches in Southern California. During the past several years, the Southern
California region has experienced adverse economic conditions, including
declining real estate values. These factors have adversely affected the ability
of certain borrowers to repay loans according to their stated terms. Although
management believes the level of allowance for estimated credit losses on loans
is adequate to absorb losses inherent in the loan portfolio, continuing weakness
in the local economy may result in increasing loan losses that cannot be
reasonably predicted at December 31, 1996.



                                      F-18

<PAGE>   79
                HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                 (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The recorded  investment in loans considered to be impaired under SFAS No. 114
was as follows:

<TABLE>
<CAPTION>
                                                                             DECEMBER 31,
                                                                    ----------------------------
                                                                       1996            1995
                                                                    ------------    ------------
<S>                                                                 <C>             <C>        
Impaired loans without specific loss reserves                       $    43,209     $    50,157
Impaired loans with specific loss reserves                                8,728          13,159
Specific loss reserves allocated to impaired loans                       (2,185)         (3,426)
                                                                    ------------    ------------
Total impaired loans, net of specific loss reserves                 $    49,752     $    59,890
                                                                    ============    ============
Average investment in impaired loans                                $    57,100     $    78,600
Interest income recognized on impaired loans                        $     3,607     $     4,356
</TABLE>

The table below reconciles the principal balance of impaired loans and troubled
debt restructurings (TDRs"), as follows:

<TABLE>
<CAPTION>
                                                                     DECEMBER 31,
                                                              ----------------------------
                                                                 1996            1995
                                                              ------------   -------------
<S>                                                           <C>             <C>        
Total impaired loans                                          $    51,937     $    63,316
Impaired loans 90 days or more days delinquent                    (16,643)        (11,298)
                                                              ------------   -------------
Performing impaired loans                                          35,294          52,018
Impaired loans which are not TDRs                                       -         (27,989)
                                                              ------------   -------------
Performing TDRs                                                    35,294          24,029
TDRs which are 90 days or more delinquent                           3,790               -
                                                              ------------   -------------
Total TDRs(1)                                                 $    39,084     $    24,029
                                                              ============   =============
</TABLE>

(1) At December 31, 1996 TDRs of $16.7 million were classified.

At December 31, 1995, the Company automatically designated as impaired loans
which were delinquent 30-89 days and collateral deficient, or SFR project
concentrations and multifamily loans classified Substandard which were
collateral deficient. That same designation was not applicable at December 31,
1996.

NOTE E - REAL ESTATE OWNED

Real estate owned at December 31 is summarized as follows:

<TABLE>
<CAPTION>
                                                   1996           1995
                                                ------------   ------------
<S>                                             <C>            <C>
Single family (1-4 units)
    Conventional                                $     2,660    $     8,815
    Project concentrations                            7,117          6,419
Multifamily (five or more units)                      3,215         18,877
Commercial                                              346            346
Construction (tract development)                     16,156         15,414
Land                                                  2,517          3,759
                                                ------------   ------------
Gross investment                                     32,011         53,630
Allowance for estimated losses                      (11,871)       (15,725)
                                                ------------   ------------
Net investment                                  $    20,140    $    37,905
                                                ============   ============
</TABLE>



                                      F-19
<PAGE>   80
                HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                 (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The table below summarizes the allowance for estimated losses on real estate
owned for the years ended December 31:

<TABLE>
<CAPTION>
                                                                 1996           1995           1994
                                                              -----------   -----------    -----------
<S>                                                           <C>           <C>            <C>       
Balance at beginning of year                                  $   15,725    $   32,609     $   39,457
Provision for estimated losses                                     3,511         5,100
Transfers from allowance for estimated credit losses               1,422        13,873         29,747
Charge-offs                                                       (8,787)      (35,857)       (36,595)
                                                              -----------   -----------    -----------
Balance at end of year                                        $   11,871    $   15,725     $   32,609
                                                              ===========   ===========    ===========
</TABLE>

Real estate operations for the years ended December 31 are summarized as
follows:

<TABLE>
<CAPTION>
                                                               1996         1995          1994
                                                            -----------   ----------   ------------
<S>                                                         <C>          <C>           <C>         
Expenses associated with real estate owned
    Property taxes                                          $     (135)  $      (35)   $    (1,965)
    Repairs, maintenance and renovation                           (160)        (475)          (361)
    Insurance                                                     (258)        (132)          (329)
                                                            -----------   ----------   ------------
                                                                  (553)        (642)        (2,655)
Net recoveries from sales of properties                          1,769        2,467          2,980
Rental income, net                                               1,339        2,839          2,108
Provision for estimated losses on real estate owned             (3,511)      (5,100)
                                                            -----------   ----------   ------------
                                                            $     (956)  $     (436)   $     2,433
                                                            ===========   ==========   ============
</TABLE>

NOTE F - OFFICE PROPERTY AND EQUIPMENT - AT COST

Office property and equipment at December 31 consists of the following:

<TABLE>
<CAPTION>
                                                                  1996         1995
                                                                ----------   ----------
<S>                                                             <C>          <C>      
Office buildings                                                $   1,140    $   4,520
Furniture and equipment                                             4,191        4,611
Leasehold improvements                                              2,290        2,249
                                                                ----------   ----------
                                                                    7,621       11,380
Less
    Accumulated depreciation and amortization                      (3,082)      (3,225)
    Allowance for estimated loss on disposal of offices                           (753)
                                                                ----------   ----------
                                                                    4,539        7,402
Land                                                                  190        2,195
                                                                ----------   ----------
                                                                $   4,729    $   9,597
                                                                ==========   ==========
</TABLE>
The Company has recognized $1.1 million, $1.0 million and $0.7 million of
depreciation expense for the years 1996, 1995 and 1994, respectively.



                                      F-20
<PAGE>   81
              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                    THREE YEARS ENDED DECEMBER 31, 1996
                (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE G - DEPOSITS

The table below summarizes the balances of and weighted average interest rates
("WAIR") for deposits at December 31:

<TABLE>
<CAPTION>
                                          1996                        1995
                                ------------------------    ------------------------
                                 WAIR        BALANCE         WAIR        BALANCE
                                --------  --------------    --------  --------------
<S>                              <C>           <C>           <C>           <C>     
Money market                     1.46%         $ 18,793      1.42%         $ 34,708
Passbook                         1.68%           22,887      1.82%           30,595
Checking/NOW                     0.99%           28,879      0.22%           29,156
Certificates of deposit
    3.00% or less                                 2,453                         648
    3.01% - 4.00%                                   340                       8,087
    4.01% - 5.00%                                98,425                     132,958
    5.01% - 6.00%                               442,393                     321,507
    6.01% - 7.00%                               103,005                     128,054
    7.01% or more                                   634                      12,295
                                          ==============              ==============
                                 5.10%         $717,809      5.04%         $698,008
                                          ==============              ==============
</TABLE>

Interest expense on deposits, by type of account, for the years ended December
31 is summarized as follows:

<TABLE>
<CAPTION>
                                   1996           1995          1994
                                ------------   -----------   ------------
<S>                             <C>           <C>            <C>        
Checking/NOW                    $       212   $       484    $       208
Passbook                                508           205          1,368
Money market                            365         1,024          2,134
Certificates of deposit              34,483        31,880         25,984
                                ------------   -----------    -----------
                                $    35,568   $    33,593    $    29,694
                                ============   ===========    ===========
</TABLE>



                                      F-21

<PAGE>   82
              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                    THREE YEARS ENDED DECEMBER 31, 1996
                (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)



      The table below sets forth the maturities of the Company's certificates of
deposit outstanding at December 31.

<TABLE>
<CAPTION>
                                                                1996
                             ---------------------------------------------------------------------------
                                                  OVER            OVER
                                              THREE MONTHS     SIX MONTHS
                             THREE MONTHS       THROUGH         THROUGH          OVER
                                OR LESS        SIX MONTHS       ONE YEAR       ONE YEAR        TOTAL
                             --------------  ---------------  -------------  -------------  ------------
<S>                          <C>              <C>             <C>             <C>           <C>        
BALANCES LESS
  THAN $100,000
    3.00% or less            $       2,345    $        -      $       -       $         4   $     2,349
    3.01% - 4.00%                      236              104                                         340
    4.01% - 5.00%                   54,800            4,556          3,239         17,127        79,722
    5.01% - 6.00%                  108,271           91,529         93,528         52,373       345,701
    6.01% - 7.00%                    9,760            6,464         40,078         22,706        79,008
    7.01% or more                      234                                            100           334
                             --------------  ---------------  -------------  -------------  ------------
                                   175,646          102,653        136,845         92,310       507,454
BALANCES GREATER
 THAN OR EQUAL
 TO $100,000
    3.00% or less                      104                                                          104
    3.01% - 4.00%
    4.01% - 5.00%                   12,609                             160          5,934        18,703
    5.01% - 6.00%                   29,449           25,322         30,697         11,224        96,692
    6.01% - 7.00%                    3,554            2,060         13,373          5,010        23,997
    7.01% or more                                       200                           100           300
                             --------------  ---------------  -------------  -------------  ------------
                                    45,716           27,582         44,230         22,268       139,796

TOTAL                        $     221,362    $     130,235   $    181,075    $   114,578   $   647,250
                             ==============  ===============  =============  =============  ============
</TABLE>

<TABLE>
<CAPTION>
                                                                1995
                             ---------------------------------------------------------------------------
                                                  OVER            OVER
                                              THREE MONTHS     SIX MONTHS
                             THREE MONTHS       THROUGH         THROUGH          OVER
                                OR LESS        SIX MONTHS       ONE YEAR       ONE YEAR        TOTAL
                             --------------  ---------------  -------------  -------------  ------------
<S>                          <C>              <C>             <C>             <C>           <C>        
BALANCES LESS
  THAN $100,000
    3.00% or less            $         545    $           2   $       -       $      -      $       547
    3.01% - 4.00%                    5,702            1,636            276             27         7,641
    4.01% - 5.00%                   64,714           16,518         25,675          2,639       109,546
    5.01% - 6.00%                   56,392           53,349        116,277         27,994       254,012
    6.01% - 7.00%                   43,515           12,807         10,977         26,312        93,611
    7.01% or more                      466            1,536          4,643          1,137         7,782
                             --------------  ---------------  -------------  -------------  ------------
                                   171,334           85,848        157,848         58,109       473,139
BALANCES GREATER
 THAN OR EQUAL
 TO $100,000
    3.00% or less                      101                                                          101
    3.01% - 4.00%                      108              338                                         446
    4.01% - 5.00%                   13,800            2,666          5,660          1,286        23,412
    5.01% - 6.00%                   12,549           16,975         31,331          6,640        67,495
    6.01% - 7.00%                   15,112            5,292          5,743          8,296        34,443
    7.01% or more                    1,020            1,191          1,672            630         4,513
                             --------------  ---------------  -------------  -------------  ------------
                                    42,690           26,462         44,406         16,852       130,410

TOTAL                        $     214,024    $     112,310   $    202,254    $    74,961   $   603,549
                             ==============  ===============  =============  =============  ============
</TABLE>



                                      F-22

<PAGE>   83

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE H - SHORT-TERM BORROWINGS

A primary alternate funding source for the Company is a $200.0 million credit
line with the FHLB of San Francisco. The FHLB system functions as a source of
credit to savings institutions which are members of a Federal Home Loan Bank.
Advances are typically secured by the Company's real estate loans and the
capital stock of the FHLB owned by the Company. Subject to the FHLB of San
Francisco's advance policies and requirements, these advances can be requested
for any business purpose in which the Company is authorized to engage. In
granting advances, the FHLB of San Francisco considers a member's
creditworthiness and other relevant factors.

The balance and rate of FHLB advances at December 31, 1996, are summarized as
follows:

<TABLE>
<CAPTION>
    ORIGINAL TERM           PRINCIPAL      RATE
-------------------         -----------    ------
<S>                         <C>             <C>  
9 Months                    $   25,000      5.99%
12 Months                       25,000      6.24%
                            -----------
                            $   50,000      6.12%
                            ===========
</TABLE>

The following schedule summarizes information relating to the Company's FHLB
advances for the periods presented:

<TABLE>
<CAPTION>
                                                      1996
                                                   -----------
<S>                                                <C>
Average balance during the year                    $   41,138
Average interest rate during the year                    6.01%
Maximum month-end balance during the year             100,000
Loans underlying the agreements at year end           360,829
</TABLE>

To supplement its funding needs in the past, the Company entered into reverse
repurchase agreements, in which it sold securities with an agreement to
repurchase the same securities at a specific future date (overnight to 90 days).
The Company entered into such transactions only with dealers determined by
management to be financially strong and who were recognized as primary dealers
in U.S. Treasury securities by the Federal Reserve Board. The following schedule
summarizes information relating to the Company's reverse repurchase agreements
for the periods presented:

<TABLE>
<CAPTION>
                                                                   1995            1994
                                                                -----------    -----------
<S>                                                             <C>            <C>        
Average balance during the year                                 $    10,694    $    14,333
Average interest rate during the year                                  6.06%          5.23%
Maximum month-end balance during the year                            38,575         48,365
Mortgage-backed and agency securities
    underlying the agreements at year end
        Carrying value                                                              55,855
        Estimated market value                                                      52,506
Outstanding reverse repurchase agreements at year end
        Balance                                                                     47,141
        Interest rate                                                                 5.85%
</TABLE>


                                      F-23

<PAGE>   84
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE I - INCOME TAXES

Provision (benefit) for income taxes for the years ended December 31 consists of
the following:

<TABLE>
<CAPTION>
                                1996         1995         1994
                             ------------   --------   ------------
<S>                          <C>            <C>         <C>        
Current
    Federal                  $    (2,139)   $   615     $   (6,333)
    State                                         2              2
                              -----------   --------   ------------
                                  (2,139)       617         (6,331)
                              -----------   --------   ------------
Deferred
    Federal                       (3,087)                    6,454
    State                         (1,156)
                              -----------   --------   ------------
                                  (4,243)                    6,454
                              -----------   --------   ------------
                              $   (6,382)   $   617     $      123
                              ===========   ========   ============
</TABLE>

The components of the net deferred income tax liability (asset) at December 31
are summarized as follows:

<TABLE>
<CAPTION>
                                              1996          1995    
                                          ------------  ------------
<S>                                        <C>           <C>        
Deferred income tax liabilities                                     
    Loan fees                              $    1,234    $    3,391 
    FHLB stock                                  1,170         1,187 
    Depreciation                                  740           719 
    Other                                       1,158           493 
                                          ------------  ------------
                                                4,302         5,790 
                                          ------------  ------------
Deferred income tax assets                                          
    Bad debts                                  (8,140)      (10,637)
    State NOL carryforward                       (703)       (1,545)
    Federal AMT credit carryforward              (936)         (936)
    Federal NOL carryforward                   (5,166)       (7,440)
    Delinquent interest                          (684)         (450)
    Other                                      (1,673)       (1,166)
                                          ------------  ------------
                                              (17,302)      (22,174)
                                          ------------  ------------
Valuation allowance                            (8,757)      (16,384)
                                          ------------  ------------
    Net deferred income tax assets        $    (4,243)  $       --
                                          ============  ============
</TABLE>




                                      F-24

<PAGE>   85
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


At December 31, 1996, the Company had (1) a federal net operating loss
carryforward of $15.2 million expiring in 2009 through 2011, (2) state net
operating loss carryforwards of $2.1 million, $2.2 million, $2.2 million and
$4.0 million expiring in 1998, 1999, 2000 and 2001, respectively and (3) a
federal alternative minimum tax credit carryover of $936,000 which can be
carried forward indefinitely.

The income tax (receivable) liability at December 31 consists of the following:

<TABLE>
<CAPTION>
                                                         1996           1995
                                                      ----------     ----------
<S>                                                   <C>            <C>       
Current
    Federal                                           $              $         
    State
                                                      ----------     ----------
                                                      $              $
                                                      ==========     ==========
Deferred
    Federal
        Income tax asset                              $   (8,997)    $  (12,066)
        Valuation allowance                                5,910         12,066
    State
        Income tax asset                                  (4,002)        (4,318)
        Valuation allowance                                2,846          4,318
                                                      ----------     ----------
                                                      $   (4,243)    $        0
                                                      ==========     ==========
</TABLE>

The table below summarizes the differences between the statutory income tax and
the Company's effective tax for the years ended December 31:

<TABLE>
<CAPTION>
                                                                     1996          1995         1994
                                                                  -----------   -----------   ---------
<S>                                                               <C>           <C>           <C>      
Federal income tax (benefit)                                      $      393    $   (4,760)   $   (994)
Addition (reduction) in rate resulting from
    Valuation allowance                                               (6,090)        4,743       1,966
    Goodwill amortization and charge-off                                  13          (163)       (852)
    California franchise tax, net of federal income taxes               (763)
    Other                                                                 65           797           3
                                                                  -----------   -----------    --------
                                                                  $   (6,382)   $      617     $   123
                                                                  ===========   ===========    ========
</TABLE>



                                      F-25
<PAGE>   86
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                      THREE YEARS ENDED DECEMBER 31, 1996
                  (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)



NOTE J - DISPOSITION OF DEPOSITS AND PREMISES

During 1996, 1995 and 1994, the Company sold certain of its branch deposits and
sold or closed the related branch facilities, consolidated deposits from certain
branches and sold the related facilities, and sold its two owned corporate
office buildings. The table below sets forth the composition of the net gain or
loss realized from these transactions for the years ended December 31:

<TABLE>
<CAPTION>
                                                              1996           1995           1994
                                                          ------------   -----------   -------------
<S>                                                       <C>            <C>            <C>        
Deposits sold                                             $   186,573    $   17,072     $   186,534
                                                          ============   ===========    ============

Net premium received from sales of deposits               $     6,305    $      265     $     3,274

Net gain (loss) on disposition of premises
    Proceeds received                                           1,826           743           5,782
    Net book value at disposition                              (1,479)         (922)         (5,721)
    Provision for loss on disposition                                          (203)           (500)
                                                          ------------   -----------    ------------
    Net gain (loss) from disposition of premises                  347          (382)           (439)

    Other sale-related expenses                                  (239)
                                                          ------------   -----------    ------------
    Net gain (loss)                                       $     6,413    $     (117)    $     2,835
                                                          ============   ===========    ============
</TABLE>

During 1996, three branches were sold with deposits of $186.6 million. The
Company received a premium of $6.3 million on these deposits as well as a net
gain of $0.3 million for the premises, offset by $0.2 million in sale-related
expenses, resulting in a net gain of $6.4 million.

During 1995, one branch was sold with deposits of $17.1 million. The Company
received a premium of $0.3 million on these deposits as well as $0.7 million for
the premises resulting in a gain of $86,000. Also during 1995, an agreement was
reached to sell a branch office facility at year end. The reserve for estimated
loss on this facility was $0.8 million. The sale was completed at no additional
loss to the Company in February 1996.

During 1994, the Company's two owned corporate headquarters buildings were sold.
These sales were financed by the Company and the resulting financings have been
discounted in order to produce a market yield over the contractual terms of the
loans. Including the discounted financings, these two sales produced net
proceeds of $2.3 million compared with a net book value at disposition of $1.9
million.

During 1994, reserves were established for the estimated future net lease
obligations associated with closed branch facilities. During 1993, reserves were
established for the estimated loss associated with the disposition, completed
during 1994, of the Company's owned corporate buildings. During 1993, the
Company wrote-off the remaining balance of intangible assets associated with
certain deposits and branch facilities acquired during the 1980's, based upon
management's conclusion that such intangibles retained no further value. The
branch deposits and related facilities to which these intangibles related were
sold during 1994.



                                      F-26
<PAGE>   87
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE K - EMPLOYEE BENEFIT PLANS

The Company has an Employee Stock Ownership Plan ("ESOP") that previously
covered substantially all employees over 21 years of age who met minimum service
requirements. As of December 15, 1995, the Company froze the ESOP and all
accounts became fully vested and nonforfeitable. At December 31, 1996, the ESOP
owned 154,753 shares of the Company's common stock. As of December 31, 1996, the
Company had a loan receivable from the ESOP of $119,000 collateralized by 7,833
shares of common stock owned by the ESOP.

Effective April 1, 1996, the ESOP was amended to include a 401(k) plan. The
Company makes a matching contribution equal to 100% of the amount each
participant elects to defer up to a maximum of 3% of the participant's
compensation for the calendar quarter. Employees are eligible to participate if
they were employed by the Company on March 1, 1996 or have been employed for 6
months, worked at least 500 hours, and be over 21 years of age.

The Company has a retirement income plan ("Retirement Plan") that previously
covered substantially all employees over 21 years of age who met minimum service
requirements. The Company does not have an accumulated post-retirement benefit
obligation associated with the Retirement Plan at December 31, 1996, as the
assets of the Retirement Plan exceeded the vested benefits of participants. At
that date, participants benefits were fixed at their levels as of May 1989.

The Company has two stock option plans ("Option Plans") which cover the issuance
of stock option grants to (1) executive officers of the Company and (2) certain
other employees of the Company. The purpose for both plans is the rewarding of
exemplary performance by key employees of the Company as well as the recruiting
and retaining of key employees. The Option Plans provide for the issuance of a
maximum of 755,000 shares of common stock of the Company upon exercise of
options. The exercise price of any option may not be less than the fair market
value of the common stock on the date of grant and the term of any option may
not exceed 10 years.

Options to purchase 247,500 shares were granted during 1994 at prices ranging
from $13.48 to $14.75. Subsequent to the initial grants, the Board of Directors
approved a reduction of the option price for all outstanding options to the then
market price for the Company's common stock of $7.22. During 1995, these grants
were canceled and replaced with options to purchase 696,000 shares of which
356,000 of these options were issued to senior executives at an exercise price
of $4.65. The remaining options to purchase 340,000 shares were issued to other
officers at an exercise price of $5.26 per share. During 1996, 46,000 of the
options to purchase 340,000 shares previously granted at $5.26 were canceled and
options to purchase 36,000 shares with an exercise price of $7.81 per share were
granted.


                                      F-27
<PAGE>   88

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
       (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE DATA)


A summary of the status of the Option Plans as of December 31, and changes
during the years ended on those dates, is presented below:

<TABLE>
<CAPTION>
                                                        1996                           1995
                                            --------------------------    ---------------------------
                                                            WEIGHTED                       WEIGHTED
                                                            AVERAGE                        AVERAGE
                                                            EXERCISE                       EXERCISE
                                              SHARES         PRICE           SHARES         PRICE
                                            ------------   -----------    --------------  -----------
<S>                                          <C>           <C>            <C>              <C>       
Outstanding at beginning of year                696,000    $    4.95            247,500   $     7.22
Granted                                          36,000         7.81            696,000         4.95
Exercised                                                                
Terminated                                      (46,000)        5.26           (247,500)        7.22
                                            ------------                  --------------
Outstanding at end of year                      686,000         5.08            696,000         4.95
                                            ============                  ==============
Options exercisable at year end                 226,050                          33,000
                                            ============                  ==============
</TABLE>

The following table summarizes information about stock options outstanding at
December 31, 1996:

<TABLE>
<CAPTION>
                                      WEIGHTED
                                       AVERAGE
                                      REMAINING
 EXERCISE           NUMBER           CONTRACTUAL          NUMBER
  PRICES          OUTSTANDING           LIFE            EXERCISABLE
------------     --------------     --------------     --------------
<S>              <C>                <C>                <C>    
$       4.65           356,000                6.00           118,700
        5.26           294,000                6.59           107,350
        7.81            36,000                8.00  
                 --------------                        --------------
                       686,000                6.35           226,050
                 ==============                        ==============
</TABLE>

If compensation costs for the Company's stock option plans had been determined
based on the fair value at the grant date for awards in 1996 and 1995 consistent
with the provisions of SFAS No. 123, the Company's net earnings and net earnings
per share would have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                         1996          1995
                                                      ---------     ---------
<S>                                                   <C>           <C>      
Net earnings (loss) - as reported                       $7,507      $(14,217)
                                                      =========     =========
Net earnings (loss) - pro forma                         $6,548      $(14,270)
                                                      =========     =========
Net earnings (loss) per share - as reported             $ 1.11      $  (5.52)
                                                      =========     =========
Net earnings (loss) per share - pro forma               $ 0.92      $  (5.54)
                                                      =========     =========
</TABLE>

The fair value of options granted under the Company's stock option plans during
1996 and 1995 were estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used: no
dividend yield, expected volatility of 124%, risk free interest rate of 5.6% and
expected lives of 3 to 5 years.



                                      F-28
<PAGE>   89

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE L - CAPITAL OFFERING

In December 1995, the Company sold $27.0 million of "investment units" at a
price of $500,000 per unit in a private placement offering (the "Offering").
Each investment unit consisted of $250,000 principal amount of the Company's
senior notes ("Senior Notes"), five shares of the Company's cumulative preferred
stock, series A ("Series A Preferred"), and one warrant to purchase 44,000
shares of the Company's common stock ("Warrants"). The Company contributed $19.0
million of the net proceeds of the Offering as qualifying Tier 1 capital to the
Bank during December to satisfy the capital-raising provisions of a Prompt
Correction Action Directive ("PCA") issued in June 1995 by the OTS and enabled
the Bank to meet the quantitative requirements to be categorized as a
"well-capitalized" institution.

Upon completion of the Offering, the Company recorded the Senior Notes, with a
face amount of $13.5 million, at $12.0 million. The Senior Notes bear interest
payable semi-annually at a rate of 12% per annum and have an effective annual
yield of 16.5% after the recording of Original Issue Discount ("OID") of $1.5
million. The OID will be accreted using the constant yield method over the five
year term of the Senior Notes. During 1996 and 1995, the Company recorded
$301,000 and $11,000, respectively, of OID as part of its interest expense. The
Company was obligated to deposit three years of interest ($4.9 million) in a
separate account in which the noteholders have a security interest. Funds in
that account may be invested in certain permitted investments (as defined),
including U.S. Government Securities. See NOTES B and C. After three years,
interest will be payable either in cash or in an equivalent value (determined in
accordance with the relevant agreement) in common stock of the Company.

The Company also recorded the receipt of $12.8 million from the issuance of 270
shares of Series A Preferred with a par value of $.01 as Capital in Excess of
Par Value - Cumulative Preferred Stock, Series A. The Series A Preferred
provides for cumulative dividends, payable quarterly commencing June 1997 at an
annual rate of 18% on the $13.5 million liquidation preference of the stock. The
Company may pay dividends in common stock if the Company does not have the
financial capability of paying the dividends in cash.

The Company recorded $2.2 million of the proceeds from the sale of the units to
the Warrants as additional paid in capital. The Warrants entitle the holders to
purchase up to an aggregate of 2.4 million shares of Common Stock for $2.25 per
share at any time after December 15, 1998. The Warrants will terminate in
December 2005.

The Company incurred offering expenses of $2.3 million which were attributable
evenly to the Senior Notes and the Series A Preferred. The $1.2 million
attributable to the Senior Notes was capitalized and included with other assets
and is being amortized over the five year term of the Senior Notes. During 1996
and 1995, the Company recorded amortization of $234,000 and $11,000 related to
these capitalized expenses. The $1.2 million attributable to the Preferred Stock
has been recorded as a reduction to Capital in Excess of Par Value - Cumulative
Preferred Stock, Series A.

NOTE M - STOCKHOLDERS' EQUITY

Retained earnings, which include bad debt deductions of approximately $25.5
million for federal income tax purposes at December 31, 1996, are restricted and
may be used only for the absorption of losses on loans and real estate acquired
through foreclosure. They are not subject to federal income tax unless used for
other purposes. The Company has not provided for federal income tax on these
amounts, since it is not contemplated that such amounts will be used for
purposes other than to absorb such losses.

Under applicable law and the capital regulations of the OTS promulgated
thereunder (the "Capital Regulations"), savings institutions are subject to
three capital requirements - a "leverage limit," a "tangible capital
requirement" and a "risk-based capital requirement."

The OTS may also establish, on a case-by-case basis, individual minimum capital
requirements for a savings institution which vary from the requirements that
would otherwise apply under the Capital Regulations. 



                                      F-29
<PAGE>   90
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The leverage limit requires each savings institution to maintain "core capital"
of not less than 3.0% of adjusted total assets. "Core Capital" generally
includes common stockholders' equity (including common stock, paid in capital,
and permanent noncumulative preferred stock) less intangible assets (other than
certain mortgage servicing rights and purchased credit card relationships).

The tangible capital requirement requires each savings institution to maintain
"tangible capital" in an amount not less than 1.5% of adjusted total assets.
"Tangible capital" means core capital less any intangible assets (including
supervisory goodwill), plus certain mortgage service rights, subject to certain
limitations.

The risk-based capital requirements provide, among other things, that the
capital ratios applicable to various classes of assets are to be adjusted to
reflect the degree of credit risk deemed to be associated with such assets. In
addition, the asset base for computing a savings institution's risk-based
capital requirement includes certain off-balance sheet items. Generally, the
risk-based capital requirement requires each savings institutions to maintain
"total capital" equal to 8.0% of risk-weighted assets. "Total capital" means
core capital and supplementary capital. Supplementary capital includes, among
other things and subject to certain limitations, general reserves up to 1.25% of
risk-weighted assets. The Bank's supplementary capital included $6.7 million of
general reserves at December 31, 1996. A savings institution's supplementary
capital may be used to satisfy the risk-based capital requirement only to the
extent of that institution's core capital.

In measuring a savings institution's compliance with the three requirements
under the Capital Regulations, the savings institution must deduct from capital
its investments in, and advances to, subsidiaries engaged in activities not
permissible for national banks. In computing an institution's total capital for
purposes of the risk-based capital standard, similar capital deduction and
phase-in provisions generally apply to: (a) other equity investments in equity
securities (not meeting the definition of a subsidiary) and in real estate and
(b) that portion of land loans and nonresidential construction loans in excess
of an 80% loan-to-value ratio. The Federal Deposit Insurance Corporation
("FDIC") may suspend deposit insurance for an institution that has no tangible
capital (computed by considering qualifying supervisory goodwill).

Any savings institution that is not in compliance with its regulatory capital
requirements must, within 60 days from the date the savings institution falls
out of compliance, submit a capital plan acceptable to the OTS demonstrating how
the savings institution will meet applicable capital standards. The OTS places
an asset growth restriction on all institutions failing any of the three capital
standards pending review of their capital plans and consideration of future
growth restrictions.

The OTS may treat the failure of any savings institution to maintain capital at
or above the minimum required levels or to comply with an approved capital plan
as an "unsafe and unsound practice." In general, unsafe and unsound practices
are subject to a number of enforcement actions, including the appointment of a
conservator or receiver.

Under the Prompt Corrective Action Rules ("PCA Rules") of the Federal Deposit
Insurance Act and regulations of the OTS thereunder, savings institutions are
classified in one of five categories based upon the regulatory capital levels.
Two of these classifications are for savings institutions that meet the Capital
Requirements ("well capitalized" and "adequately capitalized") and three are for
savings institutions that do not meet the Capital Requirements ("under
capitalized," "significantly under capitalized," and "critically under
capitalized"). In addition, the OTS also has authority, after an opportunity for
a hearing, to downgrade an institution from "well-capitalized" to "adequately
capitalized" or to subject an "adequately capitalized" or "undercapitalized"
institution to the supervisory actions applicable to the next lower category, if
the OTS deems such action to be appropriate as a result of supervisory concerns.
Progressively more stringent operational limitations and other corrective
actions are required as an institution declines in the capital ranking tiers.



                                      F-30
<PAGE>   91
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


As of December 31, 1996 and 1995, the most recent notification from the OTS
categorized the Bank as well capitalized under the PCA Rules. The following
table sets forth as of December 31, 1996, the Bank's actual regulatory capital
amounts and ratios and the regulatory capital amounts and ratios for the Bank to
be "adequately capitalized" and "well capitalized."

<TABLE>
<CAPTION>
                                                                      REQUIREMENTS
                                                       -------------------------------------------
                                       ACTUAL          ADEQUATELY CAPITALIZED  WELL CAPITALIZED
                                 --------------------  ---------------------  --------------------
                                  AMOUNT     RATIOS      AMOUNT      RATIOS     AMOUNT     RATIOS
                                 ----------  --------  ------------  -------  -----------  -------
<S>                               <C>          <C>       <C>           <C>      <C>            <C>   
AS OF DECEMBER 31, 1996:
    Total Capital
    (to Risk Weighted Assets)     $ 59,560     11.11%    $  42,879     8.00%    $ 53,599       10.00%
     Tier 1 Capital                                                            
    (to Risk Weighted Assets)       52,803      9.85%       21,439     4.00%      32,159        6.00%
     Tier 1 Capital                                                            
    (to Average Assets)             52,803      6.55%       32,269     4.00%      40,336        5.00%
     Core Capital                                                              
    (to Adjusted Assets) (1)        52,803      6.27%       25,267     3.00%         N/A         N/A
     Tangible Capital                                                            
    (to Adjusted Assets) (1)        52,803      6.27%       12,634     1.50%         N/A         N/A

AS OF DECEMBER 31, 1995
    Total Capital
    (to Risk Weighted Assets)     $ 49,448     10.27%    $  38,508     8.00%    $ 48,135       10.00%
     Tier 1 Capital
    (to Risk Weighted Assets)       43,360      9.01%       19,254     4.00%      28,881        6.00%
     Tier 1 Capital                                                            
    (to Average Assets)             43,360      5.96%       29,079     4.00%      36,349        5.00%
     Core Capital                                                              
    (to Adjusted Assets) (1)        43,360      5.80%       22,425     3.00%         N/A         N/A
     Tangible Capital                                                          
    (to Adjusted Assets) (1)        43,360      5.80%       11,213     1.50%         N/A         N/A
</TABLE>

---------------
      (1)   The term "adjusted assets" refers to the term "adjusted total
            assets" as defined in 12 C.F.R. Section 567.1(a) for purposes of
            tangible and core capital requirements, and refers to the term
            "risk-weighted assets" as defined in 12 C.F.R. Section 567.1(b) for
            purposes of risk-based capital requirements.

The thrift industry is exposed to economic trends and fluctuations in real
estate values. In recent periods, those trends have been recessionary in nature,
particularly in Southern California. Accordingly, the trends have adversely
affected both the delinquencies being experienced by institutions such as the
Bank and the ability of such institutions to recoup principal and accrued
interest through acquisition and sale of the underlying collateral. No
assurances can be given that such trends will not continue in future periods,
creating increasing downward pressure on the earnings and capital of thrift
institutions.


                                      F-31
<PAGE>   92
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE N - REGULATORY MATTERS

In early 1993, the OTS completed its annual examination of the Bank, and issued
its report thereon, dated March 5, 1993. In their report, the OTS concluded that
the Bank's future viability was threatened by inadequacies in the Board of
Directors and management, deteriorating asset quality and moderate-to-high
interest rate risk. The Board of Directors was advised to restructure itself and
to strengthen management, to commence actions to improve loan underwriting
controls, to improve the internal asset review system, to reduce large
concentrations of construction and land loans to certain developer borrowers and
to improve the internal audit department. The OTS also communicated its
intention to consider assessing civil money penalties against current and former
Directors of the Bank arising from the perceived noncompliance with the
previously issued cease and desist order and letter directive. In connection
with the OTS' examination, additional provisions for loan and real estate losses
were recorded, in the aggregate amount of $54.6 million, as of September 30,
1992.

On March 31, 1993, the Company's and the Bank's President and Chief Executive
Officer, Vernon Herbst retired. In July 1993, the Company and the Bank hired a
new President and Chief Executive Officer, Scott A. Braly. During the period
from August through December 1993, a full complement of senior management was
hired covering each of the Bank's line and staff units, and previous management
was either terminated or reassigned. Subsequent to the OTS' 1992/1993
examination, two new non-management Directors were appointed by the Boards of
Directors of the Bank and the Company.

On June 30, 1995, the Bank stipulated and consented to the issuance of a prompt
corrective action directive ("PCA Directive") by the OTS. The PCA Directive was
issued as a condition of acceptance by the OTS of the Bank's capital restoration
plan. The Directive required the Bank, among other things, (i) to comply with
the terms of the revised business plan, (ii) to achieve a capital infusion of
between $15 million and $20 million by December 15, 1995, (iii) to retain an
investment banking firm to assist in the recapitalization of the Bank, (iv) to
comply with all of the mandatory prompt corrective action provisions
automatically applicable to the Bank based on its prompt corrective action
capital category, and (v) to maintain its total assets at a level not to exceed
its total assets as of year end 1994. Unless otherwise approved by the OTS, the
Directive also required that the Bank comply with an OTS-approved time schedule
specifying dates between the execution of the Directive and December 15, 1995 by
which the Bank must complete specific intermediate steps toward achievement of
the capital infusion required by the Directive. Failure to comply with the PCA
Directive could have resulted in a forced sale of the Bank at a distressed price
under regulatory compulsion or the appointment of a conservator or receiver for
the Bank. In addition, the PCA Directive stated that it does not prevent the OTS
from taking any other type of supervisory, enforcement or resolution action that
the OTS determines to be appropriate.

In December 1995, the Company sold $27.0 million of "investment units" in a
private placement offering. See NOTE L. The Company's contribution of $19.0
million of the net proceeds of the private placement into the Bank during
December 1995 satisfied the PCA Directive, and the OTS terminated the PCA
Directive and released the Bank from its capital plan.

The President has signed legislation which repealed the tax rules formerly
applicable to bad debt reserves of thrift institutions for taxable years
beginning after December 31, 1995. The Company will thereupon be required to
change its tax method of accounting for bad debts from the reserve method
formerly permitted under section 593 of the Internal Revenue Code (the "Code")
to the "specific charge-off" method effective for its tax year beginning October
1, 1996. Under the specific charge-off method, tax deductions may be taken for
bad debts only as to the extent that the loans become wholly or partially
worthless. The enacted legislation requires thrift institutions, such as the
Company, which have previously utilized the section 593 reserve method to
recapture (i.e., include in taxable income) over a six-year period a portion of
their existing bad debt reserves equal to their "applicable excess reserves."
The Company does not believe that the recapture of its bad debt reserves, if
any, would be material. Under these provisions, the remainder of the Company's
bad debt reserve balance as of September 30, 1996 (approximately $25.5 million)
will in future years be subject to recapture in whole or in part upon the
occurrence of certain events such as a distribution to stockholders in excess of
the Company's current and accumulated earnings 



                                      F-32
<PAGE>   93
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


and profits, a redemption of shares, or upon a partial or complete liquidation
of the Company. The Company does not intend to make distributions to its
stockholders that would result in recapture of any portion of its bad debt
reserves.

NOTE O - DERIVATIVE FINANCIAL INSTRUMENTS

The Company has only limited involvement with derivative financial instruments
and does not use them for trading purposes. They are used to manage well-defined
interest rate risks.

Interest rate cap agreements were used to reduce the potential impact of
increases in interest rates on repriceable liabilities. At December 31, 1995,
the Company was a party to one interest rate cap agreement, with a notional
amount of $450.0 million and an expiration in March 1996. The agreement entitled
the Company to receive from the counterparty, on a quarterly basis, the amount,
if any, of the excess of the 3 month LIBOR rate over 7.34%. The Company
amortized the cost of this cap over its life. The Company was not a party to any
other derivative instrument contracts since March 1996.

NOTE P - COMMITMENTS AND CONTINGENCIES

LITIGATION

On September 6, 1996, the Company and the Bank were named as defendants in a
class action lawsuit entitled Stanley D. Mosler and Eileen C. Mosler vs.
Hawthorne Savings and Loan Association, Hawthorne Financial Corporation, et al.,
filed in the Superior Court of the State of California as Case No. BC154729 (the
"Action"). The plaintiffs had previously filed an individual action alleging the
same matters contained in the class action complaint. The individual action is
scheduled for trial in July 1997. Plaintiffs contend they were entitled to a
notice of availability of foreclosure counseling, which they allege they did not
receive, before the Bank foreclosed. Plaintiffs contend that the alleged failure
to provide counseling notices and the underbidding by the Bank of the loan
amount at foreclosure resulted in damages to the purported class in an amount in
excess of $40 million. The Company has been named and alleged to have liability
based upon its relationship as trustee on the Deed of Trust securing the Bank's
loans. The Company and the Bank filed responsive pleadings to the action
alleging that the complaint is defective on its face and that the plaintiffs are
not proper representatives of the purported class. The court granted the Company
and Bank's motion and dismissed the plaintiff's case. The plaintiffs have
appealed.

The Bank has been named as a defendant in an action entitled Takaki vs.
Hawthorne Savings and Loan Association, filed in the Superior Court of the State
of California, Los Angeles, as Case No. YC021815. The plaintiffs were owners of
real property which they sold in 1991 to a third party. The Bank provided escrow
services in connection with the transaction and provided purchase money
financing to the purchaser. A substantial portion of the consideration paid to
the plaintiffs took the form of a deed of trust secured by another property then
owned by an affiliate of the purchaser. The value of the collateral securing
this deed of trust ultimately proved to be inadequate. The plaintiffs allege
that the Bank knew, or should have known, that the security for the plaintiffs'
loan was inadequate and should have so advised them. The Bank disputes the
plaintiffs' allegations and believes that the law in California is unambiguous
that there is no duty which attaches to escrow providers to advise the
parties to an escrow. Trial is scheduled for April 1997. The plaintiffs have
claimed damages in excess of $5 million.


                                      F-33

<PAGE>   94
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The Company is involved in a variety of other litigation matters which, for the
most part, arise out of matters and events which were alleged to have occurred
prior to 1994. Many of these lawsuits either allege construction defects or
allege improper servicing of the loan. In the opinion of management, none of
these cases will have a material adverse effect on the Bank's or the Company's
financial condition or operations.

LENDING COMMITMENTS

At December 31, 1996, the Company had outstanding commitments to originate loans
of $64.5 million and had commitments to fund the undisbursed portion of existing
construction loans of $45.5 million.

ERRORS AND OMISSIONS INSURANCE

The Company had a mortgagee's errors and omissions insurance policy as of
December 31, 1996. The Company did not have errors and omissions insurance on
other aspects of its operation.

LEASES

The Company has entered into agreements to lease certain office facilities under
operating leases which expire at various dates to the year 2010. The leases
generally provide that the Company pay property taxes, insurance and other
items. Current rental commitments for the remaining terms of these noncancelable
leases as of December 31, 1996 are as follows:

<TABLE>
<CAPTION>
                                  AMOUNT
                               --------------
<S>                              <C>        
         1997                    $     1,106
         1998                          1,100
         1999                          1,092
         2000                            883
         2001                            343
   Thereafter                            487
                                -------------
                                 $     5,011
                                =============
</TABLE>

Lease expense for office facilities was $968,000, $966,000, and $767,000 for the
years ended December 31, 1996, 1995 and 1994, respectively.




                                      F-34
<PAGE>   95
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE Q - ESTIMATED FAIR VALUE INFORMATION

The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments." The estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is required to interpret
market data to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange. The use of different market assumptions
and or estimation methodologies may have a material effect on the estimated fair
value amounts.

<TABLE>
<CAPTION>
                                                       1996                        1995
                                            --------------------------  --------------------------
                                                           ESTIMATED                   ESTIMATED
                                             CARRYING        FAIR        CARRYING        FAIR
                                              AMOUNT         VALUE        AMOUNT         VALUE
                                            ------------  ------------  ------------  ------------
<S>                                         <C>           <C>           <C>           <C>        
Assets
    Cash and cash equivalents               $    93,978   $    93,978   $    14,015   $    14,015
    Investment securities                        38,371        38,371        62,793        62,793
    Loans receivable                            672,401       683,622       617,328       627,090

Liabilities
    Deposits
        Money market                        $    18,793   $    18,793   $    34,708   $    34,675
        Passbook                                 22,887        22,887        30,595        30,557
        Checking/NOW                             24,954        24,954        26,241        26,241
        Certificates of deposit                 647,250       646,766       603,549       590,080
        Noninterest bearing demand                3,925         3,925         2,915         2,915
    FHLB advances                                50,000        50,136
</TABLE>

The methods and assumptions used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value are
explained below.

For cash and cash equivalents, the carrying amount is considered to be their
estimated fair value.

For investment securities, fair values are based on quoted market prices
obtained from an independent pricing service (NOTES A and C).

The carrying amount of loans receivable is their contractual amounts outstanding
reduced by net deferred loan origination fees and the allowance for loan losses
(NOTE D). Variable rate loans consist primarily of loans whose interest rates
float with changes in either a specified bank's reference rate or the FHLB
eleventh district cost of funds index.

The fair value of both variable and fixed rate loans was estimated by
discounting the remaining contractual cash flows using the estimated current
rate at which similar loans would be made to borrowers with similar credit risk
characteristics over the same remaining maturities, reduced by net deferred loan
origination fees and the allocable portion of the allowance for the loan losses.
The estimated current rate for discounting purposes was not adjusted for any
change in borrowers' credit risks since the origination of such loans. Rather,
the allocable portion of the allowance for loan losses is considered to provide
for such changes in estimating fair value.



                                      F-35
<PAGE>   96
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


The fair value of nonaccrual loans (NOTE D) has been estimated at the carrying
amount of these loans as it is practicable to reasonably assess the credit risk
adjustment that would be applied in the market place for such loans.

The withdrawable amounts for checking accounts are considered to be stated at
their estimated fair value. The fair value of passbook accounts and
fixed-maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities.

The fair value of FHLB advances is estimated using the rates currently offered
on similar instruments with similar terms.

The fair value of an interest rate cap is based upon the quoted termination
price as of the reporting date, as provided by independent dealers in these
instruments. As such the interest rate cap had no fair value at December 31,
1995.

The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1996. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date and, therefore, current estimates of
fair value may differ significantly from the amounts presented above.


                                      F-36
<PAGE>   97
              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                    THREE YEARS ENDED DECEMBER 31, 1996
                (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE R - SEPARATE PARENT COMPANY FINANCIAL STATEMENTS

STATEMENTS OF FINANCIAL CONDITION

<TABLE>
<CAPTION>
                                                                                            DECEMBER 31,
                                                                                      -------------------------
                                                                                         1996          1995
                                                                                      -----------   -----------
<S>                                                                                   <C>           <C>       
ASSETS
Cash at the Bank                                                                      $    1,222    $    1,829
Investment securities                                                                      3,203         4,856
Investment in subsidiary                                                                  53,490        43,534
Other assets                                                                                 987         1,216
                                                                                      -----------   -----------
                                                                                      $   58,902    $   51,435
                                                                                      ===========   ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and other liabilities                                                $    2,673    $      463
Senior notes                                                                              12,307        12,006
                                                                                      -----------   -----------
                                                                                          14,980        12,469
Stockholders' equity
    Preferred stock - $0.01 par value; authorized 10,000,000 shares
        Cumulative preferred stock, series A:  liquidation preference,
        $50 per share; authorized, 270 shares; outstanding, 270 shares
    Common stock - $0.01 par value; authorized 20,000,000 shares;
        issued and outstanding, 2,604,675 shares                                              26            26
    Capital in excess of par value - cumulative preferred stock, series A                 11,592        11,592
    Capital in excess of par value - common stock                                          7,745         7,745
    Unrealized (loss) gain on available-for-sale securities                                 (132)            6
    Retained earnings - partially restricted                                              24,858        19,788
                                                                                      -----------   -----------
                                                                                          44,089        39,157
Less
    Treasury stock, at cost - 5,400 shares                                                   (48)          (48)
    Loan to Bank ESOP                                                                       (119)         (143)
                                                                                      -----------   -----------
                                                                                          43,922        38,966
                                                                                      -----------   -----------
                                                                                      $   58,902    $   51,435
                                                                                      ===========   ===========
</TABLE>




                                      F-37
<PAGE>   98

              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                    THREE YEARS ENDED DECEMBER 31, 1996
                (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                         YEARS ENDED DECEMBER 31,
                                                 -----------------------------------------
                                                   1996           1995            1994
                                                 ----------    ------------    -----------
<S>                                              <C>           <C>             <C>       
Interest revenues
   Interest income
     Loans                                       $       -     $        49     $       79
     Investments                                       246              13
     From subsidiary                                    16              12             30
                                                 ----------    ------------    -----------
     Total interest revenues                           262              74            109

Interest costs                                       1,921              92
Provision for credit losses
                                                 ----------    ------------    -----------
     Net interest income                            (1,659)            (18)           109

Noninterest revenues                                    13              49             96
Operating costs                                       (910)           (515)          (471)
Real estate operations, net                                           (102)
Loss on sale of loans                                   (1)            (89)
                                                 ----------    ------------    -----------
     Pre-tax loss before equity in
       earnings (loss) of subsidiary                (2,557)           (675)          (266)

Income tax benefit (expense)                                           (37)
                                                 ----------    ------------    -----------
     Loss before equity in
       earnings (loss) of subsidiary                (2,557)           (712)          (266)

Equity in earnings (loss) of subsidiary             10,064         (13,505)        (2,697)
                                                 ----------    ------------    -----------
Net earnings (loss)                              $   7,507     $   (14,217)    $   (2,963)
                                                 ==========    ============    ===========
Net earnings (loss) available for Common         $   5,704     $   (14,341)    $    2,963
                                                 ==========    ============    ===========
Net earnings (loss) per share                    $    1.11     $     (5.52)    $    (1.14)
                                                 ==========    ============    ===========
Weighted average shares                              5,141           2,599          2,599
                                                 ==========    ============    ===========
</TABLE>



                                      F-38
<PAGE>   99

              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                    THREE YEARS ENDED DECEMBER 31, 1996
                (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                          YEARS ENDED DECEMBER 31,
                                                                                 -------------------------------------------
                                                                                    1996           1995             1994
                                                                                 -----------    ------------     -----------
<S>                                                                              <C>            <C>              <C>        
Cash flows from operating activities
    Net earnings (loss)                                                          $    7,507     $   (14,217)     $   (2,963)
    Adjustments
        Equity in undistributed earnings (loss) of subsidiary                       (10,064)         13,505           2,697
        Depreciation and amortization                                                   479             112
        Increase in interest receivable                                                  (2)            (13)
        Loss on sale of REOs                                                                             80
        Increase in other assets                                                                     (1,178)
        Increase (decrease) in accounts payable and other liabilities                  (228)             14            (169)
        Other                                                                             
                                                                                 -----------    ------------     -----------
            Net cash used in operating activities                                    (2,308)         (1,697)           (435)
                                                                                 -----------    ------------     -----------
Cash flows from investing activities
    Purchases of securities                                                                          (4,845)
    Maturities of securities                                                          1,677
    Sales of loans receivable                                                                           760
    Collection of loans receivable                                                                       16              76
    Net proceeds from real estate owned                                                                 671              (3)
                                                                                 -----------    ------------     -----------
            Net cash provided by (used in) investing activities                       1,677          (3,398)             73
                                                                                 -----------    ------------     -----------
Cash flows from financing activities
    Net collection of ESOP loan                                                          24              23              21
    Cash contribution to subsidiary                                                                 (20,000)           (750)
    Net proceeds from issuance of senior notes                                                       11,994
    Net proceeds from issuance of preferred stock                                                    12,760
    Net proceeds from issuance of warrants                                                            1,078
                                                                                 -----------    ------------     -----------
            Net cash provided by (used in) financing activities                          24           5,855            (729)
                                                                                 -----------    ------------     -----------
    Increase (decrease) in cash                                                        (607)            760          (1,091)
    Cash at beginning of year                                                         1,829           1,069           2,160
                                                                                 -----------    ------------     -----------
    Cash at end of year                                                          $    1,222     $     1,829      $    1,069
                                                                                 ===========    ============     ===========

    Non-cash investing and financing items
      Net unrealized gain (loss) on available-for-sale securities                $     (124)    $         6      $

      Accrued dividends payable                                                       2,430             124
</TABLE>


                                      F-39
<PAGE>   100

              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                    THREE YEARS ENDED DECEMBER 31, 1996
                (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE S - QUARTERLY INFORMATION (UNAUDITED)

<TABLE>
<CAPTION>
                                                                   THREE MONTHS ENDED
                                                 -------------------------------------------------------
                                                   MAR 31,      JUNE 30,       SEP 30,        DEC 31,
                                                 ------------  ------------   -----------   ------------
<S>                                              <C>           <C>            <C>           <C>        
YEAR ENDED DECEMBER 31, 1996
Interest revenues                                $    15,430   $    16,491    $   17,061    $    18,802
Interest costs                                        (9,409)       (9,899)       (9,722)       (10,930)
                                                 ------------  ------------   -----------   ------------
Net interest income before contractual
   interest on nonaccrual loans                        6,021         6,592         7,339          7,872
Contractual interest on nonaccrual loans                (629)         (447)         (641)          (713)
                                                 ------------  ------------   -----------   ------------
Net interest income                                    5,392         6,145         6,698          7,159
Provision for credit losses                           (1,200)       (2,489)       (2,800)        (1,000)
                                                 ------------  ------------   -----------   ------------
                                                       4,192         3,656         3,898          6,159
Net interest income after provision
  for credit losses
Noninterest revenues                                     440           491           626            370
Operating costs                                       (5,111)       (5,344)       (5,139)        (5,452)
Real estate operations, net                              441          (395)         (597)          (405)
Other income                                             346         6,333        (3,829)           445
                                                 ------------  ------------   -----------   ------------
                                                         308         4,741        (5,041)         1,117
Income tax benefit (expense)                           2,253         1,230         2,885             14
                                                 ------------  ------------   -----------   ------------
Net earnings (loss)                              $     2,561   $     5,971    $   (2,156)   $     1,131
                                                 ============  ============   ===========   ============
Net earnings (loss) available for Common         $     2,136   $     5,523    $   (2,764)   $       668
                                                 ============  ============   ===========   ============
Net earnings (loss) per share (1)                $      0.41   $      1.07    $    (1.06)   $      0.13
                                                 ============  ============   ===========   ============
Weighted average shares (2)                            5,141         5,141         2,599          5,141
                                                 ============  ============   ===========   ============
</TABLE>

----------------------

      (1)   Calculated using the modified Treasury method.

      (2)   Calculated using actual shares outstanding for the quarter ended
            September 30, 1996.  Inclusion of options and warrants would have
            been antidilutive. 

                                      F-40
<PAGE>   101

              HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                    THREE YEARS ENDED DECEMBER 31, 1996
                (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                   THREE MONTHS ENDED
                                                 --------------------------------------------------------
                                                   MAR 31,        JUNE 30,       SEP 30,     DEC 31,
                                                 -------------   -----------   ------------  ------------
<S>                                              <C>            <C>            <C>           <C>        
YEAR ENDED DECEMBER 31, 1995
Interest revenues                                $     13,214    $   12,718    $    12,858   $    14,596
Interest costs                                         (7,913)       (8,487)        (8,806)       (9,280)
                                                 -------------   -----------   ------------  ------------
Net interest margin before contractual
 interest on nonaccrual loans                           5,301         4,231          4,052         5,316
Contractual interest on nonaccrual loans                 (730)         (677)          (420)         (565)
                                                 -------------   -----------   ------------  ------------
Net interest margin                                     4,571         3,554          3,632         4,751
Provision for credit losses                           (12,745)                      (1,700)         (450)
                                                 -------------   -----------   ------------  ------------
Net interest margin after provision                    (8,174)        3,554          1,932         4,301
  for credit losses
Noninterest revenues                                      276           364            536           135
Operating costs                                        (5,421)       (5,217)        (4,672)       (5,029)
Real estate operations                                    466           949         (2,692)          841
Other revenues, net                                     3,309           215            450           277
                                                 -------------   -----------   ------------  ------------
                                                       (9,544)         (135)        (4,446)          525
Income tax benefit (expense)                             (585)                         (32)
                                                 -------------   -----------   ------------  ------------
Net earnings (loss)                              $    (10,129)   $     (135)   $    (4,478)  $       525
                                                 =============   ===========   ============  ============
Net earnings (loss) available for Common         $    (10,129)   $     (135)   $    (4,478)  $       430
                                                 =============   ===========   ============  ============
Earnings (loss) per share (1)                    $      (3.90)   $    (0.05)   $     (1.72)  $      0.13
                                                 =============   ===========   ============  ============
Weighted average shares                                 2,599         2,599          2,599         2,599
                                                 =============   ===========   ============  ============
</TABLE>


         (1)      Calculated using the Modified Treasury method for fourth
                  quarter only.


                                      F-41

<PAGE>   102
                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


NOTE T - CONSOLIDATING SCHEDULES

<TABLE>
<CAPTION>
                                                    HAWTHORNE        HAWTHORNE
                                                     SAVINGS         FINANCIAL        ELIMINATIONS        CONSOLIDATED
                                                   -------------     -----------     ---------------     ---------------
<S>                                                <C>              <C>              <C>                 <C>           
ASSETS
Cash and cash equivalents                          $     93,782     $     1,222      $       (1,026)     $       93,978
Investment securities                                    35,168           3,203                                  38,371
Investment in subsidiary                                                 53,490             (53,490)
Loans receivable, net                                   672,391                                  10             672,401
Real estate owned, net                                   20,140                                                  20,140
Accrued interest receivable                               4,765              16                                   4,781
FHLB stock                                                6,788                                                   6,788
Office property and equipment                             4,729                                                   4,729
Other assets                                              5,046             971                 (10)              6,007
                                                   -------------     -----------     ---------------     ---------------
                                                   $    842,809     $    58,902      $      (54,516)     $      847,195
                                                   =============     ===========     ===============     ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
    Deposits                                       $    718,835     $         -      $       (1,026)     $      717,809
    Borrowings                                           50,000                                                  50,000
    Accounts payable and other liabilities               20,484           2,673                                  23,157
    Senior debt                                                          12,307                                  12,307
                                                   -------------     -----------     ---------------     ---------------
                                                        789,319          14,980              (1,026)            803,273
Stockholders' equity
    Capital stock                                           150              26                (150)                 26
    Preferred Stock
    Capital in excess of par
        value - common stock                             20,765           7,745             (20,765)              7,745
    Capital in excess of par
        value - preferred stock                                          11,592                                  11,592
    Unrealized gain (loss) on available-
      for-sale securities                                  (113)           (132)                113                (132)
    Retained earnings                                    32,688          24,858             (32,688)             24,858
                                                   -------------     -----------     ---------------     ---------------
                                                         53,490          44,089             (53,490)             44,089
    Less
        Treasury stock                                                      (48)                                    (48)
        Loan to Bank ESOP                                                  (119)                                   (119)
                                                   -------------     -----------     ---------------     ---------------
                                                         53,490          43,922             (53,490)             43,922
                                                   -------------     -----------     ---------------     ---------------
                                                   $    842,809     $    58,902      $      (54,516)     $      847,195
                                                   =============     ===========     ===============     ===============
</TABLE>




                                      F-42
<PAGE>   103

                 HAWTHORNE FINANCIAL CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                       THREE YEARS ENDED DECEMBER 31, 1996
                   (DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS)


<TABLE>
<CAPTION>
                                                      HAWTHORNE       HAWTHORNE
                                                       SAVINGS        FINANCIAL      ELIMINATIONS       CONSOLIDATED
                                                     -------------   ------------   ----------------   ---------------
<S>                                                  <C>             <C>             <C>               <C>           
YEAR ENDED DECEMBER 31, 1996
Interest revenues
    Loans                                            $     62,153    $         -     $           (1)   $       62,152
    Investments                                             5,386            262                (16)            5,632
                                                     -------------   ------------   ----------------   ---------------
                                                           67,539            262                (17)           67,784
Interest costs
    Deposits                                               35,584                               (16)           35,568
    Borrowings                                              2,471                                               2,471
    Senior notes                                                           1,921                                1,921
                                                     -------------   ------------   ----------------   ---------------
                                                           38,055          1,921                (16)           39,960
Net interest income before contractual
  interest on nonaccrual loans                             29,484         (1,659)                (1)           27,824

Contractual interest on nonaccrual loans                   (2,430)                                             (2,430)
                                                     -------------   ------------   ----------------   ---------------
Net interest income                                        27,054         (1,659)                (1)           25,394
Loan provision for credit losses                            7,489                                               7,489
                                                     -------------   ------------   ----------------   ---------------

Net interest income after  provision
  for credit losses                                        19,565         (1,659)                (1)           17,905

Noninterest revenues                                        2,057             13               (143)            1,927
Operating costs
    Employee                                                9,737             63                                9,800
    Occupancy                                               2,890                                               2,890
    Operating                                               4,103            605               (143)            4,565
    Professional                                            1,373            242                                1,615
    SAIF Premium and OTS assessment                         2,152                                               2,152
    Goodwill                                                   24                                                  24
                                                     -------------   ------------   ----------------   ---------------
                                                           20,279            910               (143)           21,046

Real estate operations                                       (956)                                               (956)
Gain on (loss) sale of loans                                  437             (1)                 1               437
Gain on sale of securities                                    248                                                 248
Disposition of deposits and premises                        6,413                                               6,413
Other revenues (expense)                                   (3,803)                                             (3,803)
                                                     -------------   ------------   ----------------   ---------------
                                                            2,339             (1)                 1             2,339
Pretax earnings (loss) before income taxes
  and equity in loss of subsidiary                          3,682         (2,557)                 -             1,125
Income tax benefit                                          6,382                                               6,382
                                                     -------------   ------------   ----------------   ---------------
Loss before equity in loss
  of subsidiary                                            10,064         (2,557)                               7,507
Equity in loss of subsidiary                                              10,064            (10,064)
                                                     -------------   ------------   ----------------   ---------------
NET EARNINGS (LOSS)                                  $     10,064    $     7,507     $      (10,064)   $        7,507
                                                     =============   ============   ================   ===============
</TABLE>


                                      F-43
<PAGE>   104

                          MANAGEMENT'S ASSERTION REPORT

January 31, 1997

To our Stockholders:

FINANCIAL STATEMENTS

The management of Hawthorne Financial Corporation ("Company") and its
subsidiary, Hawthorne Savings, F.S.B. is responsible for the preparation,
integrity, and fair presentation of its published financial statements and all
other information presented in this annual report. The financial statements have
been prepared in accordance with generally accepted accounting principles
("GAAP") and, as such, include amounts based on judgments and estimates made by
management.

The financial statements have been audited by an independent accounting firm,
which was given unrestricted access to all financial records and related data,
including minutes of all meetings of stockholders, the Board of Directors and
committees of the Board. Management believes that all representations to the
independent auditors during their audit were valid and appropriate.

INTERNAL CONTROL

Management is responsible for establishing and maintaining an effective internal
control structure over financial reporting, presented in conformity with both
GAAP and the Office of Thrift Supervisors ("OTS") instructions for the Thrift
Financial Report ("TFR"). The structure contains monitoring mechanisms, and
actions are taken to correct deficiencies identified.

There are inherent limitations in the effectiveness of any structure of internal
control, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the
effectiveness of an internal control structure may vary over time.

Management assessed the Company's internal control structure over financial
reporting presentation in conformity with both GAAP and TFR instructions as of
December 31, 1996. The assessment was based on criteria for effective internal
control over financial reporting described in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, management believes that the Company
maintained an effective internal control structure over financial reporting
presented in conformity with both GAAP and TFR instructions, as of December 31,
1996.

The Audit Committee of the Board of Directors is comprised entirely of outside
directors who are independent of management; it includes members with banking or
related management experience, has access to its own outside counsel, and does
not include any large customers of the Company. The Audit Committee is
responsible for recommending to the Board of Directors the selection of
independent auditors. It meets periodically with management, the independent
auditors, and the internal auditors to ensure that they are carrying out their
responsibilities. The Audit Committee is also responsible for performing an
oversight role by reviewing the Company's financial reports. The independent
auditors and the internal auditors have full and free access to the Audit
Committee, with or without the presence of management, to discuss the adequacy
of the internal control structure for financial reporting and any other matter
which they believe should be brought to the attention of the Audit Committee.



                                      F-44

<PAGE>   105
COMPLIANCE WITH LAWS AND REGULATIONS

Management is also responsible for ensuring the compliance with federal laws and
regulations concerning loans to insiders and federal and state laws and
regulations concerning dividend restrictions, both of which are designated by
the FDIC as safety and soundness standards.

Management assessed its compliance with the designated safety and soundness laws
and regulations and has maintained records of its determinations and assessments
as required by the OTS. Based on this assessment, Management believes that the
Company has complied, in all material respects, with the designated safety and
soundness laws and regulations for the year ended December 31, 1996.



/S/  SCOTT A. BRALY                        /s/  NORMAN A. MORALES
---------------------------                -----------------------------------
Scott A. Braly                             Norman A. Morales
President and                              Executive Vice
Chief Executive Officer                    President and
                                           Chief Financial Officer




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<PAGE>   106

                         INDEPENDENT ACCOUNTANTS' REPORT


To the Audit Committee
Hawthorne Financial Corporation
El Segundo, California


      We have examined management's assertion that, as of December 31, 1996,
Hawthorne Financial Corporation ("the Company") and its subsidiary, Hawthorne
Savings, F.S.B. maintained an effective internal control structure over
financial reporting presented in conformity with both generally accepted
accounting principles and the Office of the Thrift Supervision Instructions for
Thrift Financial Reports included in the accompanying management's report on
internal controls.

      Our examination was made in accordance with standards established by the
American Institute of Certified Public Accountants, and, accordingly, included
obtaining an understanding of the internal control structure over financial
reporting, testing and evaluating the design and operating effectiveness of the
internal control structure over financial reporting, and such other procedures
as we considered necessary in the circumstances. We believe that our examination
provides a reasonable basis for our opinion.

      Because of inherent limitations in any internal control structure, errors
or irregularities may occur and not be detected. Also, projections of any
evaluation of the internal control structure over financial reporting to future
periods are subject to the risk that the internal control structure may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies may deteriorate.

      In our opinion, management's assertion that, as of December 31, 1996, the
Company maintained an effective internal control structure over financial
reporting presented in conformity with both generally accepted accounting
principles and the Office of Thrift Supervision Instructions for Thrift
Financial Reports is fairly stated, in all material respects, based on the
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.

DELOITTE & TOUCHE LLP

January 31, 1997
Los Angeles, California




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