<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 1999
OR
[_] Transitional Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission file number 0-21845
Wilshire Financial Services Group Inc.
(Exact name of registrant as specified in its charter)
Delaware 93-1223879
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1776 SW Madison Street, Portland, OR 97205
(Address of principal executive offices) (Zip Code)
(503) 223-5600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant 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 __________
-----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at April 30, 1999
Common Stock, par value $.01 per share 10,885,000 Shares
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Interim Financial Statements (Unaudited):
Consolidated Statements of Financial Condition............. 3
Consolidated Statements of Operations...................... 4
Consolidated Statements of Cash Flows...................... 5
Consolidated Statements of Stockholders' Deficit........... 7
Notes to Interim Financial Statements...................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................ 25
Item 2. Changes in Securities........................................ 25
Item 3. Defaults Upon Senior Securities.............................. 25
Item 4. Submission of Matters to a Vote of Security Holders.......... 25
Item 5. Other Information............................................ 25
Item 6. Exhibits and Reports on Form 8-K............................. 25
</TABLE>
2
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------------- --------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents.................................................................. $ 18,774 $ 23,468
Mortgage-backed securities available for sale, at fair value............................... 106,866 114,463
Mortgage-backed securities held to maturity, at amortized cost............................. 12,582 13,580
Securities held to maturity, at amortized cost............................................. 5,967 5,962
Loans, net................................................................................. 465,253 455,561
Discounted loans, net...................................................................... 25,411 51,989
Loans held for sale, net, at lower of cost or market....................................... 109,495 284,672
Stock in Federal Home Loan Bank of San Francisco, at cost.................................. 5,405 5,332
Real estate owned, net..................................................................... 45,779 62,168
Leasehold improvements and equipment, net.................................................. 6,964 8,185
Due from affiliates, net................................................................... 9,457 --
Accrued interest receivable................................................................ 4,722 5,468
Investment in Wilshire Real Estate Investment Trust Inc.................................... 6,367 5,979
Mortgage servicing rights, net............................................................. 2,101 2,346
Income tax receivable...................................................................... -- 9,865
Prepaid expenses and other assets.......................................................... 26,328 35,215
---------- ----------
TOTAL $ 851,471 $1,084,253
========== ==========
LIABILITIES & STOCKHOLDERS' DEFICIT
Liabilities:
Liabilities not subject to compromise:
Deposits................................................................................. $ 478,631 $ 510,430
Short-term borrowings.................................................................... 231,793 420,816
Notes payable............................................................................ -- 184,245
Due to affiliates, net................................................................... -- 16,166
Accounts payable and other liabilities:
Pre-petition........................................................................... 25,653 45,391
Post-petition.......................................................................... 912 --
Liabilities subject to compromise......................................................... 235,510 --
---------- ----------
Total liabilities...................................................................... 972,499 1,177,048
---------- ----------
Commitments and Contingencies (see Note 3)
Stockholders' Deficit:
Common stock............................................................................. 117,708 117,708
Treasury stock, at cost.................................................................. (2,852) (2,852)
Retained earnings (deficit).............................................................. (209,247) (183,294)
Accumulated other comprehensive loss, net................................................ (26,637) (24,357)
---------- ----------
Total stockholders' deficit............................................................ (121,028) (92,795)
---------- ----------
TOTAL $ 851,471 $1,084,253
========== ==========
</TABLE>
See notes to interim financial statements
3
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
Quarter Ended
March 31,
-------------------------
1999 1998
-------------------------
(Unaudited)
<S> <C> <C>
INTEREST INCOME:
Loans.................................................................................... $ 13,547 $ 24,889
Mortgage-backed securities............................................................... 3,291 9,107
Securities and federal funds sold........................................................ 365 822
----------- ----------
Total interest income.................................................................... 17,203 34,818
----------- ----------
INTEREST EXPENSE:
Deposits................................................................................. 6,769 5,386
Borrowings (contractual interest $11,661)................................................ 9,858 25,074
----------- ----------
Total interest expense................................................................... 16,627 30,460
----------- ----------
NET INTEREST INCOME........................................................................... 576 4,358
PROVISION FOR ESTIMATED LOSSES ON LOANS....................................................... 70 (1,500)
----------- ----------
NET INTEREST INCOME AFTER PROVISION 506 5,858
FOR ESTIMATED LOSSES ON LOANS............................................................ ----------- ----------
OTHER INCOME:
Servicing revenue........................................................................ 1,915 1,371
Real estate owned, net................................................................... 1,473 73
Bankcard income, net..................................................................... 1,297 500
Gain on sale of loans.................................................................... 2,555 --
Gain on sale of securities............................................................... -- 2,085
Trading income........................................................................... -- 1,458
Other, net............................................................................... 2,224 651
----------- ----------
Total other income....................................................................... 9,464 6,138
----------- ----------
OTHER EXPENSES:
Compensation and employee benefits....................................................... 7,472 5,917
Loan service fees and expenses paid to affiliate......................................... 5,267 8,858
Professional services.................................................................... 3,340 1,393
Occupancy................................................................................ 799 433
FDIC insurance premiums.................................................................. 307 236
Corporate travel and development......................................................... 380 618
Depreciation and amortization............................................................ 709 281
Other general and administrative expenses................................................ 2,841 2,061
----------- ----------
Total other expenses..................................................................... 21,115 19,797
----------- ----------
LOSS BEFORE RESTRUCTURING ITEMS AND INCOME TAX EXPENSE (BENEFIT).............................. (11,145) (7,801)
RESTRUCTURING ITEMS........................................................................... (14,433) --
----------- ----------
LOSS BEFORE INCOME TAX EXPENSE (BENEFIT)...................................................... (25,578) (7,801)
INCOME TAX EXPENSE (BENEFIT).................................................................. 375 (3,136)
----------- ----------
NET LOSS...................................................................................... $ (25,953) $ (4,665)
=========== ==========
LOSS PER SHARE................................................................................ $ (2.38) $ (0.52)
WEIGHTED AVERAGE SHARES OUTSTANDING........................................................... 10,885,000 9,742,778
</TABLE>
See notes to interim financial statements
4
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended
March 31,
------------------------
1999 1998
----------- ----------
(Dollars in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................................................................... $ (25,953) $ (4,665)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Provision for estimated losses on loans......................................................... 70 (1,500)
Provision for losses on real estate owned....................................................... -- 990
Depreciation and amortization................................................................... 709 267
Gain on sale of real estate owned............................................................... (1,630) (1,450)
Origination of loans held for sale.............................................................. -- (85,722)
Purchase of loans held for sale................................................................. (832) (78,985)
Proceeds from sale of loans held for sale....................................................... 151,982 --
Gain on sale of loans........................................................................... (2,555) --
Gain on sale of securities...................................................................... -- (2,085)
Unrealized gain on trading securities........................................................... -- (1,458)
Amortization of discounts and deferred fees..................................................... 631 (5,130)
Income on equity investments.................................................................... (219) --
Other........................................................................................... -- (249)
Restructuring items:
Write-off of unamortized debt issuance costs.................................................... 11,319 --
European restructuring costs.................................................................... 2,492 --
Change in:
Trading account securities...................................................................... -- 20,038
Accrued interest receivable..................................................................... 746 1,259
Prepaid expenses and other assets............................................................... 7,491 (16,392)
Due to affiliates, net.......................................................................... 11,106 (2,018)
Accounts payable and other liabilities.......................................................... (5,847) 8,852
-------- ---------
Net cash provided by (used in) operating activities............................................. 149,510 (168,248)
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of loans............................................................................... (45,918) (38,043)
Loan repayments................................................................................. 48,255 47,513
Loan originations............................................................................... (6,056) (5,876)
Proceeds from sale of loans..................................................................... 43,281 --
Purchase of mortgage-backed securities available for sale....................................... -- (37,082)
Repayment of mortgage-backed securities available for sale...................................... 6,444 8,222
Repayments of mortgage-backed securities held to maturity....................................... 986 855
Purchase of real estate owned................................................................... -- (11,855)
Proceeds from sale of real estate owned......................................................... 17,980 42,442
Purchases of leasehold improvements and equipment............................................... (240) (1,049)
-------- ---------
Net cash provided by investing activities....................................................... 64,732 5,127
-------- ---------
</TABLE>
See notes to interim financial statements
5
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended
March 31,
---------------------------
1999 1998
------------- ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits............................................................. (31,799) 6,392
Proceeds from short-term borrowings............................................................. 41,247 463,683
Repayments of short-term borrowings............................................................. (233,384) (362,092)
Proceeds from debtor-in-possession financing.................................................... 5,000 --
Issuance of common stock........................................................................ -- 62,438
Redemption of preferred stock................................................................... -- (27,500)
--------- ---------
Net cash (used in) provided by financing activities.......................................... (218,936) 142,921
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS........................................................... (4,694) (20,200)
CASH AND CASH EQUIVALENTS:
Beginning of period............................................................................. 23,468 66,115
--------- ---------
End of period................................................................................... $ 18,774 $ 45,915
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION--Cash paid for:
Interest........................................................................................ $ 13,151 $ 30,449
Income taxes.................................................................................... -- 5,015
NONCASH INVESTING ACTIVITIES:
Additions to real estate owned acquired in settlement of loans.................................. 1,970 45,523
NONCASH FINANCING ACTIVITIES:
Pay in kind preferred stock dividend............................................................ -- 417
NONCASH RESTRUCTURING ITEMS:
Transfer of notes payable and certain related party
payables to liabilities subject to compromise.................................................. 235,510 --
</TABLE>
See notes to interim financial statements
6
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Accumulated
Preferred Stock Common Stock Treasury Stock Retained Other
----------------------------------------------------------- Earnings Comprehensive
Shares Amount Shares Amount Shares Amount (Deficit) Loss Total
----------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Share Data)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1999 -- $ -- 11,070,000 $117,708 185,000 $(2,852) $(183,294) $(24,357) $ (92,795)
Comprehensive loss:
Net loss........................... (25,953) (25,953)
Unrealized holding losses
on available for sale securities-
net of tax........................ (720) (720)
Unrealized loss on foreign currency
translation...................... (1,560) (1,560)
----------
Total comprehensive loss........... (28,233)
-----------------------------------------------------------------------------------------------
BALANCE, March 31, 1999 (Unaudited) -- $ -- 11,070,000 $117,708 185,000 $(2,852) $(209,247) $(26,637) $(121,028)
===============================================================================================
</TABLE>
See notes to interim financial statements
7
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO INTERIM FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying interim consolidated financial statements of Wilshire
Financial Services Group Inc. and Subsidiaries (the "Company") are unaudited and
should be read in conjunction with the 1998 Annual Report on Form 10-K. A
summary of the Company's significant accounting policies is set forth in Note 4
to the Consolidated Financial Statements in the 1998 Annual Report on Form 10-K.
In the opinion of management, all adjustments, other than the adjustments
described below, generally comprised of normal recurring accruals necessary for
fair presentation of the interim consolidated financial statements, have been
included and all intercompany accounts and transactions have been eliminated in
consolidation. Operating results for the quarter ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
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.
Certain reclassifications of 1998 amounts were made in order to conform to
the 1999 presentation, none of which affect previously reported net income.
2. RESTRUCTURING OF THE COMPANY
In connection with its restructuring, as discussed in the 1998 Annual
Report on Form 10-K, Wilshire Financial Services Group Inc. ("WFSG" or the
"Parent" which, along with its subsidiaries, is referred to herein as the
Company) filed a voluntary petition for relief under Chapter 11 of the U.S.
Bankruptcy Code in the Federal Court of Wilmington, Delaware on March 3, 1999.
On April 12, 1999, the restructuring plan was approved, with certain conditions,
by the Bankruptcy Court, pending regulatory approval or exemption of the two
largest noteholders. It is currently anticipated by management of WFSG that
this reorganization plan will become effective and WFSG will emerge from
bankruptcy in May 1999. However, there can be no assurance that WFSG will
ultimately emerge from bankruptcy or that the restructuring plan will have the
desired economic effect.
Under Chapter 11, certain claims against the Parent in existence prior to
the filing of the petition for relief under the Federal bankruptcy laws are
stayed while the Parent continues business operations. These claims are
reflected as Liabilities Subject to Compromise. Claims secured by the Parent's
assets are also stayed. These claims are secured primarily by liens on the
Parent's loans and mortgage-backed securities. Liabilities Subject to
Compromise in the accompanying consolidated statements of financial condition as
of March 31, 1999 consist of the following:
<TABLE>
<CAPTION>
(Dollars in thousands)
<S> <C>
Notes payable.................................................... $184,245
Accrued interest on notes payable................................ 14,536
Due to Wilshire Credit Corporation............................... 19,729
Due to Wilshire Real Estate Investment Trust Inc................. 17,000
--------
$235,510
========
</TABLE>
8
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued)
The Parent stopped accruing interest on the notes payable, which are
unsecured, on March 3, 1999. Contractual interest under the original terms of
these obligations amounts to $6.0 million for the quarter ended March 31, 1999,
which is $1.8 million greater than the amount of interest expense reported in
the accompanying consolidated statements of operations for the quarter ended
March 31, 1999.
The restructuring plan provides that (i) the noteholders will exchange
their notes for new common stock in the Company; (ii) existing common stock
would be cancelled and holders of common stock in the Company would receive
up to 0.60% of the new common stock and (iii) pending consummation of the
restructure, the noteholders would forebear from declaring certain defaults
which resulted from the net losses incurred by the Company and the actions taken
by the Company to meet collateral calls.
Wilshire Credit Corporation ("WCC"), an affiliate of the Company, provides
loan servicing to the Company. The plan of reorganization discussed above
contemplates the transfer of the servicing operations conducted by WCC to a
newly formed subsidiary of WFSG.
During the quarter ended March 31, 1999, Wilshire Real Estate Investment
Trust Inc. ("WREIT"), an affiliate of the Company, agreed to provide Wilshire
Acquisitions Corporation ("WAC"), a wholly owned subsidiary of WFSG, debtor-in-
possession financing of up to $10.0 million (the "DIP Facility") as part of a
compromise and settlement of a $17.0 million obligation payable to WREIT. The
DIP Facility bears interest at 12% and is secured by the stock of First Bank of
Beverly Hills, FSB ("First Bank"), WFSG's savings bank subsidiary. Under the
agreement, the $17.0 million obligation will convert into an unsecured note
bearing interest at 6% if WREIT funds the full $10.0 million DIP Facility. To
the extent that WREIT does not fund the DIP Facility in an amount of $10.0
million, a proportionate amount of the $17.0 million obligation will be treated
pari passu with the claims of the WFSG noteholders and converted into equity of
WFSG.
WREIT funded $5.0 million of the DIP Facility on March 3, 1999, but decided
not to provide WAC the remaining balance. Accordingly, 50%, or approximately
$8.5 million, of the obligation will be treated pari passu with WFSG's
noteholders and converted to newly issued common stock of WFSG on the effective
date of the plan of reorganization. As a result, the total balance of this
obligation is included in Liabilities Subject to Compromise in the accompanying
consolidated statement of financial condition as of March 31, 1999.
When WFSG emerges from bankruptcy, the Company will adopt fresh-start
reporting as defined in Statement of Position 90-7, Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code (the "SOP"). Under the
provisions of fresh-start reporting, the Company's assets and liabilities will
be restated to reflect their fair values and the retained deficit will be
reclassified to common stock. As a result, the Company's current stockholders'
deficit will be eliminated.
The provisions of the SOP also require that revenues and expenses resulting
from the restructuring of the Company while it is in Chapter 11 be classified
separately. As such, these items have been segregated and recorded as
Restructuring Items in the consolidated statements of operations and include the
following for the quarter ended March 31, 1999:
<TABLE>
<CAPTION>
(Dollars in thousands)
<S> <C>
Write-off of unamortized debt issuance costs................................................ $11,319
Professional services....................................................................... 609
European restructuring costs................................................................ 2,492
Other general and administrative expense.................................................... 13
-------
$14,433
=======
</TABLE>
Costs incurred to issue the notes payable were previously capitalized and
amortized over the life of the notes. The notes payable are classified as
Liabilities Subject to Compromise in the accompanying consolidated statements of
financial condition as of March 31, 1999. Accordingly, the costs associated
with the notes have been
9
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued)
written-off. Professional services included in Restructuring Items represent
services provided in connection with the restructuring plan after the March 3,
1999 Chapter 11 filing date.
During the quarter ended March 31, 1999, WFSG developed and communicated a
plan to restructure its European operations and reduce its workforce. These
costs have been accrued for as Restructuring Items as of March 31, 1999 and
consist primarily of severance related compensation, the write-off of leasehold
improvements and other office closure related costs.
Due to the Company's restructuring, management of the Company does not
believe that the results of operations for the quarter ended March 31, 1999 are
indicative of the performance of the Company following the effective date of the
restructuring plan. Additionally, due to the adoption of fresh-start reporting,
the consolidated statement of financial condition will be materially different
from that included herein following the effective date of the restructuring
plan.
3. COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
First Bank had approximately $46.4 million notional principal amount of
interest rate swap agreements outstanding at March 31, 1999, which were
designated as hedges of certain fixed rate loans in order to convert fixed rate
income streams on loans to variable rate. These swaps had the effect of
decreasing the Company's net interest income by approximately $0.1 million
during the quarter ended March 31, 1999. The market value of these swaps
currently deferred was $0.4 million at March 31, 1999.
At March 31, 1999, the Company, primarily through First Bank, had
outstanding commitments to purchase approximately $0.2 million of loans.
From time to time, the Company enters into various commitments and letters
of intent relating to purchases of loans, foreclosed real estate portfolios and
discrete operating companies. There can be no assurance that any of such
transactions will ultimately be consummated. It is the Company's policy to
generally record such transactions in the financial statements in the period in
which such transactions are closed.
The Company is a defendant in legal actions arising from transactions
conducted in the ordinary course of business. Management, after consultation
with legal counsel, believes the ultimate liability, if any, arising from such
actions will not materially affect the Company's consolidated results of
operations or financial position.
4. INCOME TAXES
The Company files consolidated federal income tax returns with its domestic
subsidiaries. Certain state and foreign tax returns are also filed on a
consolidated basis while others are filed on a separate entity basis. Deferred
tax assets and liabilities represent the tax effects, based on current tax law,
of future deductible or taxable amounts attributable to events that have been
recognized in the financial statements. A valuation allowance has been recorded
against the deferred tax assets, consisting primarily of federal, state and
foreign net operating loss carryforwards, as there is not presumptive evidence
that it is more likely than not that the deferred tax assets will be realized.
The future utilization of the loss carryforwards will be subject to
significant limitations as a result of the restructuring plan. In addition, the
loss carryforwards may be reduced by any cancellation of debt effects.
5. LOSS PER SHARE
The Company has outstanding stock options which are considered common stock
equivalents in the calculation of diluted earnings per share. During the
quarter ended March 31, 1999, the Company experienced a net loss, which resulted
in common stock equivalents having an anti-dilutive effect on earnings per
share.
10
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued)
Weighted average shares outstanding is therefore equivalent for basic and
diluted earnings per share.
6. INVESTMENT IN WREIT
In April 1998, the Company sponsored the initial public offering of
WREIT, whereby WREIT received approximately $167.0 million of proceeds. The
Company is the Manager of WREIT and earns fee income based on the level of
WREIT's investment assets. During the quarter ended March 31, 1999, the Company
earned approximately $0.9 million in management fee income.
The Company purchased 990,000 shares of WREIT common stock in connection
with the initial public offering. This investment is accounted for by the equity
method of accounting and, therefore, is not adjusted for changes in the market
price of the underlying shares but rather, increases and decreases based on the
stockholders' equity of WREIT.
7. SIGNIFICANT TRANSACTIONS
During the quarter ended March 31, 1999, the Company sold approximately
$149.4 million and $43.3 million carrying value of loans held for sale and
discounted loans, respectively, to unrelated third parties. These sales were
made primarily to repay short-term borrowing facilities for which the assets
served as collateral and to provide liquidity.
8. OPERATING SEGMENTS
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," was issued effective for fiscal years beginning after
December 15, 1998. The Company opted not to adopt this statement prior to that
date.
The Company's reportable operating segments, as defined by the Company's
management, are thrift banking and non-banking operations. The operating
segments vary in terms of regulatory environment, funding sources and asset
acquisition focus. A description of the Company's operating segments is as
follows:
Thrift Banking - The Company's thrift banking operations are conducted
through First Bank. During 1998, the Bank was engaged in the acquisitions of
mortgage loans, origination of mortgage loans, and merchant bankcard processing.
The primary source of financing for First Bank's acquisitions and originations
is wholesale and brokered certificates of deposit, and to a lesser extent,
committed short-term line of credit facilities and FHLB advances. First Bank is
a federally chartered savings bank and is regulated by the Office of Thrift
Supervision.
Non-banking - The Company's non-banking operations are conducted primarily
through Wilshire Funding Corporation, and to a lesser extent, Wilshire Servicing
Corporation and Wilshire Financial Services Group Europe Inc. In addition to
mortgage loan acquisition, the non-banking operating segment also conducts loan
sale, securitization and servicing operations. Historically, the primary
funding sources utilized for non-banking operations were line of credit and
repurchase agreement facilities with nationally recognized investment and
commercial banking firms.
11
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued)
Segment data for the quarters ended March 31, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
Thrift Non-
1999 Segment Data Banking Banking Total
----------------- ------- ------- -----
<S> <C> <C> <C>
Interest income.......................................... $ 10,403 $ 6,800 $ 17,203
Interest expense......................................... 6,851 9,776 16,627
-------- -------- --------
Net interest income (loss)............................... 3,552 (2,976) 576
Provision for loan losses................................ -- 70 70
-------- -------- --------
Net interest income (loss) after
provision for loan losses............................... 3,552 (3,046) 506
Other income............................................. 2,577 6,887 9,464
Other expense............................................ 4,366 16,749 21,115
-------- -------- --------
Income (loss) before restructuring
items and taxes......................................... 1,763 (12,908) (11,145)
Restructuring items...................................... -- (14,433) (14,433)
-------- -------- --------
Income (loss) before taxes............................... 1,763 (27,341) (25,578)
Income tax provision (benefit)........................... 958 (583) 375
-------- -------- --------
Net income (loss)........................................ $ 805 $(26,758) $(25,953)
======== ======== ========
Total assets............................................. $576,056 $275,415 $851,471
======== ======== ========
<CAPTION>
Thrift Non-
1999 Segment Data Banking Banking Total
----------------- ------- ------- -----
<S> <C> <C> <C>
Interest income.......................................... $ 8,153 $ 26,665 $ 34,818
Interest expense......................................... 5,834 24,626 30,460
-------- ---------- ----------
Net interest income...................................... 2,319 2,039 4,358
Provision for loan losses................................ (2,100) 600 (1,500)
-------- ---------- ----------
Net interest income after
provision for loan losses............................... 4,419 1,439 5,858
Other income............................................. 132 6,006 6,138
Other expense............................................ 3,859 15,938 19,797
-------- ---------- ----------
Income (loss) before taxes............................... 692 (8,493) (7,801)
Income tax provision (benefit)........................... 295 (3,431) (3,136)
-------- ---------- ----------
Net income (loss)........................................ $ 397 $ (5,062) $ (4,665)
======== ========== ==========
Total assets............................................. $426,919 $1,351,127 $1,778,046
======== ========== ==========
</TABLE>
12
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company and Notes thereto.
Wilshire Financial Services Group Inc. ("WFSG" or, along with its
subsidiaries, referred to herein as the "Company") is a diversified financial
services company. We conduct business in the U.S. and Europe, specializing in
loan portfolio acquisition and securitization, correspondent lending and
servicing. We offer wholesale banking through our subsidiary, First Bank of
Beverly Hills, F.S.B. ("First Bank"). First Bank is a federally chartered
savings institution regulated by the Office of Thrift Supervision ("OTS") with
one branch and a merchant bankcard processing center in Southern California.
Administrative headquarters of WFSG, Wilshire Funding Corporation ("WFC") and
First Bank are located in Portland, Oregon.
OVERVIEW
In response to adverse market conditions in the second half of 1998 and the
resulting effect on our operations, we focused our efforts during the quarter
ended March 31, 1999 on stabilizing the assets remaining at our non-thrift
banking subsidiaries and restructuring WFSG and its subsidiaries through a
voluntary prepackaged Chapter 11 bankruptcy filing. First Bank remained focused
on the execution of its primary business plan as it was relatively unaffected by
the severe market conditions which dramatically affected the non-banking
subsidiaries during the second half of 1998.
Our Chapter 11 bankruptcy filing was approved by the Bankruptcy Court on
April 12, 1999, and is anticipated to become effective during May 1999.
However, there can be no assurance that WFSG will ultimately emerge from
bankruptcy or that the restructuring plan will have the desired economic effect.
Upon the restructuring plan becoming effective, we will adopt fresh-start
reporting (as described in Note 2 to the interim consolidated financial
statements), which will have the effect of revaluing our assets and liabilities
to fair value and eliminating the current stockholders' deficit as of the
restructuring plan's effective date. Due to the Company's restructuring,
management believes that the financial results for the quarter ended March 31,
1999 are not indicative of performance after the effective date of the
restructuring plan. Additionally, due to the adoption of fresh-start reporting,
the consolidated statement of financial condition will be materially different
from that included herein following the effective date of the restructuring
plan.
When we emerge from bankruptcy our $100 million of Series B Notes due 2004
and $84.2 million of 13% Notes due 2004 (collectively, the "Notes") will be
converted to newly issued shares of common stock, which will eliminate our
interest expense associated with the Notes. As noted above during the quarter
ended March 31, 1999, we recognized approximately $4.2 million in interest
expense related to the Notes and approximately $14.4 million of restructuring
costs in determining net loss.
During the quarter ended March 31, 1999, the OTS cease and desist order,
which limited the growth of First Bank's assets to $750 million, was rescinded
by the OTS. As noted above, during the quarter ended March 31, 1999, First Bank
remained focused on the execution of its primary business plan as it was not
materially impacted by the dramatic market conditions that severely affected the
non-banking WFSG subsidiaries. During the quarter ended March 31, 1999, First
Bank purchased loans with a carrying value of approximately $45.9 million and
originated approximately $6.1 million of loans.
During the quarter ended March 31, 1999, and continuing to the present, we
remain committed to reducing corporate overhead where deemed appropriate by
management. Subsequent to March 31, 1999, we made strategic reductions in
overhead related to our United Kingdom operations as our focus in Europe will be
concentrated more in France during 1999 and 2000. Currently, our operations in
France have adequate capacity to absorb additional
13
<PAGE>
investment activity. We continue to review our expense levels on a line of
business basis and will make strategic reductions or investments, as necessary,
to counter reductions in business activities or to build for anticipated growth.
Based on (i) the pending effectiveness of the WFSG restructuring plan and
the related application of fresh-start reporting, (ii) the reduction in interest
expense and restructuring costs that will be achieved following restructuring,
(iii) the on-going reduction in general corporate overhead and (iv) the
undisturbed continuation of operations at First Bank, we believe we are
positioned to move forward with organizational growth and put the ill-effects of
the second half of 1998 behind us.
We adopted the strategy of increasing our investment in performing and sub-
performing loans ("Non-Discounted Loans") and decreasing our investment in non-
performing loans ("Discounted Loans") as a percentage of the total loan
portfolio on a going forward basis. Non-Discounted Loans provide more
predictable and smoother cash flows and earnings stream for us. In addition,
Non-Discounted Loans are less capital intensive than Discounted Loans, which
often require us to expend cash to prepare the loan for resolution, which
typically occurs six to nine months following acquisition.
RESTRUCTURING OF WFSG
During the quarter ended March 31, 1999, WFSG submitted a prepackaged plan
of reorganization as part of a Chapter 11 bankruptcy filing in the Federal Court
of Wilmington, Delaware. On April 12, 1999, the restructuring plan was approved
by the Bankruptcy Court. It is currently anticipated by management of WFSG that
this reorganization plan will become effective and WFSG will emerge from
bankruptcy in May 1999. However, there can be no assurance that WFSG will
ultimately emerge from bankruptcy or that the restructuring plan will have the
desired economic effect.
Wilshire Credit Corporation ("WCC"), an affiliate of the Company, provides
loan servicing to us. The plan of reorganization discussed above contemplates
the transfer of the servicing operations conducted by WCC to a newly formed
subsidiary of WFSG. The Company will own 50.01% of the newly formed subsidiary
with the remaining 49.99% owned by a third party.
RESULTS OF OPERATIONS--QUARTER ENDED MARCH 31, 1999 COMPARED TO QUARTER ENDED
MARCH 31, 1998
Net Loss
Our net loss was approximately $26.0 million for the quarter ended March
31, 1999, compared with a net loss of approximately $4.7 million for the quarter
ended March 31, 1998. The increase in net loss is primarily attributable to a
decrease in net interest income of $3.8 million due to the sale of certain
interest-earning assets as a result of market conditions during the second half
of 1998, and $14.4 million of expenses related to the WFSG restructuring, as
explained above.
Net Interest Income
Our net interest income was approximately $0.6 million for the quarter
ended March 31, 1999 compared with approximately $4.4 million for the quarter
ended March 31, 1998. This decrease was due to a decline in interest income of
$17.6 million, partially offset by a decline in interest expense of $13.8
million, reflecting our reduction in the levels of loans and other interest-
earning assets and paydown of the related short-term borrowing facilities.
Interest expense decreased by an amount less than interest income due to our
accrual of interest expense related to the Notes through March 3, 1999.
Interest Income. Our interest income was approximately $17.2 million for
the quarter ended March 31, 1999 compared with approximately $34.8 million for
the quarter ended March 31, 1998, a decrease of $17.6
14
<PAGE>
million. This decrease was primarily due to a decrease in our interest-earning
assets from approximately $1.4 billion at March 31, 1998, to approximately
$744.3 million at March 31, 1999, resulting from the sale of certain loans and
other assets to provide liquidity and repay certain short-term borrowing
facilities.
Interest Expense. Our interest expense was approximately $16.6 million for
the quarter ended March 31, 1999, compared with approximately $30.5 million for
the quarter ended March 31, 1998, a decrease of $13.9 million. The decrease in
interest expense was primarily due to a decrease in our interest-bearing
liabilities to approximately $894.7 million at March 31, 1999 from approximately
$1.5 billion at March 31, 1998, resulting primarily from the repayments of
short-term borrowing facilities with proceeds from the asset sales described
above. In addition, during the quarter ended March 31, 1999, we recognized
interest on the Notes only through the date on which we filed our voluntary
Chapter 11 petition, which was March 3, 1999. Accordingly, $1.8 million of
contractual interest due on the Notes was not included in net income for the
quarter ended March 31, 1999. The full amount of contractual interest due on
the Notes was recognized in net income for the quarter ended March 31, 1998.
Upon the effectiveness of the WFSG restructuring, the Notes will be converted to
equity of WFSG and the related interest expense will no longer be recognized.
Provisions for Estimated Losses on Loans
Provisions for estimated losses on loans for the quarter ended March 31,
1999 were approximately $0.1 million, resulting primarily from additional
provisions taken on Discounted Loans in our European portfolio. We have provided
for additional reserves to the extent market values for pools of loans have been
reduced below book value. This compares with a net recovery of $1.5 million for
the quarter ended March 31, 1998, resulting primarily from First Bank's
recapture of reserves on loans sold or paid off.
Other Income
Our other income increased to approximately $9.5 million for the quarter
ended March 31, 1999 from approximately $6.1 million for the quarter ended March
31, 1998. The components of our other income are reflected in the following
table:
<TABLE>
<CAPTION>
Quarter Ended
March 31,
------------------------
1999 1998
------------ ----------
(Dollars in thousands)
<S> <C> <C>
Other income:
Servicing revenue........................................................... 1,915 1,371
Real estate owned, net...................................................... 1,473 73
Bankcard income, net........................................................ 1,297 500
Gain on sale of loans....................................................... 2,555 ---
Gain on sale of securities.................................................. --- 2,085
Trading income.............................................................. --- 1,458
Other, net.................................................................. 2,224 651
--------- -----------
Total other income..................................................... $ 9,464 $ 6,138
========= ===========
</TABLE>
The increase in other income was primarily attributable to a $2.6 million
increase in gain on sale of loans, a $1.4 million increase in real estate
owned, net, a $0.8 million increase in bankcard income, net and a $1.6 million
increase in other, net, offset in part by a $2.1 million decrease in gain on
sale of securities and a $1.5 million decrease in trading income. The
components of other income are further described below.
Servicing Revenue. Servicing revenue increased $0.5 million, during the
quarter ended March 31, 1999, primarily as a result of the expansion of third
party servicing, including servicing for our securitizations. The
15
<PAGE>
average unpaid principal balance of third party servicing increased from
approximately $1.3 billion for the quarter ended March 31, 1998 to approximately
$1.7 billion for the quarter ended March 31, 1999.
Real Estate Owned, net. Real estate owned, net increased approximately $1.4
million from the quarter ended March 31, 1998 to the quarter ended March 31,
1999 due to the sale of properties acquired through foreclosure or deed in-lieu
thereof.
Bankcard Income, net. Bankcard income, net was approximately $1.3 million
during the quarter ended March 31, 1999, an increase of $0.8 million from the
comparable period in 1998. This increase is attributable to the expansion of
Bankcard processing operations which includes internet commerce processing
activity. During the quarter ended March 31, 1999, gross bankcard processing
revenue was $3.5 million, of which $1.8 million was attributable to internet
commerce and $0.5 million was attributable to audio text transactions. The
remainder of approximately $1.2 million is primarily attributable to mail order
transaction processing.
The financial results of First Bank's merchant bankcard processing
operations for the quarters ended March 31, 1999 and 1998 have been as follows:
<TABLE>
<CAPTION>
1999 1998
------------ -------------
(Dollars In Thousands)
<S> <C> <C>
Bankcard revenues........................................... 3,486 1,597
Bankcard processing expenses................................ (2,189) (1,097)
Other expenses.............................................. (725) (506)
------------ -------------
Net......................................................... 572 (6)
============ =============
</TABLE>
Gain on Sale of Loans. Gain on sale of loans of approximately $2.6 million
for the quarter ended March 31, 1999 is primarily the result of sales of loans
at the non-banking subsidiary to repay short-term financing lines and provide
liquidity. In addition, there were no sales of loans during the quarter ended
March 31, 1998.
Gain on Sale of Securities. Gain on sale of securities decreased by
approximately $2.1 million due to sales of securities during the quarter ended
March 31, 1998 resulting in gains of approximately $2.1 million and no sales
activity during the quarter ended March 31, 1999.
Other, net. Other, net increased $1.6 million to $2.2 million during the
quarter ended March 31, 1999, compared to $0.6 million during the quarter ended
March 31, 1998. The increase is primarily attributable to management fees
earned from WREIT of $0.9 million for the quarter ended March 31, 1999. No such
fees were earned during the quarter ended March 31, 1998, as WREIT did not
commence operations until April 6, 1998.
Other Expenses
Our other expenses totaled approximately $21.1 million for the quarter
ended March 31, 1999 compared to approximately $19.8 million for the quarter
ended March 31, 1998, an increase of $1.3 million. This increase was primarily
due to increases in compensation and employee benefits of $1.6 million,
professional services of $1.9 million, and other general and administrative
expenses of $0.8 million, partially offset by a decrease in loan service fees
and expenses of $3.6 million.
Compensation and Employee Benefits. Compensation and employee benefits
totaled approximately $7.5 million for the quarter ended March 31, 1999,
compared to approximately $5.9 million for the quarter ended March 31, 1998.
The increase was primarily due to growth at First Bank and in our European
operations from 1998 to 1999. Also included in compensation and employee
benefits expense is approximately $0.1 million of severance related compensation
which will be non-recurring in nature.
16
<PAGE>
Professional Services. Professional services increased to approximately
$3.3 million for the quarter ended March 31, 1999 from approximately $1.4
million during the quarter ended March 31, 1998. The increase of $1.9 million
is attributable to professional services incurred in connection with our
restructuring plan prior to the March 3, 1999 Chapter 11 petition filing. As
these costs are considered pre-petition expenses, they are classified as
professional services and not restructuring costs in the consolidated statement
of operations for the quarter ended March 31, 1999.
Other General and Administrative Expenses. Other general and
administrative expenses increased from approximately $2.1 million for the
quarter ended March 31, 1998 to approximately $2.8 million for the quarter ended
March 31, 1999, due primarily to growth at First Bank and in our European
operations.
Loans Service Fees and Expenses Paid to Affiliate. Loan service fees and
expenses paid to affiliate decreased from $8.9 million for the quarter ended
March 31, 1998 to approximately $5.3 million for the quarter ended March 31,
1999. This decrease was primarily due to a decline in the balance of loans
during the quarter ended March 31, 1999, as we sold a large portion of our loan
portfolio to increase liquidity and reduce outstanding debt.
Restructuring Items
During the quarter ended March 31, 1999, we incurred approximately $14.4
million of expenses related to the WFSG restructuring. These expenses primarily
consisted of the write-off of unamortized debt issuance costs of $11.3 million,
professional services of $0.6 million and costs related to the restructuring of
our European operations of $2.5 million. The $14.4 million of restructuring
expenses, as well as $4.2 million of interest expense recognized during the
period related to the Notes, will be non-recurring following the effective date
of the WFSG restructuring plan. We have recognized interest expense on the
Notes through March 3, 1999, the date WFSG filed its petition under Chapter 11
of the Bankruptcy Code.
CHANGES IN FINANCIAL CONDITION
Mortgage-Backed and Other Securities. For accounting purposes, our
mortgage-backed and other securities are classified as available for sale and
held to maturity. Our holdings of mortgage-backed securities available for sale
decreased approximately $7.6 million during the quarter ended March 31, 1999.
This decrease was primarily due to principal repayments of $6.4 million and an
increase in unrealized holding losses, net of tax of $0.7 million. Our holdings
of mortgage-backed securities held to maturity decreased approximately $1.0
million during the quarter ended March 31, 1999 primarily due to principal
repayments. The following table sets forth our holdings of mortgage-backed and
other securities as of March 31, 1999 and December 31, 1998:
Mortgage-Backed Securities and Other Securities
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------- -----------
(Dollars In Thousands)
<S> <C> <C>
Available for sale:
Mortgage-backed securities............................. $ 65,191 $ 66,829
Agency mortgage-backed securities...................... 41,675 47,634
Held to maturity:
U.S. Government and other securities................... 5,967 5,962
Mortgage-backed securities............................. 12,582 13,580
---------- -----------
Total............................................... 18,549 19,542
---------- -----------
Total investment securities......................... $ 125,415 $ 134,005
========== ===========
</TABLE>
17
<PAGE>
Loans, net. Our portfolio of loans, net of discounts and allowances,
increased by approximately $9.7 million during the quarter ended March 31, 1999.
This increase is primarily attributable to the acquisition of Non-Discounted
Loans at First Bank, reflecting our emphasis on increasing the level of
investment in Non-Discounted Loans as a percentage of the total loan portfolio.
See "Discounted Loans, net" below.
Discounted Loans, net. Our portfolio of Discounted Loans decreased by
approximately $26.6 million during the quarter ended March 31, 1999. The
decrease is primarily attributable to our sale of Discounted Loans to repay
certain short-term borrowing facilities and provide liquidity. It is
anticipated that our future investments in Discounted Loans as a percentage of
our total loan portfolio will be reduced. Discounted Loans require significant
capital resources prior to resolution, which is generally six to nine months
following acquisition. We believe we can create a more predictable and less
capital intensive earnings stream by reducing the level of investment in these
assets. Nonetheless, we make our investment decisions on an opportunistic basis
and will evaluate investment opportunities as they arise.
Loans Held for Sale, Net, at Lower of Cost or Market. Loans held for sale,
net, at lower of cost or market decreased by approximately $175.2 million during
the quarter ended March 31, 1999 primarily as a result of the sale of loans to
increase liquidity and reduce outstanding borrowings.
Real estate owned, net. Real estate owned, net decreased by approximately
$16.4 million during the quarter ended March 31, 1999. The decrease was
primarily due to sales of properties for proceeds of approximately $18.0
million, partially offset by acquisitions of real estate through foreclosure or
deed-in-lieu thereof from our portfolio of discounted loans.
Mortgage Servicing Rights, net. Mortgage servicing rights, net decreased
by $0.2 million during the quarter ended March 31, 1999, primarily due to the
amortization of previously capitalized or purchased servicing rights.
Investment in Wilshire Real Estate Investment Trust Inc. Investment in
WREIT increased $0.4 million as a result of an increase in WREIT's stockholders'
equity during the quarter ended March 31, 1999 due primarily to a decrease in
WREIT's unrealized holding losses and net income.
Deposits. First Bank's deposits decreased by approximately $31.8 million
during the quarter ended March 31, 1999. This decrease is primarily
attributable to a corresponding reduction in First Bank's asset portfolio. On
February 8, 1999, the OTS rescinded the cease and desist order under which First
Bank had previously been operating. The cease and desist order, among other
things, had prohibited First Bank from increasing total assets in excess of $750
million.
Short-Term Borrowings. Short-term borrowings decreased by approximately
$189.0 million during the quarter ended March 31, 1999, resulting primarily from
our reduction of total loans from $792.2 million at December 31, 1998 to $600.2
million at March 31, 1999.
Notes payable. The notes payable of $184.2 million at December 31, 1998
are classified as Liabilities Subject to Compromise in the consolidated
statement of financial condition at March 31, 1999. Pursuant to our prepackaged
Chapter 11 bankruptcy filing, these notes will be converted into equity of WFSG,
as described more fully in Note 2 to the interim consolidated financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the measurement of our ability to meet potential cash
requirements, including ongoing commitments to repay borrowings, fund
investments, purchase pools of loans, and fund newly originated loans, and for
general business purposes. Our sources of cash flow include certificates of
deposit, securitizations, whole loan and mortgage-backed securities sales, net
interest income and borrowings under warehouse and repurchase
18
<PAGE>
financing facilities and from institutional investors and other lenders and
public and private debt offerings. We also have borrowed money from WREIT and
WCC. In addition, First Bank has available funding through FHLB advances. Our
liquidity is actively managed on a daily basis and reviewed periodically by our
Board of Directors. This process is intended to ensure the maintenance of
sufficient funds to meet the needs of the Company, including adequate cash flows
for off-balance sheet instruments.
The Company had a secured warehouse financing facility with Prudential
Securities Credit Corporation of up to $150 million for the origination or
purchase of residential first and second lien mortgage loans. This facility
matured on March 31, 1999 and has not been extended. The Company has sold the
remaining loans financed by this facility and has eliminated its borrowings on
this line. The Company has repurchase agreements outstanding that mature
monthly and roll into new 30 day repurchase agreements. The Company does not
meet all of the financial covenants of these transactions (including
stockholders' equity requirements); however, the lenders have continued to roll
the repurchase agreements. In addition, the Company has discussed additional
lending arrangements with investment banks which may provide financing on a
transaction by transaction basis. There can be no assurance that lenders will
continue to roll the repurchase agreements or will not change material terms,
including, but not limited to, advance rates and interest rates on these
financing arrangements.
The dramatic events in the financial markets in late 1998, which included a
significant reduction in valuations of and liquidity for mortgage-backed
securities, has had a significant adverse impact on our liquidity and financial
condition. The decline in valuations resulted in collateral calls from our
lenders, which reduced our cash position and eventually prompted asset sales at
depressed prices to meet these calls and provide liquidity. While these asset
sales have improved our liquidity position, the market for mortgage-backed
securities, particularly subordinate mortgage-backed securities, remains
depressed and the financial markets generally continue to be volatile. Further,
certain of the Company's lenders have expressed concern about continued lending
given market conditions and the losses incurred by the Company. At March 31,
1999, our cash balances totaled approximately $18.8 million, however, $10.7
million of the balance was held at First Bank and is not available for use by
other than First Bank.
In order to address these concerns and improve the Company's financial
condition, management entered into discussions with an unofficial committee of
holders of a majority of the Company's $184.2 million in outstanding publicly
issued notes, concerning a restructuring of the Company's obligations under the
Notes. Following extensive discussions, the Company and the unofficial
noteholders' committee agreed to a restructuring of the Company.
The restructuring plan provides that (i) the noteholders will exchange
their notes for new common stock in the Company; (ii) existing common stock
would be cancelled and holders of common stock in the Company would receive
approximately 0.60% of the new common stock and (iii) pending consummation of
the restructure, the noteholders would forebear from declaring certain defaults
which resulted from the net losses incurred by the Company and the actions taken
by the company to meet collateral calls.
We believe that this restructuring plan will significantly improve our
financial position by reducing indebtedness by $184.2 million, the ongoing
interest cost associated with that indebtedness, significantly increase our
equity account. This restructuring is subject to a number of conditions,
including no material adverse change and negotiation of definitive documents. We
currently expect that this restructuring will be completed in May 1999. Other
creditors, including trade creditors and secured creditors, are not expected to
be adversely affected by this restructuring.
As a part of the restructuring plan, we and the unofficial noteholders
committee anticipate incorporating the servicing functions currently performed
by WCC into a new subsidiary of WFSG.
Based on our current and expected asset size, capital levels, and
organizational infrastructure, management believes that cash flows will be
sufficient to meet its needs. However, we intend to aggressively seek new
capital to permit it to more fully and more efficiently utilize its acquisition
and loan servicing platforms. There is no assurance, however, that it will be
able to do so.
19
<PAGE>
Following the losses incurred by the Company in the second half of 1998,
the Company began discussions with a number of potential new equity investors in
order to strengthen its diminished equity base and obtain additional capital to
operate and develop the business. It is currently anticipated that such
investments, if any, will be made after the effectiveness of the restructuring
plan. There can be no assurance, however, that any such investments will be
made.
Our consolidated financial statements have been prepared on a going concern
basis, which contemplates continuity of operations, realization of assets and
the liquidation of liabilities in the normal course of business. The
appropriateness of using the going concern basis is dependent upon, among other
things, the adequate resolution of our long term liquidity shortfall, as well as
the successful consummation of the reorganization described above.
Sources of liquidity for First Bank include wholesale and brokered
certificates of deposit. At March 31, 1999, First Bank had approximately $465.4
million of certificates of deposit. At March 31, 1999, scheduled maturities of
certificates of deposit during the 12 months ending March 31, 2000 and
thereafter amounted to approximately $394.8 million and approximately $70.6
million, respectively. Brokered and other wholesale deposits generally are more
responsive to changes in interest rates than core deposits and, thus, are more
likely to be withdrawn by the investor upon maturity as changes in interest
rates and other factors are perceived by investors to make other investments
more attractive. However, management of First Bank believes it can adjust the
rates paid on certificates of deposit to retain deposits in changing interest
rate environments and that brokered and other wholesale deposits can be both a
relatively cost-effective and stable source of funds.
Primarily as a result of asset sales, we have had adequate cash and cash
equivalents to meet calls for additional collateral to repay a portion of the
related indebtedness or to meet our other operating and financing requirements.
In certain instances, repurchase lenders on our mortgage-backed securities
assets have withheld principal and/or interest payments on certain assets in
order to reduce outstanding, unpaid margin calls. At March 31, 1999, there were
approximately $7.0 million of outstanding collateral calls, based on the dealers
market valuation of the underlying collateral, net of withheld principal and
interest payments.
We are party to various off-balance sheet financial instruments in the
normal course of business to manage our interest rate risk. We conduct business
with a variety of financial institutions and other companies in the normal
course of business, including counterparties to our off-balance sheet financial
instruments. We are subject to potential financial loss if the counterparty is
unable to complete an agreed upon transaction. We seek to limit counterparty
risk through financial analysis and other monitoring procedures.
Adequate credit facilities and other sources of funding, including our
ability to securitize loans, are essential to the continuation of the Company's
ability to purchase pools of loans, mortgage-backed securities and newly
originated mortgages. During the third and fourth quarters of 1998, financial
markets were severely and negatively impacted by various factors which have
resulted in reduced availability of liquidity and capital to specialty finance
companies and other holders of non-investment grade assets and certain types of
loans. This includes the ability to raise new equity capital and long-term
debt, as well as the ability to securitize or finance certain types of loans.
The Company's growth strategy is dependent on its ability to raise
additional debt and/or equity financing and growth at First Bank. To the extent
this market environment persists, such growth is likely to be significantly
curtailed or delayed.
First Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of U.S. Government,
federal agency and other investments having maturities of five years or less.
Current OTS regulations require that a savings association maintain liquid
assets of not less than 4% of its average daily balance of net withdrawable
deposit accounts and borrowings payable in one year or less, of which short-term
liquid assets must consist of not less that 1%. Monetary penalties may be
imposed for failure to meet applicable liquidity requirements. First Bank has
complied with these requirements.
20
<PAGE>
Federally insured savings associations such as the Bank are required to
maintain minimum levels of regulatory capital. Those standards generally are as
stringent as the comparable capital requirements imposed on national banks. The
OTS also is authorized to impose capital requirements in excess of these
standards on a case-by-case basis. In connection with the 1998 examination the
OTS indicated that the capital level of First Bank exceeds the minimum
requirement for "well capitalized" status under provisions of the Prompt
Corrective Action Regulation.
YEAR 2000 COMPLIANCE
We are reliant on information technology for both general business
operations and our loan servicing system. We have formed a committee to address
Year 2000 issues (the "Committee") that reports directly to our executive
committee. The Committee is headed by the Chief Information Officer and
includes representatives from across the Company.
The Committee has conducted an inventory of all of our systems, classifying
each as either "critical" or "non-critical." For non-critical systems, the
Committee has obtained a certification from the vendor that the applicable
package is "Year 2000 compliant." For systems deemed "critical," the Committee
developed detailed test plans and created separate Year 2000 test environments.
The financial impact of becoming Year 2000 compliant has not been and is
not expected to be material to us or our results of operations. Aside from
limited hardware costs, our primary expense related to Year 2000 compliance is
allocation of existing staff. The Committee estimates the total cost related to
Year 2000 compliance to be approximately $0.5 million.
The significant risk to us of Year 2000 non-compliance is the inability to
perform necessary loan servicing activities. Currently, our loan portfolio is
serviced by WCC, an affiliated entity. As of April 1999, we completed testing
of all critical systems and determined that they are Year 2000 compliant.
Based on the results of testing performed to date, the Committee is
confident that it is appropriately addressing the 2000 issues. Critical systems
supplied by outside vendors have undergone testing not only by us, but other
customers of the vendors as well. Our loan servicing system is an internally
developed system and therefore, information technology personnel are very
familiar with the system and believe their efforts will have favorable results.
As a contingency plan, the Committee is in the process of developing internal
operating procedures that would enable departments to function for a period of
time until the primary system could be restored to operations.
21
<PAGE>
IMPORTANT FACTORS RELATING TO FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those projected in such statements. All of the
statements contained in this Quarterly Report on Form 10-Q which are not
identified as historical should be considered forward-looking. In connection
with certain forward-looking statements contained in this Quarterly Report on
Form 10-Q and those that may be made in the future by or on behalf of the
Company which are identified as forward- looking, the Company notes that there
are various factors that could cause actual results to differ materially from
those set forth in any such forward-looking statements. Such factors include but
are not limited to the real estate market, the cease and desist order, the
availability of loan portfolios at acceptable prices, the availability of
financing for loan portfolio acquisitions, interest rates and expansion outside
the U.S. Accordingly, there can be no assurance that the forward-looking
statements contained in this Quarterly Report on Form 10-Q will be realized or
that actual results will not be significantly higher or lower. The forward-
looking statements have not been audited by, examined by or subjected to agreed-
upon procedures by independent accountants, and no third-party has independently
verified or reviewed such statements. Readers of this Quarterly Report on Form
10-Q should consider these facts in evaluating the information contained herein.
The inclusion of the forward-looking statements contained in this Quarterly
Report on Form 10-Q should not be regarded as a representation by the Company or
any other person that the forward-looking statements contained in this Quarterly
Report on Form 10-Q will be achieved. In light of the foregoing, readers of
this Quarterly Report on Form 10-Q are cautioned not to place undue reliance on
the forward-looking statements contained herein.
22
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
It is our objective to attempt to control risks associated with interest
rate movements. In general, management's strategy is to limit our exposure to
earnings variations and variations in the value of assets and liabilities as
interest rates change over time. Our asset and liability management strategy is
formulated and monitored by the asset and liability committees for the Company
and First Bank (the "Asset and Liability Committees") which meet regularly to
review, among other things, the sensitivity of our assets and liabilities to
interest rate changes, the book and market values of assets and liabilities,
unrealized gains and losses, including those attributable to hedging
transactions, purchase and securitization activity, and maturities of
investments and borrowings. The Asset and Liability Committees coordinate with
First Bank's Board of Directors and the Company's investment committees with
respect to overall asset and liability composition.
The Asset and Liability Committees are authorized to utilize a wide variety
of off-balance sheet financial techniques to assist them in the management of
interest rate risk. These techniques include interest rate swap agreements,
pursuant to which the parties exchange the difference between fixed-rate and
floating-rate interest payments on a specified principal amount (referred to as
the "notional amount") for a specified period without the exchange of the
underlying principal amount. Interest rate swap agreements are utilized to
reduce our exposure caused by the narrowing of the interest spread between fixed
rate loans held for investment and associated liabilities funding those loans
caused by changes in market interest rates. First Bank had approximately $46.4
million notional principal amount of interest rate swap agreements outstanding
at March 31, 1999, which were designated as hedges of certain fixed rate loans
in order to convert variable rate liabilities to fixed rate. These swaps had
the effect of decreasing our net interest income by approximately $0.1 million
during the quarter ended March 31, 1999.
At times, we have also hedged the interest rate exposure of fixed-rate or
lagging-index loans or securities that are either held or available for sale.
The Company creates a hedge which matches the principal amortization of such
assets against the maturity of our liabilities generally by entering into short
sales or forward sales of U.S. Treasury securities, Government securities,
interest rate futures contracts or interest rate swap agreements. This results
in market gains or losses on hedging instruments, in response to interest rate
increases or decreases, respectively, which approximate the amount of
corresponding market losses or gains, respectively, on assets being hedged. We
evaluate the interest rate sensitivity of each pool of loans or securities in
conjunction with the current interest rate environment and decide whether to
hedge the interest rate exposure of a particular pool. We generally do not
hedge the interest rate risk associated with holding non-lagging index
adjustable-rate mortgages pending their sale or securitization due to the
decreased significance of such risk. In general, when a pool of loans or
securities are acquired, we will determine whether or not to hedge and, with
respect to any sale or financing of any pool of loans through securitization,
will determine whether or not to discontinue its duration-matched hedging
activities with respect to the relevant loans.
In addition, as required by OTS regulations, First Bank's Asset and
Liability Committee also regularly reviews interest rate risk by forecasting the
impact of alternative interest rate environments on net interest income and
market value of portfolio equity ("MVPE"), which is defined as the net present
value of an institution's existing assets, liabilities and off-balance sheet
instruments, and evaluating such impacts against the maximum potential changes
in net interest income and MVPE that is authorized by the board of directors of
First Bank.
First Bank's interest rate sensitivity of MVPE arising from fluctuations in
interest rates in a rising 200 to 300 basis point interest rate environment has
increased since year end due to significant changes in the composition of First
Bank's loan portfolio, continued amortization of the notional amount of First
Bank's swap, as well as changes in the overall market interest rate environment.
As of March 31, 1999, the estimated change in MVPE as a result of a 200 to 300
basis point rise in interest rates was $25.4 million to $42.4 million. The
Asset and Liability Committees are in the process of reviewing the strategy to
mitigate risk of this additional exposure.
Management also believes that the assumptions (including prepayment
assumptions) used by it to evaluate the vulnerability of First Bank's operations
to changes in interest rates approximate actual experience and
23
<PAGE>
considers them reasonable; however, the interest rate sensitivity of First
Bank's assets and liabilities and the estimated effects of changes in interest
rates on First Bank's net interest income and MVPE could vary substantially if
different assumptions were used or actual experience differs from the historical
experience on which they are based.
24
<PAGE>
WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.
The Company is involved in various legal proceedings occurring in
the ordinary course of business which management of the Company
believes will not have a material adverse effect on the financial
condition or operations of the Company.
ITEM 2. Changes in Securities.
Not applicable.
ITEM 3. Defaults Upon Senior Securities.
The recent dramatic events in financial markets, which included a
significant reduction in valuations of, and liquidity for, mortgage-
backed securities, has had a significant adverse impact on the
Company's liquidity and financial condition. Primarily as a result of
these market conditions and the resulting losses, the Company is
unable to comply with the minimum net worth and other requirements
for certain of its outstanding indebtedness.
ITEM 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders during the
period covered by this report.
ITEM 5. Other Information.
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-k.
(a) Exhibits.
11 Statement re Computation of Per Share Earnings
27 Financial Data Schedule
(b) Report on form 8-K dated March 3, 1999, reporting the filing of
a voluntary petition for a pre-packaged plan of reorganization
with the United States Bankruptcy Court for the District of
Delaware.
25
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
Wilshire Financial Services Group Inc.
Date: May 24, 1999
By: /s/ Lawrence A. Mendelsohn
--------------------------
Lawrence A. Mendelsohn
President
By: /s/ Chris Tassos
----------------
Chris Tassos
Chief Financial Officer
26
<PAGE>
Exhibit 11.1
<TABLE>
<CAPTION>
Quarter Ended
March 31,
--------------------------------
1999 1998
------------- -------------
(Dollars in thousands
except share data)
<S> <C> <C>
Diluted net loss per share:
Net loss $ (25,953) $ (4,665)
Preferred Stock dividend 417
------------- --------------
Net loss available to common shareholders $ (25,953) $ (5,082)
============= ==============
Average number of shares outstanding 10,885,000 9,742,778
Net effect of dilutive stock options-based on treasury stock method ---
------------- --------------
Total average shares $ 10,885,000 9,742,778
============= ==============
Diluted net loss per share $ (2.38) $ (0.52)
============= ==============
</TABLE>
27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S BALANCE SHEET AS OF MARCH 31, 1999 AND STATEMENT OF EARNINGS FOR THE
THREE MONTHS ENDED MARCH 31, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 18,774
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 106,866
<INVESTMENTS-CARRYING> 18,549
<INVESTMENTS-MARKET> 0
<LOANS> 600,159
<ALLOWANCE> 0
<TOTAL-ASSETS> 851,471
<DEPOSITS> 478,631
<SHORT-TERM> 231,793
<LIABILITIES-OTHER> 26,565
<LONG-TERM> 0
0
0
<COMMON> 117,708
<OTHER-SE> (238,736)
<TOTAL-LIABILITIES-AND-EQUITY> 851,471
<INTEREST-LOAN> 13,547
<INTEREST-INVEST> 0
<INTEREST-OTHER> 365
<INTEREST-TOTAL> 17,203
<INTEREST-DEPOSIT> 6,769
<INTEREST-EXPENSE> 16,627
<INTEREST-INCOME-NET> 576
<LOAN-LOSSES> 70
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 21,115
<INCOME-PRETAX> (11,145)
<INCOME-PRE-EXTRAORDINARY> (25,953)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (25,953)
<EPS-BASIC> (2.38)
<EPS-DILUTED> (2.38)
<YIELD-ACTUAL> 0
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 0
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 0
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
