(Mark one)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 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 July 31, 2003 |
| Common Stock, par value $0.01 per share | 18,635,491 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...........................................16
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........30
Item 4. Controls and Procedures.............................................32
Item 1. Legal Proceedings...................................................33
Item 2. Changes in Securities...............................................33
Item 3. Defaults Upon Senior Securities.....................................33
Item 4. Submission of Matters to a Vote of Security Holders.................33
Item 5. Other Information...................................................33
Item 6. Exhibits and Reports on Form 8-K....................................33
Signature.....................................................................35
June 30, December 31,
2003 2002
ASSETS ------------ ------------
Cash and cash equivalents ........................................................... $ 15,173 $ 17,579
Government agency mortgage-backed securities available for sale, at fair value ...... 166,027 211,082
AAA mortgage-backed securities available for sale, at fair value .................... 39,321 48,320
Other mortgage-backed securities available for sale, at fair value .................. 1,585 2,133
Investment securities available for sale, at fair value ............................. 25,572 11,962
Loans, net of allowance for loan losses of $6,765 and $7,980 ........................ 487,847 486,667
Discounted loans, net of allowance for loan losses of $41,069 and $40,920 ........... 5,622 6,630
Stock in Federal Home Loan Bank of San Francisco, at cost ........................... 11,080 10,808
Real estate owned, net .............................................................. 683 1,101
Leasehold improvements and equipment, net ........................................... 3,147 3,218
Accrued interest receivable ......................................................... 3,766 4,043
Servicer advance receivables, net ................................................... 26,306 19,922
Service fees receivable ............................................................. 2,760 2,334
Purchased mortgage servicing rights, net ............................................ 9,255 5,405
Receivables from loan servicers ..................................................... 502 462
Intangible assets, net .............................................................. 3,572 3,701
Prepaid expenses and other assets ................................................... 18,382 7,654
------------ ------------
TOTAL ..................................................................... $ 820,600 $ 843,021
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits ................................................... $ 4,355 $ 3,659
Interest-bearing deposits ...................................................... 350,545 392,122
Short-term borrowings .......................................................... 94,000 91,870
Accounts payable and other liabilities ......................................... 23,404 14,284
FHLB advances .................................................................. 218,000 216,000
Investment financing ........................................................... 5,232 4,284
Trust preferred subordinated debt .............................................. 20,000 20,000
Investor participation liability ............................................... 1,435 1,346
------------ ------------
Total liabilities ......................................................... 716,971 743,565
------------ ------------
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, 24,251,037
and 23,820,874 shares issued (including treasury shares of 5,626,212) ....... 116,260 114,357
Treasury stock, 5,626,212 shares, at cost ...................................... (15,106) (15,106)
Accumulated deficit ............................................................ (126) (3,096)
Accumulated other comprehensive income, net .................................... 2,601 3,301
------------ ------------
Total stockholders' equity ................................................ 103,629 99,456
------------ ------------
TOTAL ..................................................................... $ 820,600 $ 843,021
============ ============
See notes to unaudited interim condensed consolidated financial statements
3
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
INTEREST INCOME:
Loans ....................................................... $ 8,426 $ 9,638 $ 16,896 $ 20,483
Mortgage-backed securities .................................. 2,547 2,473 6,014 5,405
Securities and federal funds sold ........................... 217 300 389 640
------------ ------------ ------------ ------------
Total interest income ......................................... 11,190 12,411 23,299 26,528
------------ ------------ ------------ ------------
INTEREST EXPENSE:
Deposits .................................................... 2,776 3,928 5,989 8,350
Borrowings .................................................. 3,233 3,234 6,696 6,505
------------ ------------ ------------ ------------
Total interest expense ...................................... 6,009 7,162 12,685 14,855
------------ ------------ ------------ ------------
NET INTEREST INCOME .................................................. 5,181 5,249 10,614 11,673
(RECAPTURE OF) PROVISION FOR LOSSES ON LOANS ......................... (700) 223 (670) 236
------------ ------------ ------------ ------------
NET INTEREST INCOME AFTER (RECAPTURE OF) PROVISION FOR LOSSES ON
LOANS ............................................................ 5,881 5,026 11,284 11,437
------------ ------------ ------------ ------------
OTHER INCOME:
Servicing income ............................................ 7,906 6,024 15,747 11,546
Loan fees and charges ....................................... 27 29 50 71
Real estate owned, net ...................................... (112) (65) (87) (111)
Gain on sale of loans ....................................... 75 2,436 80 2,480
Loss on sale of securities .................................. -- -- -- (62)
Market valuation losses and impairments...................... -- (1,373) -- (1,373)
Investor participation interest ............................. (59) (1,219) (129) (1,545)
Other, net .................................................. 517 (55) 731 1,206
------------ ------------ ------------ ------------
Total other income .......................................... 8,354 5,777 16,392 12,212
------------ ------------ ------------ ------------
OTHER EXPENSES:
Compensation and employee benefits .......................... 7,391 6,177 14,162 11,818
Professional services ....................................... 1,542 1,031 2,691 2,818
Occupancy ................................................... 527 539 1,080 1,082
FDIC insurance premiums ..................................... 107 104 215 209
Data processing ............................................. 279 337 533 601
Communication ............................................... 216 290 449 602
Insurance ................................................... 365 275 705 554
Corporate travel and development ............................ 43 79 126 169
Depreciation................................................. 396 437 804 859
Amortization of intangibles ................................. 64 64 129 129
Postage and courier expense ................................. 314 217 574 520
Provision for litigation claims ............................. -- -- -- 3,600
Other general and administrative expenses ................... 609 601 1,183 1,309
------------ ------------ ------------ ------------
Total other expenses ........................................ 11,853 10,151 22,651 24,270
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE MINORITY INTEREST AND
INCOME TAXES ..................................................... 2,382 652 5,025 (621)
MINORITY INTEREST .................................................... -- (325) -- (125)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES .................................... 2,382 327 5,025 (746)
INCOME TAX PROVISION (BENEFIT) ....................................... 976 1 2,055 (299)
------------ ------------ ------------ ------------
NET INCOME (LOSS) .................................................... $ 1,406 $ 326 $ 2,970 $ (477)
============ ============ ============ ============
Earnings (loss) per share - basic..................................... $ 0.08 $ 0.02 $ 0.16 $ (0.03)
Earnings (loss) per share - diluted................................... $ 0.07 $ 0.02 $ 0.15 $ (0.03)
Weighted average shares outstanding - basic........................... 18,435,365 16,196,365 18,330,116 16,188,615
Weighted average shares outstanding - diluted......................... 20,410,295 21,379,651 20,330,328 16,188,615
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................ 2,970 2,970
Unrealized holding loss
on available for sale
securities - net of tax
benefit of $426......... (561) (561)
Unrealized loss on
interest-rate swap - net
of tax benefit of $91... (139) (139)
--------
Total comprehensive income.... 2,270
Tax benefit from utilization
of pre-reorganizational
Net Operating Losses
(Note 3).................. 1,352 1,352
Exercise of stock options.... 430,163 551 551
------ ------ ----------- --------- ----------- ---------- ---------- ------------- ---------
BALANCE, June 30, 2003........ -- $ -- 24,251,037 $ 116,260 (5,626,212) $ (15,106) $ (126) $ 2,601 $ 103,629
====== ====== =========== ========= =========== ========== ========== ============= =========
__________
(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
Six Months Ended
June 30,
---------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ........................................................... $ 2,970 (447)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
(Recapture of) provision for losses on loans ........................... (670) 236
Provision for losses on real estate owned .............................. 110 18
Valuation adjustment for mortgage servicing rights ..................... (139) 421
Market valuation losses and impairments ................................ -- 1,373
Depreciation and amortization .......................................... 933 988
Tax effect from utilization of net operating loss carryforward ......... 1,352 --
(Gain) loss on sale of real estate owned ............................... (57) 88
Loss on sale of mortgage servicing rights .............................. -- 22
Gain on sale of loans .................................................. (80) (2,480)
Loss on sale of securities ............................................. -- 62
(Gain) loss on disposal of equipment ................................... (8) 6
Amortization of discounts and deferred fees ............................ 1,598 1,522
Amortization of mortgage servicing rights .............................. 2,375 1,868
Federal Home Loan Bank stock dividends ................................. (272) (265)
Minority interest ...................................................... -- 125
Change in:
Servicer advance receivables ........................................... (6,384) 3,074
Service fees receivable ................................................ (426) (92)
Accrued interest receivable ............................................ 277 (513)
Receivables from other loan servicers .................................. (40) 850
Prepaid expenses and other assets ...................................... 391 564
Accounts payable and other liabilities ................................. (1,707) 4,965
Investor participation liability ....................................... 89 621
------------ ------------
Net cash provided by operating activities ......................... 312 13,006
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of loans ...................................................... (17,648) --
Proceeds from sale of loans ............................................ 4,068 --
Loan repayments ........................................................ 74,579 106,846
Loan originations ...................................................... (61,417) (44,938)
Purchase of discounted loans ........................................... (30,075) (10)
Proceeds from sale of discounted loans ................................. 30,308 7,395
Purchase of mortgage-backed securities available for sale .............. (27,784) (131,979)
Proceeds from sale of mortgage-backed securities available for sale .... -- 19,513
Repayment of mortgage-backed securities available for sale ............. 79,950 15,345
Purchase of investment securities available for sale ................... (13,458) (13,731)
Proceeds from sale of real estate owned ................................ 822 498
Purchases of leasehold improvements and equipment ...................... (738) (819)
Proceeds from sale of leasehold improvements and equipment ............. 13 17
Purchase of mortgage servicing rights .................................. (6,088) (115)
Proceeds from sale of mortgage servicing rights ........................ 2 297
------------ ------------
Net cash provided by (used in) investing activities ............... 32,534 (41,681)
------------ ------------
See notes to unaudited interim condensed consolidated financial statements
6
Six Months Ended
June 30,
---------------------------
2003 2002
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits................................................ $ (40,881) $ (35,818)
Proceeds from FHLB advances ........................................ 18,000 --
Repayments of FHLB advances............................................. (16,000) --
Net increase in short-term borrowings................................... 2,130 52,333
Proceeds from servicing acquisition notes............................... 4,006 2,444
Repayment of servicing acquisition notes................................ (3,058) (9,752)
Issuance of convertible subordinated debentures......................... -- 7,690
Issuance of common stock pursuant to exercise of stock options.......... 551 40
------------ ------------
Net cash (used in) provided by financing activities................ (35,252) 16,937
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS....................................... (2,406) (11,738)
CASH AND CASH EQUIVALENTS:
Beginning of period..................................................... 17,579 39,974
------------ ------------
End of period........................................................... $ 15,173 $ 28,236
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION--Cash paid for:
Interest................................................................ $ 12,145 $ 15,292
Income taxes............................................................ 295 423
NONCASH INVESTING ACTIVITIES:
Additions to real estate owned acquired in settlement of loans.......... 457 517
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 six months ended June 30, 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 income (loss).
At June 30, 2003, the Company's banking subsidiary, First Bank of Beverly Hills, F.S.B. ("FBBH" or the "Bank"), had outstanding commitments to fund $10.0 million of 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 $0.8 million and $1.3 million, respectively, for the quarter and six months ended June 30, 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 this litigation will be dismissed. However, this dismissal would not affect any continuing obligation of the Company for legal costs of the prior officers arising from such events.
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, are 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 $1.0 million and $2.1 million, respectively, for the quarter and six months ended June 30, 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 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 June 30, 2003 and December 31, 2002 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.
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares and potentially dilutive stock options and convertible debentures 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 and six-month periods ended June 30, 2003 and 2002. For the six months ended June 30, 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 number of common shares outstanding was equivalent for both basic and diluted loss per share.
9
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Basic earnings (loss) per share:
Net income (loss) ................................ $ 1,406 $ 326 $ 2,970 $ (447)
Weighted average number of common shares
outstanding - basic ........................... 18,435,365 16,196,365 18,330,116 16,188,615
------------ ------------ ------------ ------------
Net income (loss) per share - basic .............. $ 0.08 $ 0.02 $ 0.16 $ (0.03)
============ ============ ============ ============
Diluted earnings (loss) per share:
Net income (loss) ................................ $ 1,406 $ 326 $ 2,970 $ (447)
Tax-effected interest expense attributable to 8%
Convertible Debentures ........................ -- 101 -- N/A
------------ ------------ ------------ ------------
Net earnings (loss) assuming dilution ............ $ 1,406 $ 427 $ 2,970 $ (447)
------------ ------------ ------------ ------------
Weighted average number of common shares
outstanding ................................... 18,435,365 16,196,365 18,330,116 16,188,615
Effect of potentially dilutive securities:
8% Convertible Debentures ..................... -- 3,396,416 -- N/A
Outstanding stock options ..................... 1,974,930 1,786,870 2,000,212 N/A
------------ ------------ ------------ ------------
Weighted average number of common shares
outstanding - diluted ......................... 20,410,295 21,379,651 20,330,328 16,188,615
------------ ------------ ------------ ------------
Net income (loss) per share - diluted.......... $ 0.07 $ 0.02 $ 0.15 $ (0.03)
============ ============ ============ ============
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 Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- ------------
Net income (loss), as reported................. $ 1,406 $ 326 $ 2,970 $ (447)
Less: Total stock-based employee compensation
expense determined under fair value-based
method for all awards, net of related tax
effects..................................... 123 199 246 333
----------- ----------- ----------- -----------
Pro forma net income (loss).................... $ 1,283 $ 127 $ 2,724 $ (780)
=========== =========== =========== ============
Earnings (loss) per share:
Basic - as reported......................... $ 0.08 $ 0.02 $ 0.16 $ (0.03)
=========== =========== =========== ============
Basic - pro forma........................... $ 0.07 $ 0.01 $ 0.15 $ (0.05)
=========== =========== =========== ============
Diluted - as reported....................... $ 0.07 $ 0.02 $ 0.15 $ (0.03)
=========== =========== =========== ============
Diluted - pro forma......................... $ 0.06 $ 0.01 $ 0.13 $ (0.05)
=========== =========== =========== ============
10
Effective the second quarter of 2003, the Company redefined its operating segments in order to reflect a complete separation of its investment operations from its servicing operations. Consequently, the operating results of the Company’s investment subsidiary, Wilshire Funding Corporation (“WFC”), are now reported as an individual business segment (“Mortgage Investments”), separate from those of its loan servicing subsidiary, WCC. (In prior periods, the results of WCC and WFC were combined into one operating segment known as “Specialty Servicing and Finance Operations”.) The Company continues to conduct its banking operations through FBBH.
The Company in the second quarter of 2003 also revised the method by which it allocates certain operating expenses among its business entities. As a result, in current and future periods WCC will assume higher proportions of overall compensation and benefits, insurance, depreciation and various other categories of expenses. The additional expenses allocated to WCC from the other business segments totaled approximately $0.2 million for the quarter and six-month period ended June 30, 2003. On an annual basis, the total additional expenses transferred to WCC is expected to approximate $1.5 million, with corresponding reductions at FBBH, WFC and the holding company of approximately $0.2 million, $1.0 million and $0.3 million, respectively. The Company believes that this new allocation methodology accurately reflects the costs to be incurred by each business entity, and more closely matches the operating segments’ expenses with their revenue-producing activities.
The Company’s operating segments differ in terms of regulatory environment, funding sources and asset acquisition strategies, as described below:
| o | 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 wholesale certificates of deposit, retail deposits, FHLB advances and repurchase agreements. The Bank is a federally chartered savings bank and is regulated by the Office of Thrift Supervision (“OTS”). At June 30, 2003, FBBH had total assets of $767.5 million. |
| o | Loan Servicing Operations—Through its loan 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. As of June 30, 2003, WCC serviced approximately $5.1 billion principal balance of residential and commercial mortgage pools for more than 500 individual and institutional investors and government agencies. WCC’s funding sources consist primarily of internal liquidity and commercial bank financing. |
| o | Mortgage Investment Operations— The Company’s investment subsidiary, WFC, acquires mortgage-backed securities and pools of performing, sub-performing and non-performing residential and commercial loans. WFC conducts certain of these activities with an institutional investor where such investments align the Company’s interests with those of the institutional investor. WFC’s funding sources consist primarily of commercial bank financing and co-investors, with debt service repayment terms that generally parallel the cash flows of the underlying collateral. |
| o | 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. In addition, this segment includes interest expense on the $20 million of junior subordinated debt issued in July 2002 and eliminations of intercompany accounts and transactions. Primary sources of liquidity include funds available from the Company’s non-bank subsidiaries, proceeds from the July 2002 issuance of junior subordinated debt and, to a limited extent, reimbursement payments received from FBBH pursuant to a tax allocation agreement between the Company and the Bank. However, OTS regulations limit the amount of these tax reimbursement 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 June 30, 2003 and 2002 are as follows:
Three Months Ended June 30, 2003
------------------------------------------------------------------------
Holding
Company and
Loan Mortgage Miscellaneous
Banking Servicing Investments Operations Total
------------ ------------ ------------ ------------ ------------
Interest income .................................... $ 10,417 $ 19 $ 729 $ 25 $ 11,190
Interest expense ................................... 5,624 122 20 243 6,009
------------ ------------ ------------ ------------ ------------
Net interest income (expense) ...................... 4,793 (103) 709 (218) 5,181
(Recapture of) provision for loan losses ........... (750) -- 50 -- (700)
------------ ------------ ------------ ------------ ------------
Net interest income (expense) after
(recapture of) provision for loan
losses .......................................... 5,543 (103) 659 (218) 5,881
Realized gains on asset sales ...................... -- 75 -- -- 75
Servicing income ................................... 204 8,016 (3) (311) 7,906
Other (loss) income ................................ (200) 430 (151) 294 373
Compensation and benefits .......................... 1,144 5,457 151 639 7,391
Other expense ...................................... 1,247 1,790 58 1,367 4,462
------------ ------------ ------------ ------------ ------------
Income (loss) before taxes ......................... 3,156 1,171 296 (2,241) 2,382
Income tax provision (benefit) ..................... 1,326 -- 153 (503) 976
------------ ------------ ------------ ------------ ------------
Net income (loss) .................................. $ 1,830 $ 1,171 $ 143 $ (1,738) $ 1,406
============ ============ ============ ============ ============
Total assets ....................................... $ 767,516 $ 41,970 $ 25,900 $ (14,786) $ 820,600
============ ============ ============ ============ ============
Three Months Ended June 30, 2002
------------------------------------------------------------------------
Holding
Company and
Loan Mortgage Miscellaneous
Banking Servicing Investments Operations Total
------------ ------------ ------------ ------------ ------------
Interest income ................................. $ 11,135 $ 74 $ 1,168 $ 34 $ 12,411
Interest expense ................................ 6,770 155 139 98 7,162
------------ ------------ ------------ ------------ ------------
Net interest income (expense) ................... 4,365 (81) 1,029 (64) 5,249
Provision for loan losses ....................... -- 153 70 -- 223
------------ ------------ ------------ ------------ ------------
Net interest income (expense) after
provision for loan losses .................... 4,365 (234) 959 (64) 5,026
Realized and unrealized (losses) gains .......... (1,373) 1,904 532 -- 1,063
Servicing income ................................ 148 6,480 16 (620) 6,024
Other (loss) income ............................. (179) (1,089) (569) 527 (1,310)
Compensation and benefits ....................... 936 4,663 217 361 6,177
Other expense ................................... 1,384 1,749 201 640 3,974
------------ ------------ ------------ ------------ ------------
Income (loss) before minority interest
and taxes ..................................... 641 649 520 (1,158) 652
Minority interest ............................... -- -- -- (325) (325)
------------ ------------ ------------ ------------ ------------
Income (loss) before taxes ...................... 641 649 520 (1,483) 327
Income tax provision (benefit) .................. 255 -- -- (254) 1
------------ ------------ ------------ ------------ ------------
Net income (loss) ............................... $ 386 $ 649 $ 520 $ (1,229) $ 326
============ ============ ============ ============ ============
Total assets .................................... $ 746,364 $ 28,080 $ 26,692 $ 6,779 $ 794,357
============ ============ ============ ============ ============
12
Segment data for the six months ended June 30, 2003 and 2002 are as follows:
Six Months Ended June 30, 2003
------------------------------------------------------------------------
Holding
Company and
Loan Mortgage Miscellaneous
Banking Servicing Investments Operations Total
------------ ------------ ------------ ------------ ------------
Interest income .................................... $ 21,429 $ 62 $ 1,770 $ 38 $ 23,299
Interest expense ................................... 11,867 263 48 507 12,685
------------ ------------ ------------ ------------ ------------
Net interest income (expense) ...................... 9,562 (201) 1,722 (469) 10,614
(Recapture of) provision for loan losses ........... (750) -- 80 -- (670)
------------ ------------ ------------ ------------ ------------
Net interest income (expense) after (recapture of)
provision for loan losses ....................... 10,312 (201) 1,642 (469) 11,284
Realized gains on asset sales ...................... -- 75 5 -- 80
Servicing income ................................... 503 15,811 81 (648) 15,747
Other (loss) income ................................ (238) 437 (314) 680 565
Compensation and benefits .......................... 2,275 10,566 356 965 14,162
Other expense ...................................... 2,545 3,629 186 2,129 8,489
------------ ------------ ------------ ------------ ------------
Income (loss) before taxes ......................... 5,757 1,927 872 (3,531) 5,025
Income tax provision (benefit) ..................... 2,418 -- 357 (720) 2,055
------------ ------------ ------------ ------------ ------------
Net income (loss) .................................. $ 3,339 $ 1,927 $ 515 $ (2,811) $ 2,970
============ ============ ============ ============ ============
Total assets ....................................... $ 767,516 $ 41,970 $ 25,900 $ (14,786) $ 820,600
============ ============ ============ ============ ============
Six Months Ended June 30, 2002
------------------------------------------------------------------------
Holding
Company and
Loan Mortgage Miscellaneous
Banking Servicing Investments Operations Total
------------ ------------ ------------ ------------ ------------
Interest income .................................... $ 23,086 $ 243 $ 2,878 $ 321 $ 26,528
Interest expense ................................... 13,996 337 337 185 14,855
------------ ------------ ------------ ------------ ------------
Net interest income (expense) ...................... 9,090 (94) 2,541 136 11,673
Provision for loan losses .......................... -- 166 70 -- 236
------------ ------------ ------------ ------------ ------------
Net interest income (expense) after
provision for loan losses ....................... 9,090 (260) 2,471 136 11,437
Realized and unrealized (losses) gains ............. (1,434) 1,904 576 (1) 1,045
Servicing income ................................... 371 12,162 109 (1,096) 11,546
Other (loss) income ................................ (165) (497) (618) 901 (379)
Compensation and benefits .......................... 1,880 8,798 434 706 11,818
Other expense ...................................... 2,699 4,261 420 5,072 12,452
------------ ------------ ------------ ------------ ------------
Income (loss) before minority interest
and taxes ........................................ 3,283 250 1,684 (5,838) (621)
Minority interest .................................. -- -- -- (125) (125)
------------ ------------ ------------ ------------ ------------
Income (loss) before taxes ......................... 3,283 250 1,684 (5,963) (746)
Income tax provision (benefit) ..................... 1,349 -- -- (1,648) (299)
------------ ------------ ------------ ------------ ------------
Net income (loss) .................................. $ 1,934 $ 250 $ 1,684 $ (4,315) (447)
============ ============ ============ ============ ============
Total assets ....................................... $ 746,364 $ 28,080 $ 26,692 $ (6,779) $ 794,357
============ ============ ============ ============ ============
13
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 June 30, 2003
---------------------------------
Gross Carrying Accumulated
Amount Amortization
--------------- ---------------
Goodwill............................. $ 3,393 $ (339)
Core deposit intangible.............. 1,294 (776)
--------------- ---------------
Total............................. $ 4,687 $ (1,115)
=============== ===============
For the quarter and six months ended June 30, 2003 the Company recorded amortization expense of $65 and $129, respectively, related to the core deposit intangible. The estimated amortization of the balance for the remainder of 2003 and the five succeeding fiscal years is $129 (2003), $259 (2004), $130 (2005), and none thereafter.
The Company tested goodwill for impairment as of March 31, 2003 and determined that no impairment charge was required. There were no conditions that indicated impairment as of June 30, 2003.
The Company’s purchased mortgage servicing rights (MSRs) totaled approximately $9.3 million at June 30, 2003, $5.4 million at December 31, 2002, and $6.0 million at June 30, 2002. Amortization expense for MSRs was $1.5 million and $2.4 million, respectively, for the quarter and six months ended June 30, 2003, and $0.9 million and $1.9 million, respectively, for the quarter and six months ended June 30, 2002. The estimated amortization expense of the June 30, 2003 balance of MSRs for the remainder of 2003 and the five succeeding fiscal years is $2.0 million (2003), $3.0 million (2004), $1.8 million (2005), $1.1 million (2006), $0.6 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, FBBH sold its Bankcard Division to iPayment Holdings, Inc. for a total purchase price of approximately $6.2 million, including approximately $0.4 million consisting of a contingency payment due the Bank upon one merchant customer’s attainment of certain processing volumes. In a lawsuit commenced by FBBH 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.
14
WFSG on May 13, 2002 entered into a settlement agreement to resolve litigation which arose from the financial collapse of CCL, and the Company 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 this litigation will be dismissed.
The Company is a defendant in other legal actions arising from transactions conducted in the ordinary course of business. Some of these claims involve borrowers demanding 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.
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51". FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 are effective with the first interim period beginning after June 15, 2003. The Company is currently evaluating the impact that the adoption of FIN 46 may have on its financial position and results of operations.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. SFAS No. 149 was issued to amend and clarify financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 149 is effective for contracts entered into or modified subsequent to June 30, 2003 and for hedging relationships designated subsequent to June 30, 2003. The Company does not believe that the adoption of SFAS No. 149 will have a material impact on its financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The Standard requires that certain freestanding financial instruments be classified as liabilities, including mandatorily redeemable financial instruments, obligations to repurchase the issuer’s equity shares by transferring assets and certain obligations to issue a variable number of shares. SFAS No. 150 is effective for financial instruments entered into or modified subsequent to May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not believe that the adoption of SFAS No. 150 will have a material impact on its financial position, results of operations or cash flows.
15
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"); (2) specialized mortgage loan servicing operations through Wilshire Credit Corporation ("WCC") and (3) mortgage investment operations through Wilshire Funding Corporation ("WFC"). 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 June 30, 2003 was approximately $1.4 million, or $0.08 per basic share, compared with $0.3 million, or $0.02 per basic share, for the quarter ended June 30, 2002. WFSG's pre-tax income was approximately $2.4 million for the second quarter of 2003, compared with $0.3 million for the second quarter of 2002.
The increase in income for the second quarter of 2003 over the second quarter of 2002 was primarily due to a $1.9 million increase in consolidated net servicing income, reflecting the continuing growth of our loan servicing operations. In addition, our banking subsidiary recaptured $0.75 million of loan loss reserves during the quarter pursuant to a loan sale. The results for the 2002 period included $1.4 million of impairment write-downs related to two interest-only mortgage-backed securities (I/Os) at the banking subsidiary, with no such charges in the 2003 period. Partially offsetting these factors was a $1.7 million increase in consolidated other operating expenses, which resulted primarily from higher compensation costs due to the expansion of our loan servicing operations, and a $0.6 million increase in legal expenses which we continue to incur on behalf of some former officers.
For the six months ended June 30, 2003, our net income was approximately $3.0 million, or $0.16 per basic share, compared with a net loss of $0.4 million, or $0.03 per basic share, for the six months ended June 30, 2002. Our pre-tax income was approximately $5.0 million for the first six months of 2003, compared with a pre-tax loss of $0.7 million for the corresponding 2002 period.
Our results for the six months ended June 30, 2003 versus the comparable 2002 period reflect a $4.2 million increase in net servicing income and a net increase of $0.9 million in recapture of loan loss reserves. (The 2002 results were adversely impacted by the $1.4 million of impairment charges cited above.) In addition, our consolidated operating expenses for the first six months of 2003 declined by $1.6 million compared with the corresponding 2002 period. This decrease resulted from approximately $4.75 million in legal fees and expenses which were accrued in the first quarter of 2002 and related to the May 13, 2002 settlement of litigation which arose from events prior to our 1999 restructuring. The absence of such expenses in the current year was partially offset by an increase in compensation expense, primarily at our loan servicing subsidiary.
Following is a discussion of the operating results of the Company's three principal business segments: our Banking Operations, Loan Servicing Operations and Mortgage Investment Operations.
The following table compares income before taxes for FBBH for the quarters and six-month periods ended June 30, 2003 and 2002 (dollars in thousands):
16
Quarter Ended June 30, Six Months Ended June 30,
------------------------------------------ ------------------------------------------
Increase Increase
2003 2002 (Decrease) 2003 2002 (Decrease)
------------ ------------ ------------ ------------ ------------ ------------
Interest income ................. $ 10,417 $ 11,135 $ (718) $ 21,429 $ 23,086 $ (1,657)
Interest expense ................ 5,624 6,770 (1,146) 11,867 13,996 (2,129)
------------ ------------ ------------ ------------ ------------ ------------
Net interest income ............. 4,793 4,365 428 9,562 9,090 472
Recapture of loan losses ........ (750) -- (750) (750) -- (750)
------------ ------------ ------------ ------------ ------------ ------------
Net interest income after
recapture of loan losses ...... 5,543 4,365 1,178 10,312 9,090 1,222
Realized and unrealized losses .. -- (1,373) 1,373 -- (1,434) 1,434
Servicing income ................ 204 148 56 503 371 132
Other loss ...................... (200) (179) (21) (238) (165) (73)
Compensation and benefits ....... 1,144 936 208 2,275 1,880 395
Other expense ................... 1,247 1,384 (137) 2,545 2,699 (154)
------------ ------------ ------------ ------------ ------------ ------------
Income before taxes ............. $ 3,156 $ 641 $ 2,515 $ 5,757 $ 3,283 $ 2,474
============ ============ ============ ============ ============ ============
Net Interest Income
The following table sets forth information regarding the Bank’s income from interest-earning assets and expenses from interest-bearing liabilities for the quarters ended June 30, 2003 and 2002.
Quarter Ended June 30, 2003 Quarter Ended June 30, 2002
------------------------------------ ------------------------------------
Average Annualized Average Annualized
Balance Interest Yield/Rate Balance Interest Yield/Rate
---------- ---------- ---------- ---------- ---------- ----------
Interest-Earning Assets:
Federal funds and short-term investments ..... $ 14,212 $ 43 1.20% $ 20,655 $ 94 1.80%
Mortgage-backed and other securities ......... 249,348 2,282 3.66 211,995 2,539 4.79
Loans ........................................ 482,905 8,092 6.70 482,309 8,502 7.05
---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning assets ............ $ 746,465 $ 10,417 5.52% $ 714,959 $ 11,135 6.16%
---------- ---------- ---------- ---------- ---------- ----------
Interest-Bearing Liabilities:
Interest-bearing deposits..................... $ 365,404 $ 2,776 3.05% $ 414,706 $ 3,928 3.80%
Borrowings.................................... 305,997 2,848 3.73 232,965 2,842 4.89
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities........ $ 671,401 $ 5,624 3.36% $ 647,671 $ 6,770 4.19%
---------- ---------- ---------- ---------- ---------- ----------
Net interest income................. $ 4,793 $ 4,365
========== ==========
Net interest spread................. 2.16% 1.97%
Net interest margin................. 2.58% 2.45%
The following table sets forth information regarding the Bank’s income from interest-earning assets and expenses from interest-bearing liabilities for the six-month periods ended June 30, 2003 and 2002.
Six Months Ended June 30, 2003 Six Months Ended June 30, 2002
------------------------------------ ------------------------------------
Average Annualized Average Annualized
Balance Interest Yield/Rate Balance Interest Yield/Rate
---------- ---------- ---------- ---------- ---------- ----------
Interest-Earning Assets:
Federal funds and short-term investments...... $ 14,525 $ 94 1.29% $ 27,606 $ 263 1.89%
Mortgage-backed and other securities.......... 256,259 5,145 4.02 196,699 4,916 5.00
Loans ........................................ 485,868 16,190 6.66 496,018 17,907 7.22
---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning assets............. $ 756,652 $ 21,429 5.63% $ 720,323 $ 23,086 6.37%
---------- ---------- ---------- ---------- ---------- ----------
Interest-Bearing Liabilities:
Interest-bearing deposits..................... $ 378,487 $ 5,989 3.19% $ 424,578 $ 8,350 3.97%
Borrowings.................................... 305,322 5,878 3.88 228,686 5,646 4.98
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities........ $ 683,809 $ 11,867 3.50% $ 653,264 $ 13,996 4.32%
---------- ---------- ---------- ---------- ---------- ----------
Net interest income................. $ 9,562 $ 9,090
========== ==========
Net interest spread................. 2.13% 2.05%
Net interest margin................. 2.55% 2.55%
17
The Bank’s net interest income was approximately $4.8 million for the quarter ended June 30, 2003, compared with $4.4 million for the quarter ended June 30, 2002. For the six months ended June 30, 2003, the Bank’s net interest income was approximately $9.6 million, compared with $9.1 million for the six months ended June 30, 2002. The continuing declining interest-rate environment has impacted the Bank’s interest-bearing liabilities to a slightly greater extent than its interest-earning assets, resulting in a higher interest spread in the 2003 periods.
The Bank’s net interest spread increased by 19 basis points, from 1.97% to 2.16%, from the second quarter of 2002 to the second quarter of 2003. The yield on average interest-earning assets declined by 64 basis points, from 6.16% to 5.52%, from the second quarter of 2002 to the second quarter of 2003. This drop in yield was exceeded by an 83-basis point decline, from 4.19% to 3.36%, in the Bank’s cost of interest-bearing liabilities for the same periods.
For the six-month periods ended June 30, the interest spread increased by 8 basis points, from 2.05% for the 2002 period to 2.13% for the 2003 period. The Bank’s yield on interest-earning assets declined from 6.37% for the six months ended June 30, 2002 to 5.63% for the six months ended June 30, 2003, and the Bank’s average cost of funds reflected a slightly larger decrease, from 4.32% to 3.50%, for the same periods.
The Bank’s interest income on mortgage-backed and other investment securities decreased by approximately $0.3 million from the second quarter of 2002 to the second quarter of 2003, as the 113-basis point drop in yield, from 4.79% to 3.66%, more than offset the $37 million increase in average aggregate principal balances invested in the 2003 period. For the six months ended June 30, 2003, interest income on mortgage-backed and other investment securities was $5.1 million, an increase of $0.2 million from the corresponding 2002 period. The increase in income for the six-month period was due to a larger increase in the average aggregate principal balances invested ($59.6 million) and a slightly smaller drop in yield, from 5.00% to 4.02%. Utilizing new debt facilities, the Bank purchased approximately $295 million in AAA-rated mortgage-backed and other investment securities in 2002 and an additional $41 million in the first six months of 2003. These additions to the portfolio have sustained the Bank’s interest income on securities despite significant prepayments triggering accelerated premium amortization on these assets throughout the past two years as a result of the continuing decline in interest rates.
The Bank’s interest income on loans was approximately $8.1 million for the quarter ended June 30, 2003, compared with $8.5 million for the quarter ended June 30, 2002. For the six months ended June 30, 2003, interest on loans was approximately $16.2 million, compared with $17.9 million for the six months ended June 30, 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 $10.1 million from the first six months of 2002 to the first six months of 2003, and the yield decreased substantially for the same periods. In the first six months of 2003, principal repayments on the Bank’s loans totaled $74 million. The Bank originated and purchased a total of $79 million in new loans during this period, the majority in the second quarter of 2003.
FBBH’s interest expense on deposits decreased by approximately $1.2 million from the second quarter of 2002 to the second quarter of 2003 and by $2.4 million from the six months ended June 30, 2002 to the six months ended June 30, 2003. These decreases were the result of declines in both the average balance and average rates paid for the quarters and six-month periods. The Bank raised significant amounts of wholesale 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 lower-costing debt facilities as its primary funding source. As a result, the average balance of deposits decreased by $49.3 million and $46.1 million, respectively, for the quarter and six months ended June 30, 2003 compared with the corresponding 2002 periods. The average rate paid on deposits decreased by 75 basis points and 78 basis points over the same periods.
The Bank’s interest expense on borrowings was $2.8 million for the second quarters of both 2003 and 2002, as the effects of the higher volume in the 2003 period were offset by the 116-basis point decline in the average cost. For the six months ended June 30, 2003, interest expense on borrowings was $5.9 million, compared with $5.6 million for the six months ended June 30, 2002. This increase was due to a $76.6 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 4.98% for the six months of 2002 to 3.88% for the first six months of 2003.
18
Recapture of 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 for the six months ended June 30, 2003. In the second quarter of 2003, the Bank recaptured $0.75 million of loan loss reserves, primarily as a result of the sale of its performing mobile home loan portfolio.
Realized and Unrealized Losses
The Bank’s realized
and unrealized losses totaled approximately $1.4 million for the quarter and six
months ended June 30, 2002, with no such activity through the first six months
of 2003. In June 2002, the Bank recorded approximately $1.4 million in
write-downs related to two interest-only mortgage-backed securities (I/Os).
These securities were purchased in March and April 2002 as a hedge against
possible increases in interest rates. However, as rates continued to fall, the
market values of the I/Os decreased significantly. Since this decline in market
value was deemed to be other than temporary, the write-downs were reflected as
“Market valuation losses and impairments” in the accompanying
statements of operations for the quarter and six-month period ended June 30,
2002, and not as a direct reduction to stockholders’ equity. The Bank also
recorded a loss of approximately $62 thousand on the sale of mortgage-backed
securities in the first quarter of 2002.
Compensation and Benefits
The Bank’s
compensation and benefits totaled approximately $1.1 million for the second
quarter of 2003, compared with $0.9 million for the second quarter of 2002. For
the six months ended June 30, 2003, compensation and benefits totaled $2.3
million, compared with $1.9 million for the first six months of 2002. The
increase was due to an increase in the Bank’s employee head count from 2002
to 2003, primarily as a result of the expansion of its commercial lending
operations.
Other Expenses
The Bank’s other
expenses were approximately $1.2 million for the quarter ended June 30, 2003,
compared with $1.4 million for the quarter ended June 30, 2002. For the six
months ended June 30, 2003, other expenses totaled $2.5 million, compared with
$2.7 million for the first six months of 2002. The Bank’s occupancy
expenses have declined from the prior year due to the sublease of the office
space which was previously used for its Bankcard divisions, and data processing
expenses have dropped substantially through the Bank’s efforts to control
overhead. These decreases were partially offset by higher legal expenses
associated with pending litigation related to the Bank’s sale of its
Bankcard operations in 2001 (see Note 7 to the interim condensed consolidated
financial statements).
Following are condensed statements of financial condition for FBBH as of June 30, 2003 and December 31, 2002:
June 30, December 31,
2003 2002
------------ ------------
(Dollars in thousands)
ASSETS:
Cash and cash equivalents ............................................ $ 11,932 $ 10,003
Mortgage-backed securities available for sale, at fair value ......... 205,598 259,707
Other investment securities available for sale, at fair value ........ 25,572 11,962
Loans, net ........................................................... 487,959 486,821
Real estate owned, net ............................................... 636 1,040
Other assets ......................................................... 35,819 24,545
------------ ------------
Total assets ..................................................... $ 767,516 $ 794,078
============ ============
LIABILITIES:
Deposits ............................................................. $ 354,900 $ 395,781
Short-term borrowings ................................................ 88,000 91,870
FHLB advances ........................................................ 218,000 216,000
Other liabilities .................................................... 27,085 13,795
------------ ------------
Total liabilities ................................................ 687,985 717,446
NET WORTH ............................................................ 79,531 76,632
------------ ------------
Total liabilities and net worth .................................. $ 767,516 $ 794,078
============ ============
19
Mortgage-Backed and Other Securities Available for Sale. The Bank’s total portfolio of mortgage-backed securities (MBS) available for sale decreased by $54.1 million during the six months ended June 30, 2003. This decrease was due to $79.9 million in principal repayments and $0.7 million in unrealized losses, as the declining interest-rate environment continued to trigger significant paydowns on the loans underlying the securities in the portfolio. These decreases were partially offset by $27.8 million in purchases of AAA-rated and agency MBS during the first two quarters.
The Bank’s portfolio of treasury and other investment securities available for sale increased by approximately $13.6 million during the six months ended June 30, 2003, primarily as a result of $13.5 million of agency security purchases in the first two quarters.
Loans, net. The Bank’s portfolio of loans, net of discounts and allowances, increased by approximately $1.1 million for the six months ended June 30, 2003. In the current year to date, the Bank has originated $61.4 million of predominantly commercial mortgage loans and purchased an additional $17.6 million multi-family loans. These additions to the portfolio were partially offset by $73.8 million of principal repayments and a sale of $4.1 million of loans secured by mobile homes.
Real Estate Owned, net. The Bank’s portfolio of real estate owned, net decreased by approximately $0.4 million in the first six months of 2003, as a result of sales and write-downs of properties totaling $0.9 million, partially offset by $0.5 million in new acquisitions through foreclosure.
Deposits. The Bank's deposits decreased by approximately $40.9 million during the first six months of 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 $3.9 million during the six months ended June 30, 2003. This decrease was due to repayments of $96.9 million of repurchase agreements, partially offset by repurchase advances and renewals totaling $93 million, at a weighted-average cost of 1.33%. 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 increased by $2 million for the first six months of 2003. This increase was due to $18 million of new advances during the period with a weighted average cost of 2.08%, partially offset by the maturity of a $16 million advance bearing interest at 7.10%.
Net Worth. The Bank’s total net worth increased by approximately $2.9 million during the six months ended June 30, 2003. The Bank earned net income for the period of $3.3 million, which was partially offset by after-tax unrealized losses of approximately $0.3 million on its portfolio of available-for-sale securities and $0.1 million 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.
The following table sets forth the Bank's regulatory capital ratios at June 30, 2003.
20
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)......................................... $ 80,553 15.6% $ 41,190 =>8.0% $ 51,488 =>10.0%
Tier 1 Capital to Risk-Weighted Assets............... 74,130 14.4% Not Applicable 30,893 => 6.0%
Core Capital to Tangible Assets...................... 74,130 9.7% 30,526 =>4.0% 38,158 => 5.0%
Tangible Capital to Tangible Assets.................. 74,130 9.7% 11,447 =>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 wholesale and retail deposits, FHLB advances, repurchase agreements, 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 June 30, 2003 the Bank’s cash balances totaled approximately $11.9 million, compared with $10.0 million at December 31, 2002. The slight increase in cash was primarily due to principal repayments of loans and mortgage-backed securities and proceeds from new borrowings, partially offset by originations and purchases of new loans, repayments of debt facilities and maturities of certificates of deposit.
At June 30, 2003, the Bank had approximately $303.9 million of certificates of deposit. Scheduled maturities of certificates of deposit during the 12 months ending June 30, 2004 and thereafter amounted to approximately $274.2 million and $29.7 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 Loan Servicing Operations through WCC, our servicing subsidiary which was formed pursuant to our June 10, 1999 reorganization. Some of WCC’s activities are conducted with a co-investor 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 co-investor is reflected as “Investor participation interest” in the Company’s consolidated statements of operations.
The following table compares WCC’s operating income before taxes for the quarters and six-month periods ended June 30, 2003 and 2002 (dollars in thousands).
21
Quarter Ended June 30, Six Months Ended June 30,
------------------------------------ ------------------------------------
Increase Increase
2003 2002 (Decrease) 2003 2002 (Decrease)
---------- ---------- ---------- ---------- ---------- ----------
Servicing income ............. $ 8,016 $ 6,480 $ 1,536 $ 15,811 $ 12,162 $ 3,649
Interest income .............. 19 74 (55) 62 243 (181)
Realized gains on sales ...... 75 1,904 (1,829) 75 1,904 (1,829)
Other income (loss) .......... 430 (1,089) 1,519 437 (497) 934
---------- ---------- ---------- ---------- ---------- ----------
Total income .............. 8,540 7,369 1,171 16,385 13,812 2,573
---------- ---------- ---------- ---------- ---------- ----------
Interest expense ............. 122 155 (33) 263 337 (74)
Provision for loan losses .... -- 153 (153) -- 166 (166)
Compensation and benefits .... 5,457 4,663 794 10,566 8,798 1,768
Other expenses ............... 1,790 1,749 41 3,629 4,261 (632)
---------- ---------- ---------- ---------- ---------- ----------
Total expenses ............ 7,369 6,720 649 14,458 13,562 896
---------- ---------- ---------- ---------- ---------- ----------
Income before taxes .......... $ 1,171 $ 649 $ 522 $ 1,927 $ 250 $ 1,677
========== ========== ========== ========== ========== ==========
Servicing Income
The components of WCC's servicing income are reflected in the following table:
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Dollars in thousands)
Servicing revenue .................................................. $ 7,878 $ 6,509 $ 14,702 $ 12,051
Ancillary fees ..................................................... 2,359 1,501 4,678 2,963
Amortization of mortgage servicing rights .......................... (1,344) (655) (2,054) (1,372)
Valuation adjustment for mortgage servicing rights ................. (81) (233) 77 (276)
Custodial float .................................................... 308 373 588 680
Unreimbursed servicing expenses .................................... (157) (176) (425) (260)
Prepayment interest shortfall expense .............................. (947) (839) (1,755) (1,624)
------------ ------------ ------------ ------------
Total servicing income ............................................. $ 8,016 $ 6,480 $ 15,811 $ 12,162
============ ============ ============ ============
WCC’s total servicing income for the quarter ended June 30, 2003 was approximately $8.0 million, compared with $6.5 million for the quarter ended June 30, 2002. For the six months ended June 30, 2003, servicing income totaled $15.8 million, compared with $12.2 million for the six months ended June 30, 2002. The increase over the prior periods was due to the continuing growth in WCC’s servicing volume, as shown in the table below. Through new contractual agreements and servicing rights acquisitions, WCC increased its portfolio of serviced loans by approximately $1.2 billion since June 30, 2002, despite significant repayments precipitated by the decline in interest rates. As a result of this growth, our total servicing income increased by approximately 30% from the first six months of 2002 to the first six months of 2003. Subsequent to the second quarter of 2003, WCC purchased the servicing rights for approximately $0.4 billion in unpaid principal balance of loans and contracted to service an additional $0.6 billion. The transfer of this new servicing was completed in July 2003.
The continuing decline in mortgage interest rates which began in 2001, and the currently prevailing low interest rate environment, have resulted in extremely rapid prepayments of loans comprising our serviced asset base which, in turn, has negatively impacted our servicing revenues. While WCC’s amortization of mortgage servicing rights (MSRs) and its prepayment interest shortfall expense increased in the quarter and six months ended June 30, 2003 over the comparable 2002 periods, these increases were primarily due to the significantly larger portfolio volume, rather than an acceleration of prepayments. Float income earned on deposit balances declined from the prior year to the current, due to a continued decline in interest rates.
22
The following table sets forth the composition of loans serviced by WCC by type of loan at the dates indicated.
June 30, December 31, June 30,
2003 2002 2002
------------ ------------ ------------
(Dollars in thousands)
Single-family residential ............................. $ 4,658,978 $ 3,668,401 $ 3,555,128
Multi-family residential .............................. 111,048 121,908 118,672
Commercial real estate ................................ 253,620 218,976 195,741
Consumer and other .................................... 77,701 78,880 80,060
------------ ------------ ------------
Total (1) ........................................ $ 5,101,347 $ 4,088,165 $ 3,949,601
============ ============ ============
(1) WCC's servicing portfolio at June 30, 2003 and December 31, 2002 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
WCC’s interest income
decreased slightly for the quarter and six months ended June 30, 2003 compared
with the corresponding 2002 periods. The decrease was due to a drop in loan
volume as a result of WCC’s sales of $7.3 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 corresponding decrease in
interest expense from the prior year to the current year.
Realized Gains on Sales
WCC’s gains on sales
totaled $75 thousand for the quarter and six months ended June 30, 2003,
compared with $1.9 million for both the quarter and six months ended June 30,
2002. WCC sold $7.3 million unpaid principal balance of loans in the second
quarter of 2002, resulting in the $1.9 million gain. However, one half of this
gain was shared with a co-investor and is included in other income (loss) as
discussed below.
Other Income (Loss)
The components of WCC's other income (loss) are reflected in the following table:
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Dollars in thousands)
Other income (loss):
Real estate owned, net ...................... $ -- $ (3) $ -- $ (56)
Investor participation interest ............. 2 (855) (3) (891)
Other, net .................................. 428 (231) 440 450
------------ ------------ ------------ ------------
Total other income (loss) ............... $ 430 $ (1,089) $ 437 $ (497)
============ ============ ============ ============
The increase in WCC’s total other income for the 2003 periods was a result of the $0.9 million of “Investor participation interest” expense recorded for the quarter and six months ended June 30, 2002. This charge primarily reflects the co-investor’s share of WCC’s gain on its sale of loans in June 2002. WCC’s other, net in the 2003 periods was due to a $0.3 million gain from a litigation settlement and miscellaneous gains from recoveries of servicer advances, in excess of carrying value.
Compensation and Benefits
WCC’s compensation and
employee benefits totaled approximately $5.5 million for the quarter ended June
30, 2003, compared with $4.7 million for the quarter ended June 30, 2002. For
the six months ended June 30, 2003, compensation expense was $10.6 million,
compared with $8.8 million for the six months ended June 30, 2002. The increase
in the 2003 periods was primarily due to a continuing increase in WCC’s
employee head count as a result of the expansion of our loan servicing
operations. Additionally, in the second quarter of 2003 some existing employees
were transferred to WCC’s payroll as part of the Company’s
reallocation of certain operating expenses among its business segments (see Note
5 to the interim condensed consolidated financial statements).
Other Expenses
WCC’s other expenses
for the second quarter of 2003 totaled approximately $1.8 million, compared with
$1.7 million for the second quarter of 2002. The slight increase was due to
higher allocations of certain operating expenses, particularly insurance and
depreciation, to WCC from the other operating segments (see Note 5 to the
interim condensed consolidated financial statements).
For the six months ended June 30, 2003, WCC’s other expenses decreased by approximately $0.6 million from the six months ended June 30, 2002. The decrease was primarily due to a $0.7 million decline in legal expenses as a result of a significant accrual in March 2002 in connection with the settlement of litigation arising from events prior to our June 1999 restructuring. This decrease was partially offset by slight increases in insurance, depreciation and other expense categories as a result of the Company’s reallocation of operating expenses as discussed above.
23
Following are condensed statements of financial condition for WCC as of June 30, 2003 and December 31, 2002:
June 30, December 31,
2003 2002
------------ ------------
(Dollars in thousands)
ASSETS:
Cash and cash equivalents ....................................... $ -- $ 1,598
Discounted loans, net ........................................... 580 801
Servicer advance receivables, net ............................... 26,306 19,922
Purchased mortgage servicing rights, net ........................ 8,801 4,692
Other assets .................................................... 6,283 5,807
------------ ------------
Total assets ................................................ $ 41,970 $ 32,820
============ ============
LIABILITIES:
Short-term borrowings ........................................... $ 6,000 $ --
Investment financing ............................................ 4,181 2,151
Other liabilities ............................................... 7,327 8,147
------------ ------------
Total liabilities ........................................... 17,508 10,298
NET WORTH ....................................................... 24,462 22,522
------------ ------------
Total liabilities and net worth ............................. $ 41,970 $ 32,820
============ ============
Discounted Loans, net. WCC’s discounted loans, net decreased by approximately $0.2 million from December 31, 2002 to June 30, 2003 primarily as a result of principal payments received during the period.
Servicer Advance Receivables, net. Servicer advance receivables, net increased by approximately $6.4 million during the six months ended June 30, 2003. This increase resulted primarily from new senior lien advances made by WCC during the period, partially offset by recoveries of advances on loans previously made.
Purchased Mortgage Servicing Rights, net. Purchased mortgage servicing rights, net (MSRs) increased by approximately $4.1 million for the six months ended June 30, 2003. WCC purchased approximately $6.1 million of MSRs associated with new servicing portfolio acquisitions in March 2003 and also recorded a net recovery of $0.1 million in impairment charges previously taken. These increases were partially offset by amortization of MSRs totaling $2.1 million.
Short-Term Borrowings and Investment Financing. WCC’s short-term borrowings and investment financing increased by an aggregate of $8.0 million for the six months ended June 30, 2003. WCC utilized its commercial bank lines of credit to fund new servicer advances and its acquisitions of servicing rights during the first two quarters.
WCC’s sources of cash flow include primarily servicing revenue, sales of mortgage servicing assets and/or interest-earning assets, 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. WCC’s liquidity 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 June 30, 2003, WCC’s liquidity (including cash and unused borrowings under our credit facilities) totaled $11.2 million, compared with approximately $21.1 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.
24
Adequate credit facilities and other sources of funding are essential to the continuation of the Company’s ability to purchase servicing assets and secure new contractual servicing agreements. The Company’s growth strategy is dependent in part on its ability to find credit facilities and equity partners to provide funding for such business opportunities. Otherwise, such growth could be significantly curtailed or delayed.
WFSG conducts its Mortgage Investment Operations through WFC, our wholly-owned investment subsidiary. Some of WFC’s activities are conducted with a co-investor which has participation interests in the returns generated by the assets that serve as collateral for the loans. The share of such activities held by this co-investor is reflected as “Investor participation interest” in the Company’s consolidated statements of operations.
The following table compares WFC’s operating income before taxes for the quarters and six-month periods ended June 30, 2003 and 2002 (dollars in thousands).
Quarter Ended June 30, Six Months Ended June 30,
------------------------------------ ------------------------------------
Increase Increase
2003 2002 (Decrease) 2003 2002 (Decrease)
---------- ---------- ---------- ---------- ---------- ----------
Interest income ........................ $ 729 $ 1,168 $ (439) $ 1,770 $ 2,878 $ (1,108)
Realized gains on sales ................ -- 532 (532) 5 576 (571)
Other loss ............................. (154) (553) 399 (233) (509) 276
---------- ---------- ---------- ---------- ---------- ----------
Total income ........................ 575 1,147 (572) 1,542 2,945 (1,403)
---------- ---------- ---------- ---------- ---------- ----------
Interest expense ....................... 20 139 (119) 48 337 (289)
Provision for loan losses .............. 50 70 (20) 80 70 10
Compensation expense ................... 151 217 (66) 356 434 (78)
Other expenses ......................... 58 201 (143) 186 420 (234)
---------- ---------- ---------- ---------- ---------- ----------
Total expenses ...................... 279 627 (348) 670 1,261 (591)
---------- ---------- ---------- ---------- ---------- ----------
Income before taxes .................... $ 296 $ 520 $ (224) $ 872 $ 1,684 $ (812)
========== ========== ========== ========== ========== ==========
Interest Income and Interest Expense
WFC’s interest income
was approximately $0.7 million for the quarter ended June 30, 2003, compared
with $1.2 million for the quarter ended June 30, 2002. For the six months ended
June 30, 2003, interest income was approximately $1.8 million, compared with
$2.9 million for the six months ended June 30, 2002. The decreases in the 2003
periods were primarily due to a decline in loan volume as a result of WFC’s
sale of approximately $3.3 million unpaid principal balance of loans in June
2002. In addition, in the first quarter of 2002 WFC recorded approximately $0.3
million in loan interest income on the recovery of discounts and reserves on
loans which terminated during that period. Partially offsetting the decrease in
loan interest income were increases in interest on mortgage-backed securities of
$0.3 million and $0.5 million respectively, for the quarter and six months ended
June 30, 2003 over the corresponding 2002 periods. The continuing low
interest-rate environment has triggered an acceleration of repayments on the
loans underlying WFC’s mortgage-backed securities. WFC records the receipt
of such payments directly to interest income since its portfolio of securities
has been written down to an amortized cost of zero.
WFC’s interest expense decreased by approximately $0.1 million from the second quarter of 2002 to the second quarter of 2003 and by $0.3 million from the six months ended June 30, 2002 to the six months ended June 30, 2003. These decreases resulted from WFC’s repayments of debt facilities in June 2002 with the proceeds from the loan sale described above and also from the continuing decline in interest rates.
Realized Gains on Sales
WFC’s gains on sales
decreased by approximately $0.5 million and $0.6 million, respectively, from the
quarter and six-month periods ended June 30, 2002 to the corresponding 2003
periods. The larger gains in the 2002 periods reflect WFC’s gain from the
sale of approximately $3.3 million unpaid principal balance of loans in June
2002. Since the loans sold were originally acquired with a co-investor, one half
of the gain on sale was shared with the co-investor and included in
“Investor participation interest” as discussed below.
25
Other Loss
The components of WFC's other loss are reflected in the following table:
Quarter Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Dollars in thousands)
Other loss:
Real estate owned, net ........................... $ 1 $ (28) $ (14) $ (49)
Investor participation interest .................. (60) (364) (127) (654)
Other, net ....................................... (95) (161) (92) 194
------------ ------------ ------------ ------------
Total other loss ............................. $ (154) $ (553) $ (233) $ (509)
============ ============ ============ ============
Other loss includes the co-investor’s share of certain investment activities conducted with WFC, which is reported as “Investor participation interest” expense. The larger expense amounts in the 2002 periods reflect the co-investor’s 50% share of the gain on WFC’s loan sale in June 2002.
Compensation Expense
WFC’s compensation and
employee benefits decreased by approximately $0.1 million for the quarter and
six months ended June 30, 2003 as compared with the corresponding 2002 periods.
As part of the Company’s reallocation of operating expenses among its
business segments (see Note 5 to the interim condensed financial statements),
certain employees’ compensation has been transferred to WCC from WFC,
commencing in the second quarter of 2003.
Other Expenses
WFC’s other operating
expenses decreased by approximately $0.1 million from the second quarter of 2002
to the second quarter of 2003 and by $0.2 million from the six months ended June
30, 2002 to the six months ended June 30, 2003. These decreases were primarily
due to a decline in depreciation expense from the prior year to the current
year, as a result of the transfer of certain fixed assets from WFC to
WFSG’s other business segments.
Following are WFC's condensed statements of financial condition for as of June 30, 2003 and December 31, 2002:
June 30, December 31,
2003 2002
------------ ------------
(Dollars in thousands)
ASSETS:
Cash and cash equivalents ............................................ $ 35 $ 1,172
Mortgage-backed securities available for sale, at fair value ......... 1,335 1,828
Discounted loans, net ................................................ 5,043 5,829
Real estate owned, net ............................................... 47 61
Intercompany receivables ............................................. 18,343 16,354
Other assets ......................................................... 1,097 1,851
------------ ------------
Total assets ..................................................... $ 25,900 $ 27,095
============ ============
LIABILITIES:
Investment financing ................................................. $ 1,051 $ 2,133
Other liabilities .................................................... 3,611 4,150
------------ ------------
Total liabilities ................................................ 4,662 6,283
NET WORTH ............................................................ 21,238 20,812
------------ ------------
Total liabilities and net worth .................................. $ 25,900 $ 27,095
============ ============
26
Mortgage-Backed Securities Available for Sale. WFC’s portfolio of mortgage-backed securities available for sale decreased by approximately $0.5 million during the six months ended June 30, 2003 as a result of continuing paydowns on the underlying loan portfolios. WFC received $1.2 million in principal repayments in the current year to date on its mortgage-backed securities, which have been written down to an amortized cost of zero. Consequently, any payments received on these securities are recorded directly to interest income.
Discounted Loans, net. WFC’s discounted loans, net decreased by approximately $0.8 million from December 31, 2002 to June 30, 2003 as a result of $0.7 million of principal repayments and a loan loss provision of approximately $0.1 million.
Intercompany Receivables. Intercompany receivables increased by approximately $2.0 million from year-end 2002 to June 30, 2003. This increase was primarily due to an ongoing transfer of funds from WFC to WFSG to meet the holding company’s operating costs.
Investment Financing. WFC’s investment financing decreased by approximately $1.1 million during the six months ended June 30, 2003, as a result of repayments of debt facilities which financed previous asset acquisitions.
WFC’s sources of cash flow include whole loan and mortgage-backed securities sales, net interest income, and borrowings from co-investors. WFC’s liquidity 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. Based on our current and expected asset size, capital levels, and organizational infrastructure, we believe there will be sufficient available liquidity to meet WFC’s operating needs.
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 June 30, 2003 WFC held $1.3 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 acquire additional pools of loans and other interest-earning assets. The Company’s growth strategy is dependent in part on its ability to find credit facilities and equity partners for purchases of such assets. Otherwise, such growth 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, Loan Servicing or Mortgage Investment 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.
27
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 (if any) 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 June 30, 2003, represented nearly 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, which may be temporary or other than temporary.
• Income Taxes. At June 30, 2003 we had a total deferred tax asset of approximately $52.6 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 June 30, 2003, have recorded a valuation allowance of approximately $48.1 million. The net deferred tax asset, $4.5 million, is included in prepaid expenses and other assets in our consolidated statement of financial condition as of June 30, 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.
• 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.
28
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 June 30, 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............................. $ 104,142 $ (19,537) (16)% 12.91% (165)bp
+200bp............................. 111,388 (12,291) (10) 13.56 (100)bp
+100bp............................. 118,614 (5,065) (4) 14.18 (38)bp
0bp............................. 123,679 -- -- 14.56 --
-100bp............................. 127,229 3,550 3 14.77 21 bp
-200bp............................. 134,319 10,640 9 15.36 80 bp
-300bp............................. 144,427 20,748 17 16.31 175 bp
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.
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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 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. |
On June 25, 2003, at the annual shareholder meeting, the Company's stockholders elected the following seven (7) persons to the Board of Directors of the Company: Larry B. Faigin, Howard Amster, Robert M. Deutschman, Stephen P. Glennon, Robert H. Kanner, Edmund M. Kaufman and Daniel A. Markee.
| Item 5. | Other Information. |
| Not applicable. |
| Item 6. | Exhibits and Reports on Form 8-K. |
| (a) | Exhibits. |
| 10.1 | Amendment to Change-in-Control Agreement between Wilshire Financial Services Group Inc. and Mr. Jay H. Memmott |
| 10.2 | Amendment to Change-in-Control Agreement between Wilshire Financial Services Group Inc. and Mr. Bradley B. Newman |
| 10.3 | Amendment to Change-in-Control Agreement between Wilshire Financial Services Group Inc. and Mr. Mark H. Peterman |
| 31 | Certification by the Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32 | Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.ss.1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| (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. |
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| 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. |
| Current Report on Form 8-K dated August 11, 2003, reporting the Company's operating results for the quarter ended June 30, 2003. |
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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: August 12, 2003
| By: | /s/ STEPHEN P. GLENNON |
| Stephen P. Glennon | |
| Chief Executive Officer and | |
| Chief Financial Officer |
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