<PAGE>
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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 June 30, 2000
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 INC.
(Exact name of registrant as specified in its charter)
MARYLAND 52-2081138
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1631 SW COLUMBIA STREET
PORTLAND, OR 97201
(Address of principal executive offices) (Zip Code)
(503) 721-6500
(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 JUNE 30, 2000
Common Stock, par value $0.0001 per share 10,507,313 shares
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<PAGE>
WILSHIRE REAL ESTATE INVESTMENT INC.
FORM 10-Q
I N D E X
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<TABLE>
<CAPTION>
PAGE NO.
<S> <C>
PART I--FINANCIAL INFORMATION
Item 1. Interim Financial Statements (Unaudited):
Consolidated Statements 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...................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......11
Item 3. Quantitative and Qualitative Disclosures about Market Risk..................................20
PART II--OTHER INFORMATION
Item 1. Legal Proceedings...........................................................................25
Item 2. Changes in Securities and Use of Proceeds...................................................25
Item 3. Defaults Upon Senior Securities.............................................................25
Item 4. Submission of Matters to a Vote of Security Holders.........................................25
Item 5. Other Information...........................................................................25
Item 6. Exhibits and Reports on Form 8-K............................................................26
Signatures ..........................................................................................26
</TABLE>
2
<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
WILSHIRE REAL ESTATE INVESTMENT INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------------ ------------------
ASSETS (Unaudited)
<S> <C> <C>
Cash and cash equivalents................................. $ 8,020 $ 5,862
Securities available for sale, at fair value.............. 79,974 104,572
Loans, net................................................ 30,264 31,634
Investments in real estate held for sale, net............. 53,513 63,225
Investments in WFSG and affiliates, net (see Note 6)...... 9,352 9,657
Accrued interest receivable............................... 975 1,246
Other assets.............................................. 2,805 2,470
------------------ ------------------
Total assets.......................................... $ 184,903 $ 218,666
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Short-term borrowings..................................... $ 66,955 $ 96,815
Long-term borrowings (see Note 6)......................... 57,140 64,550
Accounts payable and accrued liabilities.................. 2,931 2,339
Dividends payable......................................... 4,038 4,090
------------------ ------------------
Total liabilities..................................... 131,064 167,794
------------------ ------------------
Commitments and Contingencies (see Note 7)
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 10,507,313
shares outstanding...................................... 166,981 166,981
Treasury stock; 992,687 common shares, at cost............ (2,171) (2,171)
Accumulated deficit....................................... (85,915) (90,915)
Accumulated other comprehensive loss...................... (25,056) (23,023)
------------------ ------------------
Total stockholders' equity............................ 53,839 50,872
------------------ ------------------
Total liabilities and stockholders' equity............ $ 184,903 $ 218,666
================== ==================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, June 30,
-------------------------------- ---------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net Interest Income:
Loans .......................................... $ 983 $ 1,194 $ 2,087 $ 3,122
Securities ..................................... 2,502 4,306 5,838 8,734
Other investments .............................. 134 780 214 1,508
------------ ------------ ------------ ------------
Total interest income ....................... 3,619 6,280 8,139 13,364
Interest expense ............................... 1,708 3,345 4,004 7,038
------------ ------------ ------------ ------------
Net interest income before provision for loan
losses .................................... 1,911 2,935 4,135 6,326
Recovery of loan losses ........................ 555 -- 555 1,150
------------ ------------ ------------ ------------
Net interest income after recovery of loan
losses .................................... 2,466 2,935 4,690 7,476
------------ ------------ ------------ ------------
Real Estate Operations:
Operating income ............................... 1,463 1,889 2,827 3,843
Operating expense .............................. (103) (68) (335) (123)
Interest expense ............................... (777) (1,234) (1,589) (2,536)
Provision for losses on real estate ............ -- (303) -- (567)
Gain on sale of real estate .................... 97 -- 1,094 10
Depreciation ................................... (292) (375) (584) (769)
------------ ------------ ------------ ------------
Total real estate operations .............. 388 (91) 1,413 (142)
------------ ------------ ------------ ------------
Other Operating Income (Loss):
Gain (loss) on sale of securities .............. 2,016 (929) 5,342 (929)
Market valuation losses and impairments ........ -- (20,993) (1,791) (22,188)
Loss on foreign currency translation ........... (36) (28) (54) (76)
Other revenue .................................. 159 189 159 189
------------ ------------ ------------ ------------
Total other operating income (loss) ....... 2,139 (21,761) 3,656 (23,004)
------------ ------------ ------------ ------------
Operating Expenses:
Compensation and employee benefits ............. 1,201 -- 2,507 --
Management fees ................................ -- 831 -- 1,751
Professional fees .............................. 723 196 1,056 644
Other .......................................... 656 232 1,143 344
------------ ------------ ------------ ------------
Total operating expenses .................. 2,580 1,259 4,706 2,739
------------ ------------ ------------ ------------
Net income (loss) before provision for income taxes 2,413 (20,176) 5,053 (18,409)
Provision for income taxes ......................... 25 -- 125 --
------------ ------------ ------------ ------------
Net Income (Loss) .................................. $ 2,388 $ (20,176) $ 4,928 $ (18,409)
============ ============ ============ ============
Basic and Diluted Net Income (Loss) Per Share ...... $ 0.23 $ (1.75) $ 0.47 $ (1.60)
Weighted Average Shares Outstanding ................ 10,507,313 11,500,000 10,507,313 11,500,000
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Accumulated
Common Stock Treasury Stock Other
------------------------------------------- Accumulated Comprehensive
Shares (1) Amount Shares Amount Deficit Loss Total
---------- --------- ----------- ---------- ----------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 2000 10,507,313 $ 166,981 992,687 $ (2,171) $(90,915) $ (23,023) $ 50,872
Comprehensive income:
Net income - - - - 4,928 - 4,928
Other comprehensive loss:
Foreign currency translation - - - - - (282) (282)
Unrealized holding losses on
securities available for sale - - - - - (917) (917)
Reclassification adjustment for
net gains on securities
included in net income - - - - - (834) (834)
--------
Total comprehensive income 2,895
Recourse loans to officers to
acquire stock - - - - 45 - 45
Discount on dividend purchase - - - - 27 - 27
---------- --------- ----------- ---------- ----------- ---------- --------
Balance at June 30, 2000 10,507,313 $ 166,981 992,687 $ (2,171) $(85,915) $ (25,056) $ 53,839
=========== ========= =========== ========== =========== =========== ========
</TABLE>
-----------------------------
(1) Issued and outstanding.
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,388 $(20,176) $ 4,928 $(18,409)
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation 310 375 628 769
Amortization of premiums and accretion of
discounts, net (3) (14) (146) (14)
Recovery of loan losses (555) -- (555) (1,150)
Provision for losses on real estate -- 303 -- 567
Market valuation losses and impairments -- 20,993 1,791 22,188
Loss on foreign currency translation 36 28 54 76
(Gain) loss on sale of securities available
for sale (2,016) 929 (5,342) 929
Gain on sale of real estate (97) -- (1,094) (10)
Gain on sale of loans (159) -- (159) --
Change in:
Investments in WFSG and affiliates, net 645 (27) 664 (18,480)
Accrued interest receivable 231 2 271 409
Other assets (446) 992 (298) (246)
Accounts payable and accrued liabilities 282 (319) 606 (3,370)
-------- -------- -------- --------
Net cash provided by (used in) operating
activities 616 3,086 1,348 (16,741)
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments of securities available for sale 145 3,937 1,151 7,934
Purchase of securities available for sale (19,481) (8,885) (19,481) (8,885)
Proceeds from sale of loans 396 48,366 396 48,366
Proceeds from sale of securities available
for sale 35,134 -- 44,368 --
Purchase of loans and discounted loans -- (166) (101) (384)
Principal repayments on loans and discounted loans 177 305 1,925 38,953
Proceeds from sale of real estate 440 -- 8,774 4,056
Investments in real estate -- (103) -- (150)
Other -- 247 -- 247
-------- -------- -------- --------
Net cash provided by investing activities 16,811 43,701 37,032 90,137
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 11,069 315 11,069 721
Repayments on short-term borrowings (25,875) (39,133) (40,929) (65,863)
Repayments on other borrowings (135) (117) (6,258) (3,793)
Other (25) -- (25) --
-------- -------- -------- --------
Net cash used in financing activities (14,966) (38,935) (36,143) (68,935)
-------- -------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (35) 7 (79) (20)
-------- -------- -------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,426 7,859 2,158 4,441
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,594 1,364 5,862 4,782
-------- -------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,020 $ 9,223 8,020 $ 9,223
======== ======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 2,644 $ 2,843 $ 6,056 $ 7,034
Cash paid for taxes $ -- $ -- $ -- $ --
Non-cash investing activities:
Investment in WFSG $ -- $ 12,289 $ -- $ 12,289
Proceeds receivable on sale of available-for-sale
securities $ -- $ 26,597 $ -- $ 26,597
</TABLE>
6
<PAGE>
WILSHIRE REAL ESTATE INVESTMENT INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 Inc. and Subsidiaries ("WREI" or the "Company") (formerly
known as Wilshire Real Estate Investment Trust Inc. and Subsidiaries) 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 1999 Annual Report on Form 10-K. A summary of the Company's
significant accounting policies is set forth in Note 3 to the consolidated
financial statements in the 1999 Annual Report on Form 10-K.
In the Company's opinion, all adjustments, comprised of normal
recurring accruals necessary for the fair presentation of the interim financial
statements, have been included in the accompanying consolidated financial
statements. Operating results for the six months ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 previously reported consolidated financial
statements were reclassified to conform to the June 30, 2000 presentation, none
of which affect previously reported results of operations.
NOTE 2 - ORGANIZATION
The Company was originally incorporated as Wilshire Real Estate
Investment Trust Inc. ("WREIT") in the State of Maryland on October 24, 1997.
However, due to the tax benefit of significant net operating loss carryforwards
and to avoid any risk of not qualifying as a real estate investment trust
("REIT"), the Company elected in September 1999 (with shareholder approval) not
to be taxed as a REIT, and the Company's name was changed to Wilshire Real
Estate Investment Inc. 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 $167.0 million.
NOTE 3 - INCOME TAXES
As of June 30, 2000, the Company had, for U.S. Federal tax purposes, a
net operating loss carryforward of approximately $90 million, which begins to
expire in 2018. Tax regulations impose limitations on the use of loss
carryforwards following certain changes in ownership. If such a change were to
occur with respect to the Company, the limitation could significantly reduce the
amount of benefits that would be available to offset future taxable income each
year, starting with the year of ownership change. To reduce the potential impact
of such ownership changes, the Company established a Shareholder Rights Plan
dated as of December 23, 1999 and effective January 3, 2000. The Company has not
recorded any deferred tax assets for the future benefits of the net operating
loss carryforwards. Although the Company has a net operating loss carryforward,
the Company recorded a provision for taxes of $0.1 million for alternative
minimum taxes for the six months ended June 30, 2000.
7
<PAGE>
NOTE 4 - SIGNIFICANT TRANSACTIONS
During the quarter ended June 30, 2000, the Company resecuritized
approximately $20.5 million of its mortgage-backed securities portfolio. This
resecuritization resulted in a net gain of approximately $27 thousand. As part
of the resecuritization transaction, the Company acquired a subordinated
interest in the underlying trust for approximately $6.3 million. At June 30,
2000, this interest is included in securities available-for-sale and is carried
at fair value, as determined by the Company by estimating the present value of
the anticipated cash flows. Also, during the six months ended June 30, 2000, the
Company sold mortgage-backed securities for gains of $5.3 million. Proceeds of
$20.3 million were used to repay short-term borrowings.
In January 2000, the Company sold office properties located in
Portland, Oregon with a carrying value of $7.3 million. The gain on this
transaction of $1.0 million is reported in the consolidated statement of
operations for the six months ended June 30, 2000. Proceeds of $5.9 million were
used to repay borrowings.
In March 2000, at the direction of the Company, affiliates of Wilshire
Financial Services Group Inc. ("WFSG") transferred the servicing of the
Company's assets outside of the United States to an unrelated third party. In
April 2000, due to the expiration of the servicing agreement, an affiliate of
WFSG, Wilshire Credit Corporation ("WCC"), transferred (at the Company's
request) the servicing of the Company's loan and real estate portfolios in the
United States to the Company. WCC continues to service the loans underlying
certain of the Company's mortgage-backed securities.
NOTE 5 - MARKET VALUATION LOSSES AND IMPAIRMENTS
The Company evaluates, on an ongoing basis, the carrying value of its
securities portfolio, which is accounted for as available-for-sale. To the
extent differences between the book basis of the securities and their current
market values are deemed to be temporary in nature, such unrealized gains or
losses are reflected directly in equity, as "other comprehensive income or
loss." In calculating the extent to which declines in the value of
available-for-sale securities are other than temporary, the Company analyzes
actual performance of the securities and underlying collateral, including
prepayment and default statistics, as well as expectations for such performance
in the future. To the extent reasonable expectations for future performance are
not likely to offset declines in current market valuations, a write-down is
recorded in "Market Valuation Losses and Impairments" in the consolidated
statement of operations.
During the six months ended June 30, 2000 and 1999, market valuation
losses and impairments of $1.8 million and $22.2 million, respectively, were
recorded. During such periods, $1.8 million and $11.7 million, respectively, of
market valuation losses and impairments were recorded related to the portfolio
of mortgage-backed securities primarily reflecting higher than anticipated
delinquencies and losses in underlying loans to certain securities. During the
six months ended June 30, 1999, the Company also impaired its investment in WFSG
13% Notes due 2004 by $8.7 million and wrote-off $1.0 million in previously
capitalized fees for advisory services in connection with its investment in WFSG
stock.
8
<PAGE>
NOTE 6 - ONGOING DISPUTES WITH WFSG AND ITS AFFILIATES
The Company is engaged in litigation with WFSG relating to the
termination of the contractual and other relationships which formerly existed
between the companies. Prior to September 1999, the Company's business affairs
and day-to-day operations had been managed by a wholly-owned subsidiary of WFSG.
The Company and WFSG had the same senior management team, though the Company had
a significantly different shareholder base and the majority of its directors
were independent. In addition, the Company and WFSG had other significant
contractual relationships relating to the servicing of real estate related
assets and also had certain cross shareholdings. The Company has sought to
amicably resolve its differences with WFSG and has been unable to resolve
certain areas of dispute. The Company alleges: (1) the termination of Messrs.
Wiederhorn and Mendelsohn and the departure of other senior managers made WFSG
and its affiliates unable and/or unwilling to provide management to the Company
as required under the management agreement; (2) the inability of WFSG and its
affiliates to manage the Company's business affairs triggered application of a
facilities sharing agreement dated February 19, 1999 between the Company and
WFSG and its affiliates (the "Facilities Sharing Agreement"), which replaced the
management agreement; (3) WFSG's refusal to allow Messrs. Wiederhorn and
Mendelsohn access to WFSG's facilities, personnel, and equipment for the
Company's business violated the terms of the Facilities Sharing Agreement; (4)
the management agreement was terminated with no obligation to pay a termination
fee under a contract term allowing non-renewal upon 120-day advance notice,
which was timely given by the Company to WFSG; (5) the Company is entitled to
expanded use of prepaid service fees for the servicing of assets serviced under
pooling and servicing agreements; and (6) WFSG to be in default of its
Debtor-in-Possession ("DIP") loan agreement with the Company. WFSG alleges the
Company breached the management agreement and is claiming damages for alleged
non-payment of quarterly management fees of $0.7 million and damages under a
termination fee in a range of $3.5 million to $4.0 million. At June 30, 2000,
the Company had a reserve for potential resolution of disputes with WFSG of $2.5
million. In late July 2000, the parties entered mediation in order to resolve
their differences. While the Company believes that significant progress has been
made, the discussions are ongoing and a final settlement of all areas of dispute
has not been agreed. There can be no assurance that these discussions will
continue or lead to a final settlement.
The following table sets forth the balances of the Company's net
transactions with WFSG and its affiliates as of June 30, 2000 and December 31,
1999.
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
--------------- -----------------
Investments in WFSG and Affiliates, net:
<S> <C> <C>
WFSG Common Stock ....................................... $ 4,312,000(1) $ 3,953,000
DIP Facility ............................................ 4,583,000(2) 5,000,000(2)
Other Notes Receivable from WFSG ........................ -- 275,000
Prepaid Service Fees to WCC ............................. 2,957,000 2,974,000
Reserve for Disputes with WFSG .......................... (2,500,000) (2,545,000)
----------- -----------
$ 9,352,000 $ 9,657,000
=========== ===========
Long-term Borrowings ....................................... $ -- $ 2,569,000(3)
=========== ===========
</TABLE>
---------------
(1) Based on $1.50 per share. WFSG's common stock currently trades on the
OTC Bulletin Board and the closing price as of June 30, 2000 was $1.50
per share. At June 30, 2000, the Company included $0.7 million of
unrealized gains in "Accumulated Other Comprehensive Loss" in
stockholders' equity.
(2) The DIP Facility no longer has priority over other creditors and is
treated like any other secured loan.
(3) Investments in real estate were pledged against these loans. During the
six months ended June 30, 2000, the Company repaid these loans in full.
For the six months ended June 30, 2000, the various transactions
between the Company and WFSG and its affiliates had the net effect of increasing
net income by $0.3 million.
9
<PAGE>
NOTE 7 - COMMITMENTS, CONTINGENCIES & OFF-BALANCE SHEET RISK
The Company is authorized to utilize a wide variety of off-balance
sheet financial techniques to assist 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 June 30, 2000, the
Company had no outstanding positions in these instruments.
With the exception of disputes with WFSG and its affiliates discussed
in Note 6, 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 its consolidated financial condition or operations.
NOTE 8 - SUBSEQUENT EVENTS
On July 13, 2000, the Company announced the payment dates for its
outstanding dividend for shareholders of record as of September 30, 1998. The
Company previously declared, but had not paid, a dividend of $0.40 per share.
Shareholders of record as of September 30, 1998 will receive $0.10 per share on
each of September 28, 2000, December 28, 2000, March 28, 2001, and June 28,
2001, together with interest accrued thereon at 4% per annum from the declared
payment date, October 27, 1998.
NOTE 9 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2000, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 138, ACCOUNTING FOR CERTAIN DERIVATIVE
INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES, AN AMENDMENT OF FASB STATEMENT NO.
133 ("FAS 138") which amends certain provisions of Statement of Financial
Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES ("FAS 133"). These statements establish accounting and financial
reporting for derivative instruments and hedging activities and will require the
Company to recognize and report all derivative instruments at their fair value
in the Company's consolidated statement of financial position with changes in
fair value recorded generally in operations. These statements become effective
for the Company on January 1, 2001. The Company is in the process of evaluating
the effect, if any, that FAS 133 and FAS 138 will have on the Company's
operations and financial position.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS OF WILSHIRE REAL ESTATE
INVESTMENT INC. AND THE NOTES THERETO INCLUDED ELSEWHERE IN THIS FILING.
REFERENCES IN THIS FILING TO "WILSHIRE REAL ESTATE INVESTMENT INC.," "WE,"
"OUR," AND "US" REFER TO WILSHIRE REAL ESTATE INVESTMENT INC. AND ITS
SUBSIDIARIES UNLESS THE CONTEXT INDICATES OTHERWISE.
GENERAL
Wilshire Real Estate Investment Inc. ("WREI" or the "Company")
(formerly known as Wilshire Real Estate Investment Trust Inc.) 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.
We continue to focus our efforts on stabilizing our existing asset and
liability base as general market conditions and availability of financing for
certain of our asset categories, especially subordinated mortgage-backed
securities and mezzanine loans, continue to be uncertain. Our results of
operations for the six months ended June 30, 2000, while profitable, reflect
this continued difficult marketplace and include further impairment write-downs
of certain mortgage-backed securities.
RESULTS OF OPERATIONS -- SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS
ENDED JUNE 30, 1999
NET INCOME. Our net income for the six months ended June 30, 2000 was
$4.9 million, or $0.47 per share, compared with a net loss of $18.4 million, or
$1.60 per share, for the six months ended June 30, 1999. The net income for the
2000 period is attributable to net interest income of $4.1 million, gain on sale
of securities of $5.3 million, recovery of loan losses of $0.6 million and
income from real estate operations of $1.4 million, partially offset by market
valuation losses and impairments on our portfolio of mortgage-backed securities
of $1.8 million and other operating expenses of $4.7 million. Our net loss for
the corresponding 1999 period was primarily due to market valuation losses and
impairments of $22.2 million on our mortgage-backed securities portfolio and
investment in WFSG common stock, partially offset by the net recovery of $1.2
million of loan loss provisions.
11
<PAGE>
NET INTEREST INCOME. Our net interest income for the six months ended
June 30, 2000 was $4.1 million, compared with $6.3 million for the six months
ended June 30, 1999. The decrease is primarily attributable to a reduction of
assets (reflecting our sales of mortgage-backed securities and loans and
paydowns of the related debt facilities), resulting in decreases in interest
income on securities, loans and other investments of $2.9 million, $1.0 million
and $1.3 million, respectively, partially offset by a decrease in interest
expense of $3.0 million. The following tables set 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 Six Months Ended June 30, 2000
----------------------------------------------------
Average Interest Annualized
Balance Income (Expense) Yield/Rate
--------------- ------------------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest-Earning Assets:
Loan portfolios .................................... $ 35,355 $ 2,087 11.8%
Mortgage-backed securities available for sale ...... 87,159 5,838 13.4
Other investments .................................. 7,477 214 5.7
-------- -------- ----
Total interest-earning assets .................. 129,991 8,139 12.5
-------- -------- ----
Interest-Bearing Liabilities:
Short-term and other borrowings (1) ................ 95,079 (4,004) 8.4
-------- -------- ----
Total interest-bearing liabilities ............. 95,079 (4,004) 8.4
-------- -------- ----
Net interest income before provision for loan
losses/spread (2)............................. $ 4,135 4.1%
======== =======
Net interest margin (3)........................ 6.4%
=======
</TABLE>
----------------------
(1) Excludes borrowings related to investments in real estate.
(2) Net interest spread represents the difference between the average rate
on interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
12
<PAGE>
<TABLE>
<CAPTION>
For the Six Months Ended June 30, 1999
--------------------------------------------------------
Average Interest Annualized
Balance Income (Expense) Yield/Rate
---------------- ------------------ -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest-Earning Assets:
Loan portfolios................................. $ 63,259 $ 3,122 10.0%
Mortgage-backed securities available for
sale............................................ 146,287 8,734 12.0
Other investments............................... 39,148 1,508 7.7
---------------- ------------------ -------------
Total interest-earning assets............... 248,694 13,364 10.8
---------------- ------------------ -------------
Interest-Bearing Liabilities:
Short-term borrowings (1)....................... 188,127 (7,038) 7.5
---------------- ------------------ -------------
Total interest-bearing liabilities.......... 188,127 (7,038) 7.5
---------------- ------------------ -------------
Net interest income before provision for
loan losses/spread (2)....................... $ 6,326 3.3%
================== =============
Net interest margin (3)........................ 5.1%
=============
</TABLE>
-------------------
(1) Excludes borrowings related to investments in real estate.
(2) Net interest spread represents the difference between the average rate
on interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
RECOVERY OF LOAN LOSSES. During the six months ended June 30, 2000, we
reviewed the adequacy of loan loss reserves and recaptured the remaining reserve
balance of $0.6 million. At June 30, 2000, we had $30.3 million of loans, net
that are performing according to their terms with no required loan loss
allowance. During the six months ended June 30, 1999, we recaptured a net $1.2
million in loan loss reserves.
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 six
months ended June 30, 2000, we realized income from real estate operations of
approximately $1.4 million (net of depreciation of $0.6 million), compared with
a net loss of $0.1 million for the six months ended June 30, 1999. This increase
was primarily attributable to a gain of $1.0 million on the sale of office
properties located in Portland, Oregon.
OPERATING EXPENSES. Our other operating expenses were approximately
$4.7 million for the six months ended June 30, 2000, compared with approximately
$2.7 million for the six months ended June 30, 1999. This increase was primarily
attributable to an increase in compensation and employee benefits of $2.5
million and $0.8 million of other expenses from becoming internally managed
during the fourth quarter of 1999 and professional fees of $0.4 million. This
increase was offset by a decrease in management fees paid to our former manager
of $1.8 million.
RESULTS OF OPERATIONS -- QUARTER ENDED JUNE 30, 2000 COMPARED TO QUARTER ENDED
JUNE 30, 1999
NET INCOME. Our net income for the quarter ended June 30, 2000 was $2.4
million, or $0.23 per share, compared with a net loss of $20.2 million, or $1.75
per share, for the quarter ended June 30, 1999. The net income for the 2000
period is attributable to net interest income of $1.9 million, gain on sale of
securities of $2.0 million, recovery of loan losses of $0.6 million and income
from real estate operations of $0.4 million, partially offset by other operating
expenses of $2.6 million. Our net loss for the corresponding 1999 period was
primarily due to market valuation losses and impairments of $21.0 million on our
mortgage-backed securities portfolio and investment in WFSG common stock.
13
<PAGE>
NET INTEREST INCOME. Our net interest income for the quarter ended June
30, 2000 was $1.9 million, compared with $2.9 million for the quarter ended June
30, 1999. The decrease is primarily attributable to a reduction of assets
(reflecting our sales of mortgage-backed securities and loans and paydowns of
the related debt facilities), resulting in decreases in interest income on
securities, loans and other investments of $1.8 million, $0.2 million and $0.6
million, respectively, partially offset by a decrease in interest expense of
$1.6 million. The following tables set 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 June 30, 2000
---------------------------------------------------
Average Interest Annualized
Balance Income (Expense) Yield/Rate
--------------- ------------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest-Earning Assets:
Loan portfolios................................ $ 35,132 $ 983 11.2%
Mortgage-backed securities available for
sale 82,858 2,502 12.1
Other investments.............................. 7,762 134 6.9
--------------- ------------------- -------------
Total interest-earning assets.............. 125,752 3,619 11.5
--------------- ------------------- -------------
Interest-Bearing Liabilities:
Short-term and other borrowings (1)............ 89,953 (1,708) 7.6
--------------- ------------------- -------------
Total interest-bearing liabilities......... 89,953 (1,708) 7.6
--------------- ------------------- -------------
Net interest income before provision for
loan
losses/spread (2)............................ $ 1,911 3.9%
=================== =============
Net interest margin (3)....................... 6.1%
=============
</TABLE>
----------------------
(1) Excludes borrowings related to investments in real estate.
(2) Net interest spread represents the difference between the average rate
on interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
14
<PAGE>
<TABLE>
<CAPTION>
For the Quarter Ended June 30, 1999
--------------------------------------------------------
Average Interest Annualized
Balance Income (Expense) Yield/Rate
---------------- ------------------ -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest-Earning Assets:
Loan portfolios................................. $ 47,554 $ 1,194 10.1%
Mortgage-backed securities available for
sale............................................ 143,720 4,306 12.0
Other investments............................... 39,840 780 7.8
---------------- ------------------ -------------
Total interest-earning assets............... 231,114 6,280 10.9
---------------- ------------------ -------------
Interest-Bearing Liabilities:
Short-term borrowings (1)....................... 172,945 (3,345) 7.8
---------------- ------------------ -------------
Total interest-bearing liabilities.......... 172,945 (3,345) 7.8
---------------- ------------------ -------------
Net interest income before provision for
loan losses/spread (2)....................... $ 2,935 3.1%
================== =============
Net interest margin (3)........................ 5.1%
=============
</TABLE>
-------------------
(1) Excludes borrowings related to investments in real estate.
(2) Net interest spread represents the difference between the average rate
on interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
RECOVERY OF LOAN LOSSES. During the quarter ended June 30, 2000, we
reviewed the adequacy of loan loss reserves and recaptured the remaining reserve
balance of $0.6 million. At June 30, 2000, we had $30.3 million of loans, net
that are performing according to their terms with no required loan loss
allowance.
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 June 30, 2000, we realized income from real estate operations of
approximately $0.4 million (net of depreciation of $0.3 million), compared with
a net loss of $0.1 million for the quarter ended June 30, 1999. This increase
was primarily attributable to provision for losses of $0.3 million in 1999 with
no such provision in 2000.
OPERATING EXPENSES. Our other operating expenses were approximately
$2.6 million for the quarter ended June 30, 2000, compared with approximately
$1.3 million for the quarter ended June 30, 1999. This increase was primarily
attributable to an increase in compensation and employee benefits of $1.2
million and $0.4 million of other expenses from becoming internally managed
during the fourth quarter of 1999 and professional fees of $0.5 million. This
increase was offset by a decrease in management fees paid to our former manager
of $0.8 million.
CHANGES IN FINANCIAL CONDITION
GENERAL. Total assets decreased from approximately $218.7 million at
December 31, 1999 to approximately $184.9 million at June 30, 2000. The decrease
in total assets is primarily attributable to the sale of $20.5 million of
mortgage-backed securities available-for-sale and the sale of commercial real
estate with a carrying value of $7.7 million. Total liabilities decreased from
approximately $167.8 million at December 31, 1999 to approximately $131.1
million at June 30, 2000 primarily as a result of the repayment of borrowings
used to finance mortgage-backed securities and loans. Stockholders' equity
increased by approximately $3.0 million resulting primarily from net income of
$4.9 million for the six months ended June 30, 2000, partially offset by an
increase of $1.8 million in net unrealized losses on available-for-sale
securities and our investment in WFSG common stock.
15
<PAGE>
SECURITIES AVAILABLE FOR SALE. The Company routinely invests in and
sells mortgage-backed securities and considers this one of its core
competencies. The balance of mortgage-backed securities available for sale
decreased from $104.6 million at December 31, 1999 to $80.0 million at June 30,
2000. The decrease in the balance of mortgage-backed securities was primarily
due to the sale of securities with a carrying value of $26.0 million, the
recognition of other than temporary impairment of approximately $1.8 million,
cash receipts in excess of income accrued of approximately $1.0 million and a
net increase in the unrealized loss on available-for-sale securities of
approximately $2.1 million for the six months ended June 30, 2000, partially
offset by the purchase of a subordinated interest in the underlying trust of the
resecuritization transaction completed in the quarter ended June 30, 2000 for
$6.3 million.
For financial reporting purposes, we mark our securities portfolio to
fair value at the end of each month based primarily upon broker/dealer
valuations, subject to an internal review process. With respect to many of our
subordinate securities, valuations are typically available from either a single
or a small group of broker/dealers. For those securities that are subject to
repurchase or other financing arrangements with broker/dealers, we employ the
valuation supplied by the financing broker/dealer.
The fair value of our investment in the resecuritized mortgage-backed
securities is determined by us at each reporting date as the present value of
the anticipated cash flows from the underlying collateral (primarily "A"
quality, jumbo, fixed-rate, 15- to 30-year term loans) using certain estimates.
We are responsible for developing these estimates which include: (i) future rate
of prepayment; (ii) discount rate used to calculate present value; and (iii)
default rates and loss severity on loan pools underlying the mortgage-backed
securities in the resecuritization. At June 30, 2000, we used an annual constant
prepayment rate of 12%, a discount rate of 20%, and an annual constant default
rate of .20% with a loss severity of 32% to estimate the fair value of our
interest in the resecuritization. The future cash flows and the discount rate
represent our best estimate; however, there can be no assurance of the accuracy
of these estimates. We review the fair value of our interest in the
resecuritization by analyzing current interest rates, and prepayment, discount
rate and loss assumptions in relation to the actual experience and current rates
of prepayment and loss prevalent in the underlying loan pools. Changes in these
factors may lead to significant fluctuations in the fair value of our investment
which may affect earnings, if the fair value decrease is determined by us to be
of other-than-temporary nature.
The difference between our amortized cost of mortgage-backed securities
available for sale and current market values, which was $25.3 million at June
30, 2000, is included in "Accumulated Other Comprehensive Loss" in stockholders'
equity. This amount, unlike "market valuation losses and impairments,"
represents a market value decline that we believe is temporary. If held to
maturity, the anticipated cash flow on these securities based on interest rates,
rate of prepayment and the amount and severity of defaults would result in our
receiving amounts in excess of the current market value and would allow us to
recover our amortized cost plus our original expected return from the time of
acquisition.
Notwithstanding the foregoing, payments on mortgage-backed securities
are subject to a number of market factors which can significantly affect the
amount and rate of payments on mortgage-backed securities, including, without
limitation, defaults on the underlying mortgage loans, the level of
subordination of the mortgage-backed securities, changes in interest rates and
the rate of prepayments on the underlying mortgage loans. To the extent that
these and other factors change, the anticipated cash flow on our mortgage-backed
securities may not be sufficient to cover our amortized cost or if we sell one
of these mortgage-backed securities at market prices which are below its
amortized cost, we will realize a loss in the amount of that portion of
"Accumulated Other Comprehensive Loss" attributable to such mortgage-backed
security.
In calculating the extent to which declines in the value of
available-for-sale securities are other than temporary, we analyze actual
performance of the securities and underlying collateral, including prepayment
and default statistics, as well as the expectation for such performance in the
future. To the extent reasonable expectations for future performance are not
likely to offset declines in current market valuations, a write-down is recorded
in "Market Valuation Losses and Impairments" in the consolidated statement of
operations.
16
<PAGE>
At June 30, 2000, securities available for sale were as follows:
<TABLE>
<CAPTION>
Gross
Amortized Gross Unrealized
Cost (1) Unrealized Gains Losses Fair Value
-------------- ---------------- --------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 105,312 $ 603 $ (25,941) $ 79,974
============== =============== =============== =============
</TABLE>
(1) The amortized cost of the securities reflects the market
valuation losses and impairments discussed above and excludes
accrued interest of $0.9 million.
Included in available-for-sale securities are securities with fair
values of approximately $14.5 million, which, under their terms of issuance, do
not provide current cash flows to us. Accordingly, the determination of fair
value of these securities may be more uncertain than securities which receive
current cash flows.
LOANS, NET. During the six months ended June 30, 2000, our loans, net
decreased by approximately $1.4 million due primarily to sales of loans and
principal payments received from borrowers.
INVESTMENTS IN REAL ESTATE. Investments in real estate decreased
approximately $9.7 million from December 31, 1999 to June 30, 2000. This
decrease was primarily due to the sale of commercial properties located in
Portland, Oregon with a carrying value of approximately $7.3 million.
We are currently in the process of marketing certain other commercial
properties for sale during the rest of the year as we continue to reduce our
level of investment in commercial real estate income properties.
SHORT-TERM BORROWINGS. Short-term borrowings decreased by approximately
$30.0 million during the six months ended June 30, 2000. The decrease in
short-term borrowings is primarily attributable to the repayment from sales
proceeds of, and other payments on, our mortgage-backed securities.
LONG-TERM BORROWINGS. Long-term borrowings decreased approximately $7.4
million during the six months ended June 30, 2000 due primarily to repayments
related to the commercial properties which were sold during the reporting
period.
STOCKHOLDERS' EQUITY. Stockholders' equity increased by approximately
$3.0 million during the six months ended June 30, 2000. This increase was
primarily due to net income of $4.9 million, partially offset by an increase in
unrealized holding losses on securities available for sale of $0.9 million,
reclassification adjustment for net gains on securities included in net income
of $0.8 million and foreign currency translation losses of $0.3 million.
REGULATORY MATTERS
The Company currently owns approximately 14.4% of WFSG's common stock
on a non-diluted basis. The Company is continuing to consider what course of
action might best maximize the value of its investment in WFSG. As a result, the
Company may decide it wishes to sell some or all of its shares of WFSG, retain
its current ownership position, or increase its ownership, including
substantially.
Any course of conduct (including retention of the Company's current
position) needs to comply with requirements of the Office of Thrift Supervision
(the "OTS"), including those relating to the "control" of savings and loan
holding companies such as WFSG. For the reasons explained in the Company's Form
10-K for the year ended December 31, 1999, the Company filed an H-(e)1 control
application with
17
<PAGE>
the OTS in June 1999. The Company had anticipated it would withdraw that
application if the OTS approved the Company's request that the OTS lift interim
restrictions imposed by the OTS on the Company with respect to WFSG.
As a result of recent discussions with the OTS, the Company no longer
anticipates that the OTS will withdraw the interim restrictions. The Company is
evaluating what, if any, action to take in respect of its H-(e)1 application and
the OTS order.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measurement of our 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 June 30, 2000 consisted of net cash
provided by investing activities, including the cash repayments related to our
mortgage-backed securities portfolio, sales of mortgage-backed securities and
sales of investments in real estate.
Our short-term borrowings and the availability of further borrowings
are substantially affected by, among other things, changes in interest rates,
changes in market spreads whereby the market value of the collateral securing
such borrowings may decline substantially, or decreases in credit quality of
underlying assets. In the event of declines in market value or credit quality,
we may be required to provide additional collateral for, or repay a portion of
outstanding balances of, our short-term borrowing facilities. For additional
information with respect to our monthly mark-to-market of our securities
available for sale portfolio, see "CHANGES IN FINANCIAL CONDITION-SECURITIES
AVAILABLE FOR SALE."
The adverse market conditions, which negatively impacted us during the
third and fourth quarters of 1998, began to stabilize during 1999, but remain
uncertain. As of June 30, 2000, we had no outstanding collateral calls.
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 any floating rate debt which in turn could impact potential
returns to shareholders. See "Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK."
At June 30, 2000, we had total consolidated secured indebtedness of
$124.1 million, accrued interest payable of $0.6 million, a dividend payable of
$4.0 million, as well as $2.3 million of other liabilities. The consolidated
secured indebtedness consisted of (i) $82.4 million of repurchase agreements,
(ii) lines of credit aggregating $3.5 million which are secured by loans and
(iii) $38.2 million outstanding of other borrowings maturing between 2000 and
2008 which are secured by real estate.
Loans are financed through short-term or intermediate-term financing
facilities. 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 financing facility 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.
We generally finance acquisitions of mortgage-backed securities through
committed and uncommitted thirty-day repurchase agreements with major Wall
Street investment banks. 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. Mortgage-backed securities
18
<PAGE>
which are subject to repurchase agreements, as well as loans which secure other
indebtedness, periodically are revalued by the lender, and a decline in the
value that is recognized by the lender (whether or not the lender recognizes the
full fair value of the security) may result in the lender requiring us to
provide additional collateral to secure the indebtedness.
As of June 30, 2000, the Company had approximately $85.9 million of
indebtedness under the terms of which the lender could request additional
collateral if the value of the underlying collateral declined (including
financing facilities for both mortgage-backed securities and loans). Although
the Company believes that the likelihood of significant declines in asset values
has decreased since the third quarter of 1998, the Company is seeking to
maintain a larger cash position and more unencumbered assets to deal with any
future potential collateral calls. In addition, the Company is seeking to and
has refinanced some of this indebtedness with longer-term indebtedness which
would not be subject to the same collateral calls.
If we are unable to fund additional collateral requirements or to
repay, renew or replace maturing indebtedness on terms reasonably satisfactory
to us, we may be required to sell (potentially on short notice) a portion of our
assets, and could incur losses as a result. Furthermore, since from time to time
there is extremely limited liquidity in the market for subordinated and residual
interests in mortgage-related securities, there can be no assurance that we will
be able 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 June 30, 2000, 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 or 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 collateral calls, or an
increase in market value of our mark-to-market financial assets, generally would
positively affect our liquidity.
YEAR 2000 COMPLIANCE
The Company and its service providers utilize a number of
technologically dependent systems to operate, service mortgage loans and manage
mortgage and other related assets. 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. Management closely monitored the Company's operations subsequent to
January 1, 2000 in relation to the Year 2000 matter and continues to monitor
such operations. The Company's information systems were operational with no
apparent adverse impact arising as a result of or associated with the Year 2000
matter. Additionally, the Company is not aware of, and has not experienced, any
Year 2000 issues at its key service providers, vendors, mortgage securities
servicers, and other third parties. Management considers the risk of any
residual potential Year 2000 matter failures to be minimal.
19
<PAGE>
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, the Company's strategy is
to limit our exposure to earnings variations and variations in the value of
assets and liabilities as interest rates change over time. Our asset and
liability management strategy is formulated and monitored regularly to review,
among other things, the sensitivity of our assets and liabilities to interest
rate changes, the book and market values of assets and liabilities, unrealized
gains and losses, including those attributable to hedging transactions, purchase
and securitization activity, and maturities of investments and borrowings.
20
<PAGE>
The following tables quantify the potential changes in net interest
income and net portfolio value as of June 30, 2000 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 and instantaneous. 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 but not by
changes in interest rates. 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. The following tables apply the U.S.
Treasury yield curve generally for assets and LIBOR for repurchase agreement
liabilities and assume a uniform change in both rates. The tables assume that
changes in interest rates occur instantaneously. The tables also reflect that
the Company has a significant exposure to LIBOR rates since its repurchase
agreement borrowings are generally based on LIBOR rates. Actual results could
differ significantly from those estimated in the tables.
<TABLE>
<CAPTION>
Projected Percent Change in
----------------------------------------------------------------------------------------------
Change in Interest Rates (1) Net Interest Income Net Portfolio Value
---------------------------------- -------------------------- --------------------------
<S> <C> <C>
-400 Basis Points 27.5% 14.4%
-300 Basis Points 20.6% 10.7%
-200 Basis Points 13.7% 7.1%
-100 Basis Points 6.9% 3.5%
0 Basis Points - -
100 Basis Points (6.9)% (3.4)%
200 Basis Points (13.7)% (6.7)%
300 Basis Points (20.6)% (9.9)%
400 Basis Points (27.5)% (13.0)%
</TABLE>
(1) Assumes that uniform changes occur instantaneously in both the
yield on 10-year U.S. Treasury notes and the interest rate
applicable to U.S. dollar deposits in the London interbank
market.
<TABLE>
<CAPTION>
Change in Monthly Change in
Change in Interest Rates (1) Net Interest Income Net Portfolio Value
---------------------------------- -------------------------- --------------------------
<S> <C> <C>
-400 Basis Points $ 191,860 $ 7,742,144
-300 Basis Points $ 143,895 $ 5,756,966
-200 Basis Points $ 95,930 $ 3,798,922
-100 Basis Points $ 47,965 $ 1,877,516
0 Basis Points - -
100 Basis Points $ (47,965) $ (1,828,250)
200 Basis Points $ (95,930) $ (3,603,417)
300 Basis Points $ (143,895) $ (5,322,965)
400 Basis Points $ (191,860) $ (6,985,400)
</TABLE>
(1) Assumes that uniform changes occur instantaneously in both the
yield on 10-year U.S. Treasury note and the interest rate
applicable to U.S. dollar deposits in the London interbank
market.
21
<PAGE>
The following table sets forth information as to the type of funding
used to finance the Company's assets as of June 30, 2000. As indicated in the
table, a large percentage of the Company's fixed rate assets are financed by
floating rate liabilities and the Company's variable rate assets are generally
funded by variable rate liabilities which use the same index.
<TABLE>
<CAPTION>
Assets and Liabilities
As of June 30, 2000
(Dollars in thousands)
INTEREST-BEARING ASSETS ASSETS INTEREST LIABILITIES INTEREST
----------------------- ------ -------- ----------- --------
<S> <C> <C> <C> <C>
Fixed Assets, Financed Floating $ 78,959 Fixed $ 66,955 LIBOR
Fixed Assets, Not Financed 6,279 Fixed - None
Investments in WFSG and affiliates 4,583 Fixed - None
Floating Assets, Financed Floating 25,000 LIBOR 18,941 LIBOR
-------------- ----------------
Sub-total 114,821 85,896
OTHER ASSETS
------------
Investments in Real Estate 53,513 N/A 38,199 Fixed
Cash and Cash Equivalents 8,020 N/A - None
Investments in WFSG and affiliates 4,769 N/A - None
Other 3,780 N/A - None
-------------- ----------------
Sub-total 70,082 38,199
LIABILITY ONLY
--------------
Dividends - 4,038 Fixed
Accounts Payable and Accrued
Liabilities - 2,931 None
-------------- ----------------
Sub-total - 6,969
--------------------------------------------------------------------------------------------------------------
Grand Total $ 184,903 $ 131,064
===============================================================================================================
</TABLE>
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.
Asset and liability management can utilize a wide variety of off-balance sheet
financial techniques to assist it in the management of interest rate risk. For
example, 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. These hedges may be in the form of currency and interest rate swaps,
options, and forwards, or combinations thereof. No such techniques were in use
as of June 30, 2000.
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
22
<PAGE>
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 June
30, 2000 (dollars in thousands):
<TABLE>
<CAPTION>
Within 4 to 12 One Year to More than
3 Months Months 3 Years 3 Years TOTAL
------------- ------------ ------------ ------------ ----------
<S> <C> <C> <C> <C> <C>
INTEREST-SENSITIVE ASSETS(1):
Cash and cash equivalents $ 8,020 $ -- $ -- $ -- $ 8,020
Securities available for sale -- -- -- 79,974 79,974
Loans(2) 25,132 394 900 3,838 30,264
Investments in WFSG and affiliates 258 827 2,610 888 4,583
-------- -------- -------- -------- --------
Total rate-sensitive assets $ 33,410 $ 1,221 $ 3,510 $ 84,700 $122,841
======== ======== ======== ======== ========
INTEREST-SENSITIVE LIABILITIES :
Borrowings on loans and securities $ 85,896 $ -- $ -- $ -- $ 85,896
Borrowings on real estate -- -- -- 38,199 38,199
Dividends payable -- 4,038 -- -- 4,038
-------- -------- -------- -------- --------
Total rate-sensitive liabilities $ 85,896 $ 4,038 $ -- $ 38,199 $128,133
======== ======== ======== ======== ========
Interest rate sensitivity gap (52,486) (2,817) 3,510 46,501
Cumulative interest rate
sensitivity gap (52,486) (55,303) (51,793) (5,292)
Cumulative interest rate
sensitivity gap as a
percentage of total rate-
sensitive assets (43)% (45)% (42)% (4)%
</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%.
23
<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, THE FINANCIAL AND SECURITIES MARKETS AND THE AVAILABILITY
OF AND COSTS ASSOCIATED WITH SOURCES OF LIQUIDITY, COMPETITIVE PRODUCTS AND
PRICING, THE REAL ESTATE MARKET, FISCAL AND MONETARY POLICIES OF THE U.S.
GOVERNMENT, CHANGES IN PREVAILING INTEREST RATES, ACQUISITIONS AND THE
INTEGRATION OF ACQUIRED BUSINESSES, CREDIT RISK MANAGEMENT, YEAR 2000 AND
ASSET/LIABILITY MANAGEMENT. EXCEPT AS MAY BE 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.
24
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The registrant is not a party to any other material legal proceedings, except as
follows:
The Company is engaged in litigation with WFSG relating to the
termination of the contractual and other relationships which formerly existed
between the companies (a more detailed description of this legal proceeding is
contained in the Company's Annual Report on Form 10-K for the year ending
December 31, 1999). Prior to September 1999, the Company's business affairs and
day-to-day operations had been managed by a wholly-owned subsidiary of WFSG. The
Company and WFSG had the same senior management team, though the Company had a
significantly different shareholder base and the majority of its directors were
independent. In addition, the Company and WFSG had other significant contractual
relationships relating to the servicing of real estate related assets and also
had certain cross shareholdings. The Company has sought to amicably resolve its
differences with WFSG and has been unable to resolve certain areas of dispute.
The Company alleges: (1) the termination of Messrs. Wiederhorn and Mendelsohn
and the departure of other senior managers made WFSG and its affiliates unable
and/or unwilling to provide management to the Company as required under the
management agreement; (2) the inability of WFSG and its affiliates to manage the
Company's business affairs triggered application of a facilities sharing
agreement dated February 19, 1999 between the Company and WFSG and its
affiliates (the "Facilities Sharing Agreement"), which replaced the management
agreement; (3) WFSG's refusal to allow Messrs. Wiederhorn and Mendelsohn access
to WFSG's facilities, personnel, and equipment for the Company's business
violated the terms of the Facilities Sharing Agreement; (4) the management
agreement was terminated with no obligation to pay a termination fee under a
contract term allowing non-renewal upon 120-day advance notice, which was timely
given by the Company to WFSG; (5) the Company is entitled to expanded use of
prepaid service fees for the servicing of assets serviced under pooling and
servicing agreements; and (6) WFSG to be in default of its Debtor-in-Possession
("DIP") loan agreement with the Company. WFSG alleges the Company breached the
management agreement and is claiming damages for alleged non-payment of
quarterly management fees of $0.7 million and damages under a termination fee in
a range of $3.5 million to $4.0 million. In late July 2000, the parties entered
mediation in order to resolve their differences. While the Company believes that
significant progress has been made, the discussions are ongoing and a final
settlement of all areas of dispute has not been agreed. There can be no
assurance that these discussions will continue or lead to a final settlement.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
Not Applicable.
25
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
10.1 Amended Employment Agreement dated May 19, 2000
between the Company and Wilshire Real Estate
Partnership L.P. and Robert G. Rosen
10.2 Amended Employment Agreement dated July 27, 2000
between the Company and Wilshire Real Estate
Partnership L.P. and Robert G. Rosen
10.3 Amended Agreement dated June 1, 2000 between the
Company and Wilshire Real Estate Partnership L.P. and
Richard Brennan
11 Computation of Per Share Earnings
27 Financial Data Schedule
(b) Reports on Form 8-K:
None
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 Inc.
By: /s/ Lawrence A. Mendelsohn
-----------------------------------------
Lawrence A. Mendelsohn
President
By: /s/ Chris Tassos
-----------------------------------------
Chris Tassos
Executive Vice President and Chief Financial Officer
Date: August 9, 2000
26
