##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark one) [X]   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2004 or [  ]    Transitional Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from                      to Commission file number 0-21845 Wilshire Financial Services Group Inc.  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    93-1223879
(I.R.S. Employer Identification No.)23901 Calabasas Road, Suite 1050
Calabasas, CA
(Address of principal executive offices)
    
    91302
(Zip Code)
 (818) 223-8084
(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] Applicable only to issuers involved in bankruptcy proceedings during the
preceding five years: 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 [  ] Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. Class
Common Stock, par value $0.01 per share
    
    Outstanding at July 31, 2004
21,136,519 shares




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES INDEX PART I. FINANCIAL INFORMATIONItem 1. Interim Condensed Consolidated Financial Statements (Unaudited):Condensed Consolidated Statements of Financial Condition
    
    
    3Condensed Consolidated Statements of Operations
    
    
    4Condensed Consolidated Statements of Cash Flows
    
    
    5Notes to Interim Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    30Item 4. Controls and Procedures
    
    
    31PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    32Item 2. Changes in Securities
    
    
    32Item 3. Defaults Upon Senior Securities
    
    
    32Item 4. Submission of Matters to a vote of Security Holders
    
    
    32Item 5. Other Information
    
    
    32Item 6. Exhibits and Reports on Form 8-K
    
    
    32Signature
    
    
    33EXHIBIT 3.2EXHIBIT 31EXHIBIT 32




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
 (Unaudited)
 (Dollars in thousands, except share data)
 June 30,
    
    December 31,2004
    
    2003ASSETSCash and cash equivalents
    
    $
    12,727
    
    
    $
    18,739Government agency mortgage-backed securities available for sale, at fair value.
    
    
    177,400
    
    
    
    161,083AAA mortgage-backed securities available for sale, at fair value
    
    
    136,521
    
    
    
    62,160Other mortgage-backed securities available for sale, at fair value
    
    
    521
    
    
    
    1,069Investment securities available for sale, at fair value
    
    
    11,812
    
    
    
    22,086Investment securities held to maturity, at amortized cost (fair value of $9,512
and $9,754)
    
    
    9,632
    
    
    
    9,607Loans, net of allowance for loan losses of $6,876 and $6,735
    
    
    826,224
    
    
    
    610,807Discounted loans, net of allowance for loan losses of $29,083 and $32,041
    
    
    3,126
    
    
    
    3,817Stock in Federal Home Loan Bank of San Francisco, at cost
    
    
    18,435
    
    
    
    12,767Real estate owned, net
    
    
    2,014
    
    
    
    267Leasehold improvements and equipment, net
    
    
    536
    
    
    
    554Accrued interest receivable
    
    
    5,292
    
    
    
    4,215Deferred tax asset, net
    
    
    20,927
    
    
    
    18,054Purchased mortgage servicing rights, net
    
    
    
    
    
    
    250Receivables from loan servicers
    
    
    
    
    
    
    770Intangible assets, net
    
    
    3,313
    
    
    
    3,442Prepaid expenses and other assets
    
    
    4,033
    
    
    
    2,897Assets of subsidiary held for sale
    
    
    
    
    
    
    42,698TOTAL
    
    $
    1,232,513
    
    
    $
    975,282LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIES:Noninterest-bearing deposits
    
    $
    5,050
    
    
    $
    4,175Interest-bearing deposits
    
    
    578,153
    
    
    
    469,234Short-term borrowings
    
    
    80,000
    
    
    
    88,000Accounts payable and other liabilities
    
    
    17,680
    
    
    
    3,690FHLB advances
    
    
    392,237
    
    
    
    249,337Long-term investment financing
    
    
    
    
    
    
    681Junior subordinated notes payable to trust
    
    
    20,619
    
    
    
    20,619Investor participation liability
    
    
    905
    
    
    
    1,169Liabilities of subsidiary held for sale
    
    
    
    
    
    
    12,894Total liabilities
    
    
    1,094,644
    
    
    
    849,799COMMITMENTS AND CONTINGENCIES (NOTE 4)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, 26,775,887
and 24,491,703 shares issued (including treasury shares of 5,639,368
and
5,626,212)
    
    
    139,718
    
    
    
    136,363Treasury stock, 5,639,368 and 5,626,212 shares, at cost
    
    
    (15,224
    )
    
    
    (15,106
    )Retained earnings
    
    
    16,913
    
    
    
    3,791Accumulated other comprehensive (loss) income, net
    
    
    (3,538
    )
    
    
    435Total stockholders equity
    
    
    137,869
    
    
    
    125,483TOTAL
    
    $
    1,232,513
    
    
    $
    975,282
 See notes to unaudited interim condensed consolidated financial statements 3




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 (Dollars in thousands, except share data)
 Quarter Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003INTEREST INCOME:Loans
    
    $
    11,515
    
    
    $
    8,408
    
    
    $
    21,211
    
    
    $
    16,835Mortgage-backed securities
    
    
    2,870
    
    
    
    2,547
    
    
    
    5,490
    
    
    
    6,014Securities and federal funds sold
    
    
    269
    
    
    
    216
    
    
    
    575
    
    
    
    388Total interest income
    
    
    14,654
    
    
    
    11,171
    
    
    
    27,276
    
    
    
    23,237INTEREST EXPENSE:Deposits
    
    
    3,278
    
    
    
    2,776
    
    
    
    6,391
    
    
    
    5,989Borrowings
    
    
    3,288
    
    
    
    3,111
    
    
    
    6,014
    
    
    
    6,433Total interest expense
    
    
    6,566
    
    
    
    5,887
    
    
    
    12,405
    
    
    
    12,422NET INTEREST INCOME
    
    
    8,088
    
    
    
    5,284
    
    
    
    14,871
    
    
    
    10,815PROVISION FOR (RECAPTURE OF) LOSSES ON LOANS
    
    
    100
    
    
    
    (700
    )
    
    
    214
    
    
    
    (670
    )NET INTEREST INCOME AFTER PROVISION FOR
(RECAPTURE OF) LOSSES ON LOANS
    
    
    7,988
    
    
    
    5,984
    
    
    
    14,657
    
    
    
    11,485OTHER INCOME (LOSS):Servicing income
    
    
    312
    
    
    
    (110
    )
    
    
    521
    
    
    
    (64
    )Loan fees and charges
    
    
    97
    
    
    
    27
    
    
    
    195
    
    
    
    50Real estate owned, net
    
    
    12
    
    
    
    (112
    )
    
    
    70
    
    
    
    (87
    )Gain on sale of loans
    
    
    1
    
    
    
    
    
    
    
    48
    
    
    
    5Gain on sale of securities
    
    
    
    
    
    
    
    
    
    
    273
    
    
    
    Investor participation interest
    
    
    (69
    )
    
    
    (61
    )
    
    
    (159
    )
    
    
    (127
    )Other, net
    
    
    154
    
    
    
    88
    
    
    
    219
    
    
    
    292Total other income (loss)
    
    
    507
    
    
    
    (168
    )
    
    
    1,167
    
    
    
    69OTHER EXPENSES:Compensation and employee benefits
    
    
    1,572
    
    
    
    1,935
    
    
    
    3,394
    
    
    
    3,596Professional services
    
    
    807
    
    
    
    1,347
    
    
    
    1,627
    
    
    
    2,275Occupancy
    
    
    217
    
    
    
    185
    
    
    
    402
    
    
    
    377FDIC insurance premiums
    
    
    117
    
    
    
    107
    
    
    
    225
    
    
    
    215Data processing
    
    
    123
    
    
    
    115
    
    
    
    267
    
    
    
    179Insurance
    
    
    228
    
    
    
    157
    
    
    
    346
    
    
    
    326Depreciation
    
    
    96
    
    
    
    193
    
    
    
    186
    
    
    
    438Amortization of intangibles
    
    
    64
    
    
    
    64
    
    
    
    129
    
    
    
    129Directors expense
    
    
    224
    
    
    
    111
    
    
    
    380
    
    
    
    248Other general and administrative expenses
    
    
    351
    
    
    
    382
    
    
    
    807
    
    
    
    673Total other expenses
    
    
    3,799
    
    
    
    4,596
    
    
    
    7,763
    
    
    
    8,456INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES
    
    
    4,696
    
    
    
    1,220
    
    
    
    8,061
    
    
    
    3,098INCOME TAX PROVISION
    
    
    2,016
    
    
    
    529
    
    
    
    3,412
    
    
    
    1,333INCOME FROM CONTINUING OPERATIONS
    
    
    2,680
    
    
    
    691
    
    
    
    4,649
    
    
    
    1,765DISCONTINUED OPERATIONS:(LOSS) INCOME FROM OPERATIONS OF DISCONTINUED
SEGMENT, NET OF INCOME TAX (BENEFIT) PROVISION
OF $(137), $458, $201 AND $722
    
    
    (193
    )
    
    
    715
    
    
    
    283
    
    
    
    1,205GAIN ON SALE OF SUBSIDIARY, NET OF TAX OF $7,684
    
    
    10,832
    
    
    
    
    
    
    
    10,832
    
    
    
    NET INCOME
    
    $
    13,319
    
    
    $
    1,406
    
    
    $
    15,764
    
    
    $
    2,970Earnings per share  Basic:Income from continuing operations
    
    $
    0.13
    
    
    $
    0.04
    
    
    $
    0.23
    
    
    $
    0.10Discontinued operations
    
    
    0.51
    
    
    
    0.04
    
    
    
    0.54
    
    
    
    0.06Net income
    
    $
    0.64
    
    
    $
    0.08
    
    
    $
    0.77
    
    
    $
    0.16Earnings per share  Diluted:Income from continuing operations
    
    $
    0.12
    
    
    $
    0.03
    
    
    $
    0.22
    
    
    $
    0.09Discontinued operations
    
    
    0.50
    
    
    
    0.04
    
    
    
    0.52
    
    
    
    0.06Net income
    
    $
    0.62
    
    
    $
    0.07
    
    
    $
    0.74
    
    
    $
    0.15Weighted average shares outstanding  basic
    
    
    20,786,803
    
    
    
    18,435,365
    
    
    
    20,404,896
    
    
    
    18,330,116Weighted average shares outstanding  diluted
    
    
    21,475,649
    
    
    
    20,410,295
    
    
    
    21,393,533
    
    
    
    20,330,328
 See notes to unaudited interim condensed consolidated financial statements 4




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 (Dollars in thousands)
 Six Months EndedJune 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    15,764
    
    
    $
    2,970Income from operations of discontinued segment, net of taxes
    
    
    (283
    )
    
    
    (1,205
    )Gain on sale of subsidiary, net of taxes
    
    
    (10,832
    )
    
    
    Income from continuing operations
    
    
    4,649
    
    
    
    1,765Adjustments to reconcile income from continuing operations to net cash provided by operating
activities of continuing operations:Provision for (recapture of) losses on loans
    
    
    263
    
    
    
    (670
    )Provision for losses on real estate owned
    
    
    18
    
    
    
    110Change in valuation allowance for mortgage servicing rights
    
    
    257
    
    
    
    (139
    )Depreciation and amortization
    
    
    315
    
    
    
    933Tax effect from utilization of net operating loss carryforward
    
    
    
    
    
    
    1,352Gain on sale of real estate owned
    
    
    (97
    )
    
    
    (57
    )Gain on sale of loans
    
    
    (48
    )
    
    
    (80
    )Gain on sale of securities
    
    
    (273
    )
    
    
    Loss (gain) on disposal of equipment
    
    
    2
    
    
    
    (8
    )Amortization of discounts and deferred fees
    
    
    1,609
    
    
    
    1,598Amortization of mortgage servicing rights
    
    
    1,740
    
    
    
    2,375Federal Home Loan Bank stock dividends
    
    
    (120
    )
    
    
    (272
    )Change in:Servicer advance receivables
    
    
    (3,456
    )
    
    
    (6,384
    )Service fees receivable
    
    
    182
    
    
    
    (426
    )Accrued interest receivable
    
    
    (1,084
    )
    
    
    277Receivables from other loan servicers
    
    
    773
    
    
    
    (40
    )Prepaid expenses and other assets
    
    
    (1,416
    )
    
    
    391Accounts payable and other liabilities
    
    
    1,486
    
    
    
    (1,707
    )Investor participation liability
    
    
    (467
    )
    
    
    89Net cash used in operations of discontinued segment
    
    
    6,697
    
    
    
    4,364Net cash provided by operating activities of continuing operations
    
    
    11,030
    
    
    
    3,471CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of loans
    
    
    (105,537
    )
    
    
    (17,648
    )Proceeds from sale of loans
    
    
    
    
    
    
    4,068Loan repayments
    
    
    79,740
    
    
    
    74,579Loan originations
    
    
    (191,270
    )
    
    
    (61,417
    )Purchase of discounted loans
    
    
    
    
    
    
    (30,075
    )Proceeds from sale of discounted loans
    
    
    
    
    
    
    30,308Purchase of mortgage-backed securities available for sale
    
    
    (174,108
    )
    
    
    (27,784
    )Proceeds from sale of mortgage-backed securities available for sale
    
    
    7,859
    
    
    
    Repayment of mortgage-backed securities available for sale
    
    
    68,383
    
    
    
    79,950Purchase of investment securities available for sale
    
    
    
    
    
    
    (13,458
    )Proceeds from sale of investment securities available for sale
    
    
    10,130
    
    
    
    Proceeds from sale of real estate owned
    
    
    987
    
    
    
    822Purchase of FHLB Stock
    
    
    (5,548
    )
    
    
    Purchases of leasehold improvements and equipment
    
    
    (500
    )
    
    
    (738
    )Proceeds from sale of leasehold improvements and equipment
    
    
    
    
    
    
    13Purchase of mortgage servicing rights
    
    
    
    
    
    
    (6,088
    )Proceeds from sale of mortgage servicing rights
    
    
    
    
    
    
    2Net proceeds from sale of subsidiary
    
    
    48,709
    
    
    
    Net cash (provided by) used in investing activities of discontinued segment
    
    
    (495
    )
    
    
    6,469Net cash (used in) provided by investing activities of
continuing operations
    
    
    (261,650
    )
    
    
    39,003
 [Continued] See notes to unaudited interim condensed consolidated financial statements 5




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(Dollars in thousands) Six Months EndedJune 30,2004
    
    2003CASH FLOWS FROM FINANCING ACTIVITIES:Net increase (decrease) in deposits
    
    $
    109,794
    
    
    $
    (40,881
    )Proceeds from FHLB advances
    
    
    554,900
    
    
    
    18,000Repayments of FHLB advances
    
    
    (412,000
    )
    
    
    (16,000
    )Net (decrease) increase in short-term borrowings
    
    
    (1,000
    )
    
    
    2,130Proceeds from long-term financing
    
    
    
    
    
    
    4,006Repayment of long-term financing
    
    
    (1,871
    )
    
    
    (3,058
    )Issuance of common stock pursuant to exercise of stock options
    
    
    3,237
    
    
    
    551Dividends on common stock
    
    
    (2,642
    )
    
    
    Net cash provided by financing activities of discontinued segment
    
    
    (5,810
    )
    
    
    (8,030
    )Net cash provided by (used in) financing activities of continuing operations
    
    
    244,608
    
    
    
    (43,282
    )NET DECREASE IN CASH AND CASH EQUIVALENTS
    
    
    (6,012
    )
    
    
    (808
    )CASH AND CASH EQUIVALENTS:Beginning of period
    
    
    18,739
    
    
    
    15,981End of period
    
    $
    12,727
    
    
    $
    15,173SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION  Cash paid for:Interest
    
    $
    11,550
    
    
    $
    11,941Income taxes
    
    
    82
    
    
    
    NONCASH INVESTING ACTIVITIES:Additions to real estate owned acquired in settlement of loans
    
    
    2,074
    
    
    
    457
 See notes to unaudited interim condensed consolidated financial statements 6




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 (Dollars in thousands, except share data and where noted)
 1. BASIS OF PRESENTATION 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 WFSGs 2003
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
2003 Annual Report on Form 10-K. In July 2004, the stockholders of WFSG approved a proposed amendment to
the Companys certificate of incorporation to change the Companys name to
Beverly Hills Bancorp. The Company has applied to the state of Delaware for
the name change and is currently awaiting approval. In the opinion of management, all adjustments, other than the adjustments
described below, generally comprised of normal recurring accruals necessary for
fair presentation of the interim condensed consolidated financial statements,
have been included and all intercompany accounts and transactions have been
eliminated in consolidation. Operating results for the three and six months
ended June 30, 2004 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2004. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America (GAAP) 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 2003 amounts were made in order to conform to
the 2004 presentation. None of these reclassifications affected previously
reported net income. 2. PER-SHARE DATA 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 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, 2004 and 2003. Quarter Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Income from continuing operations
    
    $
    2,680
    
    
    $
    691
    
    
    $
    4,649
    
    
    $
    1,765(Loss) income from operations of
discontinued segment
    
    
    (193
    )
    
    
    715
    
    
    
    283
    
    
    
    1,205Gain on sale of subsidiary
    
    
    10,832
    
    
    
    
    
    
    
    10,832
    
    
    
    Net income
    
    $
    13,319
    
    
    $
    1,406
    
    
    $
    15,764
    
    
    $
    2,970Weighted average number of common
shares outstanding  basic
    
    
    20,786,803
    
    
    
    18,435,365
    
    
    
    20,404,896
    
    
    
    18,330,116Net effect of dilutive stock
options  based on treasury stock
method
    
    
    688,846
    
    
    
    1,974,930
    
    
    
    988,637
    
    
    
    2,000,212Weighted average number of common
shares outstanding  diluted
    
    
    21,475,649
    
    
    
    20,410,295
    
    
    
    21,393,533
    
    
    
    20,330,328Earnings per share  Basic:Income from continuing operations
    
    $
    0.13
    
    
    $
    0.04
    
    
    $
    0.23
    
    
    $
    0.10Discontinued operations
    
    
    0.51
    
    
    
    0.04
    
    
    
    0.54
    
    
    
    0.06Net income
    
    $
    0.64
    
    
    $
    0.08
    
    
    $
    0.77
    
    
    $
    0.16Earnings per share  Diluted:Income from continuing operations
    
    $
    0.12
    
    
    $
    0.03
    
    
    $
    0.22
    
    
    $
    0.09Discontinued operations
    
    
    0.50
    
    
    
    0.04
    
    
    
    0.52
    
    
    
    0.06Net income
    
    $
    0.62
    
    
    $
    0.07
    
    
    $
    0.74
    
    
    $
    0.15
 7




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) 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. Had compensation expense for the Companys
Equity Participation Plans been determined based on the fair value at the grant
date consistent with the methods of Statement of Financial Accounting Standards
(SFAS) No. 123, the Companys net income and earnings per share for the
quarters and six-month periods ended June 30, 2004 and 2003 would have been
reduced to the pro-forma amounts indicated below. Quarter Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income, as reported
    
    $
    13,319
    
    
    $
    1,406
    
    
    $
    15,764
    
    
    $
    2,970Less: Total
stock-based employee
compensation expense
determined under fair
value-based method for
all awards, net of
related tax effects
    
    
    122
    
    
    
    123
    
    
    
    244
    
    
    
    246Pro forma net income
    
    $
    13,197
    
    
    $
    1,283
    
    
    $
    15,520
    
    
    $
    2,724Earnings per share:Basic  as reported
    
    $
    0.64
    
    
    $
    0.08
    
    
    $
    0.77
    
    
    $
    0.16Basic  pro forma
    
    $
    0.63
    
    
    $
    0.07
    
    
    $
    0.76
    
    
    $
    0.15Diluted  as reported
    
    $
    0.62
    
    
    $
    0.07
    
    
    $
    0.74
    
    
    $
    0.15Diluted  pro forma
    
    $
    0.61
    
    
    $
    0.06
    
    
    $
    0.73
    
    
    $
    0.13
 3. SALE OF WILSHIRE CREDIT CORPORATION On April 30, 2004 the Company completed the sale of its wholly-owned
mortgage servicing subsidiary, Wilshire Credit Corporation (WCC), to Merrill
Lynch Mortgage Capital Inc. (Merrill Lynch) for net proceeds of approximately
$48.7 million, and realized a gain on the sale of approximately $18.5 million
before taxes. The final purchase price is subject to adjustment based on WCCs
closing date net asset value as determined jointly by the Company and Merrill
Lynch. WCC was formed in 1999 pursuant to the Companys reorganization, and
comprised the Companys Loan Servicing Operations business segment. At the time
of its sale, WCC serviced over $6 billion principal balance of loans for more
than 500 individual and institutional investors and governmental agencies. Effective December 31, 2003, the Company began accounting for WCC as a
disposal group held for sale in accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. Accordingly, the assets and
liabilities of WCC have each been combined and presented as separate captions
on the Consolidated Statements of Financial Condition. In addition, WCCs
results of operations have been removed from the Companys results from
continuing operations on the Consolidated Statements of Operations, and have
been presented separately in a single caption as (Loss) income from operations
of discontinued segment, net of income tax (benefit) provision. In accordance
with SFAS No. 144, the Company did not record depreciation expense on WCCs
leasehold improvements and equipment from January 1 through April 30, 2004. As
a result, the pre-tax income from operations of the discontinued segment, as
reported in the accompanying financial statements, was approximately $0.4
million more than the income actually recorded by WCC for that period.
Consequently, the gain on sale as reported is $0.4 million less, on a pre-tax
basis, than the gain actually realized by the Company, due to the higher basis
in WCC for GAAP purposes. 8




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) The following is summarized financial information for WCC: April 30,
    
    December 31,2004
    
    2003ASSETS:Cash and cash equivalents
    
    $
    30
    
    
    $
    109Discounted loans, net
    
    
    
    
    
    
    522Leasehold improvements and equipment, net
    
    
    2,577
    
    
    
    2,602Servicer advance receivables, net
    
    
    26,428
    
    
    
    22,972Purchased mortgage servicing rights, net
    
    
    6,772
    
    
    
    8,519Other assets
    
    
    7,695
    
    
    
    7,974Total assets
    
    $
    43,502
    
    
    $
    42,698LIABILITIES:Short-term borrowings and investment
financing
    
    $
    9,162
    
    
    $
    3,352Other liabilities
    
    
    4,472
    
    
    
    9,542Total liabilities
    
    $
    13,634
    
    
    $
    12,894
 Results of operations for WCC are shown in the table below. The
amounts for the quarter and six months ended June 30, 2004 reflect WCCs
results for only the month and four months ended April 30, 2004,
respectively. Quarter Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Interest income
    
    $
    
    
    
    $
    19
    
    
    $
    (10
    )
    
    $
    62Interest expense
    
    
    37
    
    
    
    122
    
    
    
    164
    
    
    
    263Net interest expense
    
    
    (37
    )
    
    
    (103
    )
    
    
    (174
    )
    
    
    (201
    )Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    49
    
    
    
    Net interest expense after provision for
loan losses
    
    
    (37
    )
    
    
    (103
    )
    
    
    (223
    )
    
    
    (201
    )Servicing income
    
    
    3,420
    
    
    
    8,016
    
    
    
    11,754
    
    
    
    15,811Other income
    
    
    223
    
    
    
    506
    
    
    
    699
    
    
    
    512Compensation and employee benefits expense
    
    
    3,324
    
    
    
    5,457
    
    
    
    9,427
    
    
    
    10,566Other expenses
    
    
    612
    
    
    
    1,789
    
    
    
    2,319
    
    
    
    3,629(Loss) income before income taxes
    
    
    (330
    )
    
    
    1,173
    
    
    
    484
    
    
    
    1,927Income tax (benefit) provision
    
    
    (137
    )
    
    
    458
    
    
    
    201
    
    
    
    722Net (loss) income
    
    $
    (193
    )
    
    $
    715
    
    
    $
    283
    
    
    $
    1,205
 9




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) 4. COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK At June 30, 2004, the Companys banking subsidiary, First Bank of Beverly
Hills, F.S.B. (FBBH or the Bank), had outstanding commitments to fund $15.1
million in mortgage loans. The Company may incur additional expenses in connection with legal costs
for a prior officer. These costs, which totaled approximately $0.3 million and
$0.5 million, respectively, for the quarter and six months ended June 30, 2004,
relate to the events that gave rise to litigation arising from the financial
collapse of Capital Consultants LLC (CCL). The Company anticipates that the
amount of such expenses will decline in future periods. The Company on May 13, 2002 entered into a settlement agreement to resolve
the litigation arising from CCLs collapse and has completed all of its
obligations under the settlement agreement. Management, after consultation
with legal counsel, believes that this litigation will be dismissed in the next
few months. 5. INCOME TAXES The Company files consolidated federal and state income tax returns with
its eligible subsidiaries. As discussed in Note 3, the Company completed the
sale of its wholly-owned loan servicing subsidiary, WCC, to Merrill Lynch
effective April 30, 2004. Consequently, the Companys consolidated income tax
returns for the year ending December 31, 2004 will include WCCs operating
results only for the period from January 1 through April 30, 2004. In the accompanying consolidated financial statements, WCC is accounted
for as a discontinued operation, and its operating results have been removed
from the Companys consolidated statements of operations and reported
separately in a single caption. Accordingly, the discussion in this note
concerns the Companys income tax provision and its deferred tax asset as they
relate to its continuing operations only. The Company recorded a current tax provision on income from continuing
operations of $2.0 million for the quarter ended June 30, 2004, compared with
$0.5 million for the quarter ended June 30, 2003. For the six months ended
June 30, 2004, the Companys tax provision on income from continuing operations
was $3.4 million, compared with $1.3 million for the six months ended June 30,
2003. The Companys deferred tax provision (benefit) is determined on a
quarterly basis pursuant to an evaluation of its 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 statements of operations. The Companys net deferred tax asset was $20.9 million and $18.1 million,
respectively, at June 30, 2004 and December 31, 2003. In accounting for the
deferred tax asset, the Company applies 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-reorganizational (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. As benefits relating to the Companys post-reorganizational period
are realized, the tax effect will be recorded as a tax benefit in the
consolidated statements of operations. As of June 30, 2004, the Company had U.S. net operating loss carryforwards
and capital loss carryforwards of approximately $109 million and $5 million,
respectively, and also has state net operating loss carryforwards. The federal
carryforward period runs through 2023. However, 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 10




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) measured over the prior three-year period. As a result of the change in
control, the Companys net operating loss carryforwards and capital loss
carryforwards that were generated prior to the change in control are subject to
a limitation on the amount that may be used annually to offset taxable income.
The Company has determined that the amount of this limitation is approximately
$6 million per year and believes that its valuation allowance against the
deferred tax asset provides adequately for this limitation. 6. OPERATING SEGMENTS The Company reports segment data in accordance with the accounting principles
discussed in Note 1 to the consolidated financial statements in the 2003 Annual
Report on Form 10-K.
As discussed in Note 3, the Company completed the sale of WCC, which
comprised WFSGs Loan Servicing segment, to Merrill Lynch effective April 30,
2004. Accordingly, the operating results of WCC are presented separately, in a
single caption titled (Loss) income from operations of discontinued segment
in the Companys condensed consolidated statements of operations. The operating segments differ in terms of regulatory environment, funding
sources and asset acquisition strategies, as described below:  
    
    Banking OperationsThrough FBBH, the Company conducts a banking
business focused primarily on specialty-niche products, including
commercial and multi-family real estate lending, purchases of
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, Federal Home Loan Bank
(FHLB) advances and repurchase agreements. The Bank is a federally
chartered savings bank and is regulated by the Office of Thrift
Supervision (OTS).
    
    Mortgage Investment Operations The Companys investment subsidiary,
Wilshire Funding Corporation (WFC), has acquired mortgage-backed
securities and pools of performing, sub-performing and non-performing
residential and commercial loans. WFC has conducted 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 have consisted primarily of commercial bank financing
and co-investors, with debt service repayment terms that generally
parallel the cash flows of the underlying collateral. The active
acquisition of assets by WFC has been significantly curtailed since
2001, and its current operations consist primarily of the management
of its existing asset portfolio.
    
    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 $20.6 million of junior subordinated notes payable issued in
July 2002 and eliminations of intercompany accounts and transactions. 11




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) Segment data for the three months ended June 30, 2004 and 2003 are as follows: Three Months Ended June 30, 2004HoldingCompany andLoan
    
    Mortgage
    
    MiscellaneousBanking
    
    Servicing
    
    Investments
    
    Operations
    
    TotalInterest income
    
    $
    14,148
    
    
    $
    
    
    
    $
    493
    
    
    $
    13
    
    
    $
    14,654Interest expense
    
    
    6,307
    
    
    
    
    
    
    
    3
    
    
    
    256
    
    
    
    6,566Net interest income (expense)
    
    
    7,841
    
    
    
    
    
    
    
    490
    
    
    
    (243
    )
    
    
    8,088Provision for loan losses
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100Net interest income (expense) after
provision for loan losses
    
    
    7,741
    
    
    
    
    
    
    
    490
    
    
    
    (243
    )
    
    
    7,988Servicing income
    
    
    357
    
    
    
    
    
    
    
    
    
    
    
    (45
    )
    
    
    312Realized gains
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    1Other income (loss)
    
    
    234
    
    
    
    
    
    
    
    (85
    )
    
    
    45
    
    
    
    194Compensation and employee benefits expense
    
    
    1,445
    
    
    
    
    
    
    
    
    
    
    
    127
    
    
    
    1,572Other expenses
    
    
    1,364
    
    
    
    
    
    
    
    5
    
    
    
    858
    
    
    
    2,227Income (loss) from continuing operations
before taxes
    
    
    5,523
    
    
    
    
    
    
    
    401
    
    
    
    (1,228
    )
    
    
    4,696Income tax provision (benefit)
    
    
    2,270
    
    
    
    
    
    
    
    167
    
    
    
    (421
    )
    
    
    2,016Income (loss) from continuing operations
    
    
    3,253
    
    
    
    
    
    
    
    234
    
    
    
    (807
    )
    
    
    2,680Loss from operations of discontinued
segment, net of taxes
    
    
    
    
    
    
    (193
    )
    
    
    
    
    
    
    
    
    
    
    (193
    )Gain on sale of subsidiary, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,832
    
    
    
    10,832Net income (loss)
    
    $
    3,253
    
    
    $
    (193
    )
    
    $
    234
    
    
    $
    10,025
    
    
    $
    13,319Total assets
    
    $
    1,210,140
    
    
    $
    
    
    
    $
    22,370
    
    
    $
    3
    
    
    $
    1,232,513
 12




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) Three Months Ended June 30, 2003HoldingCompany andLoan
    
    Mortgage
    
    MiscellaneousBanking
    
    Servicing
    
    Investments
    
    Operations
    
    TotalInterest income
    
    $
    10,417
    
    
    $
    
    
    
    $
    729
    
    
    $
    25
    
    
    $
    11,171Interest expense
    
    
    5,624
    
    
    
    
    
    
    
    20
    
    
    
    243
    
    
    
    5,887Net interest income (expense)
    
    
    4,793
    
    
    
    
    
    
    
    709
    
    
    
    (218
    )
    
    
    5,284(Recapture of) provision for loan losses
    
    
    (750
    )
    
    
    
    
    
    
    50
    
    
    
    
    
    
    
    (700
    )Net interest income (expense) after
(recapture of) provision for loan
losses
    
    
    5,543
    
    
    
    
    
    
    
    659
    
    
    
    (218
    )
    
    
    5,984Servicing income
    
    
    204
    
    
    
    
    
    
    
    (3
    )
    
    
    (311
    )
    
    
    (110
    )Other (loss) income
    
    
    (200
    )
    
    
    
    
    
    
    (151
    )
    
    
    293
    
    
    
    (58
    )Compensation and employee benefits
expense
    
    
    1,144
    
    
    
    
    
    
    
    151
    
    
    
    640
    
    
    
    1,935Other expenses
    
    
    1,247
    
    
    
    
    
    
    
    58
    
    
    
    1,356
    
    
    
    2,661Income (loss) from continuing
operations before taxes
    
    
    3,156
    
    
    
    
    
    
    
    296
    
    
    
    (2,232
    )
    
    
    1,220Income tax provision (benefit)
    
    
    1,326
    
    
    
    
    
    
    
    153
    
    
    
    (950
    )
    
    
    529Income (loss) from continuing operations
    
    
    1,830
    
    
    
    
    
    
    
    143
    
    
    
    (1,282
    )
    
    
    691Income from operations of discontinued
segment, net of tax
    
    
    
    
    
    
    715
    
    
    
    
    
    
    
    
    
    
    
    715Net income (loss)
    
    $
    1,830
    
    
    $
    715
    
    
    $
    143
    
    
    $
    (1,282
    )
    
    $
    1,406Total assets
    
    $
    767,516
    
    
    $
    42,537
    
    
    $
    25,900
    
    
    $
    (14,786
    )
    
    $
    821,167
 13




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) Segment data for the six months ended June 30, 2004 and 2003 are as
follows: Six Months Ended June 30, 2004HoldingCompany andLoan
    
    Mortgage
    
    MiscellaneousBanking
    
    Servicing
    
    Investments
    
    Operations
    
    TotalInterest income
    
    $
    26,196
    
    
    $
    
    
    
    $
    1,053
    
    
    $
    27
    
    
    $
    27,276Interest expense
    
    
    11,879
    
    
    
    
    
    
    
    13
    
    
    
    513
    
    
    
    12,405Net interest income (expense)
    
    
    14,317
    
    
    
    
    
    
    
    1,040
    
    
    
    (486
    )
    
    
    14,871Provision for loan losses
    
    
    100
    
    
    
    
    
    
    
    114
    
    
    
    
    
    
    
    214Net interest income (expense) after
provision for loan losses
    
    
    14,217
    
    
    
    
    
    
    
    926
    
    
    
    (486
    )
    
    
    14,657Servicing income
    
    
    603
    
    
    
    
    
    
    
    37
    
    
    
    (119
    )
    
    
    521Realized gains
    
    
    273
    
    
    
    
    
    
    
    48
    
    
    
    
    
    
    
    321Other income (loss)
    
    
    466
    
    
    
    
    
    
    
    (260
    )
    
    
    119
    
    
    
    325Compensation and employee benefits
expense
    
    
    3,013
    
    
    
    
    
    
    
    
    
    
    
    381
    
    
    
    3,394Other expenses
    
    
    2,678
    
    
    
    
    
    
    
    8
    
    
    
    1,683
    
    
    
    4,369Income (loss) from continuing
operations before taxes
    
    
    9,868
    
    
    
    
    
    
    
    743
    
    
    
    (2,550
    )
    
    
    8,061Income tax provision (benefit)
    
    
    4,095
    
    
    
    
    
    
    
    309
    
    
    
    (992
    )
    
    
    3,412Income (loss) from continuing operations
    
    
    5,773
    
    
    
    
    
    
    
    434
    
    
    
    (1,558
    )
    
    
    4,649Income from operations of discontinued
segment, net of tax
    
    
    
    
    
    
    283
    
    
    
    
    
    
    
    
    
    
    
    283Gain on sale of subsidiary, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,832
    
    
    
    10,832Net income
    
    $
    5,773
    
    
    $
    283
    
    
    $
    434
    
    
    $
    9,274
    
    
    $
    15,764Total assets
    
    $
    1,210,140
    
    
    $
    
    
    
    $
    22,370
    
    
    $
    3
    
    
    $
    1,232,513
 14




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) Six Months Ended June 30, 2003HoldingCompany andLoan
    
    Mortgage
    
    MiscellaneousBanking
    
    Servicing
    
    Investments
    
    Operations
    
    TotalInterest income
    
    $
    21,429
    
    
    $
    
    
    
    $
    1,770
    
    
    $
    38
    
    
    $
    23,237Interest expense
    
    
    11,867
    
    
    
    
    
    
    
    48
    
    
    
    507
    
    
    
    12,422Net interest income (expense)
    
    
    9,562
    
    
    
    
    
    
    
    1,722
    
    
    
    (469
    )
    
    
    10,815(Recapture of) provision for loan losses
    
    
    (750
    )
    
    
    
    
    
    
    80
    
    
    
    
    
    
    
    (670
    )Net interest income (expense) after
(recapture of) provision for loan
losses
    
    
    10,312
    
    
    
    
    
    
    
    1,642
    
    
    
    (469
    )
    
    
    11,485Servicing income
    
    
    503
    
    
    
    
    
    
    
    81
    
    
    
    (648
    )
    
    
    (64
    )Realized gains
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    5Other (loss) income
    
    
    (238
    )
    
    
    
    
    
    
    (314
    )
    
    
    680
    
    
    
    128Compensation and employee benefits
expense
    
    
    2,275
    
    
    
    
    
    
    
    356
    
    
    
    965
    
    
    
    3,596Other expenses
    
    
    2,545
    
    
    
    
    
    
    
    186
    
    
    
    2,129
    
    
    
    4,860Income (loss) from continuing
operations before taxes
    
    
    5,757
    
    
    
    
    
    
    
    872
    
    
    
    (3,531
    )
    
    
    3,098Income tax provision (benefit)
    
    
    2,418
    
    
    
    
    
    
    
    357
    
    
    
    (1,442
    )
    
    
    1,333Income (loss) from continuing operations
    
    
    3,339
    
    
    
    
    
    
    
    515
    
    
    
    (2,089
    )
    
    
    1,765Income from operations of discontinued
segment, net of tax
    
    
    
    
    
    
    1,205
    
    
    
    
    
    
    
    
    
    
    
    1,205Net income (loss)
    
    $
    3,339
    
    
    $
    1,205
    
    
    $
    515
    
    
    $
    (2,089
    )
    
    $
    2,970Total assets
    
    $
    767,516
    
    
    $
    42,537
    
    
    $
    25,900
    
    
    $
    (14,786
    )
    
    $
    821,167
 15




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(Unaudited)
(Dollars in thousands, except share data and where noted) 7. INTANGIBLE ASSETS 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. As a result, the Company no longer amortizes
goodwill, but tests it for impairment on an annual basis, or more frequently if
conditions arise. 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: As of June 30, 2004
    
    As of December 31, 2003Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    AmortizationGoodwill
    
    $
    3,393
    
    
    $
    (339
    )
    
    $
    3,393
    
    
    $
    (339
    )Core deposit intangible
    
    
    1,294
    
    
    
    (1,035
    )
    
    
    1,294
    
    
    
    (906
    )Total
    
    $
    4,687
    
    
    $
    (1,374
    )
    
    $
    4,687
    
    
    $
    (1,245
    )
 For the quarter and six months ended June 30, 2004 the Company recorded
amortization expense of $64 and $129, respectively, related to the core
deposit intangible. The estimated amortization of the balance for the remainder
of 2004 and the succeeding fiscal years is $129 (2004), $130 (2005), and none
thereafter. There were no changes in the carrying value of goodwill during the quarter
ended June 30, 2004. The Company tested goodwill for impairment as of March 31,
2004 and determined that no impairment charge was required. 8. CASH DIVIDEND On July 1, 2004, the Company paid its first quarterly dividend, in the
amount of $0.125 per common share to stockholders of record as of June 15,
2004. The total dividend payable, approximately $2.6 million, was accrued as
of June 30, 2004 and is reflected in the accompanying consolidated statements
of financial condition. 9. NEW ACCOUNTING PRONOUNCEMENTS In March 2004, the Financial Accounting Standards Board ratified the
consensus reached in November 2003 by the Emerging Issues Task Force on Issue
03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments.The consensus requires certain quantitative and
qualitative disclosures for debt and marketable equity securities classified as
available-for-sale or held-to-maturity under SFAS Nos. 115 and 124 that are
impaired at the balance sheet date but for which an other-than-temporary
impairment has not been recognized. The consensus also provides guidance for
determining when an investment is other-than-temporarily impaired. This
guidance is effective for periods beginning after June 15, 2004. The Company
is currently evaluating the impact that this guidance will have on its
financial condition and results of operations. 10. SUBSEQUENT EVENT In August 2004, the Federal Home Loan Bank of San Francisco increased the
Banks authorized borrowing limit for FHLB advances from 35% to 40% of the
Banks total assets as of the previous quarter-end. 16




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis should be read in conjunction with
the Interim 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. Through April 30, 2004, Wilshire Financial Services Group Inc. conducted
operations in three principal business segments: (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). Sale of Wilshire Credit Corporation On April 30, 2004, we completed the sale of WCC, our wholly-owned loan
servicing subsidiary, to Merrill Lynch Mortgage Capital Inc. (Merrill Lynch),
a division of Merrill Lynch & Co., New York, NY, for net proceeds of
approximately $48.7 million, and realized a gain on the sale of approximately
$18.5 million before taxes. The final sales proceeds are subject to adjustment
based on WCCs final net asset value as determined jointly by the Company and
Merrill Lynch. Subsequent to the sale of WCC, we have operated primarily as a unitary
bank holding company. Our business strategy is focused on the growth
and profitability of our banking segment through increased lending
and investment activity, and on the management of the existing asset
portfolio in our Mortgage Investment segment. We believe that our success
in implementing this strategy depends primarily on
our ability to (1) evaluate and manage both credit risk and interest-rate risk
and (2) employ financial leverage such that cash flows from the underlying
investments generally match the debt service requirements. RESULTS OF OPERATIONSQUARTER AND SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO
QUARTER AND SIX MONTHS ENDED JUNE 30, 2003 Our consolidated net income for the quarter ended June 30, 2004 was $13.3
million, or $0.62 per diluted share, compared with $1.4 million, or $0.07 per
diluted share, for the quarter ended June 30, 2003. For the six-month period
ended June 30, 2004, our net income was $15.8 million, or $0.74 per diluted
share, compared with $3.0 million, or $0.15 per diluted share, for the six
months ended June 30, 2003. As a result of the sale of WCC, we have presented WCCs operating results
under the Discontinued operations caption, separate and apart from Income
from continuing operations in our consolidated statements of operations for
the periods presented. Our income from continuing operations for the quarter
and six months ended June 30, 2004 was $2.7 million ($0.12 per diluted share)
and $4.6 million ($0.22 per diluted share), respectively, compared with $0.7
million ($0.03 per diluted share) and $1.8 million ($0.09 per diluted share)
for the quarter and six months ended June 30, 2003. Pre-tax income from
continuing operations was $4.7 million and $8.1 million, respectively, for the
quarter and six months ended June 30, 2004, compared with $1.2 million and $3.1
million for the corresponding 2003 periods. Our results from discontinued operations for the quarterly and six-month
periods ended June 30, 2004 reflect WCCs net loss for of $0.2 million for the
month of April 2004 and WCCs net income of $0.3 million for the four months
ended April 30, 2004, respectively. WCC recorded net income of $0.7 million and
$1.2 million, respectively, for the quarter and six months ended June 30, 2003. Our consolidated stockholders equity increased by $12.4 million during
the six months ended June 30, 2004, to $137.9 million, or $6.40 per diluted
share. This increase reflects our net income for the year to date and the sale
of 17




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##### Table of Contents



additional shares of common stock pursuant to the exercise of stock options,
partially offset by a cash dividend of $2.6 million on the Companys common
stock and net after-tax unrealized losses of $4.0 million on our portfolio of
available-for-sale securities and hedging instruments. The increase in income from continuing operations for the second quarter
of 2004 over the second quarter of 2003 was due primarily to a $2.8 million
increase in consolidated net interest income, reflecting significant lending
and investment activity at our banking subsidiary, FBBH. In addition, we
realized a $0.7 million increase in other income and a $0.8 million decrease in
consolidated operating expenses. These factors were partially offset by a loan
loss provision of $0.1 million for the quarter ended June 30, 2004, which, when
compared with recaptures of loan losses of $0.7 million for the quarter ended
June 30, 2003, represents an overall increase in provision of $0.8 million. Our results for the six months ended June 30, 2004 versus the comparable
2003 period reflect a $4.1 million increase in net interest income, a $1.1
million increase in other income, and a $0.7 million decrease in consolidated
operating expenses. These increases in income were partially offset by a loan
loss provision of $0.2 million for the six-month period ended June 30, 2004,
compared with loan loss recaptures of $0.7 million in the corresponding 2003
period, for an overall increase in provision of $0.9 million. Following is a discussion of the operating results of the Companys
Banking Operations and Mortgage Investment Operations segments, and its
discontinued Loan Servicing Operations. FIRST BANK OF BEVERLY HILLS, F.S.B. The following table compares income before taxes for FBBH for the quarters
and six-month periods ended June 30, 2004 and 2003. Quarter Ended June 30,
    
    Six Months Ended June 30,Increase
    
    
    
    
    
    
    
    
    
    Increase2004
    
    2003
    
    (Decrease)
    
    2004
    
    2003
    
    (Decrease)(Dollars in thousands)Interest income
    
    $
    14,148
    
    
    $
    10,417
    
    
    $
    3,731
    
    
    $
    26,196
    
    
    $
    21,429
    
    
    $
    4,767Interest expense
    
    
    6,307
    
    
    
    5,624
    
    
    
    683
    
    
    
    11,879
    
    
    
    11,867
    
    
    
    12Net interest income
    
    
    7,841
    
    
    
    4,793
    
    
    
    3,048
    
    
    
    14,317
    
    
    
    9,562
    
    
    
    4,755Provision for
(recapture of) loan
losses
    
    
    100
    
    
    
    (750
    )
    
    
    850
    
    
    
    100
    
    
    
    (750
    )
    
    
    850Net interest income
after provision for
(recapture of) loan
losses
    
    
    7,741
    
    
    
    5,543
    
    
    
    2,198
    
    
    
    14,217
    
    
    
    10,312
    
    
    
    3,905Realized gains on sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    273
    
    
    
    
    
    
    
    273Other income
    
    
    591
    
    
    
    4
    
    
    
    587
    
    
    
    1,069
    
    
    
    265
    
    
    
    804Compensation and
employee benefits
expense
    
    
    1,445
    
    
    
    1,144
    
    
    
    301
    
    
    
    3,013
    
    
    
    2,275
    
    
    
    738Other expenses
    
    
    1,364
    
    
    
    1,247
    
    
    
    117
    
    
    
    2,678
    
    
    
    2,545
    
    
    
    133Income before taxes
    
    $
    5,523
    
    
    $
    3,156
    
    
    $
    2,367
    
    
    $
    9,868
    
    
    $
    5,757
    
    
    $
    4,111
 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, 2004 and 2003 (dollars in thousands): 18




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##### Table of Contents



Quarter Ended June 30, 2004
    
    Quarter Ended June 30, 2003Average
    
    
    
    
    
    Annualized
    
    Average
    
    
    
    
    
    AnnualizedBalance
    
    Interest
    
    Yield/Rate
    
    Balance
    
    Interest
    
    Yield/RateInterest-Earning Assets:Federal funds and short-term
investments
    
    $
    21,191
    
    
    $
    59
    
    
    
    1.10
    %
    
    $
    14,212
    
    
    $
    43
    
    
    
    1.20
    %Mortgage-backed and other
securities
    
    
    330,787
    
    
    
    2,815
    
    
    
    3.40
    
    
    
    249,348
    
    
    
    2,282
    
    
    
    3.66Loans
    
    
    798,958
    
    
    
    11,274
    
    
    
    5.65
    
    
    
    482,905
    
    
    
    8,092
    
    
    
    6.70Total interest-earning assets
    
    $
    1,150,936
    
    
    $
    14,148
    
    
    
    4.86
    %
    
    $
    746,465
    
    
    $
    10,417
    
    
    
    5.52
    %Interest-Bearing Liabilities:Interest-bearing deposits
    
    $
    655,797
    
    
    $
    3,278
    
    
    
    2.01
    %
    
    $
    365,404
    
    
    $
    2,776
    
    
    
    3.05
    %Borrowings
    
    
    419,808
    
    
    
    3,029
    
    
    
    2.89
    
    
    
    305,997
    
    
    
    2,848
    
    
    
    3.73Total interest-bearing
liabilities
    
    $
    1,075,605
    
    
    $
    6,307
    
    
    
    2.35
    %
    
    $
    671,401
    
    
    $
    5,624
    
    
    
    3.36
    %Net interest income
    
    
    
    
    
    $
    7,841
    
    
    
    
    
    
    
    
    
    
    $
    4,793Net interest spread
    
    
    
    
    
    
    
    
    
    
    2.51
    %
    
    
    
    
    
    
    
    
    
    
    2.16
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    2.73
    %
    
    
    
    
    
    
    
    
    
    
    2.58
    %
 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, 2004 and 2003 (dollars in thousands): Six Months Ended June 30, 2004
    
    Six Months Ended June 30, 2003Average
    
    
    
    
    
    Annualized
    
    Average
    
    
    
    
    
    AnnualizedBalance
    
    Interest
    
    Yield/Rate
    
    Balance
    
    Interest
    
    Yield/RateInterest-Earning Assets:Federal funds and short-term
investments
    
    $
    20,016
    
    
    $
    111
    
    
    
    1.10
    %
    
    $
    14,525
    
    
    $
    94
    
    
    
    1.29
    %Mortgage-backed and other
securities
    
    
    299,237
    
    
    
    5,429
    
    
    
    3.63
    
    
    
    256,259
    
    
    
    5,145
    
    
    
    4.02Loans
    
    
    719,410
    
    
    
    20,656
    
    
    
    5.74
    
    
    
    485,868
    
    
    
    16,190
    
    
    
    6.66Total interest-earning assets
    
    $
    1,038,663
    
    
    $
    26,196
    
    
    
    4.99
    %
    
    $
    756,652
    
    
    $
    21,429
    
    
    
    5.63
    %Interest-Bearing Liabilities:Interest-bearing deposits
    
    $
    593,730
    
    
    $
    6,391
    
    
    
    2.16
    %
    
    $
    378,487
    
    
    $
    5,989
    
    
    
    3.19
    %Borrowings
    
    
    371,325
    
    
    
    5,488
    
    
    
    2.96
    
    
    
    305,322
    
    
    
    5,878
    
    
    
    3.88Total interest-bearing
liabilities
    
    $
    965,055
    
    
    $
    11,879
    
    
    
    2.47
    %
    
    $
    683,809
    
    
    $
    11,867
    
    
    
    3.50
    %Net interest income
    
    
    
    
    
    $
    14,317
    
    
    
    
    
    
    
    
    
    
    $
    9,562Net interest spread
    
    
    
    
    
    
    
    
    
    
    2.52
    %
    
    
    
    
    
    
    
    
    
    
    2.13
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    2.76
    %
    
    
    
    
    
    
    
    
    
    
    2.55
    %
 The Banks net interest income was $7.8 million for the quarter ended June
30, 2004, compared with $4.8 million for the quarter ended June 30, 2003. For
the six months ended June 30, 2004, the Banks net interest income was $14.3
million, compared with $9.6 million for the six months ended June 30, 2003. The Banks net interest spread increased by 35 basis points, to 2.51% for
the quarter ended June 30, 2004 compared with 2.16% for the quarter ended June
30, 2003, and its net interest margin increased by 15 basis points, to 2.73%
for the second quarter of 2004 compared with 2.58% for the second quarter of
2003. For the six-month period ended June 30, 2004, the Banks net interest
spread was 2.52%, a 39-basis point increase over the 2.13% net interest spread
for the six months ended June 30, 2003. Net interest margin increased by 21
basis points, to 2.76% for the first six months of 2004 compared with 2.55% for
the corresponding 2003 period. The increase in net interest income for the 2004 periods was primarily
attributable to the Banks significant loan originations and purchases in the
first two quarters of 2004 and in late 2003, utilizing new deposits and
low-cost borrowings as funding sources. In addition, the prevailing low
interest-rate environment has continued to impact the Banks interest-bearing
liabilities to a greater extent than its interest-earning assets, as indicated
by the higher spreads and margins in 2004. The Banks overall cost of funds
declined by more than 100 basis points from the quarterly and six-month periods
ended June 30, 2003 to the corresponding 2004 periods, while its yield on
interest-earning assets declined by only slightly more than 60 basis points
from the 2003 periods to the 2004 periods. The Banks interest income on mortgage-backed and other investment
securities was $2.8 million for the quarter ended June 30, 2004, compared with
$2.3 million for the quarter ended June 30, 2003. For the six months ended
June 30, 2004, interest on mortgage-backed and other investment securities was
$5.4 million, compared with 19




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##### Table of Contents



$5.1 million for the six months ended June 30, 2003. The increases in the 2004
periods were due to an increase in the average investment balance, primarily as
a result of the Banks purchases of $174.1 million of mortgage-backed and other
investment securities during the first six months of 2004 and $109 million in
the third and fourth quarters of 2003. A second factor contributing to the
increase in average balance was a slight slowing of prepayment rates on the
portfolio in the first two quarters of 2004. This higher earning-asset volume
was partially offset by declines in average yield of 26 basis points from the
second quarter of 2003 to the second quarter of 2004, and 39 basis points from
the first six months of 2003 to the first six months of 2004. The Banks interest income on loans was $11.3 million for the quarter
ended June 30, 2004, compared with $8.1 million for the quarter ended June 30,
2003. For the six months ended June 30, 2004, interest income on loans totaled
$20.7 million, compared with $16.2 million for the six months ended June 30,
2003. The increases in the 2004 periods were due to increases in the average
loan volume of $316.1 million from the second quarter of 2003 to the second
quarter of 2004 and $233.5 million from the first six months of 2003 to the
first six months of 2004, which more than offset the decline in yields from
2003 to 2004. The Bank originated and purchased a total of $297 million in new
commercial and multi-family loans during the first six months of 2004, in
addition to $210 million in the final six months of 2003. FBBHs interest expense on deposits was approximately $3.3 million for the
quarter ended June 30, 2004, compared with $2.8 million for the quarter ended
June 30, 2003. For the six-month period ended June 30, 2004, interest expense
on deposits was $6.4 million, compared with $6.0 million for the six-month
period ended June 30, 2003. The increases in the 2004 periods resulted from a
significant increase in the average deposit balance, as the Bank raised new
brokered certificates of deposit in the last two quarters of 2003 and the first
two quarters of 2004 to finance its loan originations and purchases. This
higher deposit volume in 2004 was partially offset by declines in the cost of
deposits of over 100 basis points from the quarter and six months ended June
30, 2003 to the corresponding 2004 periods. The Banks interest expense on borrowings for the quarter ended June 30,
2004 was approximately $3.0 million, compared with $2.8 million for the quarter
ended June 30, 2003. This increase was due to a $113.8 million increase in the
average balance outstanding, partially offset by an 84-basis point drop in cost
in the second quarter of 2004 as compared with the second quarter of 2003.
Beginning in May 2004, after receiving a deposit of $52 million representing
the gross proceeds from the sale of WCC, the Bank increasingly utilized FHLB
advances as its primary funding source in lieu of higher-costing certificates
of deposit. For the six months ended June 30, 2004, the Banks interest expense
on borrowings was $5.5 million, a $0.4 million decrease from the corresponding
2003 period. The decrease was due to a 92-basis point drop in the cost of
borrowings, which more than offset the effects of the $66 million increase in
average balance. Provision for Loan Losses Provisions for losses on loans are charged to operations to maintain an
allowance for losses on the loan portfolio at a level which the Bank believes
is adequate based on an evaluation of the inherent risks in the portfolio. The
Banks evaluation is based on an analysis of the loan portfolio, historical
loss experience, current economic conditions and trends, collateral values, and
other relevant factors. Pursuant to its quarterly evaluation of the adequacy of its loan loss
reserves, the Bank recorded a provision for loan losses of $0.1 million in the
second quarter of 2004. In the quarter ended June 30, 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 Gains on Sales The Bank sold a total of $17.7 million in mortgage-backed securities for a
realized gain of $0.3 million in February and March of 2004, with no such sales
activity in the first six months of 2003. Other Income The Banks other income increased by $0.6 million from the second quarter
of 2003 to the second quarter of 2004, and by $0.8 million from the six months
ended June 30, 2003 to the six months ended June 30, 2004. The increase in the
2004 periods was due primarily to the transfer of the servicing duties on the
Banks loan portfolio from WCC to the Bank beginning January 1, 2004. As a
result, the Bank now earns income on loan fees and late charges and no longer
pays a fee to WCC for servicing a majority of its loan portfolio. 20




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Compensation and Employee Benefits Expense The Banks compensation and employee benefits expense totaled $1.4 million
for the second quarter of 2004, compared with $1.1 million for the second
quarter of 2003. For the six months ended June 30, 2004, compensation and
employee benefits expense totaled $3.0 million, compared with $2.3 million for
the six months ended June 30, 2003. The increases in the 2004 periods were due
to an increase in bonus expense, as a result of the high level of loan fundings
and improved earnings in the first two quarters of 2004. Other Expenses The Banks other expenses increased by approximately $0.1 million for the
quarter and six months ended June 30, 2004 as compared with the corresponding
2003 periods. The Bank has incurred slightly higher professional fees in the
current year to date, primarily as a result of consulting fees incurred in
connection with its conversion to an in-house loan servicing system in January
2004. In most other expense categories, costs remained largely consistent,
reflecting the Banks efforts to control overhead. Changes in Financial Condition  First Bank of Beverly Hills Following are condensed statements of financial condition for FBBH as of
June 30, 2004 and December 31, 2003: June 30,
    
    December 31,2004
    
    2003(Dollars in thousands)ASSETS:Cash and cash equivalents
    
    $
    12,723
    
    
    $
    15,535Mortgage-backed securities available for sale, at fair value
    
    
    314,095
    
    
    
    223,450Other investment securities available for sale, at fair value
    
    
    11,812
    
    
    
    22,086Investment securities held to maturity, at amortized cost
    
    
    9,632
    
    
    
    9,607Loans, net
    
    
    826,293
    
    
    
    610,890Real estate owned, net
    
    
    2,014
    
    
    
    267Other assets
    
    
    33,571
    
    
    
    24,351Total assets
    
    $
    1,210,140
    
    
    $
    906,186LIABILITIES:Deposits
    
    $
    636,145
    
    
    $
    473,409Short-term borrowings
    
    
    80,000
    
    
    
    88,000FHLB advances
    
    
    392,237
    
    
    
    249,337Other liabilities
    
    
    11,675
    
    
    
    14,540Total liabilities
    
    
    1,120,057
    
    
    
    825,286NET WORTH
    
    
    90,083
    
    
    
    80,900Total liabilities and net worth
    
    $
    1,210,140
    
    
    $
    906,186
 Mortgage-Backed and Other Securities Available for Sale.During the six
months ended June 30, 2004, the Banks total portfolio of mortgage-backed
securities (MBS) available for sale increased by $90.6 million, primarily as a
result of $174.1 million in purchases of AAA-rated and agency MBS. These new
purchases were partially offset by principal repayments of $68.4 million and
sales of $7.6 million. In addition, the Bank recorded an increase in
unrealized holding losses of $6.4 million on its portfolio, as a result of an
increase in market rates of interest in the second quarter. The Banks portfolio of other investment securities available for sale
decreased by approximately $10.3 million during the six months ended June 30,
2004. This decrease was due to the sale of $10.1 million of government agency
securities and an increase unrealized holding losses of $0.2 million. 21




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##### Table of Contents



Loans, net.The Banks portfolio of loans, net of discounts and
allowances, increased by approximately $215.4 million in the first six months
of 2004. The Bank originated $191.3 million of primarily commercial mortgage
loans and purchased an additional $105.5 million of multi-family and commercial
loans. These additions to the portfolio were partially offset by $78.8 million
of principal repayments and $2.0 million of foreclosures during the year to
date. Real Estate Owned, net.The Banks portfolio of real estate owned, net,
increased by approximately $1.7 million for the six-month period ended June 30,
2004. This increase was due to $2.0 million in new foreclosures, partially
offset by $0.3 million in sales and write-downs of properties. Deposits.The Banks deposits increased by $162.7 million during the six
months ended June 30, 2004. The Bank raised a significant volume of new
brokered certificates of deposit through April 2004 in order to finance its new
loan originations. Subsequent to April 30, 2004, after receiving the $52
million in gross proceeds from WFSG on the sale of WCC, the Bank permitted the
run-off of its higher-rate certificates of deposit and replaced these with
lower-costing Federal Home Loan Bank advances. The $52 million in demand
deposits held by WFSG is eliminated in consolidation and thus is not reflected
in deposits on the Companys consolidated statements of financial condition. Short-Term Borrowings.The Banks short-term borrowings decreased by $8.0
million during the six months ended June 30, 2004. This decrease was due to
repayments of $83.0 million of repurchase agreements, partially offset by
repurchase agreement renewals totaling $70.0 million and federal funds
purchases of $5.0 million. 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 $142.9 million for
the six months ended June 30, 2004. This increase reflects $554.9 million in
new advances in the first two quarters, partially offset by maturities of
$412.0 million. As discussed above, the Bank utilized FHLB advances as the
primary funding source for its asset acquisitions after receiving WFSGs
deposit of the proceeds from the sale of WCC. In August 2004, the FHLB
increased the Banks borrowing limit from 35% to 40% of the Banks total assets
as of the previous quarter-end. Net Worth.The Banks total net worth increased by approximately $9.2
million for the six months ended June 30, 2004. This increase reflects the
Banks year-to-date net income of $5.8 million and a capital contribution of
$7.1 million from WFSG through the forgiveness of a portion of the Banks
income tax liability to WFSG, in accordance with a tax-sharing agreement
between the Company and the Bank. These increases were partially offset by $3.7
million in net after-tax unrealized losses on the Banks portfolio of
available-for-sale securities and hedging instruments. Regulatory Capital Requirements 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, 2004. Regulatory Capital Ratios Amount RequiredFor Capital
    
    To be CategorizedAdequacy
    
    asActual
    
    Purposes
    
    Well
CapitalizedAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(Dollars in thousands)Total Capital to Risk-Weighted Assets (Risk-Based
Capital)
    
    $
    97,136
    
    
    
    10.9
    %
    
    $
    71,016
    
    
    
    8.0
    %
    
    $
    88,770
    
    
    
    10.0
    %Tier 1 Capital to Risk-Weighted Assets
    
    
    90,505
    
    
    
    10.2
    %
    
    
    Not Applicable
    
    
    
    53,262
    
    
    
    6.0
    %Core Capital to Tangible Assets
    
    
    90,505
    
    
    
    7.5
    %
    
    
    48,537
    
    
    
    4.0
    %
    
    
    60,672
    
    
    
    5.0
    %Tangible Capital to Tangible Assets
    
    
    90,505
    
    
    
    7.5
    %
    
    
    18,201
    
    
    
    1.5
    %
    
    
    Not Applicable
 22




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##### Table of Contents



Liquidity and Capital Resources 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 August 2004, the FHLB raised the
Banks authorized borrowing limit from 35% to 40% 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, 2004, the Banks cash balances totaled approximately $12.7
million, compared with $15.5 million at December 31, 2003. The decrease in cash
was primarily due to new loan originations and purchases of loans and
mortgage-backed securities, partially offset by the generation of significant
deposits and new borrowings during the year to date. At June 30, 2004, the Bank had approximately $498.8 million of
certificates of deposit. Scheduled maturities of certificates of deposit during
the 12 months ending June 30, 2005 and thereafter amounted to $395.2 million
and $103.6 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 the Banks
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. MORTGAGE INVESTMENT OPERATIONS The Company 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 active acquisition of assets by WFC has been
significantly curtailed since 2001, and its current operations
consist primarily of the management of its existing asset portfolio. The following table compares WFCs income before taxes for the quarters
and six-month periods ended June 30, 2004 and 2003. Quarter Ended June 30,
    
    Six Months Ended June 30,Increase
    
    
    
    
    
    
    
    
    
    Increase2004
    
    2003
    
    (Decrease)
    
    2004
    
    2003
    
    (Decrease)(Dollars in thousands)Interest income
    
    $
    493
    
    
    $
    729
    
    
    $
    (236
    )
    
    $
    1,053
    
    
    $
    1,770
    
    
    $
    (717
    )Realized gains
    
    
    1
    
    
    
    
    
    
    
    1
    
    
    
    48
    
    
    
    5
    
    
    
    43Other loss, net
    
    
    (85
    )
    
    
    (154
    )
    
    
    69
    
    
    
    (223
    )
    
    
    (233
    )
    
    
    10Total revenues
    
    
    409
    
    
    
    575
    
    
    
    (166
    )
    
    
    878
    
    
    
    1,542
    
    
    
    (664
    )Interest expense
    
    
    3
    
    
    
    20
    
    
    
    (17
    )
    
    
    13
    
    
    
    48
    
    
    
    (35
    )Provision for loan losses
    
    
    
    
    
    
    50
    
    
    
    (50
    )
    
    
    114
    
    
    
    80
    
    
    
    34Compensation and employee
benefits expense
    
    
    
    
    
    
    151
    
    
    
    (151
    )
    
    
    
    
    
    
    356
    
    
    
    (356
    )Other expenses
    
    
    5
    
    
    
    58
    
    
    
    (53
    )
    
    
    8
    
    
    
    186
    
    
    
    (178
    )Total provisions and expenses
    
    
    8
    
    
    
    279
    
    
    
    (271
    )
    
    
    135
    
    
    
    670
    
    
    
    (535
    )Income before taxes
    
    $
    401
    
    
    $
    296
    
    
    $
    105
    
    
    $
    743
    
    
    $
    872
    
    
    $
    (129
    )
 23




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##### Table of Contents



Interest Income and Interest Expense WFCs interest income was $0.5 million for the quarter ended June 30,
2004, compared with $0.7 million for the quarter ended June 30, 2003. For the
six months ended June 30, 2004, interest income was approximately $1.1 million,
compared with $1.8 million for the six months ended June 30, 2003. The
decreases in the 2004 periods were due primarily to a decline in interest on
mortgage-backed securities as a result of runoff in WFCs MBS portfolio, which
has been triggered by prepayments on the loans underlying the securities. WFC
records the receipt of such payments directly to interest income, as its
portfolio of securities has been written down to an amortized cost of zero. WFCs interest expense for the quarter and six months ended June 30, 2004
decreased slightly from the corresponding 2003 periods. These decreases were
due to a lower average balance of borrowings outstanding in the current period
as a result of WFCs repayments of debt facilities. Other Loss, Net The components of WFCs other loss are reflected in the following table: Quarter Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(Dollars in thousands)Other loss:Real estate owned, net
    
    $
    3
    
    
    $
    1
    
    
    $
    3
    
    
    $
    (14
    )Investor participation interest
    
    
    (69
    )
    
    
    (60
    )
    
    
    (159
    )
    
    
    (127
    )Other, net
    
    
    (19
    )
    
    
    (95
    )
    
    
    (67
    )
    
    
    (92
    )Total other loss
    
    $
    (85
    )
    
    $
    (154
    )
    
    $
    (223
    )
    
    $
    (233
    )
 Other loss includes the co-investors share of certain investment
activities conducted with WFC, which is reported as Investor participation
interest expense in the above table. Compensation and Employee Benefits Expense WFC did not record compensation and employee benefits expense for the
first two quarters of 2004. As part of the Companys reallocation of operating
expenses among its business segments in the second quarter of 2003, certain
employees compensation was transferred to WCC from WFC. Those employees
remained with WCC subsequent to its sale, and the Company will no longer incur
their related compensation expense. Other Expenses WFC incurred minimal other operating expenses in the quarter and six
months ended June 30, 2004, compared with $58 thousand and $0.2 million,
respectively, for the corresponding 2003 periods. The decrease was primarily
due to the reallocation of certain assets and expense categories from WFC to
the Companys other business segments in the second quarter of 2003. Changes in Financial Condition  Wilshire Funding Corporation Following are WFCs condensed statements of financial condition as of June
30, 2004 and December 31, 2003: June 30,
    
    December 31,2004
    
    2003(Dollars in thousands)ASSETS:Cash and cash equivalents
    
    $
    551
    
    
    $
    37Mortgage-backed securities available for sale, at fair value
    
    
    347
    
    
    
    862Discounted loans, net
    
    
    3,126
    
    
    
    3,817Intercompany receivables
    
    
    17,870
    
    
    
    17,911Other assets
    
    
    476
    
    
    
    627Total assets
    
    $
    22,370
    
    
    $
    23,254LIABILITIES:Investment financing
    
    $
    
    
    
    $
    681Other liabilities
    
    
    1,721
    
    
    
    2,055Total liabilities
    
    
    1,721
    
    
    
    2,736NET WORTH
    
    
    20,649
    
    
    
    20,518Total liabilities and net worth
    
    $
    22,370
    
    
    $
    23,254
 24




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##### Table of Contents



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, 2004 as a result of a decline in
the fair value of the securities. WFC received $0.5 million in principal and
interest repayments in the current year 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 $0.7 million for the six months ended June 30, 2004. This
decrease resulted from $1.0 million of principal repayments and a loan loss
provision of $0.1 million, partially offset by a purchase of $0.4 million of
discounted loans. Investment Financing.WFCs investment financing consisted of a debt
facility with the co-investor. WFC repaid this borrowing in full during the
second quarter of 2004. Liquidity and Capital Resources WFCs sources of cash flow include primarily net interest income and
repayments on its portfolio of loans and mortgage-backed securities. WFCs
liquidity is actively managed and periodically reviewed by our Board of
Directors. This process is intended to ensure the maintenance of sufficient
funds to meet WFCs operating needs. 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 needs. HOLDING COMPANY AND MISCELLANEOUS OPERATIONS Our Holding Company and Miscellaneous Operations consist of other
operating revenues and expenses not directly attributable to our Banking or
Mortgage Investment Operations, and also include 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 sale
of WCC, 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 2003 the Bank remitted a total of
$1.2 million to the Company for prior years tax liabilities under the
foregoing formula. The Company will continue to depend on its non-Bank
subsidiaries to meet its liquidity needs. DISCONTINUED OPERATIONS  LOAN SERVICING The Company previously conducted Loan Servicing Operations through WCC,
our servicing subsidiary which was formed pursuant to our June 10, 1999
reorganization. As discussed earlier, on April 30, 2004, we completed the sale
of WCC to Merrill Lynch Mortgage Capital Inc. The following table summarizes WCCs income before taxes for the quarters
and six-month periods ended June 30, 2004 and 2003. The amounts for the quarter
ended June 30, 2004 reflect activity for the month of April 2004 only, and the
amounts for the six months ended June 30, 2004 reflect activity for the
four-month period ended April 30, 2004. 25




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##### Table of Contents



Quarter Ended June 30,
    
    Six Months Ended June 30,Increase
    
    
    
    
    
    
    
    
    
    Increase2004
    
    2003
    
    (Decrease)
    
    2004
    
    2003
    
    (Decrease)(Dollars in thousands)Servicing income
    
    $
    3,420
    
    
    $
    8,016
    
    
    $
    (4,596
    )
    
    $
    11,754
    
    
    $
    15,811
    
    
    $
    (4,057
    )Other income
    
    
    223
    
    
    
    525
    
    
    
    (302
    )
    
    
    689
    
    
    
    574
    
    
    
    115Total revenues
    
    
    3,643
    
    
    
    8,541
    
    
    
    (4,898
    )
    
    
    12,443
    
    
    
    16,385
    
    
    
    (3,942
    )Interest expense
    
    
    37
    
    
    
    122
    
    
    
    (85
    )
    
    
    164
    
    
    
    263
    
    
    
    (99
    )Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    49
    
    
    
    
    
    
    
    49Compensation and employee
benefits expense
    
    
    3,324
    
    
    
    5,457
    
    
    
    (2,133
    )
    
    
    9,427
    
    
    
    10,566
    
    
    
    (1,139
    )Other expenses
    
    
    612
    
    
    
    1,789
    
    
    
    (1,177
    )
    
    
    2,319
    
    
    
    3,629
    
    
    
    (1,310
    )Total provisions and expenses
    
    
    3,973
    
    
    
    7,368
    
    
    
    (3,395
    )
    
    
    11,959
    
    
    
    14,458
    
    
    
    (2,499
    )(Loss) income before taxes
    
    $
    (330
    )
    
    $
    1,173
    
    
    $
    (1,503
    )
    
    $
    484
    
    
    $
    1,927
    
    
    $
    (1,443
    )
 As a result of WCCs sale, its results of operations have been removed
from the Companys results from continuing operations on the accompanying
Consolidated Statements of Operations, and have been presented separately in a
single caption as (Loss) income from operations of discontinued segment for
the periods presented. CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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 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. We believe the following critical accounting policies involve the more
significant judgments and estimates used in the preparation of the consolidated
financial statements:  Mortgage-Backed and Other Investment Securities Available for Sale.The
Companys mortgage-backed and other investment securities available for sale
are reported at their current fair market value. In determining current fair
value when quotes from third parties are not available, we estimate the present
value of the anticipated cash flows of the securities based on certain
assumptions, including the amount and timing of future repayments, the discount
rate to be used, and default rates and expected losses on the loans underlying
the securities. If the change in market value is considered temporary, the
unrealized holding gains and losses are reported net of tax, when applicable,
as a separate component of accumulated other comprehensive income in
stockholders equity. In the event of a decline in market value, management
must evaluate whether the decline is temporary in nature or other than
temporary. Declines that are considered other than temporary are reflected as
Market valuation losses and impairments in the consolidated statements of
operations and not as a direct reduction to stockholders equity. The Companys
portfolio of mortgage-backed and other investment securities available for sale
has increased significantly over the past three years and, as of June 30, 2004,
represented more than 25% 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. The Bank maintains an allowance for loan losses
at a level believed adequate by management to absorb estimated losses inherent
in the loan portfolios. The allowance is increased by provisions for loan
losses charged against operations, recoveries of previously charged off loans,
and allocations of discounts on purchased loans, and is decreased by loan
charge-offs. Loans are charged off when they are deemed to be uncollectible. 26




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##### Table of Contents



The Bank uses its internal asset review system to evaluate its loan
portfolio and to classify loans as pass, special mention, substandard, doubtful
or loss. These terms correspond to varying degrees of risk that the loans will
not be collected in part or in full. The frequency at which a specific loan is
subjected to internal asset review depends on the type and size of the loan and
the presence or absence of other risk factors, such as delinquency and changes
in collateral values. The allowance for loan losses includes specific valuation
allowances (SVAs) established for impaired loans and for certain other
classified loans, and general valuation allowances (GVAs). SVAs are in most cases equal to the excess of the unpaid principal balance
over the fair value of the collateral for all impaired loans. GVAs are based on
qualitative and quantitative factors that are updated each quarter. The
qualitative factors are subject to managements evaluation after consideration
of certain credit risk characteristics. These factors include, but are not
limited to, the following: the institutions historical and recent loss
experience in its portfolios; the volume, severity and trend of non-performing
assets; the extent to which refinances or loan modifications are made to
maintain loans in a current status; known deterioration in credit
concentrations or certain classes of loans; loan to value ratios of real estate
secured loans; risks associated with specific types of collateral; the quality
and effectiveness of the lending policy, loan purchase policy, internal asset
review policy, charge-off, collection and recovery policies; current and
anticipated conditions in the general and local economies which might affect
the collectability of the institutions asset; anticipated changes in the
composition or volume of the loan portfolio; reasonableness standards in
accordance with regulatory agency policies; and the comparison of the Banks
allowance with that of industry peers. To assess the adequacy of the Banks allowance for loan losses, the
portfolio is segmented into three components: impaired loans, homogeneous
loans, and non-homogeneous loans.  
    
    Impaired loans have been defined as all loan types classified
either substandard, doubtful, or loss (including loans which may have
been upgraded but which are troubled debt restructurings). SVAs are
measured on a loan-by-loan basis utilizing either the discounted cash
flow or fair market value approaches, as defined under the accounting
standards for impaired loans.
    
    Homogeneous loans have been defined as loans secured by one to four
single-family residences, mobile home loans, and consumer loans, and
are analyzed by their respective loan group. GVA loss estimates are
measured utilizing an average of peer benchmark factors and the Banks
historical loss migration factors for homogeneous pools.
    
    Non-homogeneous loans include the following loan types:
multifamily, commercial real estate, bridge loans, construction
loans, and commercial unsecured. The non-homogeneous loans are
analyzed individually. GVA loss estimates are developed and based upon
risk rating utilizing migration analysis, which considers the impact of
losses on a loan-by-loan basis. A loss horizon of four years has been
developed with the objective of achieving loss data to capture a full
business cycle. When the Bank increases the allowance for loan losses related to loans, it
records a corresponding increase to the provision for loan losses in the
statement of operations. The OTS, as part of its examination process,
periodically reviews the Banks allowances for losses and the carrying values
of its assets. There can be no assurance that the OTS will not require
additional reserves following future examinations. When our Mortgage Investment Operations acquire pools of discounted loans,
we record an increase to the allowance for loan losses by allocating a portion
of the purchase discount deemed to be associated with measurable credit risk.
Amounts allocated to the allowance for loan losses from purchase discounts do
not increase the provision for loan losses recorded in the statement of
operations; rather they decrease the amounts of the purchase discounts that are
accreted into the interest income over the lives of the loans. If, after the
initial allocation of the purchase discount to the allowance for loan losses,
management subsequently identifies the need for additional allowances against
discounted loans, the additional allowances are established through charges to
the provision for loan losses.  Income Taxes. At June 30, 2004 we had a total deferred tax asset of
approximately $51.0 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 27




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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 expected utilization
of our loss carryforwards on an annual basis and have recorded a valuation
allowance of approximately $30.1 million. The net deferred tax asset, $20.9
million, is reported as an asset in our consolidated statement of financial
condition as of June 30, 2004. 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




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IMPORTANT FACTORS RELATING TO FORWARD-LOOKING STATEMENTS 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 loans at acceptable
prices, and the availability and conditions of financing for loan pool
acquisitions 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. 29




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 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 Asset and Liability Committee (ALCO) which
reviews, 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.
ALCO establishes rate sensitivity tolerances (within regulatory guidelines)
which are approved by the Board of Directors, and coordinates with the Board
with respect to overall asset and liability composition. ALCO is authorized to utilize off-balance sheet financial techniques to
assist 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, ALCO 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. ALCO further evaluates such
impacts against the maximum tolerable change in interest income that is
authorized by the Board of Directors. The following table quantifies the potential changes in the Companys net
portfolio value at June 30, 2004, 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. Interest Rate Sensitivity of Net Portfolio Value Net Portfolio Value
    
    NPV as % of Assets$Amount
    
    $ Change
    
    % Change
    
    NPV Ratio
    
    ChangeChange in Rates
    
    (Dollars in thousands)+300bp
    
    $
    120,918
    
    
    $
    (30,060
    )
    
    
    (20
    )%
    
    
    10.39
    %
    
    (186
    )bp+200bp
    
    
    130,880
    
    
    
    (20,098
    )
    
    
    (13
    )
    
    
    11.03
    
    
    (122
    )bp+100bp
    
    
    141,207
    
    
    
    (9,771
    )
    
    
    (6
    )
    
    
    11.68
    
    
    (57
    )bp0bp
    
    
    150,978
    
    
    
    
    
    
    
    
    
    
    
    12.25
    
    
    
    -100bp
    
    
    156,180
    
    
    
    5,202
    
    
    
    3
    
    
    
    12.49
    
    
    24
    bp-200bp
    
    
    151,891
    
    
    
    913
    
    
    
    1
    
    
    
    12.06
    
    
    (19
    )bp-300bp
    
    
    141,568
    
    
    
    (9,410
    )
    
    
    (6
    )
    
    
    11.23
    
    
    (102
    )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. 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. 30




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ITEM 4. CONTROLS AND PROCEDURES 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. As of the end of the period covered by this report, we
carried out an evaluation, under the supervision and with the participation of
our management, including the individual serving as our Chief Executive Officer
(CEO)/Chief Financial Officer (CFO), of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13a-15 of
the Exchange Act. Based on that evaluation, our CEO/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. 31




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##### Table of Contents



WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings. The Company is a defendant in other legal actions arising from
transactions conducted in the ordinary course of business. Some of these claims
involve individual borrowers demanding material amounts for alleged damages.
Management, after consultation with legal counsel, and based on prior
experience with consumer claims, believes the ultimate liability, if any,
arising from such actions will not materially affect the Companys financial
position, consolidated results of operations or cash flows. 
 Item 2. Changes in Securities. Not applicable. 
 Item 3. Defaults Upon Senior Securities. Not applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. 
 Item 5. Other Information. Not applicable. 
 Item 6. Exhibits and Reports onForm 8-K.  (a)
    
    Exhibits. 3.2
    
    Third Amended and Restated Bylaws31
    
    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. §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 30, 2004, reporting
the Companys sale of Wilshire Credit Corporation to Merrill
Lynch Mortgage Capital Inc.Current Report on Form 8-K dated May 27, 2004, reporting the
resignation of the Companys Chief Executive Officer and the
appointment of its new Chief Executive Officer; the election
of three new members to the Companys board of directors; and
the announcement of the date of the Companys annual
shareholder meeting.Current Report on Form 8-K dated August 4, 2004, reporting
the Companys earnings results for the quarter and six months
ended June 30, 2004. 32




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SIGNATURE 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 13, 2004
    
    By:
    
    /s/ JOSEPH W. KILEY IIIJoseph W. Kiley IIIChief Executive Officer andChief Financial Officer
 33