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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period ________ to _________

Commission file number 33-93068

WFS Financial Inc

23 Pasteur, Irvine, California 92618-3816
(Address of principal executive offices)

(949) 727-1002
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes      No  .

As of July 31, 2002, the registrant had 41,019,899 shares outstanding of common stock, no par value. The shares of common stock represent the only class of common stock of the registrant.

The total number of sequentially numbered pages is 26.

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WFS FINANCIAL INC AND SUBSIDIARIES

FORM 10-Q

June 30, 2002

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

WFS FINANCIAL INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)

See accompanying notes to consolidated financial statements.

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WFS FINANCIAL INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

See accompanying notes to consolidated financial statements.

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WFS FINANCIAL INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)

See accompanying notes to consolidated financial statements.

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WFS FINANCIAL INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to consolidated financial statements.

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WFS FINANCIAL INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements include our accounts and the accounts of our subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current year’s presentation. We are a majority owned subsidiary of Western Financial Bank, also known as the Bank, which is a wholly owned subsidiary of Westcorp, our ultimate parent company.

In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto for the year ended December 31, 2001 included in the WFS Financial Inc Form 10-K.

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, also known as SFAS No. 143, in which retirement obligations would be recorded as a liability using the present value of the estimated cash flows and a corresponding amount would be capitalized as part of the asset’s carrying amount. The capitalized asset retirement cost would be amortized to expense over the asset’s useful life using a systematic and rational allocation method. The estimate of the asset retirement obligation will change and have to be revised over time. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. If applicable, an accounting change to adopt the standard would be made as of the beginning of the company’s fiscal year. We do not expect SFAS No. 143 to have a material effect on our earnings or financial position.

Note 2 – Net Contracts Receivable

Our contract portfolio consists of contracts purchased from automobile dealers on a nonrecourse basis and contracts financed directly with the consumer. If pre-computed finance charges are added to a contract, they are added to the contract balance and carried as an offset against the contract balance as unearned discounts. Amounts paid to dealers are capitalized as dealer participation and amortized over the life of the contract.

Net contracts receivable consisted of the following:

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Contracts managed by us totaled $8.9 billion and $8.2 billion at June 30, 2002 and December 31, 2001, respectively. Of the $8.9 billion contracts managed at June 30, 2002, $6.7 billion were owned by us, $1.4 billion were owned by Westcorp, our ultimate parent, and $0.8 billion were owned by securitization trusts. Of the $8.2 billion contracts managed at December 31, 2001, $5.2 billion were owned by us, $1.8 billion were owned by Westcorp, and $1.2 billion were owned by securitization trusts.

Note 3 – Allowance for Credit Losses

Changes in the allowance for credit losses were as follows:

Note 4 – Retained Interest in Securitized Assets

The following table presents the activity of the retained interest in securitized assets, otherwise known as RISA:

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The following table presents the estimated future undiscounted retained interest earnings to be received from securitizations:

The decline in the off balance sheet allowance for credit losses on a dollar basis is the result of our securitization transactions no longer being treated as sales since the first quarter of 2000. We expect the RISA to be fully amortized or otherwise eliminated by the end of 2002. Older transactions treated as sales have lower losses each month after securitization as estimated future credit losses are realized. We believe that the off balance sheet allowance for credit losses is adequate to absorb probable losses in the sold portfolio that can be reasonably estimated.

Note 5 – Notes Payable on Automobile Secured Financing

For the three and six months ended June 30, 2002, we issued $1.8 billion and $4.3 billion of notes secured by automobile contracts, respectively, compared with none and $1.0 billion for the same respective periods in 2001. Of the $4.3 billion issued during 2002, $3.5 billion was through public transactions and $775 million was through a private placement. The private placement was through a conduit facility established in January 2002. There were $6.1 billion of notes payable on automobile secured financing outstanding at June 30, 2002 compared with $4.0 billion at December 31, 2001. Of these amounts, we had no amount outstanding on a conduit facility at June 30, 2002, compared to $650 million at December 31, 2001. We redeemed our $650 million and $775 million conduit facilities in March 2002 and May 2002, respectively.

Interest payments on the public transactions are due quarterly, in arrears, based on the respective note’s interest rate. Interest payments on the conduit facilities were due monthly, in arrears, based on the respective note’s interest rate. For the three and six months ended June 30, 2002, interest expense on all notes payable on automobile secured financing, including interest payments under interest rate swap agreements, totaled $78.0 million and $141 million, respectively, compared with $51.8 million and $103 million for the same respective periods in 2001.

Note 6 – Notes Payable – Parent

Our parent, the Bank, raised $300 million through an offering of subordinated capital debentures that closed on May 3, 2002. The debentures have a coupon of 9.625% and are expected to have a yield to maturity of 9.70%. The all-in cost of these debentures, including issue costs, is 10.0%. The debentures mature on May 15, 2012.

In order to utilize the proceeds from the debentures to fund the growth in our automobile lending operations, we entered into a promissory note payable to the Bank for the sum of $300 million on May 3, 2002. Interest payments are due semi-annually in arrears at a fixed rate per annum of 10.25%. The promissory note is due on or before May 15, 2012.

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Note 7 – Subsequent Events

On July 17, 2002, we announced that we received a proposal from Westcorp in which Westcorp offered to acquire our outstanding 16% minority interest, representing approximately 6.6 million common shares, through a reorganization of us into WFB, our ultimate parent company. Under the terms of Westcorp’s proposal, the public holders of our common shares would receive .9204 shares of Westcorp common shares for each of our common shares outstanding in a tax-free transaction. The proposal is subject to the approval of our Board of Directors and the Board of Directors of Westcorp and WFB, the negotiation and execution of a definitive agreement and any required regulatory approvals. The reorganization is also subject to the approval of a majority of our minority shareholders.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are one of the nation’s largest independent automobile finance companies with 29 years of experience in the automobile finance industry. We believe that the automobile finance industry is the second largest consumer finance industry in the United States with over $553 billion of loan and lease originations during 2001. We originate, service and securitize new and pre-owned automobile installment contracts, which are generated through our relationships with approximately 7,700 franchised and independent automobile dealers in 43 states. We originated $1.5 billion and $2.8 billion of automobile contracts during the three and six months ended June 30, 2002 and managed a portfolio of $8.9 billion at June 30, 2002.

Our primary sources of revenue are net interest income and servicing income. Net interest income is the difference between the income earned on interest earning assets and the interest paid on interest bearing liabilities. The primary components of servicing income include retained interest income on contracts sold, contractually specified servicing fees for the servicing of contracts, late charges and other miscellaneous servicing fee income.

Critical Accounting Policies

Management believes critical accounting policies are very important to the portrayal of our financial condition and results of operations. Critical accounting policies require difficult and complex judgments because they rely on estimates about the effect of matters that are inherently uncertain due to the impact of changing market conditions. The following is a summary of accounting policies we consider critical.

Retained Interest in Securitized Assets

Retained interest in securitized assets, also known as RISA, is capitalized upon the sale of automobile contracts to securitization trusts for transactions treated as sales for accounting purposes. RISA represents the present value of the estimated future cash flows to be received by us from the excess spread created in securitization transactions. Future cash flows are calculated by taking the coupon rate of the automobile contracts securitized less the interest rate paid to the investors less contractually specified servicing fees and guarantor fees, after giving effect to estimated credit losses and prepayments.

RISA is classified in a manner similar to available for sale securities and as such is marked to market each quarter. Market value changes are calculated by discounting the estimated cash flows using a current market discount rate. Any changes in the market value of the RISA are reported as a separate component of shareholders’ equity on our Consolidated Statements of Financial Condition as accumulated other comprehensive income (loss), net of applicable taxes. On a quarterly basis, we evaluate the carrying value of the RISA in light of the actual performance of the underlying automobile contracts and make adjustments to reduce the carrying value, if appropriate.

Allowance for Credit Losses

Management determines the amount of the allowance for credit losses based on a review of various quantitative and qualitative analyses. Quantitative analyses include the review of chargeoff trends by contract program and contract type on an owned and managed basis; evaluation of cumulative loss curves on both a managed and sold basis; evaluation of credit loss experience by credit tier and geographic location. Other quantitative analyses include the evaluation of the size of any particular asset group; the concentration of any credit tier; the level of non-performance and the percentage of delinquency.

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Qualitative analyses include trends in chargeoffs over various time periods and at various statistical midpoints and high points; the severity of depreciated values of repossessions; trends in the number of days repossessions are held in inventory; trends in the number of loan modifications; trends in delinquency roll rates; trends in deficiency balance collections both internally and from collection agencies; trends in custom scores and the effectiveness of our custom scores; and trends in the economy generally or in specific geographic locations. Despite these analyses, we recognize that establishing allowance for credit losses is not an exact science and can be highly judgmental in nature.

The analysis of the adequacy of the allowance for credit losses is not only dependent upon effective quantitative and qualitative analyses, but also effective contract review and asset classification. We classify our assets in accordance with regulatory guidance into five categories: Pass, Special Mention, Substandard, Doubtful and Loss. Based upon our asset classifications, we establish general and specific valuation allowances.

General valuation allowances are established based on quantitative analysis of our portfolio and other qualitative factors. Specific valuation allowances are established based on analysis of our portfolio that is classified as Loss. General valuation allowances are determined by applying various factors to loan balances that are classified as Pass, Special Mention, Substandard or Doubtful. Specific valuation allowances represent contracts that are classified as Loss. Some assets may be split into more than one asset classification due to fair value or net realizable value calculations. This approach allows for enhanced analysis as it highlights the need for more allowance than would be generally allocated if held in one classification.

All contracts that are 60 to 90 days delinquent are automatically classified as Special Mention. Any contract that is 90 or more days delinquent is automatically classified as Substandard. Any contract where the borrower has filed for bankruptcy or the vehicle has been repossessed by us and is subject to a redemption period is classified as Substandard, with the difference between the wholesale book value and contract balance classified as Loss.

The allowance for credit losses is reduced by net chargeoffs as well as decreases in required allowances due to sales of contracts and by lowering the level of required reserves based upon improved contract performance. The allowance for credit losses is increased by recording amounts to the provision for credit losses.

Hedging Activities

The contracts originated and held by us are fixed rate and, accordingly, we have exposure to changes in interest rates. To protect against potential changes in interest rates affecting interest payments on future securitization transactions, we may enter into various hedge agreements. The market value of these hedge agreements is designed to respond inversely to changes in interest rates. Because of this inverse relationship, we can effectively lock in a gross interest rate spread at the time of entering into the hedge transaction. Gains and losses on these agreements are recorded in accumulated other comprehensive income (loss). Any ineffective portion is recognized in interest expense during that period if the hedge is greater than 100% effective. Upon completion of the securitization transaction, the gains or losses are recognized in full as an adjustment to the gain or loss on the sale of the contracts if the securitization transaction is treated as a sale or amortized on a level yield basis over the duration of the notes issued if the transaction is treated as a secured financing.

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As we issued certain variable rate notes payable, we may also enter into interest rate swap agreements in order to hedge our variable interest rate exposure on future interest payments. The fair value of the interest rate swap agreements is included in notes payable on automobile secured financing, and any change in the fair value is reported as accumulated other comprehensive income (loss), net of tax, on our Consolidated Statements of Financial Condition. Any ineffective portion is recorded in interest expense during that period if the hedge is greater than 100% effective. Related interest income or expense is settled on a quarterly basis and recognized as an adjustment to interest expense in our Consolidated Statements of Income.

Results of Operations

Net Interest Income

Net interest income is affected by the difference between the rate earned on our interest earning assets and the rate paid on our interest bearing liabilities (net interest rate spread) and the relative amounts of our interest earning assets and interest bearing liabilities. For the three and six months ended June 30, 2002, net interest income totaled $111 million and $214 million, respectively, compared with $68.9 million and $134 million for the same respective periods in 2001. The increase in net interest income is the result of us holding more automobile contracts on the balance sheet as we utilize our own liquidity sources and completed $3.5 billion in public securitizations and a $775 million conduit financing accounted for as secured financings during the year.

The following table shows the average rate earned on contracts and the average rate paid on borrowings together with the corresponding net interest rate spread for the periods indicated. The average cost of borrowings represents the average combined rate of the senior note, promissory note, line of credit, and notes payable on automobile secured financings.

The decline in net interest spread is the result of the $300 million note payable to parent, which we entered into with the Bank in May 2002.

Servicing Income

We regularly securitize contracts in the public asset-backed securities market and retain the servicing rights. For accounting purposes, these transactions are treated as either secured financings or sales to a securitization trust. Since the first quarter of 2000, we have not completed a securitization that has been accounted for as a sale. For transactions treated as sales, we recorded a non-cash gain equal to the present value of the estimated future cash flows from the portfolio of contracts sold less the write-off of dealer participation balances and the effect of hedging activities. For these securitizations, net interest earned on the contracts sold and fees earned for servicing the automobile contract portfolios are recognized over the life of the transactions as contractual servicing income, retained interest income and other fee income.

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We occasionally sell contracts to Westcorp in whole loan sales. These sales are designed to utilize additional capital raised by Westcorp. These contracts are subsequently securitized by Westcorp and continue to be managed by us under the terms of such securitizations. We recognize a cash gain on a whole loan sale equal to the cash premium received adjusted for the write-off of dealer participation balances and the effect of hedging activities.

The components of servicing income were as follows: