(Mark one)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2003
[ ] Transitional Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Wilshire Financial Services Group Inc.
(Exact name of registrant as specified in its charter)
| Delaware | 93-1223879 |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
| 14523 SW Millikan Way, Suite 200, Beaverton, OR | 97005 |
| (Address of principal executive offices) | (Zip Code) |
(503) 223-5600
(Registrant's telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes [ X ] No [___]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [___] No [ X ]
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the
Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes [ X ] No [___]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
| Class | Outstanding at April 30, 2003 |
| Common Stock, par value $.01 per share | 18,253,994 shares |
Item 1. Interim Condensed Consolidated Financial Statements (Unaudited):
Consolidated Statements of Financial Condition.................................3
Consolidated Statements of Operations..........................................4
Consolidated Statements of Stockholders' Equity................................5
Consolidated Statements of Cash Flows..........................................6
Notes to Interim Condensed Consolidated Financial Statements...................8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.....................................................15
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................26
Item 4. Controls and Procedures.......................................................28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................29
Item 2. Changes in Securities.........................................................29
Item 3. Defaults Upon Senior Securities...............................................29
Item 4. Submission of Matters to a vote of Security Holders...........................29
Item 5. Other Information.............................................................29
Item 6. Exhibits and Reports on Form 8-K..............................................29
Signature...............................................................................30
Certification...........................................................................31
March 31, December 31,
2003 2002
------------ ------------
ASSETS
Cash and cash equivalents ........................................................ $ 12,273 $ 17,579
Government agency mortgage-backed securities available for sale, at fair value ... 190,107 211,082
AAA mortgage-backed securities available for sale, at fair value ................. 42,605 48,320
Other mortgage-backed securities available for sale, at fair value ............... 1,864 2,133
Investment securities available for sale, at fair value .......................... 22,260 11,962
Loans, net of allowance for loan losses of $7,822 and $7,980 ..................... 481,600 486,667
Discounted loans, net of allowance for loan losses of $40,235 and $40,920 ........ 6,062 6,630
Stock in Federal Home Loan Bank of San Francisco, at cost ........................ 10,952 10,808
Real estate owned, net ........................................................... 772 1,101
Leasehold improvements and equipment, net ........................................ 3,224 3,218
Accrued interest receivable ...................................................... 3,945 4,043
Servicer advance receivables, net ................................................ 26,383 19,922
Service fees receivable .......................................................... 2,707 2,334
Purchased mortgage servicing rights, net ......................................... 10,842 5,405
Receivables from loan servicers .................................................. 1,108 462
Intangible assets, net ........................................................... 3,636 3,701
Prepaid expenses and other assets ................................................ 7,402 7,654
------------ ------------
TOTAL .................................................................. $ 827,742 $ 843,021
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits ................................................ $ 3,836 $ 3,659
Interest-bearing deposits ................................................... 381,261 392,122
Short-term borrowings ....................................................... 92,098 91,870
Accounts payable and other liabilities ...................................... 14,654 14,284
FHLB advances ............................................................... 206,000 216,000
Long-term investment financing .............................................. 7,132 4,284
Trust preferred subordinated debt ........................................... 20,000 20,000
Investor participation liability ............................................ 1,386 1,346
------------ ------------
Total liabilities ...................................................... 726,367 743,565
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 2)
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value, 10,000,000 shares authorized, 0 shares
outstanding .............................................................. -- --
Common stock, $0.01 par value, 90,000,000 shares authorized, 23,874,206
and 23,820,874 shares issued (including treasury shares of 5,626,212) .... 115,135 114,357
Treasury stock, 5,626,212 shares, at cost ................................... (15,106) (15,106)
Accumulated deficit ......................................................... (1,532) (3,096)
Accumulated other comprehensive income, net ................................. 2,878 3,301
------------ ------------
Total stockholders' equity ............................................. 101,375 99,456
------------ ------------
TOTAL .................................................................. $ 827,742 $ 843,021
============ ============
See notes to unaudited interim condensed consolidated financial statements
- 3 -
Quarter Ended
March 31,
---------------------------
2003 2002
------------ ------------
INTEREST INCOME:
Loans ................................................................. $ 8,470 $ 10,845
Mortgage-backed securities ............................................ 3,467 2,932
Securities and federal funds sold ..................................... 172 340
------------ ------------
Total interest income ................................................. 12,109 14,117
------------ ------------
INTEREST EXPENSE:
Deposits .............................................................. 3,213 4,422
Borrowings ............................................................ 3,463 3,271
------------ ------------
Total interest expense ................................................ 6,676 7,693
------------ ------------
NET INTEREST INCOME ............................................................ 5,433 6,424
PROVISION FOR LOSSES ON LOANS .................................................. 30 13
------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOSSES ON LOANS ........................ 5,403 6,411
------------ ------------
OTHER INCOME:
Servicing income ...................................................... 7,841 5,522
Loan fees and charges ................................................. 23 42
Real estate owned, net ................................................ 25 (46)
Gain on sale of loans ................................................. 5 44
Loss on sale of securities ............................................ -- (62)
Investor participation interest ....................................... (70) (326)
Other, net ............................................................ 214 1,261
------------ ------------
Total other income .................................................... 8,038 6,435
------------ ------------
OTHER EXPENSES:
Compensation and employee benefits .................................... 6,771 5,641
Professional services ................................................. 1,149 1,787
Occupancy ............................................................. 553 543
FDIC insurance premiums ............................................... 108 105
Data processing ....................................................... 254 288
Communication ......................................................... 233 312
Insurance ............................................................. 340 279
Corporate travel and development ...................................... 83 90
Depreciation .......................................................... 408 422
Amortization of intangibles ........................................... 65 65
Postage and courier expense ........................................... 260 303
Provision for litigation claims ....................................... -- 3,600
Other general and administrative expenses ............................. 574 684
------------ ------------
Total other expenses .................................................. 10,798 14,119
------------ ------------
INCOME (LOSS) BEFORE MINORITY INTEREST AND INCOME TAXES ........................ 2,643 (1,273)
MINORITY INTEREST .............................................................. -- 200
------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES .............................................. 2,643 (1,073)
INCOME TAX PROVISION (BENEFIT) ................................................. 1,079 (300)
------------ ------------
NET INCOME (LOSS) .............................................................. $ 1,564 $ (773)
============ ============
Earnings (loss) per share - basic............................................... $ 0.09 $ (0.05)
Earnings (loss) per share - diluted............................................. $ 0.08 $ (0.05)
Weighted average shares outstanding - basic..................................... 18,223,698 16,180,604
Weighted average shares outstanding - diluted................................... 20,236,356 16,180,604
See notes to unaudited interim condensed consolidated financial statements
- 4 -
Accumulated
Preferred Stock Common Stock Treasury Stock Other
------------- --------------------- ----------------------- Accumulated Comprehensive
Shares Amount Shares Amount Shares Amount Deficit Income Total
------ ------ ----------- --------- ----------- ---------- --------- ------------- ---------
BALANCE, January 1, 2002...... -- $ -- 20,349,458 $ 105,530 (4,168,854) $ (10,005) $ (5,058) $ 953 $ 91,420
Comprehensive income:
Net income................ 1,962 1,962
Unrealized holding gains
on available for sale
securities - net of tax
expense of $1,851(1).... 2,490 2,490
Unrealized loss on
interest-rate swap - net (142) (142)
of tax benefit of $101.. --------
Total comprehensive income.... 4,310
Tax benefit from utilization
of pre-reorganizational Net
Operating Losses (Note 3). 815 815
Exercise of stock options..... 75,000 96 96
Conversion of subordinated
debentures................ 3,396,416 7,690 7,690
Receipt of income tax refund
related to pre-
reorganizational income... 226 226
Treasury stock acquired....... (1,457,358) (5,101) (5,101)
------ ------ ----------- --------- ----------- ---------- ---------- ------------- ---------
BALANCE, December 31, 2002.... -- -- 23,820,874 114,357 (5,626,212) (15,106) (3,096) 3,301 99,456
Comprehensive income:
Net income................ 1,564 1,564
Unrealized holding loss
on available for sale
securities - net of tax
benefit of $305......... (364) (364)
Unrealized loss on
interest-rate swap - net
of tax benefit of $42... (59) (59)
--------
Total comprehensive income.... 1,141
Tax benefit from utilization
of pre-reorganizational
Net Operating Losses
(Note 3).................. 709 709
Exercise of stock options.... 53,332 69 69
------ ------ ----------- --------- ----------- ---------- ---------- ------------- ---------
BALANCE, March 31, 2003....... -- $ -- 23,874,206 $ 115,135 (5,626,212) $ (15,106) $ (1,532) $ 2,878 $ 101,375
====== ====== =========== ========= =========== ========== ========== ============= =========
__________
(1) Includes reclassification adjustment for gain included in net income of $1,321, net of tax expense of $937.
See notes to unaudited interim condensed consolidated financial statements
- 5 -
Quarter Ended
March 31,
---------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................................................ $ 1,564 (773)
Adjustments to reconcile net income (loss) to net cash (used in) provided by
operating activities:
Provision for losses on loans ............................................... 30 13
Provision for losses on real estate owned ................................... 9 5
Valuation adjustment for mortgage servicing rights .......................... (225) 103
Depreciation and amortization ............................................... 473 487
Tax effect from utilization of net operating loss carryforward .............. 709 --
(Gain) loss on sale of real estate owned .................................... (54) 39
Gain on sale of loans ....................................................... (5) (44)
Loss on sale of securities .................................................. -- 62
(Gain) loss on disposal of equipment ........................................ (8) 7
Amortization of discounts and deferred fees ................................. 522 198
Amortization of mortgage servicing rights ................................... 878 977
Federal Home Loan Bank stock dividends ...................................... (144) (132)
Minority interest ........................................................... -- (200)
Change in:
Servicer advance receivables ................................................ (6,461) 1,221
Service fees receivable ..................................................... (373) (624)
Accrued interest receivable ................................................. 98 (140)
Receivables from other loan servicers ....................................... (646) (176)
Prepaid expenses and other assets ........................................... 151 (1,915)
Accounts payable and other liabilities ...................................... 722 6,110
Investor participation liability ............................................ 40 326
------------ ------------
Net cash (used in) provided by operating activities .................... (2,720) 5,544
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of loans ........................................................... (7,036) --
Loan repayments ............................................................. 41,428 61,851
Loan originations ........................................................... (29,791) (15,807)
Purchase of discounted loans ................................................ -- (10)
Proceeds from sale of discounted loans ...................................... 340 --
Purchase of mortgage-backed securities available for sale ................... (7,632) (99,750)
Proceeds from sale of mortgage-backed securities available for sale ......... -- 19,513
Repayment of mortgage-backed securities available for sale .................. 33,369 6,859
Purchase of investment securities available for sale ........................ (10,000) (9,981)
Proceeds from sale of real estate owned ..................................... 771 287
Purchases of leasehold improvements and equipment ........................... (418) (271)
Proceeds from sale of leasehold improvements and equipment .................. 12 --
Purchase of mortgage servicing rights ....................................... (6,092) (115)
Proceeds from sale of mortgage servicing rights ............................. 2 --
------------ ------------
Net cash provided by (used in) investing activities .................... 14,953 (37,424)
------------ ------------
See notes to unaudited interim condensed consolidated financial statements
- 6 -
Quarter Ended
March 31,
---------------------------
2003 2002
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits ............................................... $ (10,684) $ (14,092)
Proceeds from FHLB advances ............................................ 6,000 --
Repayments of FHLB advances ............................................ (16,000) --
Net increase in short-term borrowings .................................. 228 27,970
Proceeds from long-term financing ...................................... 4,005 --
Repayment of long-term financing ....................................... (1,157) (1,869)
Issuance of convertible subordinated debentures ........................ -- 7,690
Issuance of common stock pursuant to exercise of stock options ......... 69 --
------------ ------------
Net cash (used in) provided by financing activities ............... (17,539) 19,699
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS ...................................... (5,306) (12,181)
CASH AND CASH EQUIVALENTS:
Beginning of period .................................................... 17,579 39,974
------------ ------------
End of period .......................................................... $ 12,273 $ 27,793
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION--Cash paid for:
Interest ............................................................... $ 4,723 $ 5,641
Income taxes ........................................................... 270 270
NONCASH INVESTING ACTIVITIES:
Additions to real estate owned acquired in settlement of loans ......... 397 181
See notes to unaudited interim condensed consolidated financial statements
- 7 -
The accompanying interim condensed consolidated financial statements of Wilshire Financial Services Group Inc. and its subsidiaries ("WFSG" or the "Company") are unaudited and should be read in conjunction with the 2002 Annual Report on Form 10-K. A summary of the Company's significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements in the 2002 Annual Report on Form 10-K.
In the opinion of management, all adjustments, other than the adjustments described below, generally comprised of normal recurring accruals necessary for fair presentation of the interim condensed consolidated financial statements, have been included and all intercompany accounts and transactions have been eliminated in consolidation. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts and results could differ from those estimates.
Certain reclassifications of 2002 amounts were made in order to conform to the 2003 presentation, none of which affect previously reported net loss.
At March 31, 2003, the Company's banking subsidiary, First Bank of Beverly Hills, F.S.B. ("FBBH" or the "Bank"), had outstanding commitments to fund $5.2 million in new mortgage loans and to purchase $10.0 million of mortgage-backed securities.
The Company expects to incur additional expenses in connection with legal costs for prior officers. These costs, which totaled approximately $0.5 million for the quarter ended March 31, 2003, relate to the events that gave rise to litigation arising from the financial collapse of Capital Consultants LLC ("CCL"). The Company on May 13, 2002 entered into a settlement agreement to resolve that litigation and has completed all of its obligations under the settlement agreement. The litigation will be dismissed when plaintiffs complete their obligations. Management, after consultation with legal counsel, believes that it is likely that this litigation will be dismissed.
The Company files consolidated federal income tax returns with all of its subsidiaries. The operations of Wilshire Credit Corporation ("WCC"), the Company's loan servicing subsidiary, will be included in WFSG's consolidated income tax returns for periods beginning October 1, 2002, the effective date of WFSG's purchase of WCC's 49.99% minority interest. For tax years through the year ended December 31, 2001 and for the first three quarters of 2002, WCC's operations were excluded from WFSG's consolidated federal income tax return because WCC did not meet the required ownership threshold of 80% (the Company's economic interest was 50.01%).
The Company recorded a current income tax provision of approximately $1.1 million for the quarter ended March 31, 2003. The Company's deferred tax provision (benefit) is determined on a quarterly basis pursuant to an evaluation of WFSG's net deferred tax asset. These deferred tax assets and liabilities represent the tax effect of future deductible or taxable amounts. They are attributable to carryforwards, such as net operating losses and capital losses, and also to temporary timing differences between amounts that have been recognized in the financial statements and amounts that have been recognized in the income tax returns. An effective tax rate of approximately 41% is applied to each attribute in determining the amount of the related deferred tax asset or liability. Decreases (increases) in the net deferred tax asset are recorded as a deferred tax provision (benefit) in the consolidated statement of operations.
- 8 -
WFSG's net deferred tax asset at March 31, 2003 is included in prepaid expenses and other assets on the accompanying consolidated statements of financial condition. In accounting for the deferred tax asset, the Company applies Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." SFAS No. 109 requires, among other things, that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. Management believes that it is more likely than not that the Company will realize a portion of the deferred tax asset and has recorded the valuation allowance accordingly. As benefits relating to the Company's pre-reorganization (before June 10, 1999) period are realized and the valuation allowance is reduced, the tax effect is recorded as an increase to stockholders' equity in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code ("SOP 90-7"), and not as a tax benefit in the statement of operations.
In June 2002 the Company experienced a change in control as set forth by Section 382 of the Internal Revenue Code. In general, a change in control is defined as a greater than 50% ownership shift as measured over the prior three-year period. The change in control will limit the Company's ability to utilize certain tax attributes, such as net operating loss and capital loss carryforwards, in future periods. In addition, if the Company is found to have a net overall built-in-gain or built-in-loss at the change in control date, the realization of the tax attributes could be enhanced or limited. If the Company has a net overall built-in-gain, it will be allowed to utilize additional tax attributes. If the Company has a net overall built-in-loss, it will be subject to additional limitations on the use of its tax attributes.
As of December 31, 2002, the Company had U.S. net operating loss carryforwards and capital loss carryforwards of approximately $109 million and $12 million, respectively. In addition, the Company has state net operating loss carryforwards. The federal carryforward period runs through 2021. As a result of the change in control described above, the Company's net operating loss carryforwards and capital loss carryforwards that were generated in the pre-reorganizational period are subject to a limitation on the amount that may be used annually to offset taxable income. The Company is currently in the process of finalizing calculations with respect to the amount of the annual limitation, but estimates that the limitation is approximately $5 million per year. The Company has adequately provided for this limitation with its valuation allowance against the deferred tax asset.
In the first quarter of 2003, WCC increased its loan servicing portfolio by approximately 26%, primarily through the purchase of the rights to service approximately 5,000 loans with an aggregate unpaid principal balance of $789 million and by contracting to service approximately 17,000 additional loans totaling $766 million in unpaid principal. The transfer of these loans was completed in March 2003.
Basic earnings per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income (loss) by the weighted average number of common shares and potentially dilutive stock options outstanding during the period. Following is a reconciliation of the number of shares used in the calculation of basic and diluted earnings per share for the quarters ended March 31, 2003 and 2002.
Quarter Ended
March 31,
---------------------------
2003 2002
------------ ------------
Net income (loss)...................................... $ 1,564 $ (773)
============ ============
Weighted average number of common
shares outstanding - basic.......................... 18,223,698 16,180,604
------------ ------------
Net effect of dilutive stock options - based on
treasury stock method............................... 2,012,658 N/A
------------ ------------
Weighted average number of common
shares outstanding - diluted........................ 20,236,356 16,180,604
------------ ------------
Net income (loss) per share - basic.................... $ 0.09 $ (0.05)
============ ============
Net income (loss) per share - diluted.................. $ 0.08 $ (0.05)
============ ============
- 9 -
For the quarter ended March 31, 2002, the Company incurred a net loss, which resulted in common stock equivalents having an anti-dilutive effect on loss per share. Therefore, the weighted-average shares outstanding was equivalent for both basic and diluted loss per share.
The Company has two stock-based employee compensation plans, the 1999 Equity Participation Plan and the 2002 Equity Participation Plan, pursuant to which stock options have been granted to its directors and certain employees. The Company accounts for these plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
Quarter Ended
March 31,
---------------------------
2003 2002
------------ ------------
Net income (loss), as reported......................... $ 1,564 $ (773)
Less: Total stock-based employee compensation
expense determined under fair value-based method
for all awards, net of related tax effects.......... 123 134
------------ ------------
Pro forma net income (loss)............................ $ 1,441 $ (907)
============ ============
Earnings (loss) per share:
Basic - as reported................................. $ 0.09 $ (0.05)
============ ============
Basic - pro forma................................... $ 0.08 $ (0.06)
============ ============
Diluted - as reported............................... $ 0.08 $ (0.05)
============ ============
Diluted - pro forma................................. $ 0.07 $ (0.06)
============ ============
The Company’s reportable operating segments, as defined by the Company’s management, consist of its Banking operations and Specialty Servicing and Finance operations. The operating segments differ in terms of regulatory environment, funding sources and asset acquisition strategies, as described below:
| • | Banking Operations—Through FBBH, the Company conducts a banking business focused primarily on specialty-niche products, including small-balance commercial and multi-family real estate lending, investments in residential whole loans, and investments in primarily AAA-rated and government agency mortgage-backed securities. The primary sources of liquidity for the Bank’s acquisitions and originations are FHLB advances, repurchase agreements, wholesale certificates of deposit and retail deposits. The Bank is a federally chartered savings bank and is regulated by the Office of Thrift Supervision (“OTS”). At March 31, 2003, FBBH had total assets of $772.1 million. |
- 10 -
| • | Specialty Servicing and Finance Operations—Through its servicing subsidiary, WCC, the Company conducts a full-service mortgage and consumer loan servicing business, specializing in the servicing of labor-intensive mortgage pools requiring expertise in loss mitigation and/or investor reporting. Through its investment subsidiary, Wilshire Funding Corporation (“WFC”), the Company conducts an investment and co-investment business with institutional investors where such investments (1) align the Company’s interests with those of such institutional investors and (2) provide operating leverage for the servicing operations of WCC. Together, WCC and WFC are referred to as “Specialty Servicing and Finance Operations”. As of March 31, 2003, the Company’s Specialty Servicing and Finance Operations serviced approximately $5.1 billion principal balance of residential and commercial mortgage pools for over 500 individual and institutional investors and government agencies. The Company’s Specialty Servicing and Finance Operations’ funding sources consist primarily of internal liquidity, commercial bank financing, and co-investors, under debt service repayment terms which generally parallel the schedule of anticipated cash flows and actual cash flows of the underlying collateral. |
| • | Holding Company and Miscellaneous Operations—The Company’s Holding Company and Miscellaneous Operations consist of other operating revenues and expenses not directly attributable to the aforementioned business segments, and includes eliminations of intercompany accounts and transactions. Primary sources of liquidity include funds available from the Company’s wholly-owned non-bank subsidiaries, proceeds from the July 2002 issuance of junior subordinated debt, and payments received from FBBH pursuant to a tax allocation agreement between the Company and the Bank. However, the OTS has limited the amount of these payments to the lesser of (1) the Bank’s stand-alone tax liability and (2) the total tax payments made by the Company. |
- 11 -
Segment data for the quarters ended March 31, 2003 and 2002 are as follows:
Three Months Ended March 31, 2003
---------------------------------------------------------
Holding
Specialty Company and
Servicing and Miscellaneous
Banking Finance Operations Total
------------ ------------ ------------ ------------
Interest income ............................................ $ 11,012 $ 1,084 $ 13 $ 12,109
Interest expense ........................................... 6,243 169 264 6,676
------------ ------------ ------------ ------------
Net interest income (expense) .............................. 4,769 915 (251) 5,433
Provision for loan losses .................................. -- 30 -- 30
------------ ------------ ------------ ------------
Net interest income (expense) after provision for loan
losses .................................................. 4,769 885 (251) 5,403
Realized gains on asset sales .............................. -- 5 -- 5
Servicing income ........................................... 299 7,879 (337) 7,841
Other (loss) income ........................................ (38) (156) 386 192
Compensation and benefits .................................. 1,131 5,314 326 6,771
Other expense .............................................. 1,298 1,967 762 4,027
------------ ------------ ------------ ------------
Income (loss) before taxes ................................. 2,601 1,332 (1,290) 2,643
Income tax provision (benefit) ............................. 1,092 204 (217) 1,079
------------ ------------ ------------ ------------
Net income (loss) .......................................... $ 1,509 $ 1,128 $ (1,073) $ 1,564
============ ============ ============ ============
Total assets ............................................... $ 772,069 $ 67,272 $ (11,599) $ 827,742
============ ============ ============ ============
Three Months Ended March 31, 2002
---------------------------------------------------------
Holding
Specialty Company and
Servicing and Miscellaneous
Banking Finance Operations Total
------------ ------------ ------------ ------------
Interest income ............................................ $ 11,951 $ 1,878 $ 288 $ 14,117
Interest expense ........................................... 7,226 381 86 7,693
------------ ------------ ------------ ------------
Net interest income ........................................ 4,725 1,497 202 6,424
Provision for loan losses .................................. -- 13 -- 13
------------ ------------ ------------ ------------
Net interest income after provision for loan losses ........ 4,725 1,484 202 6,411
Realized (losses) gains on asset sales ..................... (62) 44 -- (18)
Servicing income ........................................... 223 5,776 (477) 5,522
Other income ............................................... 14 543 374 931
Compensation and benefits .................................. 944 4,353 344 5,641
Other expense .............................................. 1,316 2,731 4,431 8,478
------------ ------------ ------------ ------------
Income (loss) before minority interest and taxes ........... 2,640 763 (4,676) (1,273)
Minority interest .......................................... -- -- 200 200
------------ ------------ ------------ ------------
Income (loss) before taxes ................................. 2,640 763 (4,476) (1,073)
Income tax provision (benefit) ............................. 1,094 -- (1,394) (300)
------------ ------------ ------------ ------------
Net income (loss) .......................................... $ 1,546 $ 763 $ (3,082) $ (773)
============ ============ ============ ============
Total assets ............................................... $ 741,748 $ 61,711 $ (10,162) $ 793,297
============ ============ ============ ============
- 12 -
In June 2000, FBBH acquired a branch location and recorded goodwill of $3,393 and a core deposit intangible of $1,294. Through December 31, 2001, the goodwill was amortized on a straight-line basis over an estimated useful life of 15 years. In January 2002 the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," and, as a result, no longer amortizes goodwill, but tests it at least annually for impairment. The Company will continue to amortize the core deposit intangible over an estimated useful life of 5 years.
Following is a summary of the Company's intangible assets:
Intangible Assets
As of March 31, 2003
---------------------------------
Gross Carrying Accumulated
Amount Amortization
--------------- ---------------
Goodwill............................. $ 3,393 $ (339)
Core deposit intangible.............. 1,294 (712)
--------------- ---------------
Total............................. $ 4,687 $ (1,051)
=============== ===============
For the quarter ended March 31, 2003 the Company recorded amortization expense of $65 related to the core deposit intangible. The estimated amortization of the balance for the remainder of 2003 and the five succeeding fiscal years is $194 (2003), $259 (2004), $129 (2005), and none thereafter.
There were no changes in the carrying value of goodwill during the quarter ended March 31, 2003. The Company tested goodwill for impairment as of March 31, 2003 and determined that no impairment charge was required.
The Company’s purchased mortgage servicing rights (MSRs) totaled approximately $10.8 million at March 31, 2003, $5.4 million at December 31, 2002, and $7.5 million at March 31, 2002. Amortization expense for MSRs was $0.9 million for the quarter ended March 31, 2003, and $1.0 million for the quarter ended March 31, 2002. The estimated amortization expense of the March 31, 2003 balance of MSRs for the remainder of 2003 and the five succeeding fiscal years is $3.2 million (2003), $3.1 million (2004), $1.9 million (2005), $1.1 million (2006), $0.7 million (2007), and $0.4 million (2008). The estimated amortization expense is based only on currently held MSRs and on current information regarding loan payments and prepayments. Actual results may vary as a result of changes in the rate of prepayments and other market factors.
In June 2001, the Bank sold its Bankcard Division to iPayment Holdings, Inc. for a purchase price of approximately $6.2 million. In a lawsuit commenced by the Bank for payment of part of the purchase price, iPayment, in September 2002, filed a cross-complaint against the Bank for fraud, breach of contract and negligent misrepresentation. iPayment contends that the Bank knew, or should have known, that a merchant was concealing significant product returns by issuing checks as refunds, rather than issuing credit card refunds as required by MasterCard operating rules. iPayment claims damages for the difference in the purchase price due to the decreased value to iPayment of the merchant’s account; chargebacks that iPayment may have to pay and will not be able to recover from the merchant which may total $5-6 million; and punitive damages. The Bank denies the claims, in part because the portion of the purchase price for which the Bank is suing iPayment was held back by iPayment and was dependent upon the processing volume of this merchant, and the Bank also maintains that iPayment failed to mitigate any claimed damages. The Bank intends to defend the cross-complaint vigorously. The factual discovery process has not been completed. Although the Company expects to incur costs in defending these claims, based on the results of the discovery proceedings thus far and preliminary discussions with its lawyers, the Company currently does not believe the ultimate resolution of the claims will have a material impact on its financial condition or results of operations. The Company has not recognized, for accounting purposes, the contingency payment from iPayment which is the subject of this litigation.
- 13 -
The Company is a defendant in other legal actions arising from transactions conducted in the ordinary course of business. Some of these claims involve individual borrowers, for themselves and in one instance for a class of borrowers, demanding material amounts for alleged damages. Management, after consultation with legal counsel, and based on prior experience with consumer claims, believes the ultimate liability, if any, arising from such actions will not materially affect the Company’s financial position, consolidated results of operations or cash flows.
On April 23, 2003, the Company’s Board of Directors revised the Company’s 1999 Equity Participation Plan to remove the automatic grant of WFSG stock options to board members of the Company and FBBH upon their re-election to their respective boards.
In April 2003 the Federal Home Loan Bank increased the Bank’s borrowing authority from 30% to 35% of the Bank’s total assets as of the previous quarter-end.
- 14 -
The following discussion and analysis should be read in conjunction with the Interim Condensed Consolidated Financial Statements of Wilshire Financial Services Group Inc. and the notes thereto included elsewhere in this filing. References in this filing to "Wilshire Financial Services Group Inc.," "WFSG," the "Company," "we," "our," and "us" refer to Wilshire Financial Services Group Inc. and our wholly owned subsidiaries, unless the context indicates otherwise.
Wilshire Financial Services Group Inc., a financial services company, conducts (1) community banking operations (referred to herein as our "Banking Operations") through our wholly-owned subsidiary, First Bank of Beverly Hills, F.S.B. ("FBBH" or the "Bank"); and (2) specialized mortgage loan servicing and investment operations through our subsidiaries, Wilshire Credit Corporation ("WCC") and Wilshire Funding Corporation ("WFC"). Together, WCC and WFC are referred to as our "Specialty Servicing and Finance Operations." WFSG's administrative, investment and loan servicing headquarters are located in Beaverton, Oregon. The Bank is headquartered in Calabasas, California and conducts its branch banking activities in Beverly Hills, California.
Our consolidated net income for the quarter ended March 31, 2003 was approximately $1.6 million, or $0.09 per basic share, compared with a net loss of $0.8 million, or $0.05 per basic share, for the quarter ended March 31, 2002. WFSG's pre-tax income was approximately $2.6 million for the first quarter of 2003, compared with a pre-tax loss of $1.1 million for the first quarter of 2002.
Our consolidated stockholders' equity at March 31, 2003 was $101.4 million ($5.56 and $5.04 per basic and diluted share, respectively), an increase of $1.9 million over December 31, 2002 equity. The increase reflects net income for the quarter and $0.7 million in tax benefits relating to losses generated in the Company's pre-reorganizational period, partially offset by after-tax unrealized losses on the Company's portfolio of available-for-sale securities (approximately $0.4 million) and on its hedging transactions (approximately $59 thousand).
The increase in net income in the first quarter of 2003 over the corresponding 2002 period reflects a $1.6 million increase in consolidated other income, primarily as a result of higher net servicing income at the Company's loan servicing subsidiary, partially offset by a $1.0 million decline in net interest income.
In addition, our total other operating expenses declined by approximately $3.3 million from the first quarter of 2002. The Company's first quarter 2002 other operating expenses included approximately $4.75 million of non-recurring charges and legal expenses related to the settlement of litigation which arose from events prior to the Company's June 1999 restructuring. The absence of these settlement-related charges in the 2003 period was partially offset by a $1.1 million increase in compensation expense, primarily as a result of the expansion of the Company's Specialty Servicing and Finance Operations. The Company's other operating expenses continue to include expenses on behalf of prior officers in connection with the events that gave rise to the litigation. Such costs totaled approximately $0.5 million for each of the quarters ended March 31, 2003 and 2002.
Following is a discussion of the operating results of the Company's two business segments: our Banking Operations and our Specialty Servicing and Finance Operations.
- 15 -
The following table compares income before taxes for FBBH for the quarters ended March 31, 2003 and 2002 (dollars in thousands):
Quarter Ended March 31,
------------------------------------------
Increase
2003 2002 (Decrease)
------------ ------------ ------------
Interest income ............................. $ 11,012 $ 11,951 $ (939)
Interest expense ............................ 6,243 7,226 (983)
------------ ------------ ------------
Net interest income ......................... 4,769 4,725 44
Provision for loan losses ................... -- -- --
------------ ------------ ------------
Net interest income after provision
for loan losses ........................... 4,769 4,725 44
Realized losses on sales .................... -- (62) 62
Other income ................................ 261 237 24
Compensation and benefits ................... 1,131 944 187
Other expense ............................... 1,298 1,316 (18)
------------ ------------ ------------
Income before taxes ......................... $ 2,601 $ 2,640 $ (39)
============ ============ ============
Net Interest Income
The Bank’s net
interest income was approximately $4.8 million for the quarter ended March 31,
2003, an increase of $44 thousand over net interest income for the first quarter
of 2002. Average interest-earning assets increased by $41 million in the first
quarter of 2003 over the corresponding 2002 period, and interest-bearing
liabilities increased by approximately $37 million over the same periods.
Partially offsetting this net increase in interest-earning assets was a 3-basis
point drop in interest spread, from 2.14% for the first quarter of 2002 to 2.11%
for the first quarter of 2003. The Bank’s net interest margin decreased
slightly, from 2.64% for the quarter ended March 31, 2002 to 2.52% for the
quarter ended March 31, 2003.
The Bank’s interest income on loans was approximately $8.1 million for the first quarter of 2003, compared with $9.4 million for the first quarter of 2002. The decline in interest rates triggered both a repricing of FBBH’s variable-rate loans and rapid prepayments on its fixed-rate loans throughout 2002 and continuing into 2003. Consequently, the average aggregate loan balances decreased by $20.9 million from the quarter ended March 31, 2002 to the quarter ended March 31, 2003, and the yield decreased by 75 basis points, from 7.38% to 6.63%, for the same periods. In the first quarter of 2003, the Bank’s loan originations and purchases totaled $36.6 million, compared with principal repayments of $41.0 million.
Interest income on investment securities increased from $2.4 million for the quarter ended March 31, 2002 to $2.9 million for the quarter ended March 31, 2003. Utilizing new borrowing sources and its excess liquidity, the Bank purchased approximately $281 million in AAA-rated mortgage-backed and other investment securities in 2002 and an additional $18 million in the first quarter of 2003. Despite significant prepayments on these assets throughout the past year, the Bank’s average balance of securities increased by $81.8 million from the first quarter of 2002 to the first quarter of 2003. This significantly higher volume more than offset the effects of the 89-basis point drop in yield, from 5.24% to 4.35%, over the same periods.
FBBH’s interest expense on deposits decreased by $1.2 million from the quarter ended March 31, 2002 to the quarter ended March 31, 2003. This decrease was a result of declines in both the average balance and average rates paid. The Bank raised significant amounts of certificates of deposit in prior years to fund certain loan acquisitions, but has since permitted the run-off of the higher-rate CDs and utilized debt facilities as its primary funding source. As a result, the average balance of deposits decreased by $42.9 million from the first quarter of 2002 to the first quarter of 2003. In addition, the average rate paid on deposits declined by 80 basis points, from 4.13% to 3.33%, over the same periods.
The Bank’s interest expense on borrowings increased by approximately $0.2 million from the first quarter of 2002 to the first quarter of 2003. This increase was due to an $80.2 million increase in the total average balance of borrowings for the periods. The proceeds from these borrowings were used primarily to fund the purchases of mortgage-backed and other securities described above and, to a lesser extent, to replace matured certificates of deposit. This increase in the volume of borrowings was partially offset by a decrease in the weighted-average rate paid from 5.07% for the first quarter of 2002 to 4.03% for the first quarter of 2003. The decrease in market interest rates primarily affected the cost of the Bank’s repurchase agreements only; substantially all of the Bank’s FHLB advances had fixed rates of interest and thus were unaffected by rate changes.
- 16 -
Provision for Loan Losses
Provisions for losses on
loans are charged to operations to maintain an allowance for losses on the loan
portfolio at a level which the Bank believes is adequate based on an evaluation
of the inherent risks in the portfolio. The Bank’s evaluation is based on
an analysis of the loan portfolio, historical loss experience, current economic
conditions and trends, collateral values, and other relevant factors. Based on
its quarterly evaluations of the adequacy of its loan loss reserves, the Bank
did not record a provision for loan losses in 2002 or in the first quarter of
2003.
Realized Losses on Sales
The Bank sold approximately
$19.6 million of mortgage-backed securities for a realized loss of $62 thousand
during the quarter ended March 31, 2002, with no such sales activity in the
first quarter of 2003.
Compensation and Benefits
The Bank’s
compensation and benefits totaled approximately $1.1 million for the first
quarter of 2003, compared with $0.9 million for the first quarter of 2002. This
increase was due to an increase in the Bank’s employee head count from
March 31, 2002 to March 31, 2003, primarily as a result of the expansion of its
commercial lending operations.
Other Expenses
The Bank’s other
expenses totaled approximately $1.3 million for the quarter ended March 31,
2003, compared with a similar amount for the quarter ended March 31, 2002. Costs
remained largely consistent in most expense categories, reflecting the
Bank’s efforts to control overhead.
Following are condensed statements of financial condition for FBBH as of March 31, 2003 and December 31, 2002:
March 31, December 31,
2003 2002
------------ ------------
(Dollars in thousands)
ASSETS:
Cash and cash equivalents ................................................. $ 9,234 $ 10,003
Mortgage-backed securities available for sale, at fair value .............. 233,000 259,707
Other investment securities available for sale, at fair value ............. 22,260 11,962
Loans, net ................................................................ 481,741 486,821
Real estate owned, net .................................................... 725 1,040
Other assets .............................................................. 25,109 24,545
------------ ------------
Total assets .......................................................... $ 772,069 $ 794,078
============ ============
LIABILITIES:
Deposits .................................................................. $ 385,097 $ 395,781
Short-term borrowings ..................................................... 87,098 91,870
FHLB advances ............................................................. 206,000 216,000
Other liabilities ......................................................... 16,036 13,795
------------ ------------
Total liabilities ..................................................... 694,231 717,446
NET WORTH ................................................................. 77,838 76,632
------------ ------------
Total liabilities and net worth ....................................... $ 772,069 $ 794,078
============ ============
- 17 -
Mortgage-Backed and Other Securities Available for Sale. The Bank’s total portfolio of mortgage-backed securities (MBS) available for sale decreased by $26.7 million during the quarter ended March 31, 2003. This decrease was primarily due to $33.4 million in principal repayments and $0.4 million in unrealized losses. The declining interest-rate environment continued to trigger significant paydowns on the loans underlying the securities in the portfolio and, as a result of an acceleration of our prepayment-rate assumptions, negatively impacted the securities’ market values. These decreases were partially offset by $7.6 million in purchases of AAA-rated MBS during the quarter.
The Bank’s portfolio of treasury and other investment securities available for sale increased by approximately $10.3 million during the first quarter of 2003 as a result of the purchase of an agency security during the quarter.
Loans, net. The Bank’s portfolio of loans, net of discounts and allowances, decreased by approximately $5.1 million during the quarter ended March 31, 2003. This net decrease was attributable to principal repayments of $41.0 million as a result of the continuing decline in market interest rates. The Bank partially offset these paydowns with $29.8 million in new loan originations and $6.8 million in new loan portfolio acquisitions in the quarter.
Real Estate Owned, net. The Bank’s portfolio of real estate owned, net decreased by approximately $0.3 million in the first quarter of 2003, as a result of sales of $0.7 million of properties, partially offset by $0.4 million in new acquisitions through foreclosure.
Deposits. The Bank's deposits decreased by approximately $10.7 million during the quarter ended March 31, 2003, primarily due to maturities of higher-rate certificates of deposit. The Bank has permitted the run-off of such deposits in an effort to reduce its overall cost of funds, and is utilizing short-term repurchase agreements and FHLB advances as its primary funding source.
Short-Term Borrowings. The Bank’s short-term borrowings decreased by approximately $4.8 million in the first quarter of 2003. This decrease was due to repayments of $52.8 million of repurchase agreements bearing interest at an average rate of 1.57%, partially offset by $48 million in new borrowings with an average rate of 1.35%. These borrowings are used primarily to finance the Bank’s purchases of mortgage-backed and other investment securities.
FHLB Advances. The Bank’s FHLB advances decreased by $10 million in the first quarter of 2003. This decrease was due to the maturity in March 2003 of a $16 million, 3-year advance bearing interest at 7.10%. The Bank replaced a portion of this matured advance with a new $6 million advance bearing interest at 2.81% and maturing in 2007.
Net Worth. The Bank’s total net worth increased by approximately $1.2 million during the quarter ended March 31, 2003. The Bank earned net income for the first quarter of $1.5 million, which was partially offset by after-tax unrealized losses of approximately $0.2 million on its portfolio of available-for-sale securities and $59 thousand on its hedging transactions.
Federally insured savings associations such as FBBH are required to maintain minimum levels of regulatory capital. Those standards generally are as stringent as the comparable capital requirements imposed on national banks. The OTS has indicated that the capital level of FBBH exceeds the minimum requirement for “well capitalized” status under provisions of the Prompt Corrective Action Regulation.
- 18 -
The following table sets forth the Bank's regulatory capital ratios at March 31, 2003.
Amount Required
For Capital To be Categorized
Adequacy as
Actual Purposes "Well Capitalized"
----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Total Capital to Risk-Weighted Assets (Risk-Based
Capital)........................................... $ 78,412 15.9% $ 39,490 =>8.0% $ 49,363 =>10.0%
Tier 1 Capital to Risk-Weighted Assets................. 72,235 14.6% Not Applicable 29,618 => 6.0%
Core Capital to Tangible Assets........................ 72,235 9.4% 30,700 =>4.0% 38,375 => 5.0%
Tangible Capital to Tangible Assets.................... 72,235 9.4% 11,513 =>1.5% Not Applicable
Liquidity is the measurement of the Bank’s ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund investments, purchase pools of loans, and make payments for general business purposes. The Bank’s sources of liquidity include FHLB advances, repurchase agreements, retail and wholesale deposits, whole loan and mortgage-backed securities sales, and net interest income. In April 2003, the FHLB raised the Bank’s authorized borrowing limit from 30% to 35% of the Bank’s total assets as of the previous quarter-end. Liquidity in the Bank’s operations is actively managed on a daily basis and periodically reviewed by the Bank’s Board of Directors.
At March 31, 2003 the Bank’s cash balances totaled approximately $9.2 million, compared with $10.0 million at December 31, 2002. The slight decrease in cash was primarily due to repayments of debt facilities and maturities of certificates of deposit during the first quarter of 2003, partially offset by principal repayments of loans and mortgage-backed securities.
At March 31, 2003, the Bank had approximately $334.7 million of certificates of deposit. Scheduled maturities of certificates of deposit during the 12 months ending March 31, 2004 and thereafter amounted to approximately $223.7 million and approximately $111.0 million, respectively. Wholesale deposits generally are more responsive to changes in interest rates than core deposits, and thus are more likely to be withdrawn by the investor upon maturity as changes in interest rates and other factors are perceived by investors to make other investments more attractive. Bank management continues its effort to reduce its exposure to interest rate changes by utilizing funding sources whose repricing characteristics more closely match those of the Bank’s interest-earning assets.
In 2001 the OTS rescinded the regulatory requirement that institutions maintain an average daily balance of liquid assets of at least 4% of its liquidity base. Even though the percentage requirement has been eliminated, each bank is still required by the OTS to maintain adequate liquidity to assure safe and sound operation. It is the Bank’s responsibility to determine the appropriate level of liquidity to be maintained.
WFSG conducts its Specialty Servicing and Finance Operations through WCC, our servicing subsidiary which was formed pursuant to our June 10, 1999 reorganization, and through WFC, our investment subsidiary. Certain of WCC’s and WFC’s activities are conducted with a lender which has participation interests in the returns generated by the assets that serve as collateral for the related borrowings. The share of such activities held by this lender is reflected as “Investor participation interest” in the Company’s consolidated statements of operations.
- 19 -
The following table compares operating income before taxes of our Specialty Servicing and Finance Operations for the quarters ended March 31, 2003 and 2002 (dollars in thousands).
WCC and WFC for the Quarter
Ended March 31,
------------------------------------------
Increase
2003 2002 (Decrease)
------------ ------------ ------------
Servicing income ....................... $ 7,879 $ 5,776 $ 2,103
Interest income ........................ 1,084 1,878 (794)
Realized gains on sales ................ 5 44 (39)
Other (loss) income .................... (156) 543 (699)
------------ ------------ ------------
Total income ........................ 8,812 8,241 571
------------ ------------ ------------
Interest expense ....................... 169 381 (212)
Provision for loan losses .............. 30 13 17
Compensation and benefits .............. 5,314 4,353 961
Other expenses ......................... 1,967 2,731 (764)
------------ ------------ ------------
Total expenses ...................... 7,480 7,478 2
------------ ------------ ------------
Income before taxes .................... $ 1,332 $ 763 $ 569
============ ============ ============
Servicing Income
The components of servicing income in our Specialty Servicing and Finance Operations are reflected in the following table:
Quarter Ended
March 31,
---------------------------
2003 2002
------------ ------------
(Dollars in thousands)
Servicing revenue........................................... $ 7,009 $ 5,955
Ancillary fees ............................................. 2,320 1,462
Amortization of mortgage servicing rights .................. (881) (977)
Valuation adjustment for mortgage servicing rights.......... 228 (103)
Custodial float ............................................ 279 308
Unreimbursed servicing expenses ............................ (268) (84)
Prepayment interest shortfall expense ...................... (808) (785)
------------ ------------
Total servicing income.................................. $ 7,879 $ 5,776
============ ============
Total servicing income for the quarter ended March 31, 2003 was approximately $7.9 million, compared with $5.8 million for the quarter ended March 31, 2002. The increase was due to the continuing growth in WCC’s servicing volume (see portfolio growth, below). As a result of new contractual flow agreements and, to a lesser extent, servicing rights acquisitions, WCC has increased its portfolio of serviced loans by approximately $1.5 billion since March 31, 2002, despite significant repayments precipitated by the decline in interest rates. As a result of this expansion, our total servicing income increased by approximately 36% from the first quarter of 2002 to the first quarter of 2003.
The continuing decline in mortgage interest rates which began in 2001 and the currently prevailing low interest rate environment have resulted in relatively rapid prepayments of loans comprising our serviced asset base which, in turn, has impacted negatively servicing revenues. However, prepayment speeds have generally declined or remained stable over the past two quarters ending March 31, 2003. Our amortization of MSRs was approximately $0.9 million for the quarter ended March 31, 2003, compared with approximately $1.0 million for the first quarter of 2002. In addition, our float income earned on deposit balances remained constant at $0.3 million for each period, and the interest we are required to pay to securitization trusts (“prepayment interest shortfall expense”) under our servicing agreements was approximately $0.8 million for both quarters.
WCC’s serviced loan assets increased by approximately $1.05 billion during the quarter, reflecting WCC’s purchase of the rights to service approximately 5,000 loans with an aggregate unpaid principal balance of $789 million, and additional contracts to service approximately 17,000 loans totaling $766 million in unpaid principal. The transfer of these loans was completed in March 2003. These additions were offset by an approximate $503 million runoff of WCC’s serviced asset base, primarily from prepayments.
- 20 -
The following table sets forth the composition of loans serviced by WCC by type of loan at the dates indicated.
March 31, December 31, March 31,
2003 2002 2002
------------ ------------ ------------
(Dollars in thousands)
Single-family residential ........................ $ 4,700,019 $ 3,668,401 $ 3,290,208
Multi-family residential ......................... 120,876 121,908 117,274
Commercial real estate ........................... 236,809 218,976 188,699
Consumer and other ............................... 81,868 78,880 89,693
------------ ------------ ------------
Total (1) ................................... $ 5,139,572 $ 4,088,165 $ 3,685,874
============ ============ ============
(1) WCC's servicing portfolio at March 31, 2003 and December 31, 2002 also included approximately $0.3 billion unpaid principal balance of non-performing consumer loans in addition to those reflected in the above table.
Interest Income and Interest Expense
Interest income in our
Specialty Servicing and Finance Operations was approximately $1.1 million for
the quarter ended March 31, 2003, compared with $1.9 million for the quarter
ended March 31, 2002. The decrease was due to a drop in loan volume as a result
of WCC’s and WFC’s sales of $10.6 million unpaid principal balance of
loans in the second quarter of 2002. Proceeds from these sales were used to pay
down certain debt facilities, resulting in a decrease in interest expense for
the corresponding periods.
Other (Loss) Income
The components of other (loss) income in our Specialty Servicing and Finance Operations are reflected in the following table:
Quarter Ended
March 31,
---------------------------
2003 2002
------------ ------------
(Dollars in thousands)
Other (loss) income:
Real estate owned, net ........................... $ (15) $ (74)
Investor participation interest .................. (70) (326)
Other, net ....................................... (71) 943
------------ ------------
Total other (loss) income .................... $ (156) $ 543
============ ============
Other (loss) income includes the co-investor’s share of certain investment activities conducted with WCC and WFC, which is reported as “Investor participation interest.” Other, net decreased from the first quarter of 2002 to the first quarter of 2003, primarily as a result of a $0.7 million gain from recoveries in connection with certain servicer advances during the 2002 period.
Compensation and Benefits
Compensation and employee
benefits totaled approximately $5.3 million for the quarter ended March 31,
2003, compared with approximately $4.4 million for the quarter ended March 31,
2002. This increase was due to a continuing increase in WCC’s employee head
count as a result of the expansion of our loan servicing operations.
Other Expenses
Other expenses in our
Specialty Servicing and Finance Operations were approximately $2.0 million for
the quarter ended March 31, 2003, compared with $2.7 million for the quarter
ended March 31, 2002. This decrease was due to a $0.7 million decline in legal
expenses. In March 2002 we accrued significant expenses and charges related to
the settlement of litigation arising from events prior to our June 1999
restructuring. (See “RESULTS OF OPERATIONS – QUARTER ENDED MARCH 31,
2003 COMPARED TO QUARTER ENDED MARCH 31, 2002” above.)
- 21 -
Following are condensed statements of financial condition for our Specialty Servicing and Finance Operations as of March 31, 2003 and December 31, 2002:
March 31, December 31,
2003 2002
------------ ------------
(Dollars in thousands)
ASSETS:
Cash and cash equivalents....................................................... $ -- $ 2,770
Mortgage-backed securities available for sale, at fair value.................... 1,575 1,828
Discounted loans, net........................................................... 6,062 6,630
Real estate owned, net.......................................................... 47 61
Servicer advance receivables, net............................................... 26,383 19,922
Purchased mortgage servicing rights, net........................................ 10,842 5,405
Intercompany receivables........................................................ 16,224 15,144
Other assets.................................................................... 6,139 5,807
------------ -----------
Total assets................................................................ $ 67,272 $ 57,567
============ ===========
LIABILITIES:
Short-term borrowings........................................................... $ 5,000 $ --
Long-term investment financing.................................................. 7,132 4,284
Other liabilities............................................................... 10,786 8,958
------------ -----------
Total liabilities.......................................................... 22,918 13,242
NET WORTH....................................................................... 44,354 44,325
------------ -----------
Total liabilities and net worth............................................. $ 67,272 $ 57,567
============ ===========
Mortgage-Backed Securities Available for Sale. WFC’s portfolio of mortgage-backed securities available for sale decreased by approximately $0.3 million during the quarter ended March 31, 2003 as a result of a decrease in net unrealized gains. WFC received $0.7 million in principal repayments in the first quarter of 2003 on its mortgage-backed securities, which have been written down to a book value of zero. Any subsequent payments received are recorded directly to interest income. We currently hold only those securities which are backed by loans in WCC’s servicing portfolio, as such investments provide operating leverage to our core business.
Discounted Loans, net. Discounted loans, net decreased by approximately $0.6 million from December 31, 2002 to March 31, 2003 primarily as a result of principal payments received during the quarter.
Servicer Advance Receivables, net. Servicer advance receivables, net increased by approximately $6.5 million during the quarter ended March 31, 2003. This increase resulted from new principal and interest advances by WCC during the quarter, partially offset by recoveries of advances on loans previously made.
Purchased Mortgage Servicing Rights, net. Purchased mortgage servicing rights, net (MSRs) increased by approximately $5.4 million for the quarter ended March 31, 2003, primarily as a result of purchases of $6.1 million of MSRs associated with new servicing portfolio acquisitions. In addition, we recorded a net recovery of approximately $0.2 million in impairment charges previously taken. These increases were partially offset by $0.9 million of amortization of MSRs during the quarter.
Intercompany Receivables. Intercompany receivables increased by approximately $1.1 million from year-end 2002 to March 31, 2003. This increase was primarily due to an ongoing transfer of funds from WFC to WFSG to meet WFSG’s operating costs.
Short-Term Borrowings and Long-Term Investment Financing. Short-term borrowings and long-term investment financing in our Specialty Servicing and Finance Operations increased by approximately $7.8 million during the quarter ended March 31, 2003. WCC utilized its commercial bank lines of credit to fund new servicer advances and its acquisitions of servicing rights during the quarter.
- 22 -
Liquidity is the measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund investments, purchase pools of loans, and make payments for general business purposes. Our sources of cash flow for our Specialty Servicing and Finance Operations include primarily servicing revenue, sales of mortgage servicing assets and/or interest-earning assets, net interest income and lines of credit from commercial banks. The availability of liquidity from our line of credit facilities is subject to the Company’s maintenance of sufficient available collateral to pledge against such borrowings. We are currently maintaining sufficient collateral under the credit agreements. Liquidity in our Specialty Servicing and Finance Operations is actively managed on a daily basis and is periodically reviewed by our Board of Directors. This process is intended to ensure the maintenance of sufficient funds to meet the needs of the Company.
At March 31, 2003, liquidity in our Specialty Servicing and Finance Operations (including cash and unused borrowings under our credit facilities) totaled $10.0 million, compared with approximately $22.3 million at December 31, 2002. Based on our current and expected asset size, capital levels, and organizational infrastructure, we believe there will be sufficient available liquidity to meet our needs. In addition, we intend to use our available capital in a manner which will not make us dependent on securitizations as a source of liquidity. As a result, we have no present intent to securitize loans as a source of liquidity.
We no longer own subordinated mortgage-backed securities backed by loan pools serviced by unaffiliated third parties, and currently hold subordinated mortgage-backed securities only where we act as servicer of the loan pools backing these securities. At March 31, 2003 we held $1.6 million of such mortgage-backed securities.
Adequate credit facilities and other sources of funding are essential to the continuation of the Company’s ability to purchase and contract for servicing assets and to acquire pools of loans. The Company’s strategy is dependent in part on its ability to find credit facilities and equity partners for purchases of servicing assets and, to a lesser extent, loan pools. This strategy will depend largely on the Company’s ability to find and use capital partners for our Specialty Servicing and Finance Operations. Otherwise, our business could be significantly curtailed or delayed.
Our Holding Company and Miscellaneous Operations consist of other operating revenues and expenses not directly attributable to our Banking Operations or Specialty Servicing and Finance Operations, and also includes eliminations of intercompany accounts and transactions. Primary sources of liquidity include funds available from the Company’s wholly-owned non-bank subsidiaries, proceeds from the July 2002 issuance of junior subordinated debt, and payments received from FBBH pursuant to a tax allocation agreement between the Company and the Bank. However, the OTS has limited the amount of these payments to the lesser of (1) the Bank’s stand-alone tax liability and (2) the total tax payments made by the Company. In January 2003 the Bank remitted $0.4 million to the Company for a portion of its 2001 liability under the foregoing formula. WFSG will continue to depend on its non-Bank subsidiaries to meet its liquidity needs.
The “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as disclosures included elsewhere in this Form 10-Q, are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingencies. On an ongoing basis, we evaluate the estimates used, including those related to allowances for loan losses, other than temporary impairment in the market values of investment securities and other assets, assumptions used to estimate fair values of certain financial instruments for which there is not an active market, the allocation of basis between assets sold and retained, the selection of yields utilized to recognize interest income on certain mortgage-backed securities, and contingencies and litigation. We base our estimates on historical experience, current conditions and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources as well as identifying and assessing our accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions.
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We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of the consolidated financial statements:
• Mortgage-Backed and Other Investment Securities Available for Sale. The Company’s mortgage-backed and other investment securities available for sale are reported at their current fair market value. In determining current fair value when quotes from third parties are not available, we estimate the present value of the anticipated cash flows of the securities based on certain assumptions, including the amount and timing of future repayments, the discount rate to be used, and default rates and expected losses on the loans underlying the securities. If the change in market value is considered temporary, the unrealized holding gains and losses are reported net of tax, when applicable, as a separate component of accumulated other comprehensive income in stockholders’ equity. In the event of a decline in market value, management must evaluate whether the decline is temporary in nature or other than temporary. Declines that are considered other than temporary are reflected as “Market valuation losses and impairments” in the consolidated statements of operations and not as a direct reduction to stockholders’ equity. The Company’s portfolio of mortgage-backed and other investment securities available for sale has increased significantly over the past two years and, as of March 31, 2003, represented more than 30% of consolidated total assets. Consequently, fluctuations in the securities’ values can have a significant impact on our financial condition and results of operations.
• Allowance for Loan Losses. In estimating the allowance for loan losses, management utilizes historical experience as well as other factors, including the effect of changes in the real estate market on collateral values, the effect on the loan portfolio of current economic indicators and their probable impact on borrowers, and increases or decreases in nonperforming and impaired loans. Changes in these factors may cause management’s estimate of the allowance to increase or decrease and result in adjustments to the Company’s provision for loan losses in its consolidated statements of operations and the carrying value of the Company’s loans on its consolidated statement of financial condition.
• Mortgage Servicing Rights. Our loan servicing business represents an increasingly significant proportion of our core operations. In determining the fair value of our mortgage servicing rights (MSRs), we make assumptions of market discount rates, prepayment speeds, default rates and related servicing costs which affect the estimated present value of future cash flows. Changes in these assumptions and economic factors may result in increases or decreases in the carrying value of our MSRs and increases or decreases in the amortization of MSRs and valuation allowances related to MSRs.
• Income Taxes. At March 31, 2003 we had a total deferred tax asset of approximately $53.6 million. This asset represents the tax effect of future deductible or taxable amounts and is attributable to carryforwards, such as net operating losses and capital losses, and also to temporary differences between amounts that have been recognized in the financial statements and amounts that have been recognized in the Company’s income tax returns. In accounting for the deferred tax asset, we apply Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” which requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. We evaluate the deferred tax asset quarterly and, as of March 31, 2003, have recorded a valuation allowance of approximately $49.2 million. The net deferred tax asset, $4.4 million, is included in prepaid expenses and other assets in our consolidated statement of financial condition as of March 31, 2003. We currently believe that it is more likely than not that this portion of the deferred tax asset will be realized. However, there can be no assurance that the amount, if any, that we ultimately realize will not differ materially from our assessment. As portions of the deferred tax asset are realized and the valuation allowance is reduced, the related benefits, to the extent they relate to our post-reorganizational period, are recorded as a deferred tax benefit in our consolidated statements of operations. As benefits relating to our pre-reorganizational period are realized, they are recorded as a direct increase to stockholders’ equity.
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• Contingencies. We are party to various legal proceedings, as discussed above and in the notes to the consolidated financial statements. These matters have a degree of uncertainty associated with them. We continually assess the likely outcomes of these proceedings, the amounts of any related ongoing costs, and the adequacy of amounts provided for these matters. There also can be no assurance that all matters that may be brought against us or that we may bring against other parties are known to us at any point in time.
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The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in such statements. All of the statements contained in this Quarterly Report on Form 10-Q which are not identified as historical should be considered forward-looking. In connection with certain forward-looking statements contained in this Quarterly Report on Form 10-Q and those that may be made in the future by or on behalf of the Company which are identified as forward-looking, the Company notes that there are various factors that could cause actual results to differ materially from those set forth in any such forward-looking statements. Such factors include, but are not limited to, the condition of the real estate market, interest rates, regulatory matters, the availability of pools of servicing rights and loans at acceptable prices, and the availability and conditions of financing for loan pool acquisitions, mortgage loan servicing rights and other financial assets. Accordingly, there can be no assurance that the forward-looking statements contained in this Quarterly Report on Form 10-Q will be realized or that actual results will not be significantly higher or lower. The forward-looking statements have not been audited by, examined by or subjected to agreed-upon procedures by independent accountants, and no third party has independently verified or reviewed such statements. Readers of this Quarterly Report on Form 10-Q should consider these facts in evaluating the information contained herein. The inclusion of the forward-looking statements contained in this Quarterly Report on Form 10-Q should not be regarded as a representation by the Company or any other person that the forward-looking statements contained in this Quarterly Report on Form 10-Q will be achieved. In light of the foregoing, readers of this Quarterly Report on Form 10-Q are cautioned not to place undue reliance on the forward-looking statements contained herein.
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It is our objective to attempt to control risks associated with interest rate movements. In general, management’s strategy is to limit our exposure to earnings volatility and variations in the value of assets and liabilities as interest rates change over time. Our asset and liability management strategy is formulated and monitored by the investment committee of the Company and the asset and liability committee of the Bank (the “Committees”) which meet 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 activity, and maturities of investments and borrowings. FBBH’s Asset and Liability Committee establishes rate sensitivity tolerances (within regulatory guidelines) which are approved by the Bank’s Board of Directors, and coordinates with the Bank’s Board with respect to overall asset and liability composition.
The Committees are authorized to utilize off-balance sheet financial techniques to assist them in the management of interest rate risk. These techniques include interest rate swap agreements, pursuant to which the parties exchange the difference between fixed-rate and floating-rate interest payments on a specified principal amount (referred to as the “notional amount”) for a specified period without the exchange of the underlying principal amount. The Bank has entered into a $35 million notional principal amount interest rate swap agreement, which became effective in December 2002 and matures in December 2004. Pursuant to the agreement, the Bank will pay interest at a fixed rate of 2.22% and receive quarterly interest payments at the three-month LIBOR rate.
We continually monitor the interest rate sensitivity of our portfolios of interest-earning assets and interest-bearing liabilities in conjunction with the current interest rate environment. When a new pool of loans, securities or mortgage servicing rights is acquired, we will assess the incremental change in our sensitivity to interest rates, and determine accordingly whether or not to hedge.
In addition, as required by OTS regulations, the Bank’s Asset and Liability Committee also regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on the interest rate sensitivity of Net Portfolio Value (“NPV”), which is defined as the net present value of an institution’s existing assets, liabilities and off-balance sheet instruments. The Committee further evaluates such impacts against the maximum tolerable change in interest income that is authorized by the Board of Directors of the Bank.
The following table quantifies the potential changes in the Company’s net portfolio value at March 31, 2003, should interest rates increase or decrease by 100 to 300 basis points, assuming the yield curves of the rate shocks will be parallel to each other.
Net Portfolio Value NPV as % of Assets
------------------------------------- --------------------
$ Amount $ Change % Change NPV Ratio Change
---------- ---------- ---------- --------- --------
Change in Rates (Dollars in thousands)
+300bp............................. $ 97,815 $ (34,337) (26)% 12.08% (315)bp
+200bp............................. 112,684 (19,468) (15) 13.54 (169)bp
+100bp............................. 127,363 (4,789) (4) 14.90 (33)bp
0bp............................. 132,152 -- -- 15.23 --
-100bp............................. 129,908 (2,244) (2) 14.86 (37)bp
-200bp............................. 126,158 (5,994) (5) 14.38 (85)bp
-300bp............................. 123,150 (9,002) (7) 14.04 (119)bp
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In determining net portfolio value, Management relies upon various assumptions, including, but not limited to, prepayment speeds on the Company’s assets and the discount rates to be used. We review our assumptions regularly and adjust them when it is deemed appropriate based on current and future expected market conditions. At March 31, 2003, we utilized a lower discount rate than at the previous quarter-end because we believe the lower rate represents a more typical coupon rate that could be earned on newly-originated commercial and multi-family loans. As a result, our consolidated NPV increased substantially over the prior quarter under every rate-change scenario.
Management believes that the assumptions (including prepayment assumptions) it uses to evaluate the vulnerability of our operations to changes in interest rates approximate actual experience and considers them reasonable. However, the interest rate sensitivity of our assets and liabilities and the estimated effects of changes in interest rates on NPV could vary substantially if different assumptions were used or actual experience differs from the historical experience on which they are based.
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Evaluation of Controls and Procedures
We maintain a set of
disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our reports filed under the Securities Exchange Act
of 1934, as amended (“Exchange Act”) is recorded, processed,
summarized and reported within the time periods specified in the SEC’s
rules and forms. Within the 90 days prior to the date of this report, we carried
out an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act.
Based on that evaluation, our CEO and CFO concluded that the Company’s
disclosure controls and procedures are effective in timely alerting him to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company’s Exchange Act
filings.
Changes in internal controls
There have been no
significant changes in the Company’s internal controls or in other factors
that could significantly affect internal controls subsequent to the date of that
evaluation.
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| PART II. | OTHER INFORMATION |
| Item 1. | Legal Proceedings. |
The Company is a defendant in other legal actions arising from transactions conducted in the ordinary course of business. Some of these claims involve individual borrowers, for themselves and in one instance for a class of borrowers, demanding material amounts for alleged damages. Management, after consultation with legal counsel, and based on prior experience with consumer claims, believes the ultimate liability, if any, arising from such actions will not materially affect the Company’s financial position, consolidated results of operations or cash flows.
| Item 2. | Changes in Securities. |
| Not applicable. |
| Item 3. | Defaults Upon Senior Securities. |
| Not applicable. |
| Item 4. | Submission of Matters to a Vote of Security Holders. |
| Not applicable. |
| Item 5. | Other Information. |
| Not applicable. |
| Item 6. | Exhibits and Reports on Form 8-K. |
| (a) | Exhibits. |
| 99.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.§1350 |
| (b) | The following reports on Form 8-K were filed during the quarter covered by this report, and subsequently through the date of issuance: |
| Current Report on Form 8-K dated April 18, 2003, reporting the resignation of the Company’s Executive Vice President and Chief Financial Officer and appointment of its interim Chief Financial Officer. |
| Current Report on Form 8-K dated April 30, 2003, reporting the Company’s operating results for the quarter ended March 31, 2003. |
| Current Report on Form 8-K dated May 6, 2003, announcing the date of the Company’s annual shareholder meeting. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| WILSHIRE FINANCIAL SERVICES GROUP INC. |
Date: May 12, 2003
| By: | /s/ STEPHEN P. GLENNON |
| Stephen P. Glennon | |
| Chief Executive Officer and | |
| Chief Financial Officer |
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I, Stephen P. Glennon, certify that:
| 1. | I have reviewed this quarterly report on Form 10-Q of Wilshire Financial Services Group Inc.; |
| 2. | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; |
| 4. | The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: |
| a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; |
| b) | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and |
| c) | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
| 5. | The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): |
| a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| b) | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
| 6. | The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. |
| Date: May 12, 2003 | /s/ STEPHEN P. GLENNON |
| Stephen P. Glennon | |
| Chief Executive Officer and | |
| Chief Financial Officer |
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