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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Mark one)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
OR
|_| 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
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(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 |X| No |_|.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at April 30, 1999
Common Stock, par value $0.0001 per share 11,500,000
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
FORM 10-Q/A
I N D E X
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Page No.
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PART I--FINANCIAL INFORMATION
Item 1. Interim Financial Statements (Unaudited):
Consolidated Statements of Financial Condition........................3
Consolidated Statement of Operations..................................4
Consolidated Statements of Changes in Stockholders' Equity............5
Consolidated Statement of Cash Flows..................................6
Notes to Consolidated Financial Statements............................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................10
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........20
PART II--OTHER INFORMATION
Item 1. Legal Proceedings....................................................23
Item 2. Changes in Securities................................................23
Item 3. Defaults Upon Senior Securities......................................23
Item 4. Submission of Matters to a Vote of Security Holders..................23
Item 5. Other Information....................................................23
Item 6. Exhibits and Reports on Form 8-K.....................................23
Signatures....................................................................24
<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
--------- ---------
<S> <C> <C>
Assets (Unaudited)
Cash and cash equivalents ................................ $ 1,364 $ 4,782
Securities available for sale, at fair value ............. 157,865 158,738
Loans held for sale, net ................................. 47,955 44,006
Loans, net ............................................... 30,668 69,124
Discounted loans, net .................................... 1,946 2,498
Investments in real estate, net .......................... 79,640 85,005
Due from affiliate ....................................... 8,798 12,352
Debtor-in-possession financing to WFSG ................... 5,000 --
Accrued interest receivable .............................. 1,532 1,939
Prepaid servicing fees to WCC ............................ 3,070 --
Other assets ............................................. 3,950 2,673
--------- ---------
Total assets ...................................... $ 341,788 $ 381,117
========= =========
Liabilities and Stockholders' Equity
Liabilities:
Short-term borrowings .................................... $ 199,272 $ 225,566
Other borrowings ......................................... 56,368 60,577
Accounts payable and accrued liabilities ................. 3,182 6,233
Due to affiliates ........................................ -- 11,698
Dividends payable ........................................ 4,600 4,600
--------- ---------
Total liabilities ........................................ 263,422 308,674
========= =========
Commitments and Contingencies (see Note 6)
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 1
Additional paid-in capital ............................... 166,980 166,980
Accumulated deficit ...................................... (62,326) (64,093)
Accumulated other comprehensive loss ..................... (26,289) (30,445)
========= =========
Total stockholders' equity ............................. 78,366 72,443
========= =========
Total liabilities and stockholders' equity ............. $ 341,788 $ 381,117
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(dollars in thousands, except share data)
Quarter Ended
March 31, 1999
--------------
Net Interest Income:
Loans and discounted loans ................................ $ 1,928
Securities ................................................ 4,428
Other investments ......................................... 728
-----------
Total interest income ................................... 7,084
Interest expense .......................................... 3,693
-----------
Net interest income before provision for losses ......... 3,391
Provision for losses ...................................... (1,150)
-----------
Net interest income after provision for loss ............ 4,541
-----------
Real Estate Operations:
Operating income .......................................... 1,954
Operating expense ......................................... (55)
Interest expense .......................................... (1,302)
Provision for losses on real estate ....................... (264)
Depreciation .............................................. (394)
-----------
Net loss from real estate operations .................... (61)
-----------
Other Operating Income (Loss):
Gain on sale of real estate ............................... 10
Loss on foreign currency translation ...................... (48)
Market valuation losses and impairments ................... (1,195)
-----------
Total other operating loss .............................. (1,233)
-----------
Operating Expenses:
Management fees paid to affiliate ......................... 920
Servicing fees paid to affiliates ......................... (52)
Loan expenses paid to affiliates .......................... 27
Other ..................................................... 585
-----------
Total operating expenses ................................ 1,480
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NET INCOME .................................................... $ 1,767
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BASIC AND DILUTED NET INCOME PER SHARE ........................ $ 0.15
WEIGHTED AVERAGE SHARES OUTSTANDING ........................... 11,500,000
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
-------------------------- PAID-IN- ACCUMULATED COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT LOSS TOTAL
=====================================================================================
<S> <C> <C> <C> <C> <C> <C>
Initial capital ................... -- -- $ 2 $ -- $ -- $ 2
Issuance of common stock .......... 11,500,000 1 166,978 -- -- 166,979
Comprehensive loss:
Net loss ........................ -- -- -- (56,388) -- (56,388)
Other comprehensive loss:
Foreign currency
translation ................. (7) (7)
Unealized holding
losses on securities
available for sale .......... -- -- -- -- (67,817) (67,817)
Reclassification adjustment
for losses on securities
included in net loss ........ 37,379 37,379
-----------
Total compehensive loss ........... -- -- -- -- -- (86,833)
Dividends declared ................ -- -- -- (7,705) -- (7,705)
-------------------------------------------------------------------------------------
Balance at December 31, 1998 ...... 11,500,000 1 166,980 (64,093) (30,445) 72,443
Compehensive income:
Net income ........................ -- -- 1,767 -- 1,767
Other compehensive income
(loss):
Unrealized holding gains
on securities available for
sale ............................ -- -- -- -- 3,872 3,872
Reclassification adjustment
for losses on securities
included in net loss ............ 447 447
Foreign currency translation ...... -- -- -- -- (163) (163)
-----------
Total comprehensive income ........ -- -- -- -- -- 5,923
-------------------------------------------------------------------------------------
Balance at March 31, 1999
(Unaudited) ....................... 11,500,000 $ 1 $ 166,980 $ (62,326) $ (26,289) $ 78,366
=====================================================================================
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(dollars in thousands)
Quarter Ended
March 31, 1999
--------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................. $ 1,767
Adjustments to reconcile net loss to net cash used in
operating activities:
Provision for losses ....................................... (1,150)
Provision for losses on real estate owned .................. 264
Depreciation ............................................... 394
Market valuation losses and impairments .................... 1,195
Gain on sale of real estate ................................ (10)
Change in:
Due from affiliate, net .................................. (10,383)
Accrued interest receivable .............................. 407
Prepaid servicing fees ................................... (3,070)
Other assets ............................................. (1,215)
Accounts payable and accrued liabilities ................. (3,051)
--------
Net cash used in operating activities ................ (14,852)
--------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments of securities available for sale ................ 3,997
Loan originations .......................................... (218)
Principal payments received on loans and discounted loans .. 38,646
Investments in real estate ................................. (47)
Proceeds on sale of real estate ............................ 4,056
Debtor-in-possession financing ............................. (5,000)
--------
Net cash provided by investing activities ............ 41,434
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings ........................ 406
Repayments on short-term borrowings ........................ (26,730)
Repayments on other borrowings ............................. (3,676)
--------
Net cash used in financing activities ................ (30,000)
--------
NET DECREASE IN CASH AND CASH EQUIVALENTS ....................... (3,418)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD .................................................. 4,782
--------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................... $ 1,364
========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION--
Cash paid for interest .......................................... $ 4,191
Cash paid for income taxes....................................... --
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(dollars in thousands, except share data and where noted)
NOTE 1 - BASIS OF PRESENTATION
The accompanying interim consolidated financial statements of Wilshire
Real Estate Investment Trust Inc. and Subsidiaries ("WREIT" or the "Company")
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 interim
consolidated financial statements should be read in conjunction with the
Company's 1998 Annual Report on Form 10-K, as amended. A summary of the
Company's significant accounting policies is set forth in Note 4 to the
consolidated financial statements in the 1998 Annual Report on Form 10-K.
In the Company's opinion, all adjustments are comprised of normal
recurring accruals necessary for the fair presentation of the interim financial
statements. Operating results for the quarter ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain items in the consolidated statement of financial condition as of
December 31, 1998 were reclassified to conform to the March 31, 1999
presentation.
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. Prior to April 6,
1998, the Company had substantially no operating activity and therefore,
comparative 1998 consolidated statements of operations and cash flows are not
presented. 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 is a party to a management agreement with Wilshire Realty
Services 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 on April 6 of 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 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: (i) $16.00 and (ii) the 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 reasonable out-of-pocket expenses.
For the quarter ended March 31, 1999, the Company incurred approximately $920 of
management fees. No incentive fees were paid.
7
<PAGE>
During the quarter ended March 31, 1999, WFSG submitted a prepackaged plan
of reorganization as part of a Chapter 11 bankruptcy filing in the Federal Court
of Wilmington, Delaware. On April 12, 1999, the WFSG restructuring plan was
approved by the Bankruptcy Court, and, on June 10, 1999, WFSG emerged from
bankruptcy pursuant to the restructuring plan.
Wilshire Credit Corporation ("WCC"), an affiliate of WFSG, provides loan
and real property servicing to the Company. The WFSG plan of reorganization
discussed above includes the transfer of the servicing operations conducted by
WCC to a newly formed company controlled by WFSG. The Company believes that the
transfer of servicing operations will have no negative impact on the Company.
To date, these events have not had a significant effect on WRSC's ability
to act as manager of the Company.
NOTE 3 - INCOME TAXES
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 first 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 carefully to reevaluate its current tax status. As a
result of the Company's significant net loss during the year ended December 31,
1998, the Company and its shareholders may derive a greater benefit by deferring
a REIT election until a subsequent taxable year. A decision by the Company to
not make a REIT election requires a two-thirds vote by its stockholders.
If the Company does not make a REIT election, it will be subject to
corporate taxation. During the quarter ended March 31, 1999, the Company would
have a current tax provision of approximately $200 due to the alternative
minimum tax.
On March 31, 1999, the Company had, for U.S. Federal income tax purposes,
a net operating loss carryforward in excess of $70 million, which expires in
2018.
NOTE 4 - SIGNIFICANT TRANSACTIONS.
During the quarter ended March 31, 1999, the Company recovered its
carrying value in a loan of approximately $38.6 million through a loan payoff.
The loan was secured by certain mortgage-backed securities and classified in
loans, net in the consolidated statements of financial condition.
On April 29, 1999, the Company sold a loan held for sale secured by
commercial properties in the United Kingdom ("UK") with a carrying value of
approximately $47.9 million as of March 31, 1999. As a result of this sale, the
Company reversed $3.9 million of a valuation allowance previously provided for
in the provision for losses in the accompanying interim consolidated statement
of operations for the quarter ended March 31, 1999. This valuation allowance had
been established in 1998 based upon WRSC's estimate at that time of the ultimate
recoverability of the asset.
NOTE 5 - RELATED PARTY TRANSACTIONS
In addition to holding certain of WFSG's publicly traded notes, the
Company had an outstanding receivable of approximately $17.0 million from WFSG,
which bore interest at 13% per annum, arising out of funds loaned by the Company
to WFSG. WFSG incurred significant losses as a result of adverse market
conditions in 1998 and on March 3, 1999 filed a prepackaged plan of
reorganization (the "Restructuring Plan") with the U.S. Bankruptcy Court for the
District of Delaware as part of a voluntary bankruptcy filing under Chapter 11
of the U.S. Bankruptcy Code. Prior to the solicitation of WFSG's Restructuring
Plan, the unofficial note holders committee of WFSG (which did not include the
Company) negotiated a compromise and settlement of the Company's claim against
WFSG in respect of the $17.0 million receivable. The Company was represented by
its independent directors in connection with the compromise and settlement
negotiations. Under this compromise and settlement, if the Company funded the
full amount of the debtor-in-possession facility described below, the Company
would have received a new note for the full amount of the receivable,
8
<PAGE>
which bears interest at 6% per annum, payable monthly in arrears and will be
treated the same as the other holders of WFSG's 13% Series B Notes. Without
funding of the debtor-in-possession facility, it is unlikely that the Company
would have received as favorable treatment for its investments. The new note
will bear interest at 6%, and, therefore, the carrying value of the receivable
has been reduced by $5.9 million at December 31, 1998 to reflect the reduction
in interest rate.
The Restructuring Plan was approved by the court on April 12, 1999, and,
on June 10, 1999, WFSG emerged from bankruptcy pursuant to the Restructuring
Plan. As part of the Restructuring Plan, during the quarter ended March 31,
1999, the Company entered into an agreement to provide WFSG with
debtor-in-possession financing of up to $10.0 million (the "DIP Facility"). The
DIP facility bears interest at 12% and is secured by the stock of First Bank of
Beverly Hills, FSB, WFSG's savings bank subsidiary. The DIP Facility matures on
February 29, 2004 and repayment is made through fully amortizing principal and
interest payments commencing on February 29, 2000. Prior to February 29, 2000,
only interest payments are required. The Company loaned $5.0 million under the
DIP Facility on March 3, 1999 but did not provide WFSG with the remaining half.
Accordingly, under the agreement negotiated by the Company's independent
directors with WFSG and its creditors, 50%, or approximately $8.5 million, of
WFSG's obligation was treated pari passu with the claims of WFSG's noteholders
and converted, together with approximately $21.4 million (in principal plus
accrued but unpaid interest) of WFSG's 13% Series B Notes, to 2,874,791 shares
of newly issued common stock of WFSG on June 10, 1999, the effective date of the
Restructuring Plan. During the quarter ended March 31, 1999, the Company accrued
interest on the note receivable at its current contractual interest rate of 13%.
The Company considered the estimated book value of the WFSG common stock
received in exchange for the 50% portion of the receivable and recognized a net
write-down of approximately $2.7 million, included in the provision for losses
in the consolidated statement of operations, in determining its net income for
the quarter ended March 31, 1999.
During the quarter ended March 31, 1999 the Company recorded a write-down
of approximately $0.8 million to the carrying value of its holdings of WFSG 13%
Notes due 2004. The write-down is included in market valuation losses and
impairments in the interim consolidated statement of operations.
During the quarter ended March 31, 1999, the Company remitted $15 million
to WCC consisting of a payment of amounts owed by the Company to WCC of $11.8
million and the prepayment of $3.2 million of future servicing fees for a
release of a guarantee by the Company of $35 million of WCC's indebtedness and
of any and all claims against the Company relating thereto. The amortized
balance of the prepaid servicing fee is included in the accompanying
consolidated statement of financial condition as of March 31, 1999. However, the
noteholders of WFSG claim that less than $3.2 million of future servicing fees
were paid by the Company. The noteholders of WFSG claim that the amount owed to
WCC was approximately $900,000 higher, thereby reducing the amount of the
prepayment credit to $2.3 million. The Company believes that the $3.2 million
figure is correct and that this matter will be resolved in the Company's favor
based on preliminary conversations with WFSG.
During the quarter ended March 31, 1999, the Company recaptured
approximately $100 of property servicing fees previously paid to WCC. The
recapture, resulting from retroactive restatement of the property servicing
fees, was made to better reflect market rates for property servicing.
9
<PAGE>
NOTE 6 - COMMITMENTS, CONTINGENCIES & OFF-BALANCE SHEET RISK
The Asset and Liability Committee is authorized to utilize a wide variety
of off-balance sheet financial techniques to assist the Company in the
management of interest rate risk. 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 March 31, 1999, the Company was a party to a swap contract in
connection with its investment in a commercial mortgage loan secured by real
property in the UK. The swap contract, which covers the approximate five-year
term of the asset and related financing, 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 March 31, 1999, was $49.7 million. As discussed in Note 4,
this loan was sold on April 29, 1999 and, in connection therewith, this swap
agreement was terminated.
The Company is also a party to a five year swap in connection with its
investment in real property in the UK. The notional amount is GBP 11,224,000 and
has the financial impact of converting floating rate financing to a fixed rate
of interest.
The Company is involved in various legal proceedings occurring in the
ordinary course of business which the Company believes will not have a material
adverse effect on the financial condition or operations of the Company.
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. ("WREIT" or the "Company") is a
Nasdaq-listed corporation that was formed in October 1997 and commenced
operations in April 1998 following the completion of our initial public
offering.
In response to adverse market conditions in the second half of 1998 and
the resulting effect on our operations, we focused our efforts on stabilizing
our existing asset base and greatly reduced acquisition activities during the
quarter ended March 31, 1999. Based on our results of operations for the quarter
ended March 31, 1999 and the restructuring of the Wilshire Financial Services
Group Inc. ("WFSG"), as described below, the Company believes that general
market conditions have stabilized and we can return our operational focus to our
primary business plan.
As we resume acquisition activities, we anticipate lessening the level of
investment in commercial operating properties and increasing investments in
loans. We believe that investments in loans provides higher yields and allows us
to more efficiently leverage our existing capital, thereby providing us a higher
return on equity. We believe there may be attractive opportunities for
additional investments in Europe, particularly in France. In addition to the
direct acquisition of loans and other investments, we may seek to invest in
other companies that invest in real estate related assets, especially where the
market capitalizations of such companies do not reflect the inherent values of
the underlying assets or franchises. Nonetheless, we make investment decisions
on an opportunistic basis and will evaluate investment opportunities as they
arise.
The following discussion of our results of operations, changes in
financial condition and liquidity and capital resources should be read in
conjunction with the Interim Consolidated Financial Statements and related Notes
included in Item 1 herein.
10
<PAGE>
RESTRUCTURING OF WFSG
During the quarter ended March 31, 1999, WFSG, the parent of our manager,
Wilshire Realty Services Corporation ("WRSC"), submitted a prepackaged plan of
reorganization as part of a Chapter 11 bankruptcy filing in the Federal Court of
Wilmington, Delaware. On April 12, 1999, the WFSG restructuring plan was
approved by the Bankruptcy Court, and WFSG's bankruptcy organization was
consummated on June 10, 1999. In the Company's opinion, completion of the WFSG
restructuring plan is a major step in our efforts to return focus to our primary
business plan and move beyond the turmoil encountered in the second half of
1998. In addition to resolving outstanding claims, completion of the WFSG
restructuring plan reduced the uncertainty related to the ability of WRSC to
continue as our manager.
Through our independent directors, we were a party to the restructuring
negotiations since we had a $17.0 million unsecured receivable from WFSG,
bearing interest at 13%. During the quarter ended March 31, 1999, we entered
into an agreement to provide WFSG with debtor-in-possession financing of up to
$10.0 million (the "DIP Facility") as part of a compromise and settlement of the
$17.0 million receivable due from WFSG. Under this compromise and settlement, if
the Company funded the full amount of the DIP Facility, the Company would have
received a new note for the full amount of the receivable, which bears interest
at 6% per annum payable monthly in arrears and will be treated the same as the
other holders of WFSG's 13% Series B Notes. The DIP Facility bears interest at
12% and is secured by the stock of First Bank of Beverly Hills, FSB, WFSG's
savings bank subsidiary. The DIP Facility matures on February 29, 2004 and
repayment is made through fully amortizing principal and interest payments
commencing on February 29, 2000. Prior to February 29, 2000, only interest
payments are required. The business decision to provide the DIP Facility was
based on the independent directors' desire to obtain the best possible treatment
for the Company's holdings of WFSG's 13% Series B Notes and the account
receivable due from WFSG and the fact that the debtor-in-possession facility had
priority as a matter of law and was fully secured by the stock of WFSG's healthy
bank subsidiary. Without funding of the DIP Facility, it is unlikely that the
Company would have received as favorable treatment for its investments.
We funded $5.0 million of the DIP Facility on March 3, 1999, but did not
provide WFSG with the remaining half. Accordingly, under the agreement
negotiated by the Company's independent directors with WFSG and its creditors,
50%, or approximately $8.5 million, of WFSG's obligation was treated pari passu
with the claims of WFSG's noteholders and converted, together with approximately
$21.4 million (in principal plus accrued but unpaid interest) of WFSG's 13%
Series B Notes, to 2,874,791 shares of newly issued common stock of WFSG on June
10, 1999, the effective date of the restructuring plan. Additionally, on the
effective date of the restructuring plan, the Company acquired approximately
$8.5 million in principal amount of WFSG's 6% Convertible PIK Notes due 2006
(the "New Notes") in exchange for the remaining 50% of the $17.0 million
intercompany receivable owed by WFSG to the Company. The Company may elect to
convert the New Notes into new common stock of WFSG upon receipt of a notice of
redemption of the New Notes by WFSG.
We have considered the estimated book value of the WFSG common stock
received in exchange for the 50% portion of the receivable and recognized a net
write down of approximately $2.7 million, included in the provision for losses
in the consolidated statement of operations, in determining net income for the
quarter ended March 31, 1999. The note receivable is classified in due from
affiliate in the consolidated statements of financial condition.
In addition to the above mentioned $2.7 million provision for losses
related to the $17.0 million note receivable from WFSG, we recognized $0.8
million of market valuation losses and impairments related to our holdings of
WFSG 13% Notes due 2004. Our net income for the quarter ended March 31, 1999
would have been $5.3 million, excluding these WFSG restructuring related losses
and was $1.7 million including such losses.
INCOME TAX STATUS
To qualify as a REIT, we must first make an affirmative election to be
taxed as a REIT at the time we file our first federal income tax return later
this year. During 1998, we incurred substantial losses resulting from volatile
conditions in the global financial marketplace, as explained in the Annual
Report on Form 10-K, as amended. As a result, we are
11
<PAGE>
evaluating whether we and our shareholders will derive greater benefit from not
electing REIT status at this time. A decision to not make a REIT election
requires approval by two-thirds of our stockholders.
If we do not elect to be taxed as a REIT, we would be subject to corporate
taxation. During the quarter ended March 31, 1999, we would have a current tax
provision of approximately $0.2 million as a result of the alternative minimum
tax.
On March 31, 1999, the Company had, for U.S. Federal income tax purposes,
a net operating loss carryforward in excess of $70 million, which expires in
2018.
RESULTS OF OPERATIONS - QUARTER ENDED MARCH 31, 1999
NET INCOME. Our net income for the quarter ended March 31, 1999 was $1.8
million, or $0.15 per share. The net income is primarily attributable to net
interest income after provision for losses of $4.5 million, partially offset by
a loss on real estate operations of $0.1 million, market valuation losses and
impairments of $1.2 million (of which $0.8 million is attributable to our
holdings of WFSG 13% Notes due 2004 and $0.4 million is attributable to our
portfolio of mortgage-backed securities) and operating expenses and management
fees of $1.5 million.
NET INTEREST INCOME. The following table sets forth information regarding
the total amount of income from interest-earning assets and expense from
interest-bearing liabilities and the resulting average yields and rates:
<TABLE>
<CAPTION>
For the Quarter Ended March 31, 1999
-----------------------------------------------
Average Interest Annualized
Balance Income Yield/Rate
-----------------------------------------------
(dollars in thousands)
<S> <C> <C> <C>
Interest-Earning Assets:
Loan portfolios (3) ............................. $ 86,627 $ 1,928 9.0%
Mortgage-backed securities available for sale ... 147,738 4,428 12.2
Other securities available for sale (4) ......... 9,924 -- --
Due from affiliates ............................. 11,968 585 19.8
Debtor-in-possession financing to WFSG .......... 2,555 77 12.0
Other investments ............................... 5,965 66 4.5
-------- -------- ----
Total interest-earning assets .............. 264,777 7,084 10.9
-------- -------- ----
Interest-Bearing Liabilities:
Short-term borrowings ........................... 207,559 3,693 7.2
Other borrowings ................................ 59,241 1,302 8.9
-------- -------- ----
Total interest-bearing liabilities ......... 266,800 4,995 7.6
-------- -------- ----
Net interest income before provision for loan
losses/spread (1) .......................... $ 2,089 3.3%
======== ====
Net interest margin (2) ......................... 3.2%
====
</TABLE>
12
<PAGE>
(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.
(3) As discussed in Note 4 to the interim consolidated financial statements,
in April 1999 we sold a loan with a carrying value of approximately $47.9
million at March 31, 1999. The net interest margin attributable to this
loan, net of related swaps, was approximately 5.4% during the quarter
ended March 31, 1999.
(4) Other securities available for sale represents our investment in WFSG 13%
Notes due 2004 which, upon WFSG's emergence from bankruptcy, in June 1999,
were converted to common stock of WFSG. Accordingly, we have not accrued
interest income on these securities during the quarter ended March 31,
1999.
PROVISION FOR LOSSES. During the quarter ended March 31, 1999, we reversed
a provision for losses of $3.9 million taken in prior periods for a loan held
for sale. As discussed in Note 4 to the interim consolidated financial
statements, this loan was sold on April 29, 1999. This provision reversal was
partially offset by a provision for losses on loans of $0.1 million. In
addition, as discussed in Note 5 to the interim consolidated financial
statements, during the quarter ended March 31, 1999 we recognized a net
write-down of $2.7 million in the carrying value of a $17.0 million note
receivable from WFSG to reflect the estimated value of the common stock of WFSG
to be received in exchange for a portion of the note. The write-down is included
in provision for losses in the consolidated statement of operation for the
quarter ended March 31, 1999.
REAL ESTATE OPERATIONS. Such operations represent activity from our
investment in various office buildings, retail stores, and other commercial
property located in Oregon, California and the United Kingdom. During the
quarter ended March 31, 1999, we realized a loss of approximately $0.1 million
on these properties. This loss was attributable to provision for losses on real
estate of $0.3 million, interest expense of $1.3 million, depreciation expense
of $0.4 million, and operating expense of $0.1 million which, in the aggregate,
exceeded gross rental and other revenues of $2.0 million. Excluding $0.7 million
of non-cash charges to real estate operations, including depreciation and loss
provision, we had positive cash flow from such operations of approximately $0.6
million.
OTHER LOSS. Our other loss was approximately $1.2 million for the quarter
ended March 31, 1999, resulting primarily from $1.2 million of market valuation
losses and impairments. During the quarter ended March 31, 1999 we recorded $0.8
million of market valuation losses and impairments related to our holdings of
WFSG 13% Notes due 2004, which are included in other securities in the
consolidated statements of financial condition, and $0.4 related to our
portfolio of mortgage-backed securities available for sale. These market
valuation losses and impairments were deemed by the Company to be other than
temporary in nature. The devaluation, and subsequent write-down, of these assets
results from the residual effect of market turmoil experienced during the second
half of 1998. Although the market for mortgage-backed securities, in particular
subordinate classes of mortgage-backed securities, has not fully recovered from
the events of 1998, the Company believes the markets have stabilized during the
first quarter of 1999 as reflected in the substantial decline in market
valuation losses and impairments related to mortgage-backed securities from $1.2
million for the quarter ended December 31, 1998 to $0.4 million for the quarter
ended March 31, 1999.
OPERATING EXPENSES. Management fees of $0.9 million for the quarter ended
March 31, 1999 were comprised solely of the 1% (per annum) base management fee
paid to WRSC for the period, as provided pursuant to our management agreement
with WRSC. WRSC earned no incentive fee for this period. Other expenses were
comprised of professional services, insurance premiums and other sundry
expenses. During the quarter ended March 31, 1999, we recaptured loan service
fees of approximately $0.1 million. The recapture of service fees resulted from
a review of, and retroactive reduction in, certain property servicing fees
charged to us.
CHANGES IN FINANCIAL CONDITION
GENERAL. Total assets decreased from approximately $381.1 million at
December 31, 1998 to approximately $341.8 million at March 31, 1999. The
decrease in total assets is primarily attributable to a reduction of $38.5
million in loans, net that resulted from the payoff of a loan secured by
mortgage-backed securities with a carrying value of $38.6 million at December
31, 1998. Total liabilities decreased from approximately $308.7 million at
December 31, 1998 to approximately $263.4 million at March 31, 1999 primarily as
a result of a reduction in short-term borrowings related to the
13
<PAGE>
loan payoff noted above, and an $11.7 million decrease in due to affiliates.
Stockholders' equity increased approximately $5.9 million due primarily to a
reduction of $4.3 million in unrealized loss on available for sale securities,
and net income of $1.8 million for the quarter ended March 31, 1999.
SECURITIES AVAILABLE FOR SALE. The balance of securities available for
sale was substantially unchanged from December 31, 1998 to March 31, 1999. This
resulted from a decrease in carrying value of $4.0 million due to cash receipts,
offset by a net decrease in the unrealized loss on available for sale securities
of approximately $4.3 million from December 31, 1998 to March 31, 1999 and to a
lesser extent, the recognition of other than temporary impairment of
approximately $1.2 million, of which approximately $0.8 million is attributable
to our holdings of WFSG 13% Notes due 2004 and $0.4 million is attributable to
our portfolio of mortgage-backed securities.
We mark our 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, we request 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 many of our 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, we evaluate whether and to what extent any unrealized loss is to be
recognized as other than temporary.
At March 31, 1999, we valued our securities available for sale portfolio
and gross unrealized gains and losses thereon as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Cost Unrealized Unrealized
(1) Gains Losses Fair Value
-------------- ------------- ----------- -------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 174,799 $ 1,268 $ (27,387) $ 148,680
Other securities 9,185 -- -- 9,185
----------------------------------------------------------
$ 183,984 $ 1,268 $ (27,387) $ 157,865
==========================================================
</TABLE>
(1) The amortized cost of the investment securities reflects the market
valuation losses and impairments discussed in "Results of Operations".
LOAN PORTFOLIO. During the quarter ended March 31, 1999, our loan
portfolio of non-discounted loans (including loans and loans held for sale)
decreased by approximately $34.5 million due primarily to the payoff of a loan,
which was secured by certain mortgage-backed securities, with a carrying value
of approximately $38.6 million at the time of payoff, and by a provision for
losses on loans of $0.1 million. These decreases in the loan portfolio balance
were partially offset by the reversal of a provision for losses on loans held
for sale of $3.9 million, as discussed previously. There were no other sales and
no purchases of loan assets during the quarter ended March 31, 1999.
Subsequent to March 31, 1999, we sold a loan secured by a second lien on
five luxury hotels in the UK. As of March 31, 1999, this loan comprised the
entire balance of loans held for sale in the consolidated statements of
financial condition.
As we begin to return our focus to execution of our business plan, it is
likely that our investment activities will focus more on the purchase of loan
assets, and our investments in commercial operating properties will be reduced.
We believe that certain loan assets provide higher yield returns, especially
when coupled with our servicer's expertise in servicing international loans and
domestic non-conforming and sub-performing loan assets. We remain optimistic
about investment opportunities in Europe and, in particular, France.
14
<PAGE>
The following table sets forth certain information relating to the payment
status of loans in the Company's loan portfolio at March 31, 1999:
Unpaid Principal
Balance
(dollars in thousands)
Current or past due less than 31 days .................. $ 30,848
Past due 31 to 89 days ................................. --
-----------
$ 30,848
===========
We maintain an allowance for loan losses on non-discounted loans at a
level that the Company considers adequate, based upon the advice of WRSC, to
provide for probable losses based upon an evaluation of known and inherent
risks.
DISCOUNTED LOAN PORTFOLIO. The balance of discounted loans is
substantially unchanged from December 31, 1998 to March 31, 1999. During the
quarter ended March 31, 1999, we did not purchase or sell any discounted loan
assets. As noted above, we currently plan to increase our concentration of
investment into loan related assets, including discounted loans when
appropriate, and decrease our level of investment in commercial operating
properties. Nonetheless, we make investment decisions on an opportunistic basis
and will evaluate investment opportunities as they arise.
The following table sets forth certain information relating to the payment
status of loans in our discounted loan portfolio at March 31, 1999:
Unpaid Principal
Balance
(dollars in thousands)
Current or past due less than 31 days .................. $ 1,252
Past due 31 to 89 days ................................. --
Past due 90 days or greater ............................ 6,891
-----------
$ 8,143
===========
The Company maintains an allowance for loan losses on discounted loans at
a level that the Company considers adequate, based upon the advice of WRSC, to
provide for probable losses on discounted loans based upon an evaluation of
known and inherent risks. No additional allowance for loan losses for discounted
loans was provided for during the quarter ended March 31, 1999.
INVESTMENTS IN REAL ESTATE. Investments in real estate decreased
approximately $5.4 million from December 31, 1998 to March 31, 1999 due
primarily to the sale of one operating property for proceeds of approximately
$4.1 million. In addition, we recognized approximately $0.4 million of
depreciation expense related to operating properties and recorded a $0.3 million
provision for real estate losses during the quarter ended March 31, 1999.
SHORT-TERM BORROWINGS. Short-term borrowings decreased by approximately
$26.3 million during the quarter ended March 31, 1999 due primarily to the
repayment of borrowings related to a loan which paid off. The balance of
outstanding borrowings related to this loan at the time of payoff was
approximately $20.0 million. The remaining change is primarily attributable to
principal payments made from receipts from mortgage-backed securities.
15
<PAGE>
OTHER BORROWINGS. Other borrowings decreased approximately $4.2 million
during the quarter ended March 31, 1999 due primarily to the repayment of
borrowings related to an operating property which was sold during the reporting
period.
STOCKHOLDERS' EQUITY. Stockholders' equity increased by approximately $5.9
million during the quarter ended March 31, 1999 as the result of a $4.3 million
decrease in unrealized holding losses on available for sale securities resulting
from an increase in the fair value of our mortgage-backed securities portfolio
in relation to amortized cost, and net income of $1.8 million for the quarter
ended March 31, 1999.
FUNDS FROM OPERATIONS
The Company considers 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 our performance or
to cash flow from operating, investing and financing activities as a measure of
liquidity or the Company's ability to make distributions.
We compute FFO in accordance with the definition recommended by National
Association of Real Estate Investment Trusts ("NAREIT") as described in the
NAREIT White Paper. For the quarter ended March 31, 1999, our FFO was $3.3
million or $0.29 per weighted average common share. The following table provides
the calculation of the Company's FFO:
For the
Quarter Ended
March 31, 1999
----------------------
(dollars in thousands,
except share data)
Net income ............................................. $ 1,767
Real estate related depreciation ....................... 394
Gain on sale of real estate ............................ (10)
Market valuation losses and impairments (1) ............ 1,195
-----------
FFO (2) ....................................... $ 3,346
===========
FFO per common share ................................... $ 0.29
(1) The Company 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 losses
and impairments have been excluded from the net loss in arriving at FFO.
(2) NAREIT's definition of FFO does not adjust net income by provisions for
loan losses. However, we provided $2.7 million of loan loss during the
quarter ended March 31, 1999 on our note receivable from WFSG, which we
believe is non-recurring in nature. Including this additional adjustment
for WFSG related loan loss provisions, FFO would have been $6.0 million
for the quarter ended March 31, 1999. FFO for the
16
<PAGE>
three months ended March 31, 1999 principally reflects the significant
impact on the Company of the difficult financial conditions in the third
and fourth quarters of 1998, which had a substantial impact on our
liquidity position and resulted in significant losses for the period and
continued to affect our operations in 1999. FFO may not actually represent
the amount made available to shareholders in the form of dividends, since
the Company is only required to distribute 95% of its taxable income to
qualify as a REIT and that taxable income is calculated differently than
FFO. The Company may not calculate FFO in the same manner as other real
estate investment trusts and accordingly the Company's FFO may not be
directly comparable to that of other real estate investment trusts.
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 quarter ended March 31, 1999 consisted of net cash provided
by investing activities, including the cash repayments related to our
mortgage-backed securities portfolio and a loan receivable which paid off during
the quarter. The adverse market conditions, which negatively impacted us during
the third and fourth quarters of 1998, began to stabilize during the quarter
ended March 31, 1999. As of March 31, 1999, we had outstanding collateral calls
with one of our lenders, net of cash retained, of approximately $2.6 million,
which is a substantial decrease from the balance outstanding as of December 31,
1998 of $4.4 million.
Fluctuations in interest rates will continue to impact our net interest
income to the extent our fixed rate assets are funded by variable rate debt or
our 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. See "Item 3 - Quantitative and Qualitative
Disclosures about Market Risk". The flexibility in our 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, we
would be required to provide additional collateral in connection with our
short-term, floating-rate borrowing facilities. 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."
At March 31, 1999, we had total consolidated secured indebtedness of
$255.6 million, as well as $3.2 million of other liabilities. This consolidated
indebtedness consisted of (i) $159.9 million of repurchase agreements, (ii)
lines of credit aggregating $39.4 million which are secured by loans and
securities and (iii) $56.3 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 $1.7 million, $1.6
million and $1.7 million for the months of January, February and March 1999,
respectively.
In general, we finance acquisitions of mortgage-backed securities through
uncommitted thirty-day repurchase agreements with primary securities dealers.
Loans are financed through short-term warehouse facilities or intermediate term
loans. Warehouse agreements are secured lending arrangements. If the value of
the assets securing the loan declines as determined by the lender, the lender
may request that the amount of the loan be reduced by cash payments from the
borrower or additional collateral be provided by the borrower (generally known
as "collateral calls"). Accordingly, in an environment where lenders
consistently mark down the value of the underlying assets, a borrower can become
subject to collateral calls, which can have a significant impact on liquidity.
Similarly, if interest rates increase significantly, the borrowing cost under
the short term warehouse agreement may also increase while the interest rate on
the assets securing the loan may not increase at the same time or to the same
degree. Real property acquisitions are financed with intermediate or long-term
mortgages with banks and other financial institutions.
Repurchase agreements are secured lending arrangements which involve the
borrower selling an asset to a lender at a fixed price with the borrower having
an obligation to repurchase the asset within a specified period (generally 30
days) at a higher price reflecting the interest cost of the loan. If the value
of the underlying asset declines or the lender marks the asset lower, the lender
may request that the amount of the loan be reduced by cash payments from the
borrower or additional collateral be provided by the borrower (generally known
as "collateral calls"). Mortgage-backed
17
<PAGE>
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 us to provide
additional collateral to secure the indebtedness. As of March 31, 1999, the
Company had approximately $181.1 million of indebtedness under the terms of
which the lender could request additional collateral if the value of the
underlying collateral declined. Although the Company believes that the
likelihood of significant declines in asset values has decreased since the
fourth quarter of 1998, the Company is seeking to maintain a larger cash
position and more unencumbered assets to deal with future potential collateral
calls. In addition, the Company is seeking to refinance some of this short term
indebtedness with longer term indebtedness which would not be subject to the
same collateral calls.
In addition to payment and, in the case of our secured indebtedness,
collateralization requirements, we are subject to various other covenants in our
indebtedness, including the maintenance of specified amounts of equity. At March
31, 1999, we were in compliance with all obligations in our indebtedness and
equity, as defined in the applicable agreements, except for one such facility,
which, subsequent to March 31, 1999, has been restructured into a facility
secured by certain real properties. There can be no assurance that operating
losses, if any, will not result in our violation of 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, unless
the applicable lender or lenders allowed us to remain in violation of the
agreements. Were a default to be declared, we would not be able to continue to
operate without the consent of our lenders. We are currently considering various
alternatives to enhance our ability to meet payment and other obligations under
our indebtedness and the funding requirements discussed below. 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 we are unable to fund additional collateral needs or to repay, renew or
replace maturing indebtedness on terms reasonably satisfactory to us, we may be
required to sell, under adverse market conditions, a portion of our assets, and
could incur 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 our ability to dispose of such securities promptly for fair
value in such situations.
Based on our monthly interest and other expenses, monthly cash receipts
and collateral calls through April 30, 1999, we believe that our existing
sources of funds will be adequate for purposes of meeting our short-term
liquidity needs. There can be no assurance that this will 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 our liquidity. On the other hand, material decreases in
interest expense from variable rate funding sources or in collateral calls
generally would positively affect our 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. We, WRSC
and the companies that service our loan portfolio (our "Servicers") utilize a
number of technologically dependent systems to operate, service mortgage loans
and manage mortgage assets. WRSC, together with Wilshire Credit Corporation
("WCC", an affiliate of WFSG) and Wilshire Servicing Company U.K. Limited (a
wholly-owned subsidiary of WFSG), who are our two Servicers, formed a committee
to address year 2000 issues ("the Committee") that reports directly to WFSG's
executive committee. The Committee is headed by WFSG's Chief Information Officer
and includes representatives from across departments within WRSC and our
Servicers as well as our management.
The Committee established and completed a project plan with respect to
Year 2000 readiness. In the first phase of the project, the Committee conducted
an inventory of all systems for WRSC and our Servicers, classifying each as
either "critical" or "non-critical". For systems deemed "critical", the
Committee developed detailed test plans and created separate Year 2000 test
environments. After the testing phase, in which Year 2000 issues were
identified, phases of resolution, retesting, implementation and certification
were completed.
18
<PAGE>
WRSC and our Servicers began testing of all critical systems in 1997 and
completed all necessary testing of such systems, including both systems supplied
by outside vendors and internally developed systems, by the end of February
1999. In each case, issues which were identified were resolved. Changes which
resulted from testing were coded, retested and implemented and moved into
production. Following these phases, each department's executive management
certified that their staff had tested critical code and deemed it adequate. In
addition, for all critical systems supplied by outside vendors, the Committee
obtained a written certification from the vendor that the applicable package is
"Year 2000 compliant". With respect to non-critical systems supplied by outside
vendors, the Committee has consulted substantially all of the vendors' Internet
sites and has obtained copies of Year 2000 compliance certifications from those
sites. All phases of the Committee's Year 2000 readiness project were completed
by the end of April 1999. As a result, WRSC's management believes that the
Company is Year 2000 compliant in all material respects.
In addition to the information technology systems ("IT systems"), various
"environmental systems" ("non-IT systems") used for the Company's business,
including the telephone, elevator and security systems, incorporate technology
that could be impaired by the year 2000 date change. The Committee has received
written certification that each significant non-IT system is Year 2000
compliant.
Our operations are overseen by WRSC, 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 us or our
results of operations. Aside from limited hardware costs, WRSC'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, substantially all of which had been
incurred by December 31, 1998.
Our most likely worst case Year 2000 scenario would be one in which our
Servicers are unable to perform necessary loan servicing activities. To the
extent the loan servicing system is not Year 2000 compliant, the ability to
service loans would be in jeopardy. This, in turn, would limit the collections
of payments on mortgage loans, which would, further, hinder the Company's
ability to meet its own debt service and other cash requirements. Although WRSC
and the Company do not believe that it is reasonably likely that the Year 2000
date change will cause such a scenario to occur, the Committee has developed a
contingency plan with procedures for manual loan servicing, for up to a week,
should the loan servicing system cease to be operational. The loan servicing
system was developed internally, and WRSC has advised us that it believes that,
in the event of an unexpected Year 2000 issue, the source of the issue could be
isolated, and the issue could be corrected, rapidly by WRSC's existing staff
without significant cost. Accordingly, we do not believe that such a failure of
the loan servicing system would result in any material loss of revenue or have
any other material impact on the Company.
Based on the results of Committee's Year 2000 readiness project, we are
confident that WRSC and our Servicers are appropriately addressing the Year 2000
issues. Critical IT systems supplied by outside vendors have undergone testing
not only by WRSC and our Servicers, 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.
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
19
<PAGE>
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. EXCEPT
AS REQUIRED BY LAW, 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices, and equity prices. The
primary market risk to which the Company is exposed is interest rate risk, which
is highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations, and
other factors beyond the control of the Company. Changes in the general level of
interest rates can affect the Company's net interest income, which is the
difference between the interest income earned on interest-earning assets and the
interest expense incurred in connection with its interest-bearing liabilities,
by affecting the spread between the Company's interest-earning assets and
interest-bearing liabilities. Changes in the level of interest rates also can
affect, among other things, the ability of the Company to acquire loans, the
value of the Company's mortgage-backed securities and other interest-earning
assets, and its ability to realize gains from the sale of such assets.
It is the objective of the Company to attempt to control risks associated
with interest rate movements. In general, WRSC's strategy for the Company 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 following table quantifies the potential changes in net interest
income and net portfolio value should interest rates go up or down (shocked) by
100 to 400 basis points, assuming the yield curves of the rate shocks will be
parallel to each other. Net portfolio value is calculated as the sum of the
value of off-balance sheet instruments and the present value of cash in-flows
generated from interest-earning assets net of cash out-flows in respect of
interest-bearing liabilities. The cash flows associated with the loan portfolios
and securities available for sale are calculated based on prepayment and default
rates that vary by asset. Projected losses, as well as prepayments, are
generated based upon the actual experience with the subject pool, as well as
similar, more seasoned pools. To the extent available, loan characteristics such
as loan-to-value ratio, interest rate, credit history and product types are used
to produce the projected loss and prepayment assumptions that are included in
the cash flow projections of the securities. Actual results could differ
significantly from those estimated in the table.
Projected Percent Change In
Change in Interest Rates Net Interest Income Net Portfolio Value
- ------------------------ ------------------- -------------------
-400 Basis Points 35.2% 19.4%
-300 Basis Points 26.4% 14.7%
-200 Basis Points 17.6% 9.9%
-100 Basis Points 8.8% 5.0%
0 Basis Points 0.0% 0.0%
100 Basis Points -8.8% -5.0%
200 Basis Points -17.6% -9.9%
300 Basis Points -26.4% -14.7%
400 Basis Points -35.2% -19.6%
20
<PAGE>
Asset and liability management involves managing the timing and magnitude
of the repricing of assets and liabilities. It is the objective of the Company
to attempt to control risks associated with interest rate movements. In general,
the Manager's strategy for the Company is to match asset and liability balances
within maturity categories 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 Asset and Liability Committee is authorized to utilize a wide variety
of off-balance sheet financial techniques to assist us in the management of
interest rate risk. In hedging the interest rate and exchange rate exposure of a
foreign currency denominated asset or liability, we may enter into hedge
transactions to counter movements in the different currencies as well as
interest rates in those currencies. Other than as discussed below, no such
techniques were in use as of March 31, 1999.
Methods for evaluating interest rate risk include an analysis of the
Company's interest rate sensitivity "gap," which is defined as the difference
between interest-earning assets and interest-bearing liabilities maturing or
repricing within a given time period. A gap is considered positive when the
amount of interest-rate sensitive assets exceeds the amount of interest-rate
sensitive liabilities. A gap is considered negative when the amount of
interest-rate sensitive liabilities exceeds interest-rate sensitive assets.
During a period of rising interest rates, a negative gap would tend to adversely
affect net interest income, while a positive gap would tend to result in an
increase in net interest income. During a period of falling interest rates, a
negative gap would tend to result in an increase in net interest income, while a
positive gap would tend to affect net interest income adversely. Since different
types of assets and liabilities with the same or similar maturities may react
differently to changes in overall market rates or conditions, changes in
interest rates may affect net interest income positively or negatively even if
an institution were perfectly matched in each maturity category.
The following tables set forth the estimated maturity or repricing of the
Company's interest-earning assets and interest-bearing liabilities at December
31, 1998 and at June 30, 1999.
As of December 31, 1998
-----------------------
(Dollars in thousands)
<TABLE>
<CAPTION>
Within 4 to 12 One Year More than 3
3 Months Months to 3 Years Years TOTAL
------------ ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C>
INTEREST SENSITIVE ASSETS(1):
CASH AND CASH EQUIVALENTS $ 4,782 $ 4,782
SECURITIES AVAILABLE FOR SALE 47,413 111,325 158,738
LOANS(2) 114,068 117 312 1,131 115,628
DUE FROM AFFILIATES 12,352 12,352
------------ ----------- ---------- ------------ ------------
TOTAL RATE SENSITIVE ASSETS $ 131,202 $ 47,530 $ 312 $ 112,456 $ 291,500
============ =========== ========== ============ ============
INTEREST SENSITIVE LIABILITIES:
REVERSE REPURCHASE AGREEMENTS $ 181,557 $ 181,557
NOTES PAYABLE 42,209 42,209
BORROWING ON REAL ESTATE(4) -- 1,093 59,484 60,577
DUE TO AFFILIATES 11,698 11,698
DIVIDENDS PAYABLE 4,600 4,600
------------ ----------- ---------- ------------ ------------
TOTAL RATE SENSITIVE LIABILITIES 235,464 4,600 1,093 59,484 300,641
============ =========== ========== ============ ============
INTEREST RATE SENSITIVITY GAP (104,262) 42,930 (781) 52,972
CUMULATIVE INTEREST RATE
SENSITIVITY GAP (104,262) (61,332) (62,113) (9,141)
CUMULATIVE INTEREST RATE
SENSITIVITY GAP AS A PERCENTAGE OF
TOTAL RATE-SENSITIVE ASSETS -36% -21% -21% -3%
</TABLE>
- ----------------
(1) Real estate property holdings are not considered interest rate sensitive.
(2) Amortizing fixed rate loans are assumed to prepay at a Constant Prepayment
Rate ("CPR") of 10%.
21
<PAGE>
22
<PAGE>
As of June 30, 1999
-------------------
(Dollars in thousands)
<TABLE>
<CAPTION>
Within 4 to 12 One Year to More than 3
3 Months Months 3 Years Years TOTAL
------------- ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
INTEREST SENSITIVE ASSETS(1):
CASH AND CASH EQUIVALENTS 9,223 $ 9,223
SECURITIES AVAILABLE FOR SALE(2) 52,385 68,150 120,535
LOANS(3) 26,054 79 211 5,763 32,107
DIP LOAN -- 5,000 5,000
NOTE RECEIVABLE - WFSG -- 5,763 5,763
------------- ------------ ----------- ------------ ------------
TOTAL RATE SENSITIVE ASSETS $ 35,277 $ 52,464 $ 211 $ 84,676 $ 172,628
============= ============ =========== ============ ============
INTEREST SENSITIVE LIABILITIES:
REVERSE REPURCHASE AGREEMENTS $ 119,262 $ 119,262
NOTES PAYABLE 23,062 18,130 41,192
BORROWING ON REAL ESTATE(4) -- 1,087 -- 54,777 55,864
DIVIDENDS PAYABLE 4,600 4,600
------------- ------------ ----------- ------------ ------------
TOTAL RATE SENSITIVE LIABILITIES $ 146,924 $ 19,217 -- $ 54,777 $ 220,918
============= ============ =========== ============ ============
INTEREST RATE SENSITIVITY GAP(4) (111,647) 33,247 211 29,899
CUMULATIVE INTEREST RATE
SENSITIVITY GAP (111,647) (78,400) (78,189) (48,290)
CUMULATIVE INTEREST RATE
SENSITIVITY GAP AS A PERCENTAGE
OF TOTAL RATE-SENSITIVE ASSETS -65% -45% -45% -28%
</TABLE>
- ----------------
(1) Real estate property holdings are not considered interest rate sensitive.
(2) Includes treasury bills maturing in October 1999.
(3) Amortizing fixed rate loans are assumed to prepay at a CPR of 10%.
(4) Includes borrowings of $24.0 million related to mortgage-backed security
assets sold in June 1999 but which settle in July 1999. Adjusting for the
paydown of these borrowings upon settlement, cumulative interest rate
sensitivity gap percentages for the periods presented would have been
-51%, -32%, -31% and -14%, respectively.
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.
The Company is a party to a five year swap in connection with its
investment in real property in the UK. The notional amount is GBP 11,224,000 and
has the financial impact of converting floating rate financing to a fixed rate
of interest.
At March 31, 1999, the Company had a swap contract in connection with its
investment in a commercial mortgage loan secured by real property in the U.K.
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
March 31, 1999, was $49.7 million. Under the terms of the agreement, the Company
will settle in U.S. dollars. As previously discussed, this loan was sold on
April 29, 1999 and, in connection therewith, this swap agreement was terminated.
23
<PAGE>
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings.
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 Disposition of Assets
On April 29, 1999, the Company sold a loan secured by
commercial properties in the United Kingdom with a carrying value of
approximately $47.9 million at March 31, 1999. Proceeds from the sale
were substantially used to repay a facility with Merrill Lynch Mortgage
Capital for which this loan served as collateral. The pro forma effect
on this loan sale is reported and attached hereto as Exhibit 99.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
11 Statement re Computation of Per Share Earnings
27 Financial Data Schedule
99 Pro Forma Financial Information - Narrative Format
(b) Reports on Form 8-K during the three months ended March 31, 1999:
(i) Report on Form 8-K/A dated April 20, 1998, filed
January 11, 1999, containing pro forma financial
information concerning an acquisition of real estate
assets purchased from G.I. Joe's, Inc. on April 20,
1998 and reported under Item 2 of the Report on Form
8-K filed on September 29, 1998.
(ii) Report on Form 8-K/A dated June 30, 1998, filed
January 11, 1999, containing pro forma financial
information concerning an acquisition of real estate
assets located in the United Kingdom purchased from
various unaffiliated sellers on June 30, 1998 and
reported under Item 2 of the Report on Form 8-K filed
on September 29, 1998.
(iii) Report on Form 8-K/A dated July 30, 1998, filed
January 11, 1999, containing revised financial
statements and pro forma financial information
concerning the purchase of a secured loan from Credit
Suisse First Boston Mortgage Capital LLC on July 30,
1998 and reported under Item 2 of the Report on Form
8-K filed on September 29, 1998.
24
<PAGE>
SIGNATURES
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: September 9, 1999
25
EXHIBIT 11
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
Quarter Ended
March 31, 1999
--------------
Diluted net income per share:
Net income to common shareholders ........................ $ 1,767,000
Average number of shares outstanding ..................... 11,500,000
-----------
Net effect of dilutive stock options-based
on treasury stock method .............................. N/A
-----------
Total average shares ..................................... 11,500,000
-----------
Diluted net income per share ............................. $ 0.15
26
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S BALANCE SHEET AS OF MARCH 31, 1999 AND STATEMENT OF EARNINGS FOR THE
THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 1,364
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 157,865
<INVESTMENTS-CARRYING> 157,865
<INVESTMENTS-MARKET> 157,865
<LOANS> 80,569
<ALLOWANCE> 0
<TOTAL-ASSETS> 341,788
<DEPOSITS> 0
<SHORT-TERM> 199,272
<LIABILITIES-OTHER> 7,782
<LONG-TERM> 56,368
0
0
<COMMON> 166,981
<OTHER-SE> (88,615)
<TOTAL-LIABILITIES-AND-EQUITY> 341,788
<INTEREST-LOAN> 1,928
<INTEREST-INVEST> 4,428
<INTEREST-OTHER> 728
<INTEREST-TOTAL> 7,084
<INTEREST-DEPOSIT> 0
<INTEREST-EXPENSE> 3,693
<INTEREST-INCOME-NET> 3,391
<LOAN-LOSSES> (1,150)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 2,675
<INCOME-PRETAX> 1,767
<INCOME-PRE-EXTRAORDINARY> 1,767
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,767
<EPS-BASIC> 0.15
<EPS-DILUTED> 0.15
<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>
EXHIBIT 99
WILSHIRE REAL ESTATE INVESTMENT TRUST INC.
PRO FORMA FINANCIAL INFORMATION - NARRATIVE FORMAT
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 March
31, 1999.
On April 29, 1999, the Company sold a loan secured by commercial
properties in the United Kingdom to an unrelated third party. The terms of the
sale were determined through arm's-length negotiations between the Company and
the purchaser. The loan had a carrying value of approximately $47.9 million at
March 31, 1999. The loan earned interest at a LIBOR-based rate and matures in
August 2003. A substantial amount of the proceeds from the sale were used to
repay a repurchase facility with Merrill Lynch Mortgage Capital for which this
loan served as collateral. This debt facility bore interest at LIBOR +125 bps
and settled on a quarterly basis.
The pro forma effect of this transaction on the March 31, 1999 statement
of financial condition would have resulted in a decrease in total assets from
$341.8 million to $307.3 million and decrease in total liabilities from $263.4
million to $229.5 million. The decrease in total assets is the result of the
sale of the loan's carrying value, offset in part by an increase in cash and
cash equivalents. 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
March 31, 1999 would be a decrease from $78.4 million to $77.8 million. The $0.6
million decrease is due to the pro forma effect of adjusting retained earnings
by $0.6 million for the interest income earned during the quarter ended March
31, 1999 on this loan, net of interest expense on the related borrowing.
Additionally, the pro forma effect to the historical statement of
operations for the quarter ended March 31, 1999 includes the following:
o Decrease in interest income of $1.1 million and a decrease in interest
expense of $0.5 million, which results in a decrease in net interest
income of $0.6 million.
o Decrease in net income from $1.8 million, or $0.15 per share, to $1.2
million, or $0.10 per share.
30
