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 September 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-23911
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
(Exact name of registrant as specified in its charter)
MARYLAND 52-2081138
-------------- -----------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
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 (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__ No_X_.
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 OCTOBER 31, 1998
Common Stock, par value $0.0001 per share 11,500,000
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
FORM 10-Q
I N D E X
PAGE NO.
PART I--FINANCIAL INFORMATION
Item 1. Interim Financial Statements (Unaudited).............................3
Consolidated Statement of Financial Condition........................3
Consolidated Statements of Operations................................4
Consolidated Statement of Changes in Stockholders' Equity............5
Consolidated Statements of Cash Flows................................6
Notes to Consolidated Financial Statements...........................8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...............................................19
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........32
PART II--OTHER INFORMATION
Item 1. Legal Proceedings..................................................33
Item 2. Changes in Securities..............................................33
Item 3. Defaults Upon Senior Securities....................................33
Item 4. Submission of Matters to a Vote of Security Holders................33
Item 5. Other Information..................................................33
Item 6. Exhibits and Reports on Form 8-K...................................33
Signature ...............................................................35
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
SEPTEMBER 30, 1998
(Unaudited)
(DOLLARS IN THOUSANDS)
ASSETS
Cash and cash equivalents $ 3,970
Securities available for sale, at fair value 299,598
Loans, net 615,080
Discounted loans, net 10,364
Investments in real estate, net 80,935
Due from affiliates, net 325
Accrued interest receivable 4,809
Other assets 2,934
Total assets $1,018,015
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Short-term borrowings $ 475,351
Securitized mortgage obligations 372,318
Other borrowings 60,804
Accounts payable and accrued liabilities 4,540
Dividends payable 4,600
Total liabilities 917,613
Commitments and Contingencies (see Note 16)
Stockholders' Equity:
Preferred stock, $.0001 par value; 25,000,000
shares authorized; no shares
issued and outstanding -
Common Stock, $.0001 par value; 200,000,000
shares authorized; 11,500,000 shares issued
and outstanding 1
Additional paid-in capital 166,980
Net loss and distributions (53,543)
Accumulated other comprehensive loss (13,036)
Total stockholders' equity 100,402
Total liabilities and stockholders equity $ 1,018,015
================
The accompanying notes are an integral part of these
consolidated financial statements.
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WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
Three Months Ended Six Months Ended
September 30, 1998 September 30, 1998
Net Interest Income:
Loans and discounted loans $ 4,167 $ 5,491
Securities 7,152 10,758
Other investments 326 486
Total interest income 11,645 16,735
Interest expense 6,012 7,513
Net interest income before
provision for loan losses 5,633 9,222
Provision for loan losses 3,000 3,000
Net interest income after
provision for loan losses 2,633 6,222
Real Estate Operations:
Operating income 2,011 2,960
Operating expense (129) (192)
Real estate operations before
interest and depreciation 1,882 2,768
Interest expense 1,060 1,408
Depreciation 394 569
Total real estate operations 428 791
Other Operating Income (Loss):
Gain on sale of securities 934 934
Market valuation adjustments (49,520) (49,520)
Total other operating loss (48,586) (48,586)
Operating Expenses:
Management fees paid to affiliate 1,340 1,942
Servicing fees paid to affiliate 204 252
Loan expenses paid to affiliate 193 278
Other 1,618 1,793
Total operating expenses 3,355 4,265
NET LOSS $ (48,880) $ (45,838)
NET LOSS PER SHARE $ (4.25) $ (4.03)
WEIGHTED AVERAGE SHARES OUTSTANDING 11,500,000 11,381,356
The accompanying notes are an integral part of this
consolidated financial statement.
4
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<TABLE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1998
(Unaudited)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<CAPTION>
ACCUMULATED
ADDITIONAL NET LOSS OTHER
COMMON STOCK PAID-IN- AND COMPREHENSIVE
SHARES AMOUNT CAPITAL DISTRIBUTIONS LOSS TOTAL
<S> <C> <C> <C> <C> <C> <C>
Balance at April 1,
1998 -- $ -- $ 2 $ -- $ -- $ 2
Issuance of common
stock 11,500,000 1 166,978 -- -- 166,979
Comprehensive loss:
Net loss -- -- -- (45,838) -- (45,838)
Other comprehensive
loss:
Change in
unrealized
loss on
securities
available
for sale -- -- -- -- (13,036) (13,036)
Total comprehensive
loss -- -- -- -- -- (58,874)
Dividends declared -- -- -- (7,705) -- (7,705)
Balance at
September 30, 1998 11,500,000 $ 1 $166,980 $ 53,543 $(13,036) $ 100,402
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
<TABLE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(dollars in thousands)
<CAPTION>
Three Months Ended Six Months Ended
September 30, 1998 September 30, 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (48,880) $ (45,838)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation 394 569
Amortization of premiums and discounts, net (52) (336)
Provision for loan losses 3,000 3,000
Market valuation adjustments 49,520 49,520
Gain on sale of securities (934) (934)
Change in:
Due from affiliate, net 2,713 (325)
Accrued interest receivable (1,919) (4,809)
Other assets (771) (2,934)
Accounts payable and accrued liabilities 1,738 4,540
Other, net 400 400
Net cash provided by operating activities 5,209 2,853
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available for sale (108,989) (365,918)
Repayments of securities available for sale 3,215 3,859
Proceeds from sale of securities available for sale 16,817 16,817
Purchase of loans (595,276) (637,711)
Purchase of discounted loans -- (13,389)
Principal payments received on loans and discounted loans 2,207 6,338
Investments in real estate (4,910) (81,256)
Other -- 28
Net cash used in investing activities (686,936) (1,071,232)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 272,695 508,230
Repayments on short-term borrowings (27,981) (32,879)
Proceeds from securitized mortgage obligations 372,318 372,318
Proceeds from other borrowings 15,629 60,940
Repayments on other borrowings (47) (136)
Dividend payments on common stock (3,105) (3,105)
Proceeds from issuance of common stock -- 166,979
Net cash provided by financing activities 629,509 1,072,347
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (52,218) 3,968
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 56,188 2
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,970 $ 3,970
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
<TABLE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(DOLLARS IN THOUSANDS)
<CAPTION>
Three Months Ended Six Months Ended
September 30, 1998 September 30, 1998
<S> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION--
Cash paid for interest $ 6,028 $ 7,347
NONCASH FINANCING AND INVESTING ACTIVITIES--
Common stock dividends declared but not paid 4,600 4,600
Additions to investment in real estate acquired in
settlement of loans -- 276
(concluded)
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
7
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS, EXCEPT WHERE NOTED)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying interim consolidated financial statements are
unaudited and have been prepared in conformity with the requirements of
Regulation S-X promulgated under the Securities Exchange Act of 1934 as amended
(the "Exchange Act"), particularly Rule 10-01 thereof, which governs the
presentation of interim financial statements. Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting
principles ("GAAP") for complete financial statements.
The accompanying consolidated financial statements include the
accounts of Wilshire Real Estate Investment Trust Inc. and its four wholly-owned
subsidiaries, including Wilshire Real Estate Partnership L.P., ("WREP"),
Wilshire Real Estate Partnership 1998-1 LLC, WREP Trust Series 1998-1, and WREP
Islands Limited (collectively "WREIT" or the "Company"). Intercompany accounts
have been eliminated in consolidation.
In the opinion of management, all adjustments, other than the
adjustments described below, generally are comprised of normal recurring
accruals necessary for the fair presentation of the interim financial
statements. Operating results for the abbreviated six months ended September 30,
1998 are not necessarily indicative of the results that may be expected for the
abbreviated year ending December 31, 1998.
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.
NOTE 2 - ORGANIZATION AND RELATIONSHIPS
WREIT was incorporated in the State of Maryland on October 24, 1997.
The Company was initially formed with a capital investment of $2.0. Prior to
April 6, 1998, the Company had substantially no operating activity. On April 6,
1998, the Company was capitalized with the sale of 11,500,000 shares of common
stock, par value $.0001 per share, at a price of $16.00 per share (the
"Offering"). Total net proceeds of the Offering after underwriting and offering
expenses were $166,979.
The Company has entered into a management agreement with Wilshire Real
Estate Service Corporation ("WRSC"), a wholly owned subsidiary of Wilshire
Financial Services Group Inc. ("WFSG"), under which WRSC advises the Company on
various facets of its business and manages its day-to-day operations, subject to
the supervision of the Company's Board of Directors. WFSG currently owns 990,000
shares, or 8.6%, of the Company's outstanding common stock and has options to
purchase an additional 1,135,000 shares (25% of which vest each year over the
next four years) at an exercise price of $16.00 per share. For its services,
WRSC receives a base management fee of 1% per annum of the first $1.0 billion of
average invested assets, as defined in the related agreement, 0.75% of the next
$500 million of average invested assets and 0.50% of average invested assets
above $1.5 billion, payable quarterly. In addition, WRSC receives incentive
compensation in an amount generally equal to 25% of the dollar amount by which
funds from operations ("FFO"), as adjusted, exceeds an amount equal to the
product of the weighted average of the price per share at the offering and the
general ten-year Treasury rate plus 5% per annum multiplied by the weighted
average number of shares of common stock outstanding during such period.
Finally, WRSC is entitled to receive reimbursements of all due diligence costs
and
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reasonable out-of-pocket expenses. Through September 30, 1998, such fees
payable to WFSG aggregated $1,942.
As further discussed in the Form 10-Q of WFSG for the quarterly period
ended September 30, 1998, the recent dramatic events in financial markets, which
include a significant reduction in valuations of, and liquidity for,
mortgage-backed securities, has had a significant adverse impact on WFSG's
liquidity and financial condition. As a result, management entered into
discussions with an unofficial committee of holders of WFSG's outstanding
publicly issued notes and its financial advisors, Houlihan Lokey Howard & Zukin,
concerning a restructuring of its obligations under the notes. Following
extensive discussions, WFSG and the unofficial committee of noteholders,
representing a majority of noteholders, agreed on November 23, 1998 to a
restructuring of WFSG whereby (i) the noteholders would exchange their notes for
common stock in WFSG, (ii) existing holders of common stock of WFSG would
receive warrants in exchange for their holdings or highly diluted new common
stock in exchange for their holdings, and (iii) pending consummation of the
restructure, the noteholders would forbear from declaring certain defaults which
resulted from the net losses incurred by WFSG during this period and from other
actions taken by WFSG during this period to meet collateral calls. WFSG believes
that this restructuring will significantly improve WFSG's financial position by
reducing indebtedness, the interest cost associated therewith, and significantly
improve its debt to equity ratio. This restructuring is subject to a number of
conditions, including no material adverse change and negotiation of definitive
documents, and WFSG currently expects that this restructuring will be completed
by the end of the first quarter of 1999. Other creditors, including trade
creditors and secured creditors, are not expected to be affected by this
restructuring. It is uncertain at this time what effect, if any, these events
could have on WRSC's ability to perform its duties as manager of WREIT. If WRSC
cannot continue to perform its duties as manager of WREIT, it is anticipated
WREIT would terminate its contract with WRSC and become internally managed.
NOTE 3 - GENERAL MARKET CONDITIONS
Beginning in August 1998, and more significantly, since mid October
1998, the global financial marketplace has experienced overwhelming changes and
volatility. The market for mortgages and mortgage-backed securities and, in
particular, subordinate credit related tranches of these securities has
experienced dramatically widening spreads. Liquidity problems affecting certain
Wall Street firms, hedge funds and other financial instruments investors have
exacerbated this market phenomenon through forced liquidation of their assets.
This has led to an increased need for liquidity at the Company both to meet
collateral calls and as a preemptive measure to protect against future
mortgage-backed securities spread distortions that the Company expects may be
experienced by the markets in general.
As a result, the Company, subsequent to September 30, 1998, sold
approximately $525.2 million of its loans and mortgage-backed securities in
order to meet collateral calls, primarily by certain affiliates of Salomon Smith
Barney Inc., and reduce outstanding debt. The sales of these assets are not
reflected in the balance sheet except that the basis of the assets sold has been
reduced equal to the market valuation adjustments (see Note 4). These sales have
been reported on Current Report Form 8-K filed subsequent to September 30, 1998
and discussed further on Note 4 below. In addition, on November 16, 1998, the
Company sold a mezzanine loan secured by a partnership interest in commercial
real estate for $61.6 million in proceeds. The Company has reduced the recorded
carrying amount as of September 30, 1998 of these assets on the financial
statements to match the amounts realized upon subsequent disposition.
Accordingly, the Company reflected their write-downs as "market valuation
adjustments" (see Note 4) in determining net loss for the three months ended
September 30, 1998. Had the Company not been forced to sell these assets, but
rather held these assets until market conditions stabilized, management believes
the Company's losses would have been far less severe.
As a result of difficult conditions in the financial markets, in
particular the market for mortgage-backed securities, and in order to enhance
its ability to meet the obligations under its indebtedness, the
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<PAGE>
Company has decided that, for the foreseeable future, it will limit
acquisitions or funding of additional investments (other than existing
commitments), and it will work to accelerate the stabilization of its existing
assets and increase its overall liquidity position. As a result, the Company has
currently reduced activity in each of its business lines, which include the
acquisition of subordinate interests in residential mortgage-backed securities,
underperforming real estate and commercial real estate loans.
NOTE 4 - MARKET VALUATION ADJUSTMENTS
As noted above, subsequent to September 30, 1998, the Company sold a
significant amount of its loans and mortgage-backed securities to meet
collateral calls and increase liquidity. The declines in values on the assets
included in these sales have been recognized as market valuation adjustments as
of September 30, 1998 and recognized in determining net loss for the three
months then ended. In addition, the Company has also evaluated the impact of the
current market conditions on the remainder of its mortgage-backed and other
securities portfolio and reflected in market valuation adjustments any
impairments which have been deemed to be other than temporary. The evaluation of
other than temporary impairment considers the magnitude and trend in the decline
of the market value of securities, and the Company's ability to collect all
amounts due according to the contractual terms. If current market conditions
continue to negatively impact the value of these assets, additional other than
temporary impairments may be realized in the future.
Subsequent to September 30, 1998, primarily as a result of collateral
calls by certain affiliates of Salomon Smith Barney Inc., the Company sold loans
for proceeds of $471.0 million and mortgage-backed securities for proceeds of
$116.2 million. As a result of these sales, short-term borrowings were reduced
by $202.5 million and the securitized mortgage obligations of $372.3 million was
eliminated. These assets, and the related short-term financing, are reflected in
the Company's consolidated statement of financial condition as of September 30,
1998 net of the applicable market valuation adjustments. The effect of these
sales on the consolidated statements of financial condition as of September 30,
1998 would be to reduce total assets from approximately $1.0 billion to $443.3
million. Loans would be reduced from $615.1 million to $144.1 million and
mortgage-backed securities would be reduced from $292.6 million to $176.4
million. Short-term borrowings would be reduced from $475.4 million to $272.9
million and the securitized mortgage obligation of $372.3 million would be
eliminated.
Total market valuation adjustments recorded in earnings for the three
and six months ended September 30, 1998 was $49.5 million. Of this amount, $16.1
million relates to the sales of $116.2 million of mortgage-backed securities and
$16.5 million relates to the sales of $470.6 million of loans. Additionally,
$16.9 million relates to market valuation adjustments for other than temporary
impairment of other mortgage-backed securities and other securities (primarily
WFSG 13% Series B Notes) not sold.
Based on the use of the current data in the valuation of its assets,
the Company's management believes it is proper to reflect the decline of these
assets as an adjustment to the Company's earnings for the three months ended
September 30, 1998. The following table sets forth information regarding the
total amount of losses from market value adjustments:
<TABLE>
<CAPTION>
For the Six Months Ended September 30, 1998
Assets Total
Retained Subsequently Market
Assets Sold Adjustment
<S> <C> <C> <C>
Loan portfolio $ -- $ 16,499 $ 16,499
Mortgage-backed securities available for sale 9,646 16,096 25,742
Other securities available for sale 7,279 -- 7,279
Total $ 16,925 $ 32,595 $ 49,520
============================================
</TABLE>
10
<PAGE>
Management cannot readily predict the impact of continued adverse
market conditions on asset sales, temporary impairment of assets, and the impact
of such potential events on the profits and capital of the Company.
NOTE 5 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
For purposes of reporting financial condition and cash flows, cash and
cash equivalents include cash and due from banks, federal funds sold and
securities with original maturities less than 90 days.
SECURITIES AVAILABLE FOR SALE
Certain mortgage-backed securities and mortgage-related securities are
designated as assets available for sale because the Company does not intend to
hold them to maturity. Securities available for sale are carried at fair value
with the net unrealized gains or losses reported as a separate component in the
statement of changes in stockholders' equity. Other than temporary declines in
the carrying value of securities, if any, are charged to earnings and the basis
of each security is adjusted, accordingly. At disposition, the realized net gain
or loss is included in earnings on a specific identification basis. The
amortization of premiums and accretion of discounts are computed using the
interest method after considering actual and estimated prepayment rates, if
applicable. Actual prepayment experience is periodically reviewed and effective
yields are recalculated when differences arise between prepayments originally
anticipated and amounts actually received plus anticipated future prepayments.
LOANS, DISCOUNTED LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company acquires performing loan portfolios for prices generally
at par or at a premium or modest discount to principal face amount (i.e., unpaid
principal balance plus accrued interest) and re-performing and sub-performing
loan portfolios for prices generally at or below their principal amount.
Non-performing loans are generally acquired at deep discounts to principal face
and are classified as discounted loans in the consolidated statement of
financial condition. Purchased sub-performing and non-performing loans are
generally classified as discounted loans in the consolidated statement of
financial condition. Loans other than discounted loans are classified as loans.
Discounted loans are presented in the consolidated statement of
financial condition net of unamortized discounts and allowance for loan losses
established for those loans. Unamortized discounts represent the portion of the
difference between the purchase price and the principal face amount on specific
loans that is available for accretion to interest income. The allowance for loan
losses includes valuation allowances for estimated losses against the principal
face amount that are established at acquisition and for subsequent valuation
adjustments that are provided for through current period earnings and are based
on discounted future cash flows or the fair value of the underlying real estate
collateral for collateral dependent loans. If total cash received on a pool of
loans exceeds original estimates, excess specific valuation allowances are
recorded as additional discount accretion on the cost-recovery method. The
allocated specific valuation allowances are included in the allowance for loan
losses. Where appropriate, discounts are accreted into interest income on a cash
basis.
Loans, other than discounted loans, are presented in the consolidated
statement of financial condition in substantially the same manner as discounted
loans. Interest income is recognized on an accrual basis. Deferred fees and
costs and premiums were applicable, are recognized in interest income over the
life of the loan using a method that approximates the interest method.
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The Company evaluates loans for impairment. Commercial and
multi-family real estate loans are considered to be impaired, for financial
reporting purposes, when it is probable that the Company will be unable to
collect all principal or interest due, according to the contractual terms of the
loan agreement.
All specific valuation allowances established for pools of loans and
discounted loans are recorded in the allowance for loan losses. The allowance
for each pool is decreased by the amount of loans charged off and is increased
by the provision for estimated losses on loans and recoveries of previously
charged-off loans. The allowance for each pool is maintained at a level believed
adequate by management to absorb probable losses. Management's determination of
the adequacy of the allowance is based on an evaluation of the portfolio,
previous loan loss experience, current economic conditions, volume, growth and
composition of the portfolio and other relevant factors. Actual losses may
differ from management's estimates.
It is the Company's policy to establish an allowance for uncollectible
interest on performing loans that are past due more than 90 days or sooner when,
in the judgment of management, the probability of collection of interest is
deemed to be insufficient to warrant further accrual. Upon such a determination,
those loans are placed on non-accrual status and deemed to be non-performing.
When a loan is placed on non-accrual status, previously accrued but unpaid
interest is reversed by a charge to interest income.
INVESTMENTS IN REAL ESTATE
Real estate purchased directly or acquired in settlement of loans is
originally recorded at the lower of fair value less estimated costs to sell, or
purchase price. Any excess of net loan cost basis over the fair value less
estimated selling costs of real estate acquired through foreclosure is charged
to the allowance for loan losses. Any subsequent operating expenses or income,
reductions in estimated fair values, as well as gains or losses on disposition
of such properties, are recorded in current operations.
INCOME TAXES
The Company's long-term intention is to qualify as a Real Estate
Investment Trust ("REIT") under Sections 856 through 860 of the Internal Revenue
Code of 1986, as amended. However, to qualify as a REIT, the Company must first
make an affirmative election to be taxed as a REIT. As the election is not made
until the time the Company files its federal income tax return, the Company has
not yet made the election to be taxed as a REIT. Recent economic conditions, and
other factors, have caused the Company's management to carefully evaluate the
Company's current tax status. The Company and its shareholders may derive a
greater benefit by deferring a REIT election until a subsequent taxable year
should the Company's results from operations for the year ending December 31,
1998 reflect a significant net loss. A decision by the Company to not make a
REIT election requires a two-thirds vote by stockholders.
If the Company were to make an election to be taxed as a REIT, it will
generally not be subject to federal income taxation on that portion of its
income that qualifies as REIT taxable income to the extent that it distributes
at least 95 percent of its taxable income to shareholders and complies with
certain other requirements. Accordingly, no provision has been made for federal
income taxes for the Company and its subsidiaries in the accompanying
consolidated financial statements.
The accompanying consolidated financial statements have been prepared
under the assumption the company will qualify and will elect to be taxed as a
reit. Accordingly, no provision for income taxes has been reflected in these
consolidated financial statements.
If the Company were not to make the election to be taxed as a REIT for
its current taxable year, its provision for federal and state taxes, as of
September 30, 1998, would be $2,855. However, based upon loss events described
in Note 4, the Company believes that it will not need nor have any income tax
provision for the year ending December 31, 1998 even if it elects not to be
taxed as a REIT.
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NET LOSS PER SHARE
The Financial Accounting Standards Board ("FASB") has issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share"
("EPS"). SFAS No. 128 replaces primary EPS with basic EPS, and fully diluted EPS
with diluted EPS. Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS is computed in a similar manner as fully
diluted EPS, and reflects the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the Company.
During the three months and six months ended September 30, 1998,
however, the Company experienced a net loss, which resulted in common stock
equivalents having an anti-dilutive effect on earnings per share. Weighted
average shares outstanding is therefore equivalent for basic and diluted net
loss per share.
NOTE 6 -- RECENTLY ISSUED ACCOUNTING STANDARDS
The FASB recently issued SFAS No. 129, "Disclosure of Information
about Capital Structure", and SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information". SFAS No. 129 applies to all entities that
issue any securities other than ordinary common stock and continues the existing
requirements to disclose the pertinent rights and privileges of all securities.
SFAS No. 131 establishes standards for the way that public entities report
information about operating segments in annual financial statements and requires
that those entities report selected information about operating segments in
interim financial reports issued to shareholders. SFAS Nos. 129 and 131 are
effective for fiscal years beginning after December 15, 1997 and were adopted by
the Company. The adoption of SFAS Nos. 129 or 131 did not have any effect on the
financial position or results of operations of the Company.
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income", which requires companies to report all changes in equity during a
period, except those relating to investment by owners and distributions to
owners, in a financial statement for the period in which they are recognized.
The Company has chosen to disclose comprehensive loss for the three months and
six months ended September 30, 1998, which encompasses net income and unrealized
losses on available for sale securities, with no tax effect, on the face of the
accompanying consolidated statement of changes in stockholders' equity.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". The Statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
consolidated statement of financial condition as either an asset or liability
measured at its fair value. The Statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gain or loss to be offset with the related results on the
hedged item in the consolidated statement of operations, and requires that a
company formally document, designate, and assess the effectiveness of
transactions that receive hedge accounting. Management expects that the Company
will adopt SFAS No. 133 on January 1, 2000. Management has not yet quantified
the impact of adopting SFAS No. 133 on its financial statements and has not
determined the method of its adoption of SFAS No. 133. However, the Statement
could increase volatility in earnings and other comprehensive income.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise", an amendment of FASB Statement
No. 65. This Statement is effective for the first fiscal quarter beginning
13
<PAGE>
after December 15, 1998. This Statement standardizes how mortgage banking firms
account for certain securities and other interests they retain after
securitizing mortgage loans that were held for sale. Adoption of this
pronouncement is not expected to have a material impact on the Company's
consolidated financial statements.
NOTE 7 - SECURITIES AVAILABLE FOR SALE
The Company marks its securities portfolio to fair value at the end of
each month based upon broker/dealer marks, subject to an internal review
process. For those securities that do not have an available market quotation,
the Company requests market values and underlying assumptions from the various
broker/dealers that underwrote, are currently financing the securities, or have
had prior experience with the securities. Because the Company's subordinate
securities may not be readily marketable, as trading activity may be infrequent,
the market value is typically available from only a small group of
broker/dealers, and in many cases only one broker/dealer. As of each reporting
period, the Company evaluates whether and to what extent any unrealized loss is
to be recognized in earnings as other than temporary.
During the week of October 12, 1998, as a result of collateral calls
caused by circumstances described in Note 3, the Company sold approximately
$116.2 million of mortgage-backed securities. Based on the use of the current
data in the valuation of its assets, the Company's recorded a loss of $16.1
million as market valuation adjustment in earnings for the three months ended
September 30, 1998 to reflect the decline in the value of these assets. The
Company also has provided for an additional market valuation adjustment of
$16,925 for securities not subsequently sold based on a variety of factors.
At September 30, 1998, securities available for sale were valued as
follows:
<TABLE>
<CAPTION>
Amortized Cost Gross Unrealized Gross Fair Value
(1) Gains Unrealized
Losses
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 298,634 $ 1,540 $ (7,576) $ 292,598
Other securities 14,000 -- (7,000) 7,000
$ 312,634 $ 1,540 $ (14,576) $ 299,598
=========== ========== ============= ==========
</TABLE>
(1) The amortized cost of the investment securities reflects the
market valuation adjustments discussed in Note 4 above.
Subsequent to September 30, 1998, management believes that the market
values for mortgage-backed securities held have continued to decline. See Note
15 for further discussion.
Other securities available for sale consists of $20 million (face
value) of 13% WFSG Series B Notes due in 2004 at a carrying value of $7 million,
net of realized and unrealized losses. As described above, WFSG and the
unofficial committee of noteholders, representing a majority of the noteholders,
agreed on November 23, 1998 to a restructuring of WFSG whereby the noteholders
(including holders of WFSG's 13% Series B Notes) would exchange their notes for
common stock in WFSG. The Company is also a party to such agreement.
The Company expects to receive payments on securities over periods
that are considerably shorter than the contractual maturities of the securities,
which range from 6 to 30 years due to principal amortization and prepayments.
At September 30, 1998, securities available for sale with an amortized
cost of $312.6 million and
14
<PAGE>
fair values of approximately $299.6 million were pledged to secure short-term
borrowings and lines of credit (see Note 10). After the sales of securities
described in Note 3 and 4 above, securities had an amortized cost of $196.4
million and fair values of approximately $183.4 million.
Gains from the sale of securities available for sale were $934 during
the three months ended September 30, 1998. The declines in values of securities
sold subsequent to September 30, 1998 are included in market valuation
adjustments (see Note 4).
NOTE 8 - LOANS AND DISCOUNTED LOANS
The Company's loans are comprised of loans and discounted loans.
Following is a summary of each loan category by type:
<TABLE>
<CAPTION>
Loans Discounted
Loans
<S> <C> <C>
Unpaid principal balance of real estate loans:
One to four units $ 381,273 $ 46
Over four units 25,086 3,270
Commercial 149,817 14,332
Land 196 3,165
Total loans secured by real estate 556,372 20,813
Other (1) 40,000 --
Premium on purchased loans (2) 42,722 --
Less:
Market valuation adjustments 16,499 --
Allowance for loan losses 4,499 5,916
Discount on purchased loans and deferred fees 3,016 4,533
$ 615,080 $ 10,364
========== =============
</TABLE>
Includes $40,000 of securities under agreement to repurchase. On October 1,
1998, the counterparty filed a petition for reorganization under
Chapter 11 in the United States Bankruptcy Court for the District of
Oregon. On November 20, 1998, the counterparty and the Company
reached a tentative agreement in which the repurchase agreement will
be converted into a loan. This agreement is expected to be approved
by the Court on December 7, 1998. The Company anticipates to be paid
all amounts to which it is entitled. At September 30, 1998 these
assets were pledged to secure repurchase borrowings included in
short-term borrowings (see Note 10).
Premium associated with the acquisition of a pool of one to four unit real
estate loans from Salomon Smith Barney Inc.
As of September 30, 1998, the unpaid principal balances of loans with
adjustable rates of interest were $474.2 million and loans with fixed rates of
interest were $103.0 million. Adjustable-rate loans are generally indexed to
U.S. Treasury Bills, the FHLB's Eleventh District Cost of Funds Index, LIBOR or
Prime and are subject to limitations on the timing and extent of adjustment.
Most loans adjust within six months of changes in the index. After the sales of
certain loans described in Note 3 above, however, the unpaid principal balance
of loans with adjustable and fixed rates of interest was reduced to $121.6
million
15
<PAGE>
and $8.7 million, respectively.
At September 30, 1998, loans with an unpaid principal balance of
approximately $183.0 million and $380.9 million were pledged to secure credit
line borrowings included in short-term borrowings and securitized mortgage
obligations, respectively (see Notes 10 & 11). Additionally, other loans of
$82.7 million ($76.7 million net of market valuation adjustments) were pledged
to secure repurchase agreements (see Note 10). Certain financing lines were
reduced as a result of the sales of certain loans described in Note 3 above, and
as a result, loans with an unpaid principal balance of $117.0 remain pledged to
secure credit line borrowings included in short-term borrowings, the securitized
mortgage obligation was eliminated and other loans of $40.0 million remain
pledged to secure repurchase agreements.
During the three and six months ended September 30, 1998, the Company
recorded a provision for loan losses of $3,000, in light of the difficult
economic conditions discussed in Note 3 above. Activity in the allowance for
loan losses is summarized as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, 1998 September 30, 1998
<S> <C> <C>
Balance, beginning of period $ 7,215 $ --
Allocation of purchased loan discounts:
At acquisition 200 7,415
At disposition -- --
Provision for loan losses 3,000 3,000
Balance, end of period $ 10,415 $ 10,415
=========== ============
</TABLE>
NOTE 9 -- INVESTMENTS IN REAL ESTATE
At September 30, 1998, the Company's investments in real estate were
comprised of the following:
Commercial and Multi-family Real Estate:
Land $ 23,157
Building and improvements 57,646
Less: Accumulated depreciation (569)
80,234
Other real estate owned, net 701
$ 80,935
============
Approximately $56.6 million or 70.5 % of the investments in commercial
and multi-family real estate were located in the United States and the remainder
of commercial or multi-family properties were located in the United Kingdom.
Investments in real estate are recorded at cost less accumulated
depreciation (which, in the opinion of management, is less than the net
realizable value of the properties). The Company reviews its investments in real
estate for impairment whenever events or changes in circumstances indicate that
the carrying amount may not be recoverable. Depreciation is computed on a
straight-line basis over the estimated useful lives of the assets as follows:
Buildings and improvements 35 years
Tenant improvements Lesser of lease term
or useful life
16
<PAGE>
Furniture, fixtures and equipment 7 years
Expenditures for repairs and maintenance are charged to operations as
incurred. Significant renovations are capitalized and amortized over their
expected useful lives. Fees and costs incurred in the successful negotiation of
leases are deferred and amortized on a straight-line basis over the terms of the
respective leases. Rental revenue is reported on a straight-line basis over the
terms of the respective leases.
NOTE 10 -- SHORT-TERM BORROWINGS
Short-term borrowings at September 30, 1998 include repurchase
agreements and line of credit borrowings. Proceeds from the various credit
facilities are used primarily for the acquisition of mortgage-backed securities
and loan pools. Following is information about short-term borrowings:
<TABLE>
<CAPTION>
Repurchase Line of Credit
Agreements
<S> <C> <C>
Average balance during the period $ $
159,773 57,930
Highest amount outstanding during the period $ 254,406 $ 220,944
Average interest rate-during the period 6.94% 6.64%
Average interest rate-end of period 6.48% 7.42%
Carrying value of pledged assets $ 292,598 $ 259,562
</TABLE>
As of September 30, 1998, the Company had committed lines of credit,
including repurchase agreements, totaling $475.4 million and as a result of the
sales described in Note 3, short-term borrowings have been reduced by $202.5
million to $272.9 million.
In addition to payment and, in the case of the Company's secured
indebtedness, collateralization requirements, the Company is subject to various
other covenants in the agreements evidencing its indebtedness, including the
maintenance of specified amounts of equity. At September 30, 1998, the Company
was in compliance with all obligations under the agreements evidencing its
indebtedness and the Company's equity, as defined in the applicable agreements.
NOTE 11 - SECURITIZED MORTGAGE OBLIGATIONS
On September 29, 1998, the Company purchased a pool of one to four
family mortgage loans. The purchase was financed by securitizing these loans
through its wholly owned subsidiary, Wilshire REIT Trust Series 1998-1. The
securitization was accounted for as a financing based on a call option included
in the equity certificates retained by the Company. The $372.3 million of
investment-grade, publicly offered securities were tranched into four classes
and were underwritten by Salomon Smith Barney Inc. These bonds carry a variable
rate of interest and mature in October 2028.
The Company's liability for these bonds was transferred to Salomon
Smith Barney Inc. on October 14, 1998 when the Company sold the equity
certificates in the securitization. See Note 3.
NOTE 12 - OTHER BORROWINGS
At September 30, 1998, the Company had $60,804 of other borrowings.
The loans had a weighted average interest rate of 8.5%. At September 30, 1998,
investments in real estate with a carrying amount of $80.9 million were pledged
as collateral against these loans. Maturities of these borrowings range from
1999 to 2008. Included in other borrowings is $15.6 million of mortgage
borrowings payable
17
<PAGE>
to WFMC 1997-1 as discussed in Note 14, below.
NOTE 13 - DIVIDENDS PAYABLE
On October 26, 1998, the Company revised the expected payment date of a
$0.40 cash dividend payable on October 27, 1998 to shareholders of record on
September 30, 1998 to January 27, 1999. The Company will pay interest, at the
rate of 4% per annum, on the amount due calculated from the previously announced
payment date through the date of the actual payment.
NOTE 14 - RELATED PARTY TRANSACTIONS
Included in "Due from Affiliates, net" is approximately $17.7 million
due from WFSG and its subsidiaries and approximately $17.4 million due to
Wilshire Credit Corporation ("WCC") and its affiliated companies. Excluding
normal monthly servicing-related remittances due from WCC, balances outstanding
bear interest at 13% per annum and are payable with thirty days notice. Included
in "Other Borrowings" is approximately $15.6 million of first mortgages due to
WMFC 1997-1 Inc., a wholly owned subsidiary of WFSG secured by real estate.
These mortgages, which have loan-to-value ratios up to 85%, are due on October
1, 2008, bear interest at 10% per annum and are collateralized by real estate.
During the six months ended September 30, 1998, the Company purchased
from WFSG, or wholly owned subsidiaries of WFSG, assets totaling approximately
$198.8 million. The purchases were arms length transactions for which prices
approximated market value determined with either dealer marks, third party
appraisals or broker price opinions. The majority of the assets purchased from
WFSG were in connection with the Company's initial public offering. The total
assets purchased from WFSG consisted of $47.4 million of loans, $127.2 million
of mortgage-backed securities and $24.2 million of investment in real estate.
NOTE 15 - SUBSEQUENT EVENTS
In addition to certain subsequent sales of assets and repayments of
outstanding debt (as described in Note 3 - "General Market Conditions" and Note
4 - "Market Valuation Adjustments"), management has determined since September
30, 1998, and specifically, since mid-October, the market for mortgage-backed
securities and, in particular, subordinate credit related tranches of these
securities continued to experience widening spreads as described in Note 3,
above. A substantial portion of these losses are reflected in the September 30,
1998 financial statements as a result of market valuation adjustments taking
into account such market value declines. There can be no assurance that this
trend will stabilize and the Company may experience further losses in the fourth
quarter unless market conditions improve. Management believes that current
spreads do not reflect the true value of these securities from a cash flow
perspective and reflect market distortions due to limited liquidity and the risk
adverse posture of market participants. Accordingly, management believes these
declines in market value are temporary.
As of October 31, 1998, management's estimate of these additional
declines in market value would have increased the Company's net unrealized loss
on mortgage-backed securities available for sale from $6.0 million to $10.7
million.
NOTE 16 - COMMITMENTS, CONTINGENCIES & OFF-BALANCE SHEET RISK
The Company has an outstanding option granted by WFSG to acquire all
or a portion of WFSG's interest in an acquisition currently under negotiation.
The targeted company is a wholly owned subsidiary
18
<PAGE>
of a European insurance company, which holds a portfolio of loans and other
financial instruments. If the transaction were to be consummated, WFSG expects
to finance approximately 80% of the purchase price with unrelated third parties.
The Company has granted WREIT an option to purchase all or a portion of the
Company's interest in such assets. As of the date this Form 10-Q was required to
be filed with the Securities and Exchange Commission, it was uncertain whether
this transaction would ultimately be consummated.
In hedging the interest rate and/or exchange rate exposure of a
foreign currency denominated asset or liability, the Company may enter into
hedge transactions to counter movements in the different currencies as well as
interest rates in those currencies. These hedges may be in the form of currency
and interest rate swaps, options, and forwards, or combinations thereof.
At September 30, 1998, the Company has a swap contract in connection
with its investment in a commercial mortgage loan secured by real property in
the United Kingdom ("UK"). The swap contract is intended to hedge the interest
rate basis and currency exposure between UK Libor (the lending rate) and US
Libor (the borrowing rate) payments, as well as the principal (notional) amount
of the loan which, as of September 30, 1998, was $49.7 million. Under the terms
of the agreement, the Company will settle in U.S. dollars.
19
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE
INTERIM CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AND NOTES THERETO.
GENERAL
Wilshire Real Estate Investment Trust Inc. and Subsidiaries (the
"Company") is a Maryland corporation that was formed in October 1997. In April
1998, the Company consummated its initial public offering (the "Offering") of
11,500,000 shares of common stock with net proceeds to the Company of
approximately $167.0 million.
In April 1998, the Company, using the net proceeds from the Offering,
purchased, primarily from WFSG and other affiliates, $18.1 million of domestic
and international loans, $95.0 million of mortgage-backed securities and $11.7
million of real estate. Subsequently during the second and third quarters of
1998, the Company has increased its assets to $1,018.0 million at September 30,
1998, including, $299.6 million of securities, $80.9 million of real estate,
$615.1 million of loans and $10.4 million of discounted loans.
After the sales of assets described in "General Market Conditions"
section below, the Company's assets decreased from $1.0 billion at September 30,
1998 to approximately $443.3 million. These sales reduced loans from $615.1
million to $144.1 million and mortgage-backed securities from $292.6 million to
$176.4 million. Short-term borrowings would be reduced from $475.4 million to
$272.9 million and the securitized mortgage obligation of $372.3 million would
be eliminated.
The following discussion of the Company's results of operations,
changes in financial condition, and capital resources and liquidity should be
read in conjunction with the Interim Consolidated Financial Statements and
related Notes included in Item 1 herein.
GENERAL MARKET CONDITIONS
Beginning in August 1998, and more significantly since October 12,
1998, and continuing to the present, the Company was adversely affected by
various market factors. These factors, which are discussed further below,
resulted in a dramatic reduction in market valuations for certain of the
Company's mortgage-backed securities and other assets, as well as a reduction in
the availability of borrowings for those assets and certain of the Company's
loans.
Turmoil in the Russian financial markets, following a prolonged period
of uncertainty in Asian financial markets, caused investors to reassess their
risk tolerance. This resulted in a dramatic movement of liquidity toward lower
risk assets (e.g., U.S. Treasury instruments) and away from higher risk assets,
including most non-investment grade assets and commercial and other mortgage and
asset-backed securities.
This movement toward higher quality investments extinguished most
available liquidity to non-investment grade assets. Without available funding
sources, many investors in these assets, including several well-known hedge
funds, were forced to liquidate holdings at reduced prices. With greater sales
pressure and supply outpacing demand, prices continued to fall as more lenders
made collateral calls, demanding additional collateral for their loan positions.
Many companies were rapidly depleting available cash reserves.
20
<PAGE>
These conditions continued to worsen throughout September and into
early October. On October 12, 1998, a well-known hedge fund was liquidated. This
event triggered significant further collateral calls, forcing additional
companies to sell assets to cover borrower equity calls, and continuing the
downward spiral in prices. On October 15, 1998 the Federal Reserve lowered
interest rates largely in response to this liquidity crisis.
During October and continuing into the month of November 1998, the
Company sold a significant amount of assets in response to the above conditions
to meet collateral calls by lenders, primarily from certain affiliates of
Salomon Smith Barney Inc, and to increase liquidity. The downward pressure on
prices and the Company's need to sell assets to meet these collateral calls
resulted in the Company disposing of certain assets. Beginning during the week
of October 12, 1998, primarily as a result of collateral calls from certain
affiliates of Salomon Smith Barney Inc., the Company sold a pool of performing
loans for proceeds of $409.0 million and mortgage-backed securities for proceeds
of $93.1 million, and on which $12.5 million and $12.5 million, respectively,
was reflected in market valuation adjustments and charged to earnings in the
quarter ended September 30, 1998. Had the Company not been forced to sell these
assets, but rather held these assets until market conditions stabilized,
management believes the Company's net loss would have been far less severe.
Also during the week of October 12, 1998, the Company sold additional
assets consisting of subordinate mortgage-backed securities for proceeds of
$41.3 million and on November 16, 1998 the Company sold a mezzanine loan secured
by a partnership interest in commercial real estate for proceeds of $61.6
million. The Company reduced the recorded carrying amount of the these assets
sold on the financial statements as of September 30, 1998 to the amounts
realized upon disposition and, accordingly, reflected a write-down as market
valuation adjustments of $3.6 million and $4.0 million, respectively, related to
the declines in values of these assets in determining net loss during the three
and six months ended September 30, 1998.
Total market valuation adjustments recorded in earnings for the three
and six months ended September 30, 1998 were $49.5 million. Of this amount,
$16.1 million relates to the sales of mortgage-backed securities and $16.5
million relates to the sales of loans described in Note 3 above. Additionally,
$16.9 million relates to market valuation adjustments for other than temporary
impairment of other investment securities not sold. The following table sets
forth information regarding the total amount of loss recognized in earnings from
market value adjustments:
<TABLE>
<CAPTION>
For the Three and Six Months Ended September 30, 1998
Assets Total
Retained Subsequently Market
Assets Sold Adjustment
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Loan portfolio $ -- $ 16,499 $ 16,499
Mortgage-backed securities available for sale 9,646 16,096 25,742
Other securities available for sale 7,279 -- 7,279
Total $ 16,925 $ 32,595 $ 49,520
===========================================
</TABLE>
A continuation of the aforementioned market factors has led to further
declines in market values of mortgage-backed securities. As of October 31, 1998,
management's estimates of these additional declines in market value would have
increased the Company's net unrealized loss on available for sale
mortgage-backed securities from $6.0 million to $10.7 million. Management
believes that current spreads do not reflect the true value of these securities
from a cash flow perspective and reflect market distortions due to limited
liquidity and the risk adverse posture of market participants. While there have
been indications that the severity of the decline in market values of
mortgage-backed securities generally may be subsiding, there can be no assurance
that this trend will not continue and the Company may experience further losses
in the fourth quarter unless market conditions improve.
21
<PAGE>
On October 26, 1998, the Company revised the expected payment date of a
$0.40 cash dividend payable on October 27, 1998 to shareholders of record on
September 30, 1998 to January 27, 1999. The Company will pay interest, at the
rate of 4% per annum, on the amount due calculated from the previously announced
payment date through the date of the actual payment. The recent dramatic events
in financial markets, which include a significant reduction in valuations of,
and liquidity for, mortgage-backed securities has had a significant adverse
impact on WFSG's, the parent company of WRSC (the Company's manager), liquidity
and financial condition. As a result, WFSG's management entered into discussions
with an unofficial committee of holders of WFSG's outstanding publicly issued
notes and its financial advisors, Houlihan Lokey Howard & Zukin, concerning a
restructuring of its obligations under the notes. Following extensive
discussions, WFSG and the unofficial committee of noteholders, representing a
majority of noteholders, agreed on November 23, 1998 to a restructuring of WFSG
whereby (i) the noteholders would exchange their notes for common stock in WFSG,
(ii) existing holders of common stock of WFSG would receive warrants in exchange
for their holdings or highly diluted new common stock in exchange for their
holdings, and (iii) pending consummation of the restructure, the noteholders
would forbear from declaring certain defaults which resulted from the net losses
incurred by WFSG during this period and from other actions taken by WFSG during
this period to meet collateral calls. WFSG believes that this restructuring will
significantly improve WFSG's financial position by reducing indebtedness, the
interest cost associated therewith, and significantly improve its debt to equity
ratio. This restructuring is subject to a number of conditions, including no
material adverse change and negotiation of definitive documents, and WFSG
currently expects that this restructuring will be completed by the end of the
first quarter of 1999. Other creditors, including trade creditors and secured
creditors, are not expected to be affected by this restructuring. It is
uncertain at this time what effect, if any, these events could have on WRSC's
ability to perform its duties as manager of WREIT. If WRSC cannot continue to
perform its duties as manager of WREIT, it is anticipated WREIT would terminate
its contract with WRSC and become internally managed.
FUNDS FROM OPERATIONS
Most industry analysts, including the Company, consider funds from
operations ("FFO") an appropriate supplementary measure of operating performance
of a REIT. In general, FFO adjusts net income for non-cash charges such as
depreciation, and certain amortization expenses and most non-recurring gains and
losses. However, FFO does not represent cash provided by operating activities in
accordance with generally accepted accounting principles ("GAAP") and should not
be considered an alternative to net income as an indication of the results of
the Company's performance or to cash flows as a measure of liquidity.
The Company computes FFO in accordance with the definition recommended
by National Association of Real Estate Investment Trusts ("NAREIT"). For the
three and six months ended September 30, 1998, the Company's FFO was $0.1
million or $0.01 per weighted average common share and $3.3 million or $0.29 per
weighted average common share, respectively. The following table provides the
calculation of the Company's FFO:
<TABLE>
<CAPTION>
For The Three For The Six
Months Ended Months Ended
September 30, 1998 September 30, 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
Net loss $ (48,880) $ (45,838)
Real estate related depreciation 394 569
Gain on sales of securities (934) (934)
Market valuation adjustments (1) 49,520 49,520
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
FFO $ 100 $ 3,317
============ ===========
FFO per common share $ 0.01 $ 0.29
</TABLE>
For the three and six months ended September 30, 1998, the Company
provided $3.0 million for the allowance for loan losses, which is included in
net interest income. Without this provision, FFO for the six months ended
September 30, 1998 would have been $6.3 million or $0.56 per share.
(1) Management understands that NAREIT's intent in the creation of FFO
was to produce a measure of operating performance that is
recurring in nature. Accordingly, NAREIT believes that items
classified by GAAP as extraordinary or unusual, along with
significant non-recurring events that materially distort the
comparative measurement of company performance over time, are not
meant to be reductions or increases in FFO, and should be
disregarded in its calculation. Accordingly, the market valuation
adjustments have been excluded from the net loss in arriving at
FFO. A detail of the nature of the market valuation adjustment is
discussed in the "Market Valuation Adjustments" section of this
document.
INCOME TAX STATUS
The Company's long-term intention is to qualify as a Real Estate
Investment Trust ("REIT") under Sections 856 through 860 of the Internal Revenue
Code of 1986, as amended. However, to qualify as a REIT, the Company must first
make an affirmative election to be taxed as a REIT. As the election is not made
until the time the Company files its federal income tax return, the Company has
not yet made the election to be taxed as a REIT. Recent economic conditions, and
other factors, have caused the Company's management to carefully evaluate the
Company's current tax status. The Company and its shareholders may derive a
greater benefit by deferring a REIT election until a subsequent taxable year
should the Company's results from operations for the year ending December 31,
1998 reflect a significant net loss. A decision by the Company to not make a
REIT election requires a two-thirds vote by stockholders.
If the Company were to make an election to be taxed as a REIT, it
generally will not be subject to federal income taxation on that portion of its
income that qualifies as REIT taxable income to the extent that it distributes
at least 95 percent of its taxable income to shareholders and complies with
certain other requirements. Accordingly, no provision has been made for federal
income taxes for the Company and its subsidiaries in the accompanying
consolidated financial statements.
The accompanying consolidated financial statements have been prepared
under the assumption the Company will qualify and will elect to be taxed as a
REIT. Accordingly, no provision for income taxes has been reflected in these
consolidated financial statements.
If the Company were not to make the election to be taxed as a REIT for
its current taxable year, its provision for federal and state taxes, as of
September 30, 1998, would be $2.9 million. However based upon loss events
described in Note 4, the Company believes that it will not need nor have any
income tax provision for the year ending December 31, 1998 even if it elects not
to be taxed as a REIT.
RESULTS OF OPERATIONS - SIX MONTHS ENDED SEPTEMBER 30, 1998
NET LOSS. The Company's net loss for the six months ended September
30, 1998 amounted to $45.8 million, or $4.03 per share. The net loss is
primarily attributable to $49.5 million of market valuation adjustments (as
described in "General Market Conditions" section, above) and $3.0 million of
provision for loan losses recognized by the Company. Excluding these significant
items, net income would
23
<PAGE>
have been $6.7 million, or $0.59 per share and FFO would have been $6.3 million,
or $0.56 per share.
NET INTEREST INCOME. The following tables set forth information
regarding the total amount of income from interest-earning assets and expense
from interest-bearing liabilities and the resultant average yields and rates:
<TABLE>
<CAPTION>
For the Six Months Ended September 30, 1998
Average Interest Annualized
Balance Income Yield/Rate
(DOLLARS IN THOUSANDS)
Interest-Earning Assets:
<S> <C> <C> <C>
Loan portfolios $ 92,585 $ 5,491 11.9%
Mortgage-backed securities available for sale 205,444 9,723 9.5
Other securities available for sale 19,700 1,035 10.5
Other investments 24,963 486 3.9
Total interest-earning assets 342,692 16,735 9.7
=============
Interest-Bearing Liabilities:
Short-term borrowings 231,328 7,513 6.5
Total interest-bearing liabilities $ 231,328 7,513 6.5
=============
Net interest income before provision for
loan losses/spread (1) $ 9,222 3.2%
======================
Net interest margin (2) 5.4%
========
</TABLE>
(1) Net interest spread represents the difference between the
average rate on interest-earning assets and the average cost
of interest-bearing liabilities.
Net interest margin represents net interest income divided by average
interest-earning assets.
For the six months ended September 30, 1998, the Company provided $3.0
million for the allowance for loan losses. This provision is not reflected in
net interest income/spread, above.
REAL ESTATE OPERATIONS. Such income represents income generated from
the Company's investment in various office buildings, retail stores, and other
commercial property located in Oregon, California and the United Kingdom. During
the six months ended September 30, 1998, operating income was comprised
primarily of $3.0 million in gross rental and other income earned on such
investments. Additionally, expenses incurred on real estate investments include
$1.4 million of interest expense, $0.2 million of rental operations and $0.6
million of depreciation expense.
OTHER INCOME (LOSS). The Company's other loss was approximately $48.6
million for the six months ended September 30, 1998. The components of the
Company's net non-interest loss is comprised of the following:
MARKET VALUATION ADJUSTMENTS. During the six months ended September
30, 1998, the Company recorded $49.5 million of market value adjustments that
were deemed by management to be other than temporary in nature and duration.
During the week of October 12, 1998, the Company sold certain assets,
in response to conditions described in the "General Market Conditions" section
of this document. The carrying values of these assets were reduced by $32.6
million, which have been recognized in the market valuation adjustments for the
six months ended September 30, 1998.
24
<PAGE>
Additionally, a market valuation adjustment of $16.9 million relates
to other than temporary impairment on other investment securities not sold.
Based on the use of the current data in the valuation of its assets,
the Company's management believes it is proper to reflect the decline of these
assets as an adjustment to the Company's earnings for the three months ended
September 30, 1998.
The following table sets forth information regarding the total amount
of losses recognized in earnings from the market valuation adjustments.
Valuation of the other than temporary losses were determined primarily through
the subsequent sales of certain assets and consistent with respect to the
Company's monthly mark-to-market of its securities available for sale portfolio
for the assets retained, see "Changes in Financial Condition - Securities
Available for Sale."
<TABLE>
<CAPTION>
For the Six Months Ended September 30, 1998
Assets Total
Retained Subsequently Market
Assets Sold Adjustment
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Loan portfolio $ -- $ 16,499 $ 16,499
Mortgage-backed securities available for sale 9,646 16,096 25,742
Other securities available for sale 7,279 -- 7,279
Total $ 16,925 $ 32,595 $ 49,520
==========================================
</TABLE>
GAIN ON THE SALE OF SECURITIES. During the six months ended September
30, 1998, the Company sold to unrelated third parties mortgage-backed securities
for approximately $16.8 million resulting in gains of approximately $0.9
million. The carrying values of assets sold subsequent to September 30, 1998
have been reduced through market valuation adjustments for the six months ended
September 30, 1998.
OPERATING EXPENSES. Management fees of $1.9 million for the six months
ended September 30, 1998, were comprised solely of the 1% (per annum) base
management fee paid to Wilshire Real Estate Service Corporation ("WRSC"), a
wholly owned subsidiary of Wilshire Financial Services Group Inc. ("WFSG") for
the period (as provided pursuant to the management agreement between WRSC and
the Company). WRSC earned no incentive fee for this period. In addition to the
management fee, the Company incurred loan service fees and expenses of $0.5
million during the six months ended September 30, 1998, which were paid by WRSC
on behalf of the Company and for which WRSC was subsequently reimbursed by the
Company. Other expenses were comprised of professional services, insurance
premiums and other sundry expenses.
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 1998
NET LOSS. The Company's net loss for the three months ended September
30, 1998 amounted to $48.9 million, or $4.25 per share. The net loss is
primarily attributable to $49.5 million of market valuation adjustments (as
described in "General Market Conditions" section, above) and $3.0 million of
provision for losses recognized by the Company. Excluding these significant
items, net income would have been $3.6 million, or $0.32 per share and FFO would
have been $3.1 million, or $0.27 per share.
NET INTEREST INCOME. The following tables set forth information
regarding the total amount of income from interest-earning assets and expense
from interest-bearing liabilities and the resultant average yields and rates:
25
<PAGE>
<TABLE>
<CAPTION>
For the Three Months Ended September 30, 1998
Average Interest Annualized
Balance Income Yield/Rate
(DOLLARS IN THOUSANDS)
Interest-Earning Assets:
<S> <C> <C> <C>
Loan portfolios $ 151,632 $ 4,167 11.0%
Mortgage-backed securities available for sale 274,093 6,575 9.6
Other securities available for sale 21,500 577 10.7
Other investments 23,486 326 5.6
Total interest-earning assets 470,711 11,645 9.9
=============
Interest-Bearing Liabilities:
Short-term borrowings 363,133 6,012 6.6
Total interest-bearing liabilities $ 363,133 6,012 6.6
==============
Net interest income before provision for
loan losses/spread (1) $ 5,633 3.3%
========================
Net interest margin (2) 4.8%
========
</TABLE>
(1) Net interest spread represents the difference between the average rate
on interest-earning assets and the average cost of interest-bearing
liabilities.
(2) Net interest margin represents net interest income divided by average
interest-earning assets.
For the three months ended September 30, 1998, the Company provided
$3.0 million for the allowance for loan losses. This provision is not reflected
in net interest income/spread above.
REAL ESTATE OPERATIONS. Such income represents income generated from
the Company's investment in various office buildings, retail stores, and other
commercial property located in Oregon, California and the United Kingdom. During
the three months ended September 30, 1998, operating income was comprised
primarily of $2.0 million in gross rental and other income earned on such
investments. Additionally, expenses incurred on real estate investments include
$1.1 million of interest expense, $0.1 million of rental operations and $0.4
million of depreciation expense.
OTHER INCOME (LOSS). The Company's other loss was approximately $48.6
million for the three months ended September 30, 1998. The components of the
Company's net non-interest loss is comprised of the following:
MARKET VALUATION ADJUSTMENTS. During the three months ended September
30, 1998, the Company recorded $49.5 million of market valuation adjustments
that were deemed by management to be other than temporary in nature and
duration.
During the week of October 12, 1998, the Company sold certain assets,
in response to conditions described in the "General Market Conditions" section
of this document and the liquidation of a well known hedge fund. The carrying
values of these assets were reduced by $32.6 million, which have been recognized
in the market valuation adjustment for the three months ended September 30,
1998.
Additionally, a market valuation adjustment of $16.9 million relates
to other than temporary impairment on other investment securities not sold.
26
<PAGE>
Based on the use of the current data in the valuation of its assets,
the Company's management believes it is proper to reflect the decline of these
assets as an adjustment to the Company=s earnings for the three months ended
September 30, 1998.
The following table sets forth information regarding the total amount
of losses from the market valuation adjustments. Valuation of the other than
temporary losses were determined primarily through the subsequent sales of
certain assets and consistent with respect to the Company's monthly
mark-to-market of its securities available for sale portfolio for the assets
retained, see "Changes in Financial Condition - Securities Available for Sale."
<TABLE>
<CAPTION>
For the Three Months Ended September 30, 1998
Assets Total
Retained Subsequently Market
Assets Sold Adjustment
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Loan portfolio $ -- $ 16,499 $ 16,499
Mortgage-backed securities available for sale 9,646 16,096 25,742
Other securities available for sale 7,279 -- 7,279
Total $ 16,925 $ 32,595 $ 49,520
=========================================
</TABLE>
GAIN ON THE SALE OF SECURITIES. During the three months ended
September 30, 1998, the Company sold to unrelated third parties mortgage-backed
securities for approximately $16.8 million resulting in gains of approximately
$0.9 million. The carrying values of assets sold subsequent to September 30,
1998 have been reduced through market valuation adjustments for the three months
ended September 30, 1998.
OPERATING EXPENSES. Management fees of $1.3 million for the three
months ended September 30, 1998, were comprised solely of the 1% (per annum)
base management fee paid to Wilshire Real Estate Service Corporation ("WRSC"), a
wholly owned subsidiary of Wilshire Financial Services Group Inc. ("WFSG") for
the period (as provided pursuant to the management agreement between WRSC and
the Company). WRSC earned no incentive fee for this period. In addition to the
management fee, the Company incurred loan service fees and loan related expenses
of $0.4 million during the three months ended September 30, 1998, which were
paid by WRSC on behalf of the Company and for which WRSC was subsequently
reimbursed by the Company. Other expenses were comprised of professional
services, insurance premiums and other sundry expenses.
CHANGES IN FINANCIAL CONDITION
From April 1, 1998 to September 30,1998, total assets increased to
$1,018.0 million. This increase was primarily comprised of $4.0 million of cash
and cash equivalents, $299.6 million of securities available for sale, $80.9
million of investments in real estate and $625.4 million of loans and discounted
loans. Total liabilities increased to $917.6 million during the period,
primarily as a result of $475.4 million of short-term borrowings associated with
mortgage-backed securities, loans and discount loans, $372.3 million of
securitized mortgage obligations, $60.8 million of other borrowings on
investment in real estate, $4.6 million of declared but unpaid dividends and
$4.5 million in accounts payable and other accrued liabilities.
SECURITIES AVAILABLE FOR SALE. At September 30, 1998, securities
available for sale include mortgage-backed securities with an aggregate market
value of $292.6 million and $7.0 million of WFSG's 13% Series B Notes, net of
realized and unrealized losses.
During the six months ended September 30, 1998, the Company purchased
137 subordinated residential mortgage-backed securities from 26 different
issuers for an aggregate purchase price of
27
<PAGE>
approximately $344.1 million. The weighted average rating of these securities is
BB. In September 1998, the Company sold two subordinated residential
mortgage-backed securities from one issuer for a market price of $16.8 million.
The balance of mortgage-backed securities available for sale of $292.6
million at September 30, 1998 was the result of $95.0 million of initial
purchases, $245.2 million of additional purchases, offset in part, by $15.9
million sales of securities, other than temporary market valuation adjustments
of $25.7 million and $6.0 million of net unrealized losses.
The Company marks its securities portfolio to fair value at the end of
each month based upon broker/dealer marks, subject to an internal review
process. For those securities that do not have an available market quotation,
the Company requests market values and underlying assumptions from the various
broker/dealers that underwrote the securities, are currently financing the
securities, or have had prior experience with the type of securities. Because
the Company's subordinate securities are not readily marketable, as trading
activity may be infrequent, the market value is typically available from only a
small group of broker/dealers, and in most cases only one broker/dealer. As of
each reporting period, the Company evaluates whether and to what extent any
unrealized loss is to be recognized as other than temporary.
At September 30, 1998, the Company valued its securities available for
sale portfolio and gross unrealized gains and losses thereon as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized
Cost (1) Gains Losses Fair Value
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 298,634 $ 1,540 $ (7,576) $ 292,598
Other securities 14,000 -- (7,000) 7,000
$ 312,634 $ 1,540 $ (14,576) $ 299,598
=========== ========== ========== ==========
</TABLE>
(1) The amortized cost of the investment securities reflects the
market valuation adjustments discussed in "Results of Operations".
The fair value of securities available for sale, after taking into
account subsequent sales, see the "General Market Conditions" section of this
document, is $183.4 million.
LOAN PORTFOLIO. During the six months ended September 30, 1998, the
Company acquired U.S. and international commercial real estate loans with an
unpaid principal balance of $556.6 million. The balance of loans is $615.1
million at September 30, 1998 and $134.1 million of the loans are serviced by an
affiliate of WFSG.
The following table sets forth certain information relating to the
payment status of loans in the Company's loan portfolio at September 30, 1998:
Unpaid Principal
Balance
(DOLLARS IN THOUSANDS)
Past due less than 31 days $ 553,436
Past due 31 to 89 days 2,937
28
<PAGE>
$ 556,563
==============
The Company maintains an allowance for loan losses at a level that
management considers adequate to provide for probable losses based upon an
evaluation of known and inherent risks. In connection with the sale of a loan
pool and other loans in the fourth quarter, the Company recorded a market
valuation adjustment for $16.5 million as of September 30, 1998. In addition,
during the six months ended September 30, 1998, the Company provided for $3.0
million for the allowance for loan losses.
Included in the loan balance on the consolidated statement of
financial condition is $40 million of securities under agreement to repurchase.
On October 1, 1998, the counterparty filed a petition for reorganization under
Chapter 11 in the United States Bankruptcy Court for the District of Oregon. On
November 20, 1998, the counterparty and the Company reached a tentative
agreement in which the repurchase agreement will be converted into a loan. This
agreement is expected to be approved by the Court on December 7, 1998. At
September 30, 1998, these assets were pledged to secure borrowings included in
short-term borrowings.
Also included in the loan balance is a $42.7 million ($36.7 million
after market valuation adjustment) purchase premium associated with the
acquisition of a pool of one to four unit real estate loans from Salomon Smith
Barney Inc.
The balance of loans decreased by $409.0 million as a result of the
sale of the Salomon Smith Barney Inc. loan pool on October 12, 1998 as discussed
in the "General Market Conditions" section of this document.
DISCOUNTED LOAN PORTFOLIO. During the three months ended September 30,
1998, the Company acquired U.S. and international commercial real estate loans
with an unpaid principal balance of $20.8 million. The balance of discount loans
is $10.4 million at September 30, 1998, and are also serviced by an affiliate of
WFSG.
The following table sets forth certain information relating to the
payment status of loans in the Company's discounted loan portfolio at September
30, 1998:
<TABLE>
<CAPTION>
Unpaid Principal
Balance
(DOLLARS IN THOUSANDS)
<S> <C>
Past due less than 31 days $ 9,430
Past due 31 to 89 days 1,907
Past due 90 days or greater 9,476
$ 20,813
============
</TABLE>
The Company maintains an allowance for loan losses at a level that
management considers adequate to provide for probable losses based upon an
evaluation of known and inherent risks. During the six months ended September
30, 1998, no provisions for loan losses had been provided for discounted loans.
INVESTMENTS IN REAL ESTATE. During the six months ended September 30,
1998, the Company acquired approximately $81.5 million of properties located in
California, Oregon and the United Kingdom.
SHORT-TERM BORROWINGS. Short-term borrowings increased by
approximately $475.4
29
<PAGE>
million during the six months ended September 30, 1998, resulting primarily from
the use of repurchase agreements to fund the purchase of securities. Interest
rates on borrowings under these facilities are based on overnight to 30-day
London Interbank Offer Rate ("LIBOR") rates.
SECURITIZED MORTGAGE OBLIGATIONS. On September 29, 1998, the Company
purchased a pool of one to four family mortgage loans. The purchase was financed
by securitizing these loans through its wholly owned subsidiary, Wilshire REIT
Trust Series 1998-1. The securitization was initially accounted for as a
financing due to a call option included in the equity certificates retained by
the Company. The $372.3 million of investment-grade, publicly offered securities
were tranched into four classes and were underwritten by Salomon Smith Barney
Inc. These bonds carry a variable rate of interest and mature in October 2028.
The Company=s liability for these bonds was transferred to Salomon
Smith Barney Inc. on October 14, 1998 when the Company sold the equity
certificates in the securitization.
The Company has reduced the recorded carrying amount of the loans sold
on the financial statements as of September 30, 1998 to the amounts realized
upon disposition and, accordingly, reflected the write-down in market valuation
adjustments of $12.5 million related to this transaction in determining net loss
during the six months ended September 30, 1998.
OTHER BORROWINGS. At September 30, 1998, the Company had $60.8 million
of other borrowings, which financed the acquisition of real estate investments.
The loans had a weighted average interest rate of 8.5%. At September 30, 1998,
certain investments in real estate with a carrying amount of $80.9 million were
pledged as collateral against these loans.
STOCKHOLDERS' EQUITY. Stockholders' equity increased to $100.4 million
from April 1, 1998 to September 30, 1998. The increase in stockholders' equity
during this period was attributable to net proceeds of $167.0 million from the
Offering, offset by a net operating loss of $45.8 million, unrealized losses on
securities available for sale of $13.0 million and $7.7 million of dividends on
common stock.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measurement of the Company's ability to meet potential
cash requirements, including ongoing commitments to repay borrowings, fund
investments, engage in loan acquisition and lending activities, meet collateral
calls and for other general business purposes. The primary sources of funds for
liquidity during the six months ended September 30, 1998 consisted of net cash
provided by the Offering, operating activities, repurchase facilities and other
secured borrowings, maturities and principal payments on loans and securities
and proceeds from sales thereof and unsecured loans from WCC to meet collateral
calls.
The recent dramatic events in financial markets, which included a
significant reduction in values of, and liquidity for, mortgage-backed
securities, has had an adverse impact on the Company's liquidity. The decline in
valuations resulted in collateral calls from the Company's lenders, which
reduced the Company's cash position and eventually prompted asset sales at
depressed prices to meet collateral calls and provide liquidity. While these
asset sales have improved the liquidity position of the Company, the market for
mortgage-backed securities - particularly subordinated mortgage-backed
securities - has not recovered and the financial markets generally continue to
be volatile. In addition, the securitization markets remains weak limiting the
Company's ability to use this market as a source of liquidity.
Primarily as a result of asset sales, the Company has had adequate
cash and cash equivalents to meet calls for additional collateral to repay a
portion of the related indebtedness or to meet its other operating and financing
requirements. However, there can be no assurance that sufficient levels of such
assets will continue to be available.
30
<PAGE>
Fluctuations in interest rates will continue to impact the Company's
net interest income to the extent the Company's fixed rate assets are funded by
variable rate debt or the Company's variable rate assets reprice on a different
schedule or in relation to a different index than its floating rate debt which
in turn could impact potential returns to shareholders. The flexibility in the
Company's leverage is dependent upon, among other things, changes in interest
rates, changes in market spreads, or decreases in credit quality of underlying
assets. In such circumstances, the Company would be required to provide
additional collateral in connection with its short-term, floating-rate borrowing
facilities. During the three months ended September 30, 1998, the Company was
required to and did fund requests by its lenders for additional collateral calls
under its outstanding repurchase agreements collateralized by securities
available for sale. For additional information with respect to the Company's
monthly mark-to-market of its securities available for sale portfolio, see
"Changes in Financial Condition - Securities Available for Sale."
The Company has significant debt service obligations, as discussed
above. At September 30, 1998, the Company had total consolidated indebtedness of
$908.5 million, which was secured, as well as $9.1 million of other liabilities.
This consolidated indebtedness consisted of (i) $326.4 million of repurchase
agreements, (ii) lines of credit aggregating $149.0 million which are secured by
loans and securities, (iii) $372.3 million of securitized mortgage obligations
which are secured by loans, and (iv) $60.8 million outstanding of other
borrowings which mature between 1999 and 2008 which are secured by real estate.
The monthly interest expense on the Company's total consolidated indebtedness
was $1.8 million, $2.4 million and $2.8 million for the months of July, August
and September 1998, respectively. The securitized mortgage obligations, which
amounted to $372.3 million at September 30, 1998, were transferred to Salomon
Smith Barney Inc. on October 14, 1998 (in connection with the sale of certain
residential mortgage loans that secured this securitization bond liability).
Mortgage-backed securities which are subject to repurchase agreements,
as well as loans and real estate which secure other indebtedness, periodically
are revalued by the lender, and a decline in such value may result in the lender
requiring the Company to provide additional collateral to secure the
indebtedness.
In addition to payment and, in the case of the Company's secured
indebtedness, collateralization requirements, the Company is subject to various
other covenants in its indebtedness, including the maintenance of specified
amounts of equity. At September 30, 1998, the Company was in compliance with all
obligations in its indebtedness and the Company's equity, as defined in the
applicable agreement. There can be no assurance that additional operating losses
will not result in the Company's violation of its financial covenants in the
future. In the event of a default in such covenants, the lender generally would
be able to accelerate repayment of the subject indebtedness and pursue other
available remedies, which could result in defaults on other indebtedness of the
Company, unless the applicable lender or lenders allowed the Company to remain
in violation of the agreements. Were a default to be declared, the Company would
not be able to continue to operate without the consent of its lenders. The
Company currently is considering various alternatives to enhance its ability to
meet its payment and other obligations under its indebtedness and the funding
requirements discussed below, including the sale of certain assets and the
potential tax and other consequences associated therewith. There can be no
assurance that the Company will have sufficient liquidity to meet these
obligations on a short-term or long-term basis.
If the Company is unable to fund additional collateral needs or to
repay, renew or replace maturing indebtedness on terms reasonably satisfactory
to the Company, the Company may be required to continue to sell, under adverse
market conditions, a portion of its assets, and could incur further losses as a
result. Furthermore, an extremely limited market for subordinate and residual
interests in mortgage-related securities exists under current conditions and
there can be no assurance that one will fully develop, thereby limiting the
Company's ability to dispose of such securities promptly for fair value in such
situations.
Based on its monthly interest and other expenses, monthly cash
receipts and collateral calls through October 31, 1998, the Company believes
that its existing sources of funds will be adequate for purposes of meeting its
short-term and long-term liquidity needs. There can be no assurance that this
will
31
<PAGE>
be the case, however. Material increases in interest expense from variable
rate funding sources, collateral calls, or material decreases in monthly cash
receipts, generally would negatively impact the Company's liquidity. On the
other hand, material decreases in interest expense from variable rate funding
sources or in collateral calls generally would positively affect the Company's
liquidity.
OTHER - YEAR 2000 COMPLIANCE
Many existing computer software programs and other technologically
dependent systems use two digits to identify the year in date fields and, as
such, could fail or create erroneous results by or at the Year 2000. The
Company, Wilshire Real Estate Services Corporation (the "Manager") and its loan
servicer utilize a number of technologically dependent systems to operate,
service mortgage loans and manage mortgage assets. The Company=s Manager has
formed a committee to address year 2000 issues ("the Committee") that reports
directly to the Manager's executive committee. The Committee is headed by the
Manager's Chief Information Officer and includes representatives from across
departments within the Manager's company as well as management of the Company.
The Committee has conducted an inventory of all systems for the
Manager, 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 has developed detailed test plans and created separate
Year 2000 test environments.
The Manager has begun testing of critical systems and is scheduled to
complete all necessary testing by the end of 1998. Testing of the Manager's
internally developed systems is near completion, and changes which have resulted
from testing to date are being coded and moved into production. Of the testing
begun on critical systems supplied by outside vendors, one system's testing is
complete and the other is scheduled during November 1998. Following the testing
phase, each departments executive management will be responsible for certifying
that their staff has tested critical code and deemed it adequate.
The Company operations are overseen by the Company's Manager, and in
accordance with the management agreement, all operating costs including costs
related to the Year 2000 issue are covered in the management fee agreement. The
financial impact of becoming Year 2000 compliant has not been and is not
expected to be material to the Company or its results of operations. Aside from
limited hardware costs, the Manager's parent company's 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 the Company of Year 2000 non-compliance is
Manager's inability to perform necessary loan servicing activities. Currently,
the Company's loan portfolio is serviced by Wilshire Credit Corporation ("WCC"),
an affiliated entity of the Manager. To the extent the loan servicing system is
not Year 2000 compliant, the ability to service the Company's loans would be in
jeopardy.
Based on the results of testing performed to date, the Manager is
confident that it is appropriately addressing the Year 2000 issues. Critical
systems supplied by outside vendors have undergone testing not only by the
manager, but by other customers of the vendors as well. WCC's 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 Company is in the process of
identifying an alternative servicer for the Company's loan portfolio. To date,
the Company has no formal agreement in place regarding back-up servicers.
32
<PAGE>
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED HEREIN AND CERTAIN STATEMENTS CONTAINED IN FUTURE
FILINGS BY THE COMPANY WITH THE SEC MAY NOT BE BASED ON HISTORICAL FACTS AND ARE
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED. FORWARD-LOOKING STATEMENTS WHICH ARE BASED ON VARIOUS ASSUMPTIONS
(SOME OF WHICH ARE BEYOND THE COMPANY'S CONTROL) MAY BE IDENTIFIED BY REFERENCE
TO A FUTURE PERIOD OR PERIODS, OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY,
SUCH AS "MAY," "WILL," "BELIEVE," "EXPECT," "ANTICIPATE," "CONTINUE," OR SIMILAR
TERMS OR VARIATIONS ON THOSE TERMS, OR THE NEGATIVE OF THOSE TERMS. ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN FORWARD-LOOKING
STATEMENTS DUE TO A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE
RELATED TO THE ECONOMIC ENVIRONMENT, PARTICULARLY IN THE MARKET AREAS IN WHICH
THE COMPANY OPERATES, COMPETITIVE PRODUCTS AND PRICING, FISCAL AND MONETARY
POLICIES OF THE U.S. GOVERNMENT, CHANGES IN PREVAILING INTEREST RATES,
ACQUISITIONS AND THE INTEGRATION OF ACQUIRED BUSINESSES, CREDIT RISK MANAGEMENT,
ASSET/LIABILITY MANAGEMENT, YEAR 2000 COMPLIANCE ISSUES, THE FINANCIAL AND
SECURITIES MARKETS AND THE AVAILABILITY OF AND COSTS ASSOCIATED WITH SOURCES OF
LIQUIDITY. THE COMPANY DOES NOT UNDERTAKE, AND SPECIFICALLY DISCLAIMS ANY
OBLIGATION, TO PUBLICLY RELEASE THE RESULTS 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.
33
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
It is the objective of the Company to attempt to control risks
associated with interest rate movements. In general, management's strategy is to
limit the Company's exposure to earnings variations and variations in the value
of assets and liabilities as interest rates change over time. The Company's
asset and liability management strategy is formulated and monitored by WRSC
regularly to review, among other things, the sensitivity of the Company's 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 Committee is authorized to utilize a wide
variety of off-balance sheet financial techniques to assist them in the
management of interest rate risk. Other than as discussed below, no such
techniques were in use as of September 30, 1998.
In hedging the interest rate and exchange rate exposure of a foreign
currency denominated asset or liability, the Company may enter into hedge
transactions to counter movements in the different currencies as well as
interest rates in those currencies. These hedges may be in the form of currency
and interest rate swaps, options, and forwards, or combinations thereof.
At September 30, 1998, the Company has a swap contract in connection
with its investment in a commercial mortgage loan secured by real property in
the United Kingdom ("UK"). The swap contract is intended to hedge the interest
rate basis and currency exposure between UK Libor (the lending rate) and US
Libor (the borrowing rate) payments, as well as the principal (notional) amount
of the loan which, as of September 30, 1998, was $49.7 million. Under the terms
of the agreement, the Company will settle in U.S. dollars.
34
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Registrant is currently in litigation in the United States Bankruptcy
Court for the District of Oregon to confirm that certain mortgage-backed
securities are not subject to the bankruptcy proceeding.
The registrant is not a party to any other material legal proceedings.
ITEM 2. CHANGES IN SECURITIES.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
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.
Acquisition or Distribution of Assets
On November 16, 1998, the Company sold a mezzanine loan
secured by a partnership interest in commercial real estate for $61.6
million in proceeds. The loan was secured by a first lien on the
membership interests in the limited liability company which owns the
MGM Plaza, a 1,079,076 square foot office complex comprised of six (6)
class "A" office buildings located in Santa Monica, California. The
loan's interest rate was LIBOR plus 350 basis points and would mature
in November 2000. Cash proceeds from the sale were used to repay a
facility with Credit Suisse First Boston Mortgage Capital LLC for which
this loan served as collateral. The pro forma effect of this loan sale
is reported and attached hereto as Exhibit 99.1
Other Events
On October 28, 1998, Mr. Steven Kapiloff, an independent
director of the Company, resigned from the Board of Directors of the
Company. As discussed in Mr. Kapiloff's letter of resignation, which is
attached hereto as Exhibit 99.2, his resignation was due to personal
and professional reasons related to his recent change in employment and
was not related to the Company's business, prospects or management, or
any act or omission of the Company.
The Company is actively seeking a replacement for Mr. Kapiloff
to serve on the Company's Board of Directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibits
11 Statement re Computation of Per Share Earnings
27 Financial Data Schedule
99.1 Pro Forma Financial Information - Narrative Format
99.2 Letter, dated October 28, 1998, from Steven Kapiloff to
Andrew Wiederhorn,
35
<PAGE>
Chairman of the Board of Directors of the Company.
(b) Reports on Form 8-K during the three months ended September 30, 1998
and through the date hereof:
1) September 29, 1998
Item 2. Acquisition of Assets - acquisition of operating
properties on April 20, 1998 from G.I. Joe's Inc.
2) September 29, 1998
Item 2. Acquisition of Assets - acquisition of operating
properties on June 30, 1998 from Warner Estates Ltd.
Item 7. Financial Statements or Exhibits - Sale Contract dated
June 30, 1998
3) September 29, 1998
Item 2. Acquisition of Assets - purchased a $66.0 million loan
from Credit Suisse First Boston Mortgage Capital LLC
Item 7. Financial Statements or Exhibits - Mezzanine Loan Sale
Agreement dated July 30, 1998
4) September 29, 1998
Item 2. Acquisition of Assets - made a $49.7 million junior
loan secured by five luxury hotels in London, England.
Item 7. Financial Statements or Exhibits - Junior Loan
Facility dated April 30, 1998; Intercreditor Agreement dated
April 30, 1998; Debenture dated April 7, 1998; Novation
Certificate dated August 18, 1998.
5) October 8, 1998
Item 5. Other Events - news release announcing the Company's
repurchase agreement with Southern Pacific Corporation.
Item 7. Financial Statements or Exhibits - news release of the
Company dated October 1, 1998.
6) October 14, 1998
Item 2. Acquisition of Assets - purchase of $56.0 million of
"AA" and "Aa2" rated mortgage-backed securities.
7) October 14, 1998
Item 2. Acquisition of Assets - purchase of several pools of
performing residential loans from Salomon Smith Barney Inc.
for $380.9 million through a securitization.
8) November 4, 1998
Item 2. Acquisition of Assets - amendment to filing on October
14, 1998 regarding the purchase of several pools of performing
residential loans from Salomon Smith Barney Inc. for $380.9
million through a securitization. Amended to include the pro
forma financial information required under Item 7.
Item 7. Pro Forma Financial Information
36
<PAGE>
9) November 5, 1998
Item 2. Acquisition of Assets - sale of several pools of
performing residential loans and other mortgage-backed
securities to various purchasers.
Item 7. Pro Forma Financial Information
SIGNATURE
Pursuant to the requirements of the exchange act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Wilshire Real Estate Investment Trust Inc.
By: /s/ Lawrence A. Mendelsohn
--------------------------------------------------------------
Lawrence A. Mendelsohn
President
By: /s/ Chris Tassos
-------------------------------------------------------------
Chris Tassos
Executive Vice President and Chief Financial Officer
Date: November 23, 1998
37
EXHIBIT 11
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, 1998 September 30, 1998
-------------------- ------------------
<S> <C> <C>
Diluted net loss per share:
Net loss to common shareholders $ (48,880,000) $ (45,838,000)
Average number of shares outstanding 11,500,000 11,381,356
Net effect of dilutive stock options-based
on treasury stock method N/A N/A
---------- ----------
Total average shares 11,500,000 11,381,356
========== ==========
Fully dilutive net loss per share $ (4.25) $ (4.03)
</TABLE>
38
EXHIBIT 99.1
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
PRO FORMA FINANCIAL INFORMATION - NARRATIVE FORMAT
Wilshire Real Estate Investment Trust Inc. ("WREIT" or the "Company")
commenced operations on April 6, 1998. Accordingly, the acquisition of certain
real estate related assets subsequently disposed of occurred on or after this
date. The following pro forma financial information give effect to the operating
activity of the Company as if certain assets disposed of were not acquired by
the Company.
The unaudited pro forma financial information reflects the effect of
the disposition of the assets along with the required pro forma adjustments. The
unaudited pro forma financial information should be read in conjunction with the
historical consolidated financial statements of WREIT, together with the related
notes thereto, which were filed herewith on Form 10-Q for the period ended
September 30, 1998.
-----------------------------------
On November 16, 1998, the Company sold a mezzanine loan secured by a
partnership interest in commercial real estate to an unrelated third party for
approximately $61.6 million in proceeds. The carrying value included an
impairment write-down of approximately $4.0 million, which was recognized during
the quarter ended September 30, 1998. The sales price was determined through
arms length negotiations between the various purchasers and the Company. The
loan was secured by a first lien on the membership interests in the limited
liability company which owns the MGM Plaza, a 1,079,076 square foot office
complex comprised of six (6) class "A" office buildings located in Santa Monica,
California. The loan's interest rate was LIBOR plus 350 basis points and would
mature in November 2000. The cash proceeds from the sale were used to repay
principal and interest on an repurchase agreement with Credit Suisse First
Boston Mortgage Capital LLC for which this loan served as collateral totaling
$56.1 million.
The pro forma effect of this transaction on the September 30, 1998
statement of financial condition would have resulted in a decrease in total
assets from $1,018.0 million to $965.5 million and decrease in total liabilities
from $917.6 million to $861.5 million. The decrease in total assets of $52.5
million is the result of the sale of the loan's unpaid principal balance of
$66.0 million, the reversal of $1.3 million of accrued interest receivable and
$0.3 million related to the reversal of historical earnings of the loan, offset
in part, by and the reversal of $4.0 million in market valuation adjustment
reflected in earnings for the three and six months ended September 30, 1998 and
net increase of cash of $11.1 million for cash which was used to purchase the
loan. Liabilities decreased as a result of terminating the short-term financing
on the assets sold.
The pro forma effect of this transaction on Stockholders' Equity as of
September 30, 1998 would be a increase from $100.4 million to $104.0 million.
The $3.6 million decrease is due to the reversal of the market valuation
adjustment related to this loan of $4.0 million, offset in part, by the pro
forma effect of adjusting retained earnings by $0.3 million for the income
earned during the quarter ended September 30, 1998 associated with loans.
Additionally, the pro forma effect to the historical statement of
operations for the six-months ended September 30, 1998:
Decrease in interest income of $1.0 million and a decrease in interest
expense of $0.7 million, which results in a decrease in net interest
income of $0.3 million.
41
<PAGE>
Net loss would have decreased from $45.8 million to a net loss of $42.2
million. Basic loss per share of $4.03 would decrease to $3.71.
42
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This Schedule contains summary financial information extracted from the
Company's balance sheet as of September 30, 1998 and statement of earnings for
the six months ended September 30, 1998 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> APR-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,970
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 299,598
<INVESTMENTS-MARKET> 299,598
<LOANS> 625,444
<ALLOWANCE> 0
<TOTAL-ASSETS> 1,018,015
<DEPOSITS> 0
<SHORT-TERM> 475,351
<LIABILITIES-OTHER> 9,140
<LONG-TERM> 433,122
0
0
<COMMON> 166,981
<OTHER-SE> (66,579)
<TOTAL-LIABILITIES-AND-EQUITY> 1,018,015
<INTEREST-LOAN> 5,491
<INTEREST-INVEST> 10,758
<INTEREST-OTHER> 486
<INTEREST-TOTAL> 16,735
<INTEREST-DEPOSIT> 0
<INTEREST-EXPENSE> 7,513
<INTEREST-INCOME-NET> 9,222
<LOAN-LOSSES> 3,000
<SECURITIES-GAINS> 934
<EXPENSE-OTHER> 53,785
<INCOME-PRETAX> (45,838)
<INCOME-PRE-EXTRAORDINARY> (45,838)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (45,838)
<EPS-PRIMARY> (4.03)
<EPS-DILUTED> (4.03)
<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>
