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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 March 31, 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
    
    93-1223879(State or other jurisdiction of incorporation or
    
    (I.R.S. Employer Identification No.)organization)23901 Calabasas Road, Suite 1050Calabasas, CA
    
    91302(Address of principal executive offices)
    
    (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 April 30, 2004
20,587,985 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
    
    
    16Item 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 31EXHIBIT 32




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
 (Unaudited)
(Dollars in thousands, except share data)
 March 31,
    
    December 31,2004
    
    2003ASSETSCash and cash equivalents
    
    $
    29,607
    
    
    $
    18,739Government agency mortgage-backed securities available for sale, at fair value
    
    
    184,497
    
    
    
    161,083AAA mortgage-backed securities available for sale, at fair value
    
    
    115,087
    
    
    
    62,160Other mortgage-backed securities available for sale, at fair value
    
    
    756
    
    
    
    1,069Investment securities available for sale, at fair value
    
    
    11,964
    
    
    
    22,086Investment securities held to maturity, at amortized cost (fair value of $9,752
and $9,754)
    
    
    9,619
    
    
    
    9,607Loans, net of allowance for loan losses of $6,741 and $6,735
    
    
    753,996
    
    
    
    610,807Discounted loans, net of allowance for loan losses of $31,787 and $32,041
    
    
    3,174
    
    
    
    3,817Stock in Federal Home Loan Bank of San Francisco, at cost
    
    
    15,867
    
    
    
    12,767Real estate owned, net
    
    
    2,029
    
    
    
    267Leasehold improvements and equipment, net
    
    
    515
    
    
    
    554Accrued interest receivable
    
    
    4,908
    
    
    
    4,215Deferred tax asset, net
    
    
    17,629
    
    
    
    18,054Purchased mortgage servicing rights, net
    
    
    203
    
    
    
    250Receivables from loan servicers
    
    
    375
    
    
    
    770Intangible assets, net
    
    
    3,377
    
    
    
    3,442Prepaid expenses and other assets
    
    
    3,006
    
    
    
    2,897Assets of subsidiary held for sale
    
    
    43,835
    
    
    
    42,698TOTAL
    
    $
    1,200,444
    
    
    $
    975,282LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIES:Noninterest-bearing deposits
    
    $
    3,582
    
    
    $
    4,175Interest-bearing deposits
    
    
    632,544
    
    
    
    469,234Short-term borrowings
    
    
    75,000
    
    
    
    88,000Accounts payable and other liabilities
    
    
    5,310
    
    
    
    3,690FHLB advances
    
    
    317,337
    
    
    
    249,337Long-term investment financing
    
    
    638
    
    
    
    681Junior subordinated notes payable to trust
    
    
    20,619
    
    
    
    20,619Investor participation liability
    
    
    1,008
    
    
    
    1,169Liabilities of subsidiary held for sale
    
    
    13,568
    
    
    
    12,894Total liabilities
    
    
    1,069,606
    
    
    
    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, 26,144,199
and 24,491,703 shares issued (including treasury shares of 5,626,212)
    
    
    138,690
    
    
    
    136,363Treasury stock, 5,626,212 shares, at cost
    
    
    (15,106
    )
    
    
    (15,106
    )Retained earnings
    
    
    6,236
    
    
    
    3,791Accumulated other comprehensive income, net
    
    
    1,018
    
    
    
    435Total stockholders equity
    
    
    130,838
    
    
    
    125,483TOTAL
    
    $
    1,200,444
    
    
    $
    975,282
 See notes to unaudited interim condensed consolidated financial statements 3




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 (Dollars in thousands, except share data)
 Quarter EndedMarch 31,2004
    
    2003INTEREST INCOME:Loans
    
    $
    9,696
    
    
    $
    8,427Mortgage-backed securities
    
    
    2,620
    
    
    
    3,467Securities and federal funds sold
    
    
    306
    
    
    
    172Total interest income
    
    
    12,622
    
    
    
    12,066INTEREST EXPENSE:Deposits
    
    
    3,113
    
    
    
    3,213Borrowings
    
    
    2,726
    
    
    
    3,322Total interest expense
    
    
    5,839
    
    
    
    6,535NET INTEREST INCOME
    
    
    6,783
    
    
    
    5,531PROVISION FOR LOSSES ON LOANS
    
    
    114
    
    
    
    30NET INTEREST INCOME AFTER PROVISION FOR LOSSES ON LOANS
    
    
    6,669
    
    
    
    5,501OTHER INCOME:Servicing income
    
    
    209
    
    
    
    46Loan fees and charges
    
    
    98
    
    
    
    23Real estate owned, net
    
    
    58
    
    
    
    25Gain on sale of loans
    
    
    47
    
    
    
    5Gain on sale of securities
    
    
    273
    
    
    
    Investor participation interest
    
    
    (90
    )
    
    
    (66
    )Other, net
    
    
    65
    
    
    
    204Total other income
    
    
    660
    
    
    
    237OTHER EXPENSES:Compensation and employee benefits
    
    
    1,822
    
    
    
    1,661Professional services
    
    
    820
    
    
    
    928Occupancy
    
    
    185
    
    
    
    192FDIC insurance premiums
    
    
    108
    
    
    
    108Data processing
    
    
    144
    
    
    
    64Communication
    
    
    62
    
    
    
    42Insurance
    
    
    118
    
    
    
    169Depreciation
    
    
    90
    
    
    
    245Amortization of intangibles
    
    
    65
    
    
    
    65Other general and administrative expenses
    
    
    550
    
    
    
    386Total other expenses
    
    
    3,964
    
    
    
    3,860INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
    
    
    3,365
    
    
    
    1,878INCOME TAX PROVISION
    
    
    1,396
    
    
    
    804INCOME FROM CONTINUING OPERATIONS
    
    
    1,969
    
    
    
    1,074INCOME FROM OPERATIONS OF SUBSIDIARY HELD FOR SALE, NET OF
INCOME TAX PROVISION OF $338 (2004) AND $264 (2003)
    
    
    476
    
    
    
    490NET INCOME
    
    $
    2,445
    
    
    $
    1,564Earnings per share  Basic:Income from continuing operations
    
    $
    0.10
    
    
    $
    0.06Discontinued operations
    
    
    0.02
    
    
    
    0.03Net income
    
    $
    0.12
    
    
    $
    0.09Earnings per share  Diluted:Income from continuing operations
    
    $
    0.09
    
    
    $
    0.05Discontinued operations
    
    
    0.02
    
    
    
    0.03Net income
    
    $
    0.11
    
    
    $
    0.08Weighted average shares outstanding  basic
    
    
    20,022,989
    
    
    
    18,223,698Weighted average shares outstanding  diluted
    
    
    21,288,258
    
    
    
    20,236,356
 See notes to unaudited interim condensed consolidated financial statements 4




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 (Dollars in thousands)
 Quarter EndedMarch 31,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    2,445
    
    
    $
    1,564Income from operations of subsidiary held for sale, net of taxes
    
    
    (476
    )
    
    
    (490
    )Income from continuing operations
    
    
    1,969

    
    
    
    1,074Adjustments to reconcile income from continuing operations to net cash
provided by operating activities of continuing operations:Provision for losses on loans
    
    
    163
    
    
    
    30Provision for losses on real estate owned
    
    
    18
    
    
    
    9Change in valuation allowance for mortgage servicing rights
    
    
    97
    
    
    
    (225
    )Depreciation and amortization
    
    
    154
    
    
    
    473Tax effect from utilization of net operating loss carryforward
    
    
    
    
    
    
    709Gain on sale of real estate owned
    
    
    (87
    )
    
    
    (54
    )Gain on sale of loans
    
    
    (47
    )
    
    
    (5
    )Gain on sale of securities
    
    
    (273
    )
    
    
    Loss (gain) on disposal of equipment
    
    
    2
    
    
    
    (8
    )Amortization of discounts and deferred fees
    
    
    674
    
    
    
    522Amortization of mortgage servicing rights
    
    
    1,385
    
    
    
    878Federal Home Loan Bank stock dividends
    
    
    (120
    )
    
    
    (144
    )Change in:Servicer advance receivables
    
    
    (3,491
    )
    
    
    (6,461
    )Service fees receivable
    
    
    314
    
    
    
    (373
    )Accrued interest receivable
    
    
    (695
    )
    
    
    98Receivables from other loan servicers
    
    
    381
    
    
    
    (646
    )Prepaid expenses and other assets
    
    
    80
    
    
    
    151Accounts payable and other liabilities
    
    
    2,051
    
    
    
    722Investor participation liability
    
    
    (181
    )
    
    
    40Net cash used in operations of subsidiary held for sale
    
    
    1,143
    
    
    
    16,717Net cash provided by operating activities of continuing operations
    
    
    3,537
    
    
    
    13,507CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of loans
    
    
    (85,585
    )
    
    
    (7,036
    )Loan repayments
    
    
    39,591
    
    
    
    41,428Loan originations
    
    
    (98,922
    )
    
    
    (29,791
    )Proceeds from sale of discounted loans
    
    
    
    
    
    
    340Purchase of mortgage-backed securities available for sale
    
    
    (105,229
    )
    
    
    (7,632
    )Proceeds from sale of mortgage-backed securities available for sale
    
    
    7,859
    
    
    
    Repayment of mortgage-backed securities available for sale
    
    
    22,253
    
    
    
    33,369Purchase of investment securities available for sale
    
    
    
    
    
    
    (10,000
    )Proceeds from sale of investment securities available for sale
    
    
    10,130
    
    
    
    Proceeds from sale of real estate owned
    
    
    850
    
    
    
    771Purchase of FHLB Stock
    
    
    (2,980
    )
    
    
    Purchases of leasehold improvements and equipment
    
    
    (355
    )
    
    
    (418
    )Proceeds from sale of leasehold improvements and equipment
    
    
    
    
    
    
    12Purchase of mortgage servicing rights
    
    
    
    
    
    
    (6,092
    )Proceeds from sale of mortgage servicing rights
    
    
    
    
    
    
    2Net cash provided by investing activities of subsidiary held for sale
    
    
    (282
    )
    
    
    (6,251
    )Net cash (used in) provided by investing activities of
continuing operations
    
    
    (212,670
    )
    
    
    8,702
 [Continued] See notes to unaudited interim condensed consolidated financial statements 5




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WILSHIRE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(Dollars in thousands) Quarter EndedMarch 31,2004
    
    2003CASH FLOWS FROM FINANCING ACTIVITIES:Net increase (decrease) in deposits
    
    $
    162,717
    
    
    $
    (10,684
    )Proceeds from FHLB advances
    
    
    230,000
    
    
    
    6,000Repayments of FHLB advances
    
    
    (162,000
    )
    
    
    (16,000
    )Net (decrease) increase in short-term borrowings
    
    
    (11,500
    )
    
    
    228Proceeds from long-term financing
    
    
    
    
    
    
    4,005Repayment of long-term financing
    
    
    (1,233
    )
    
    
    (1,157
    )Issuance of common stock pursuant to exercise of stock options
    
    
    2,327
    
    
    
    69Net cash provided by financing activities of subsidiary held for sale
    
    
    (310
    )
    
    
    (8,378
    )Net cash provided by (used in) financing activities of continuing operations
    
    
    220,001
    
    
    
    (25,917
    )NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    10,868
    
    
    
    (3,708
    )CASH AND CASH EQUIVALENTS:Beginning of period
    
    
    18,739
    
    
    
    15,981End of period
    
    $
    29,607
    
    
    $
    12,273SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATIONCash paid for:Interest
    
    $
    4,610
    
    
    $
    4,621Income taxes
    
    
    
    
    
    
    NONCASH INVESTING ACTIVITIES:Additions to real estate owned acquired in settlement of loans
    
    
    1,962
    
    
    
    397
 See notes to unaudited interim condensed consolidated financial statements 6




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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 the 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 the opinion of management, all adjustments, other than the adjustments
described below, generally comprised of normal recurring accruals necessary for
fair presentation of the interim condensed consolidated financial statements,
have been included and all intercompany accounts and transactions have been
eliminated in consolidation. Operating results for the three months ended
March 31, 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 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 ended March 31, 2004 and 2003. Quarter Ended March 31,2004
    
    2003Income from continuing operations
    
    $
    1,969
    
    
    $
    1,074Discontinued operations
    
    
    476
    
    
    
    490Net income
    
    $
    2,445
    
    
    $
    1,564Weighted average number of common
shares outstanding  basic
    
    
    20,022,989
    
    
    
    18,223,698Net effect of dilutive stock
options  based on treasury stock
method
    
    
    1,265,269
    
    
    
    2,012,658Weighted average number of common
shares outstanding  diluted
    
    
    21,288,258
    
    
    
    20,236,356Earnings per share  Basic:Income from continuing operations
    
    $
    0.10
    
    
    $
    0.06Discontinued operations
    
    
    0.02
    
    
    
    0.03Net income
    
    $
    0.12
    
    
    $
    0.09Earnings per share  Diluted:Income from continuing operations
    
    $
    0.09
    
    
    $
    0.05Discontinued operations
    
    
    0.02
    
    
    
    0.03Net income
    
    $
    0.11
    
    
    $
    0.08
 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 ended March 31, 2004 and 2003 would have been reduced to the pro-forma
amounts indicated below. Quarter EndedMarch 31,2004
    
    2003Net income, as reported
    
    $
    2,445
    
    
    $
    1,564Less: Total stock-based employee
compensation expense determined under fair
value-based method for all awards, net of
related tax effects
    
    
    122
    
    
    
    123Pro forma net income
    
    $
    2,323
    
    
    $
    1,441Earnings per share:Basic  as reported
    
    $
    0.12
    
    
    $
    0.09Basic  pro forma
    
    $
    0.12
    
    
    $
    0.08Diluted  as reported
    
    $
    0.11
    
    
    $
    0.08Diluted  pro forma
    
    $
    0.11
    
    
    $
    0.07
  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
$48.8 million, and realized a gain on the sale of approximately $19.1 million
before taxes. The final purchase price is subject to adjustment based on WCCs
closing date net asset value as determined by the Company and Merrill Lynch. WCC was formed in 1999 pursuant to the Companys reorganization, and
comprised WFSGs Loan Servicing Operations business segment. As of March 31,
2004, WCC serviced $6.0 billion principal balance of loans for more than 500
individual and institutional investors and governmental agencies. In the accompanying financial statements, WCC is accounted for 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 Income from operations of
subsidiary held for sale, net of income tax provision. In accordance with
SFAS No. 144, the Company did not record depreciation expense on WCCs fixed
assets for the quarter ended March 31, 2004. 8




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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 following is summarized financial information for WCC: March 31,
    
    December 31,2004
    
    2003ASSETS:Cash and cash equivalents
    
    $
    34
    
    
    $
    109Discounted loans, net
    
    
    444
    
    
    
    522Leasehold improvements and equipment, net
    
    
    2,905
    
    
    
    2,602Servicer advance receivables, net
    
    
    26,463
    
    
    
    22,972Purchased mortgage servicing rights, net
    
    
    7,085
    
    
    
    8,519Other assets
    
    
    6,904
    
    
    
    7,974Total assets
    
    $
    43,835
    
    
    $
    42,698LIABILITIES:Short-term borrowings and investment
financing
    
    $
    3,662
    
    
    $
    3,352Other liabilities
    
    
    9,906
    
    
    
    9,542Total liabilities
    
    $
    13,568
    
    
    $
    12,894
 Results of operations for WCC were as follows: Quarter Ended March 31,2004
    
    2003Interest income
    
    $
    (10
    )
    
    $
    43Interest expense
    
    
    127
    
    
    
    141Net interest expense
    
    
    (137
    )
    
    
    (98
    )Provision for loan losses
    
    
    49
    
    
    
    Net interest expense after provision for loan losses
    
    
    (186
    )
    
    
    (98
    )Servicing income
    
    
    8,334
    
    
    
    7,795Other income
    
    
    476
    
    
    
    6Compensation and employee benefits expense
    
    
    6,103
    
    
    
    5,109Other expenses
    
    
    1,707
    
    
    
    1,840Income before income taxes
    
    
    814
    
    
    
    754Income tax provision
    
    
    338
    
    
    
    264Net income
    
    $
    476
    
    
    $
    490
 Following is a summary of WCCs loan servicing portfolio by type of loan: March 31,
    
    December 31,2004
    
    2003Single-family residential
    
    $
    5,905,683
    
    
    $
    5,973,070Multi-family residential
    
    
    6,623
    
    
    
    116,119Commercial real estate
    
    
    16,542
    
    
    
    289,629Consumer and other
    
    
    68,298
    
    
    
    71,135Total (1)
    
    $
    5,997,146
    
    
    $
    6,449,953
  (1)
    
    WCCs servicing portfolio at March 31, 2004 and December 31, 2003 also
included approximately $0.3 billion unpaid principal balance of
non-performing consumer loans in addition to those presented above. 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 March 31, 2004, the Companys banking subsidiary, First Bank of Beverly
Hills, F.S.B. (FBBH or the Bank), had outstanding commitments to fund $25.2
million in mortgage loans and to purchase $1.3 million of new loans. The Company expects to 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 quarters ended March 31, 2004
and 2003, relate to the events that gave rise to litigation arising from the
financial collapse of Capital Consultants LLC (CCL). The Company on May 13, 2002 entered into a settlement agreement to resolve
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 disposal group held for sale, and its assets and liabilities and
operating results have each been removed from the Companys consolidated
statements of financial condition and operations, respectively, and reported
separately in a single caption. Accordingly, the discussion in this note
concerns primarily the Companys income tax provision and its deferred tax
asset as they relate to its continuing operations. The Company recorded a current tax provision on income from continuing
operations of approximately $1.4 million for the quarter ended March 31, 2004,
compared with $0.8 million for the quarter ended March 31, 2003. The Companys
deferred tax provision (benefit) is determined on a quarterly basis pursuant to
an evaluation of WFSGs net deferred tax asset. These deferred tax assets and
liabilities represent the tax effect of future deductible or taxable amounts.
They are attributable to carryforwards, such as net operating losses and
capital losses, and also to temporary 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. WFSGs net deferred tax asset was approximately $17.6 million and $18.1
million, respectively, at March 31, 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 March 31, 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 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 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) 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. Beginning with the year ending December 31, 2004, the Company will be
determining its utilization of net operating and capital loss carryforwards on
an annual, rather than quarterly, basis. As a result, the tax effect from the
utilization of WFSGs loss carryforwards will not be reflected in the Companys
quarterly financial statements. WCCs allocable share of the consolidated income tax provision was
approximately $0.3 million for the first quarters of both 2004 and 2003. At
March 31, 2004 and December 31, 2003, WCCs total deferred tax asset,
representing the tax effect of net future deductions, was $3.7 million.  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. Effective the second quarter of 2003, the Company
redefined its reportable operating segments in order to reflect a complete
separation of its investment operations from its servicing operations.
Consequently, the operating results of the Companys investment subsidiary,
Wilshire Funding Corporation (WFC), are reported as an individual business
segment (Mortgage Investments), separate from those of its loan servicing
subsidiary, WCC (Loan Servicing). (In prior periods, the results of WCC and
WFC were combined into one operating segment known as Specialty Servicing and
Finance Operations.) The results for the quarter ended March 31, 2003 have
been revised to give effect to the new segments. As discussed in Note 3, the Company completed the sale of WCC to Merrill
Lynch effective April 30, 2004. Accordingly, the operating results of WCC are
presented separately, in a single caption titled Income from operations of
subsidiary held for sale 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, investments in
residential whole loans, and investments in primarily AAA-rated and
government agency mortgage-backed securities. The primary sources of
liquidity for the Banks acquisitions and originations are wholesale
certificates of deposit, retail deposits, FHLB advances and repurchase
agreements. The Bank is a federally chartered savings bank and is
regulated by the OTS.
    
    Mortgage Investment Operations The Companys investment subsidiary,
WFC, acquires mortgage-backed securities and pools of performing,
sub-performing and non-performing residential and commercial loans.
WFC conducts certain of these activities with an institutional
investor where such investments align the Companys interests with
those of the institutional investor. WFCs funding sources consist
primarily of commercial bank financing and co-investors, with debt
service repayment terms that generally parallel the cash flows of the
underlying collateral.
    
    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 quarters ended March 31, 2004 and 2003 are as
follows: Three Months Ended March 31, 2004HoldingCompany andLoan
    
    Mortgage
    
    MiscellaneousBanking
    
    Servicing
    
    Investments
    
    Operations
    
    TotalInterest income
    
    $
    12,048
    
    
    $
    
    
    
    $
    560
    
    
    $
    14
    
    
    $
    12,622Interest expense
    
    
    5,572
    
    
    
    
    
    
    
    10
    
    
    
    257
    
    
    
    5,839Net interest income (expense)
    
    
    6,476
    
    
    
    
    
    
    
    550
    
    
    
    (243
    )
    
    
    6,783Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    114
    
    
    
    
    
    
    
    114Net interest income (expense) after
provision for loan losses
    
    
    6,476
    
    
    
    
    
    
    
    436
    
    
    
    (243
    )
    
    
    6,669Servicing income
    
    
    246
    
    
    
    
    
    
    
    37
    
    
    
    (74
    )
    
    
    209Realized gains
    
    
    273
    
    
    
    
    
    
    
    47
    
    
    
    
    
    
    
    320Other income (loss)
    
    
    232
    
    
    
    
    
    
    
    (175
    )
    
    
    74
    
    
    
    131Compensation and employee benefits expense
    
    
    1,568
    
    
    
    
    
    
    
    
    
    
    
    254
    
    
    
    1,822Other expenses
    
    
    1,314
    
    
    
    
    
    
    
    3
    
    
    
    825
    
    
    
    2,142Income (loss) from continuing operations before taxes
    
    
    4,345
    
    
    
    
    
    
    
    342
    
    
    
    (1,322
    )
    
    
    3,365Income tax provision (benefit)
    
    
    1,825
    
    
    
    
    
    
    
    142
    
    
    
    (571
    )
    
    
    1,396Income (loss) from continuing operations
    
    
    2,520
    
    
    
    
    
    
    
    200
    
    
    
    (751
    )
    
    
    1,969Income from operations of subsidiary held
for sale, net of tax
    
    
    
    
    
    
    476
    
    
    
    
    
    
    
    
    
    
    
    476Net income (loss)
    
    $
    2,520
    
    
    $
    476
    
    
    $
    200
    
    
    $
    (751
    )
    
    $
    2,445Total assets
    
    $
    1,129,780
    
    
    $
    43,835
    
    
    $
    23,055
    
    
    $
    3,774
    
    
    $
    1,200,444
 12




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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) Three Months Ended March 31, 2003HoldingCompany andLoan
    
    Mortgage
    
    MiscellaneousBanking
    
    Servicing
    
    Investments
    
    Operations
    
    TotalInterest income
    
    $
    11,012
    
    
    $
    
    
    
    $
    1,041
    
    
    $
    13
    
    
    $
    12,066Interest expense
    
    
    6,243
    
    
    
    
    
    
    
    28
    
    
    
    264
    
    
    
    6,535Net interest income (expense)
    
    
    4,769
    
    
    
    
    
    
    
    1,013
    
    
    
    (251
    )
    
    
    5,531Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    30Net interest income (expense) after
provision for loan losses
    
    
    4,769
    
    
    
    
    
    
    
    983
    
    
    
    (251
    )
    
    
    5,501Servicing income
    
    
    299
    
    
    
    
    
    
    
    84
    
    
    
    (337
    )
    
    
    46Realized gains
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    5Other (loss) income
    
    
    (38
    )
    
    
    
    
    
    
    (162
    )
    
    
    386
    
    
    
    186Compensation and employee benefits expense
    
    
    1,131
    
    
    
    
    
    
    
    205
    
    
    
    325
    
    
    
    1,661Other expenses
    
    
    1,298
    
    
    
    
    
    
    
    128
    
    
    
    773
    
    
    
    2,199Income (loss) from continuing operations
before taxes
    
    
    2,601
    
    
    
    
    
    
    
    577
    
    
    
    (1,300
    )
    
    
    1,878Income tax provision (benefit)
    
    
    1,092
    
    
    
    
    
    
    
    204
    
    
    
    (492
    )
    
    
    804Income (loss) from continuing operations
    
    
    1,509
    
    
    
    
    
    
    
    373
    
    
    
    (808
    )
    
    
    1,074Income from operations of subsidiary held for
sale, net of tax
    
    
    
    
    
    
    490
    
    
    
    
    
    
    
    
    
    
    
    490Net income (loss)
    
    $
    1,509
    
    
    $
    490
    
    
    $
    373
    
    
    $
    (808
    )
    
    $
    1,564Total assets
    
    $
    772,069
    
    
    $
    42,455
    
    
    $
    26,437
    
    
    $
    (12,652
    )
    
    $
    828,309
 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)  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, and, as a result, no longer amortizes goodwill, but
tests it at least annually for impairment. The Company will continue to
amortize the core deposit intangible over an estimated useful life of 5 years. Following is a summary of the Companys intangible assets: As of March 31, 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
    
    
    
    (971
    )
    
    
    1,294
    
    
    
    (906
    )Total
    
    $
    4,687
    
    
    $
    (1,310
    )
    
    $
    4,687
    
    
    $
    (1,245
    )
 For the quarter ended March 31, 2004 the Company recorded amortization
expense of $65 related to the core deposit intangible. The estimated
amortization of the balance for the remainder of 2004 and the succeeding fiscal
years is $194 (2004), $129 (2005), and none thereafter. There were no changes in the carrying value of goodwill during the quarter
ended March 31, 2004. The Company tested goodwill for impairment as of March
31, 2004 and determined that no impairment charge was required. The Companys purchased mortgage servicing rights (PMSRs) totaled
approximately $0.2 million at March 31, 2004 and $0.25 million at December 31,
2003. Amortization expense for PMSRs was $0.1 million for the quarter ended
March 31, 2004, and $0.2 million for the quarter ended March 31, 2003. The
estimated amortization expense of the March 31, 2004 balance of PMSRs for the
remainder of 2004 and the five succeeding fiscal years is $77 thousand (2004),
$58 thousand (2005), $32 thousand (2006), $17 thousand (2007), $10 thousand
(2008), and $6 thousand (2009). The estimated amortization expense is based
only on currently held PMSRs and on current information regarding loan payments
and prepayments. Actual results may vary as a result of changes in the rate of
prepayments and other market factors.  8.
    
    LEGAL MATTERS WFSG on May 13, 2002 entered into an agreement to resolve litigation which
arose from the financial collapse of CCL in September 2000. All parties have
completed all of their obligations under the settlement agreement, including
the Companys purchase of the 49.99% minority interest in WCC in October 2002.
The execution of the settlement agreement does not affect WFSGs complete
denial of all such claims. Management, after consultation with legal counsel,
believes that this litigation will be dismissed in the next few months. 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.  9.
    
    SUBSEQUENT EVENTS On April 30, 2004, the Company completed the sale of WCC, its wholly-owned
mortgage servicing subsidiary, to Merrill Lynch. See Note 3 to the condensed
consolidated financial statements for further discussion. Upon the sale of WCC,
WFSGs corporate headquarters were relocated and consolidated with the
headquarters of FBBH at 23901 14




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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) Calabasas Road, Suite 100, Calabasas, California 91302. WCC will continue to
operate at its current Beaverton, Oregon location. On April 30, 2004, the Company announced the initiation of a regular
quarterly cash dividend in the amount of $0.125 per share. The first dividend
is payable July 1, 2004 to stockholders of record on June 15, 2004. 15




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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 the quarter ended March 31, 2004, Wilshire Financial Services
Group Inc., a financial services company, 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 $48.8 million, and realized a gain on the sale of $19.1 million
before taxes. The final sales proceeds are subject to adjustment based on
WCCs final net asset value as determined by WFSG and Merrill Lynch. Subsequent to the sale of WCC, we will operate primarily as a unitary bank
holding company. Our business strategy will be focused on the growth and
profitability of our remaining Banking and Mortgage Investments segments,
through increased lending and investment activity. We believe that our success
in implementing this dual strategy in these two segments 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 ENDED MARCH 31, 2004 COMPARED TO QUARTER ENDED
MARCH 31, 2003 Our consolidated net income for the quarter ended March 31, 2004 was $2.4
million, or $0.11 per diluted share, compared with $1.6 million, or $0.08 per
diluted share, for the quarter ended March 31, 2003. As a result of the sale of WCC, we have presented the operating results of
WCC as Income from operations of subsidiary held for sale, separate and apart
from Income from continuing operations in the condensed consolidated
statements of operations for the quarterly periods presented. Our income from
continuing operations for the quarter ended March 31, 2004 was $1.9 million, or
$0.09 per diluted share, compared with approximately $1.1 million, or $0.05 per
diluted share, for the quarter ended March 31, 2003. Pre-tax income from
continuing operations was $3.4 million for the first quarter of 2004, compared
with $1.9 million for the first quarter of 2003. WCCs net income was
approximately $0.5 million for the first quarters of both 2004 and 2003. Our consolidated stockholders equity increased by $5.3 million for the
quarter ended March 31, 2004 to $130.8 million, or $6.10 per diluted share. The
increase reflects our net income for the quarter and the sale of additional
shares of common stock pursuant to the exercise of stock options. In addition,
we recorded an increase in after-tax unrealized gains of $0.6 million on our
portfolio of available-for-sale securities and hedging instruments. WFSGs
increase in stockholders equity for the quarter ended March 31, 2004 does not
reflect the utilization of our net operating loss or capital loss
carryforwards. We will determine the utilization, if any, of our carryforwards
on an annual, rather than quarterly, basis commencing in 2004. 16




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The increase in our income from continuing operations for the first
quarter of 2004 as compared with the first quarter of 2003 was due primarily to
a $1.25 million increase in consolidated net interest income, reflecting
significant loan origination activity at our banking subsidiary. In addition,
consolidated other income increased by $0.4 million, primarily as a result of
gains on sales of investment securities. These increases were partially offset
by slight increases in other operating expenses and provision for loan losses. Following is a discussion of the operating results of the Companys three
business segments: our Banking Operations, Loan Servicing Operations, and
Mortgage Investment Operations. FIRST BANK OF BEVERLY HILLS, F.S.B. The following table compares income before taxes for FBBH for the quarters
ended March 31, 2004 and 2003. Quarter Ended March 31,Increase2004
    
    2003
    
    (Decrease)(Dollars in thousands)Interest income
    
    $
    12,048
    
    
    $
    11,012
    
    
    $
    1,036Interest expense
    
    
    5,572
    
    
    
    6,243
    
    
    
    (671
    )Net interest income
    
    
    6,476
    
    
    
    4,769
    
    
    
    1,707Provision for loan losses
    
    
    
    
    
    
    
    
    
    
    Net interest income after provision for loan losses
    
    
    6,476
    
    
    
    4,769
    
    
    
    1,707Realized gains on sales
    
    
    273
    
    
    
    
    
    
    
    273Other income
    
    
    478
    
    
    
    261
    
    
    
    217Compensation and employee benefits expense
    
    
    1,568
    
    
    
    1,131
    
    
    
    437Other expenses
    
    
    1,314
    
    
    
    1,298
    
    
    
    16Income before taxes
    
    $
    4,345
    
    
    $
    2,601
    
    
    $
    1,744
 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 March 31, 2004 and 2003 (dollars in thousands): Quarter Ended March 31, 2004
    
    Quarter Ended March 31, 2003Annualized
    
    
    
    
    
    
    
    
    
    AnnualizedAverage Balance
    
    Interest
    
    Yield/Rate
    
    Average Balance
    
    Interest
    
    Yield/RateInterest-Earning Assets:Federal funds and short-term
investments
    
    $
    18,841
    
    
    $
    53
    
    
    
    1.10
    %
    
    $
    14,837
    
    
    $
    52
    
    
    
    1.39
    %Mortgage-backed and other
securities
    
    
    267,686
    
    
    
    2,614
    
    
    
    3.91
    
    
    
    263,170
    
    
    
    2,862
    
    
    
    4.35Loans
    
    
    639,863
    
    
    
    9,381
    
    
    
    5.86
    
    
    
    488,831
    
    
    
    8,098
    
    
    
    6.63Total interest-earning assets
    
    $
    926,390
    
    
    $
    12,048
    
    
    
    5.15
    %
    
    $
    766,838
    
    
    $
    11,012
    
    
    
    5.75
    %Interest-Bearing Liabilities:Interest-bearing deposits
    
    $
    531,662
    
    
    $
    3,113
    
    
    
    2.35
    %
    
    $
    391,571
    
    
    $
    3,213
    
    
    
    3.33
    %Borrowings
    
    
    322,842
    
    
    
    2,459
    
    
    
    3.05
    
    
    
    304,647
    
    
    
    3,030
    
    
    
    4.03Total interest-bearing
liabilities
    
    $
    854,504
    
    
    $
    5,572
    
    
    
    2.62
    %
    
    $
    696,218
    
    
    $
    6,243
    
    
    
    3.64
    %Net interest income
    
    
    
    
    
    $
    6,476
    
    
    
    
    
    
    
    
    
    
    $
    4,769Net interest spread
    
    
    
    
    
    
    
    
    
    
    2.53
    %
    
    
    
    
    
    
    
    
    
    
    2.11
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    2.80
    %
    
    
    
    
    
    
    
    
    
    
    2.52
    %
 The Banks net interest income was $6.5 million for the quarter ended
March 31, 2004, compared with $4.8 million for the quarter ended March 31,
2003. The net interest spread increased by 42 basis points, from 2.11% to
2.53%, and the net interest margin increased from 2.52% to 2.80% for the same
periods. 17




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##### Table of Contents



The increase in net interest income was primarily attributable to the
Banks significant loan originations and purchases in the first quarter of 2004
and late 2003, utilizing new deposits and low-cost borrowings as funding
sources. As a result, the Banks total average interest-earning assets
increased by $159.6 million from the first quarter of 2003 to the first quarter
of 2004. This increase in earning-asset volume more than offset the effects of
the 60-basis point decline in overall yield, resulting in a $1.0 million
increase in interest income. The continuing low interest-rate environment has impacted the Banks
interest-bearing liabilities to a greater extent than its interest-earning
assets. For the quarter ended March 31, 2004, the Banks overall cost of funds
was 2.62%, a 102-basis point decline from the cost of funds for the quarter
ended March 31, 2003. As a result, the Banks interest expense decreased by
$0.7 million from the first quarter of 2003 to the first quarter of 2004,
despite a $158.3 million increase in total average interest-bearing
liabilities. The Banks interest income on mortgage-backed and other investment
securities was $2.6 million for the quarter ended March 31, 2004, compared with
$2.9 million for the quarter ended March 31, 2003. This decrease was due to a
44-basis point drop in average yield, from 4.35% to 3.91%, partially offset by
a $4.5 million increase in average balance. Utilizing new debt facilities and
certificates of deposit, the Bank purchased $108.6 million in AAA-rated
mortgage-backed and other investment securities in the third and fourth
quarters of 2003 and an additional $105.2 million in the first quarter of 2004. The Banks interest income on loans for the quarter ended March 31, 2004
was $9.4 million, compared with $8.1 million for the quarter ended March 31,
2003. The increase was due to a $151 million increase in the average balance
of loans in the first quarter of 2004 as compared with first quarter of 2003,
partially offset by a 77-basis point drop in yield, from 6.63% to 5.86%. The
Bank originated and purchased a total of $184.5 million in new commercial and
multi-family loans during the first quarter of 2004, contributing to the $1.3
million increase in loan interest income despite the continuing decline in
interest rates. FBBHs interest expense on deposits decreased by $0.1 million from the
quarter ended March 31, 2003 to the quarter ended March 31, 2004. The decrease
was due to a 98-basis point decline in cost, from 3.33% for the first quarter
of 2003 to 2.35% for the first quarter of 2004, which slightly offset the
effects of the $140.1 million increase in average balance. The Bank raised
significant new certificates of deposit in the first quarter of 2004 as it
approached its authorized limits on FHLB advance borrowings. The Banks interest expense on borrowings for the quarter ended March 31,
2004 was approximately $2.5 million, compared with $3.0 million for the quarter
ended March 31, 2003. The decrease in the first quarter of 2004 was due to a
98-basis point decline in the average cost, from 4.03% to 3.05%, reflecting the
continuing declining interest-rate environment. The lower average cost in 2004
was partially offset by an $18.2 million increase in the average borrowing
balance, as the Bank obtained additional FHLB advances to finance its
earning-asset acquisitions. Provision for Loan Losses Provisions for losses on loans are charged to operations to maintain an
allowance for losses on the loan portfolio at a level which the Bank believes
is adequate based on an evaluation of the inherent risks in the portfolio. The
Banks evaluation is based on an analysis of the loan portfolio, historical
loss experience, current economic conditions and trends, collateral values, and
other relevant factors. Based on its quarterly evaluations of the adequacy of
its loan loss reserves, the Bank did not record a provision for loan losses in
the first quarter of 2004 or 2003. Realized Gains on Sales The Bank sold approximately $17.7 million of mortgage-backed securities
for a realized gain of $0.3 million during the quarter ended March 31, 2004,
with no such sales activity in the first quarter of 2003. 18




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##### Table of Contents



Compensation and Employee Benefits Expense The Banks compensation and employee benefits expense totaled
approximately $1.6 million for the first quarter of 2004, compared with $1.1
million for the first quarter of 2003. This increase was due to an increase in
bonus expense, primarily as a result of the level of loan fundings in the first
quarter of 2004. Other Expenses The Banks other expenses totaled approximately $1.3 million for the
quarter ended March 31, 2004, compared with a similar amount for the quarter
ended March 31, 2003. Costs remained largely consistent in most expense
categories, 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
March 31, 2004 and December 31, 2003: March 31,
    
    December 31,2004
    
    2003(Dollars in thousands)ASSETS:Cash and cash equivalents
    
    $
    25,019
    
    
    $
    15,535Mortgage-backed securities available for sale, at fair value
    
    
    299,785
    
    
    
    223,450Other investment securities available for sale, at fair value
    
    
    11,964
    
    
    
    22,086Investment securities held to maturity, at amortized cost
    
    
    9,619
    
    
    
    9,607Loans, net
    
    
    754,072
    
    
    
    610,890Real estate owned, net
    
    
    1,994
    
    
    
    267Other assets
    
    
    27,327
    
    
    
    24,351Total assets
    
    $
    1,129,780
    
    
    $
    906,186LIABILITIES:Deposits
    
    $
    636,126
    
    
    $
    473,409Short-term borrowings
    
    
    75,000
    
    
    
    88,000FHLB advances
    
    
    317,337
    
    
    
    249,337Other liabilities
    
    
    10,057
    
    
    
    14,540Total liabilities
    
    
    1,038,520
    
    
    
    825,286NET WORTH
    
    
    91,260
    
    
    
    80,900Total liabilities and net worth
    
    $
    1,129,780
    
    
    $
    906,186
 Mortgage-Backed and Other Securities Available for Sale.The Banks total
portfolio of mortgage-backed securities (MBS) available for sale increased by
$76.3 million during the quarter ended March 31, 2004. This increase was due
to $105.2 million in purchases of AAA-rated and agency MBS during the quarter,
in addition to $1.3 million in unrealized gains on the portfolio. These
increases were partially offset by principal repayments of $22.3 million and
sales of $7.6 million of MBS. The Banks portfolio of other investment securities available for sale
decreased by approximately $10.1 million during the quarter ended March 31,
2004, as a result of the sale of government agency securities. Loans, net.The Banks portfolio of loans, net of discounts and
allowances, increased by approximately $143.2 million in the first quarter of
2004. The Bank originated $98.9 million of predominantly commercial mortgage
loans and purchased an additional $85.6 million of multi-family loans. These
additions to the portfolio were partially offset by $39.1 million of principal
repayments and $1.9 million of foreclosures during the quarter. 19




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##### Table of Contents



Real Estate Owned, net.The Banks portfolio of real estate owned, net
increased by approximately $1.7 million for the quarter ended March 31, 2004.
This increase was due to $1.9 million in new foreclosures, partially offset by
$0.2 million in sales and write-downs of properties. Deposits.The Banks deposits increased by $162.7 million during the
first quarter of 2004, primarily due to a significant increase in brokered
certificates of deposit. The Bank used the funds generated by these new
deposits primarily for commercial loan originations. As part of an ongoing
strategy to reduce its cost of funds, the Bank generally seeks to utilize lower-costing debt facilities in lieu of deposits as
its primary funding source, and, throughout 2002 and the first two quarters of
2003, permitted the run-off of higher-rate certificates of deposit. However,
due to authorized limits on its FHLB advance borrowings, the Bank from time to
time must raise new CDs to finance its acquisitions of interest-earning assets. Short-Term Borrowings.The Banks short-term borrowings decreased by
$13.0 million during the quarter ended March 31, 2004. This decrease was due
to repayments of $48.0 million of repurchase agreements, partially offset by
renewals totaling $35.0 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 $68.0 million for
the quarter ended March 31, 2004. During the quarter, the Bank secured $230.0
million in new advances, the proceeds from which provided the financing for the
Banks asset acquisitions discussed above. These new advances were partially
offset by maturities of $162.0 million. The Banks FHLB advances are currently
limited to 35% of its total assets as of the previous quarter-end. Net Worth.The Banks total net worth increased by approximately $10.4
million in the first quarter of 2004. The Bank earned net income for the
quarter of $2.5 million and recorded $0.8 million in net after-tax unrealized
gains on its portfolio of available-for-sale securities and hedging
instruments. In addition, in March 2004 WFSG contributed $7.1 million of
capital to the Bank 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. 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 March
31, 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)
    
    $
    93,674
    
    
    
    11.4
    %
    
    $
    65,724
    
    
    
    8.0
    %
    
    $
    82,155
    
    
    
    10.0
    %Tier 1 Capital to Risk-Weighted Assets
    
    
    87,188
    
    
    
    10.6
    %
    
    Not Applicable
    
    
    49,293
    
    
    
    6.0
    %Core Capital to Tangible Assets
    
    
    87,188
    
    
    
    7.7
    %
    
    
    45,041
    
    
    
    4.0
    %
    
    
    56,301
    
    
    
    5.0
    %Tangible Capital to Tangible Assets
    
    
    87,188
    
    
    
    7.7
    %
    
    
    16,890
    
    
    
    1.5
    %
    
    Not Applicable
 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 (up to 20




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##### Table of Contents



35% of the Banks total assets as of the
previous quarter-end), repurchase agreements, whole loan and mortgage-backed
securities sales, and net interest income. Liquidity in the Banks operations
is actively managed on a daily basis and periodically reviewed by the Banks
Board of Directors. At March 31, 2004 the Banks cash balances totaled approximately $25.0
million, compared with $15.5 million at December 31, 2003. The increase in cash
was primarily due to the generation of significant deposits and new
borrowings during the quarter, partially offset by new loan originations and
purchases of loans and mortgage-backed securities. At March 31, 2004, the Bank had approximately $558.5 million of
certificates of deposit. Scheduled maturities of certificates of deposit during
the 12 months ending March 31, 2005 and thereafter amounted to approximately
$462.8 million and approximately $95.7 million, respectively. Wholesale
deposits generally are more responsive to changes in interest rates than core
deposits, and thus are more likely to be withdrawn by the investor upon
maturity as changes in interest rates and other factors are perceived by
investors to make other investments more attractive. Bank management continues
its effort to reduce its exposure to interest rate changes by utilizing funding
sources whose repricing characteristics more closely match those of the Banks
interest-earning assets. In 2001 the OTS rescinded the regulatory requirement that institutions
maintain an average daily balance of liquid assets of at least 4% of its
liquidity base. Even though the percentage requirement has been eliminated,
each bank is still required by the OTS to maintain adequate liquidity to assure
safe and sound operation. It is the Banks responsibility to determine the
appropriate level of liquidity to be maintained. LOAN SERVICING OPERATIONS WFSG has conducted its 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 the Company completed
the sale of WCC to Merrill Lynch Mortgage Capital Inc. Consequently, WCCs
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 Income
from operations of subsidiary held for sale for the quarters ended March 31,
2004 and 2003. The following table compares WCCs income before taxes for the quarters
ended March 31, 2004 and 2003. Quarter Ended March 31,Increase2004
    
    2003
    
    (Decrease)(Dollars in thousands)Servicing income
    
    $
    8,334
    
    
    $
    7,795
    
    
    $
    539Other income
    
    
    466
    
    
    
    49
    
    
    
    417Total revenues
    
    
    8,800
    
    
    
    7,844
    
    
    
    956Interest expense
    
    
    127
    
    
    
    141
    
    
    
    (14
    )Provision for loan losses
    
    
    49
    
    
    
    
    
    
    
    49Compensation and employee
benefits expense
    
    
    6,103
    
    
    
    5,109
    
    
    
    994Other expenses
    
    
    1,707
    
    
    
    1,840
    
    
    
    (133
    )Total provisions and expenses
    
    
    7,986
    
    
    
    7,090
    
    
    
    896Income before taxes
    
    $
    814
    
    
    $
    754
    
    
    $
    60
 21




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##### Table of Contents



Servicing Income The components of WCCs servicing income are reflected in the following
table: Quarter EndedMarch 31,2004
    
    2003(Dollars in thousands)Servicing revenue
    
    $
    8,197
    
    
    $
    6,824Ancillary fees
    
    
    2,826
    
    
    
    2,320Amortization of mortgage servicing rights
    
    
    (1,243
    )
    
    
    (710
    )Valuation adjustment for mortgage
servicing rights
    
    
    (191
    )
    
    
    158Custodial float
    
    
    318
    
    
    
    279Unreimbursed servicing expenses
    
    
    (250
    )
    
    
    (268
    )Prepayment interest shortfall expense
    
    
    (1,323
    )
    
    
    (808
    )Total servicing income
    
    $
    8,334
    
    
    $
    7,795
 WCCs total servicing income for the quarter ended March 31, 2004 was $8.3
million, compared with $7.8 million for the quarter ended March 31, 2003. The
increase was due primarily to the growth in WCCs servicing volume, as shown in
the table below. Through new contractual agreements and servicing rights
acquisitions, WCC increased its portfolio of serviced loans by approximately
$0.9 billion since March 31, 2003, despite significant loan principal repayments
precipitated by the continuing low-interest rate environment. As a result of
this growth, WCCs total servicing revenues and ancillary fees (including late
charges) increased by approximately 21% from the first quarter of 2003 to the
first quarter of 2004. Net servicing income has continued to be negatively impacted by the
prevailing low interest-rate environment, which has triggered extremely rapid
prepayments of loans comprising our serviced asset base. These accelerated
prepayments have resulted in significant amortization expense on our purchased
mortgage servicing rights (PMSRs) over the past three years (though the
increases from the first quarter of 2003 to the first quarter of 2004 shown
above are attributable also to the larger portfolio volume). In addition, as a
result of rapid prepayments on serviced loans, WCC continued to incur
significant prepayment interest shortfall expense, representing the interest
required to be paid to securitization trusts in accordance with WCCs servicing
agreements. The following table sets forth the composition of loans serviced by WCC by
type of loan at the dates indicated. March 31,
    
    December 31,
    
    March 31,2004
    
    2003
    
    2003(Dollars in thousands)Single-family residential
    
    $
    5,905,683
    
    
    $
    5,973,070
    
    
    $
    4,700,019Multi-family residential
    
    
    6,623
    
    
    
    116,119
    
    
    
    120,876Commercial real estate
    
    
    16,542
    
    
    
    289,629
    
    
    
    236,809Consumer and other
    
    
    68,298
    
    
    
    71,135
    
    
    
    81,868Total (1)
    
    $
    5,997,146
    
    
    $
    6,449,953
    
    
    $
    5,139,572
 (1) WCCs servicing portfolio as of the above dates included approximately $0.3
billion unpaid principal balance of non-performing consumer loans in addition
to those reflected in the table. Other Income WCCs other income increased by approximately $0.4 million from the
quarter ended March 31, 2003 to the quarter ended March 31, 2004, primarily as
a result of an increase in miscellaneous gains from recoveries of servicer
advances in excess of the advances carrying values. Interest Expense WCCs interest expense was $0.1 million for the first quarters of both
2004 and 2003, as its overall average borrowing balances under its debt
facilities were similar for both periods. 22




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##### Table of Contents



Compensation and Employee Benefits Expense WCCs compensation and employee benefits totaled $6.1 million for the
quarter ended March 31, 2004, compared with $5.1 million for the quarter ended
March 31, 2003. This increase was primarily due to an increase in WCCs
employee head count, which resulted from two factors: (1) the continuing growth
of its loan servicing operations and (2) the transfer of some existing
employees to WCCs payroll in the second quarter of 2003 as part of the
Companys reallocation of certain operating expenses among its business
segments. Those employees remain with WCC subsequent to its sale, and the
Company will no longer incur their related compensation expense. WCC also
incurred increases in other employee benefits expenses such as payroll taxes
and 401(k) match as a result of WCCs payout of all vacation and sick time that
had accrued as of December 31, 2003. Other Expenses WCCs other expenses totaled $1.7 million for the quarter ended March 31,
2004, compared with approximately $1.8 million for the first quarter of 2003.
In the first quarter of 2004, for consolidated financial reporting purposes,
the Company did not record depreciation expense on WCCs leasehold improvements
and equipment, in accordance with SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. (WCCs depreciation expense would have been
approximately $0.3 million if WCC were not accounted for as a disposal group
held for sale.) WCC incurred slight increases in other expense categories as a
result of the Companys reallocation of certain expenses among its operating
segments in the second quarter of 2003. Changes in Financial Condition  Wilshire Credit Corporation Following are condensed statements of financial condition for WCC as of
March 31, 2004 and December 31, 2003: March 31,
    
    December 31,2004
    
    2003(Dollars in thousands)ASSETS:Cash and cash equivalents
    
    $
    34
    
    
    $
    109Discounted loans, net
    
    
    444
    
    
    
    522Servicer advance receivables, net
    
    
    26,463
    
    
    
    22,972Purchased mortgage servicing rights, net
    
    
    7,085
    
    
    
    8,519Other assets
    
    
    9,809
    
    
    
    10,576Total assets
    
    $
    43,835
    
    
    $
    42,698LIABILITIES:Short-term borrowings and investment financing
    
    $
    3,662
    
    
    $
    3,352Other liabilities
    
    
    9,906
    
    
    
    9,542Total liabilities
    
    
    13,568
    
    
    
    12,894NET WORTH
    
    
    30,267
    
    
    
    29,804Total liabilities and net worth
    
    $
    43,835
    
    
    $
    42,698
 Discounted Loans, net.WCCs discounted loans, net decreased by $78
thousand for the quarter ended March 31, 2004, primarily as a result of a
provision for losses. Servicer Advance Receivables, net.Servicer advance receivables, net
increased by approximately $3.5 million during the quarter ended March 31,
2004. This increase resulted primarily from new advances made by WCC in
January 2004, partially offset by subsequent recoveries of advances on loans
previously made. Purchased Mortgage Servicing Rights, net.WCCs purchased mortgage
servicing rights, net (PMSRs) decreased by $1.4 million during the first
quarter of 2004. WCC incurred $1.2 million of amortization of PMSRs during
the quarter, and also recorded an impairment of $0.2 million. 23




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##### Table of Contents



Short-Term Borrowings and Investment Financing.WCCs short-term
borrowings and investment financing increased by a net of $0.3 million during
the quarter ended March 31, 2004. WCCs borrowings under its commercial bank
line of credit increased by $1.5 million during the quarter, and provided
funding for WCCs new servicer advances. This increase in the line-of-credit
borrowing was partially offset by $1.2 million in paydowns on WCCs servicer
acquisition notes, which financed previous acquisitions of PMSRs. Liquidity and Capital Resources WCCs sources of cash flow have included primarily servicing revenue and
lines of credit from commercial banks. The availability of liquidity from our
line of credit facilities has been subject to the Companys maintenance of
sufficient available collateral to pledge against such borrowings, and the
Company has maintained sufficient capital under the credit agreements. WCCs
liquidity has been actively managed on a daily basis and periodically reviewed
by the Companys Board of Directors to ensure the maintenance of sufficient
funds to meet WCCs operating needs. At March 31, 2004, WCCs liquidity (including cash and unused borrowings
under credit facilities) totaled $18.4 million, compared with approximately
$18.8 million at December 31, 2003. Adequate credit facilities and other
sources of funding have been essential to the continuation of WCCs ability to
purchase servicing assets, secure new contractual servicing agreements, and to
meet our advancing obligations under the servicing agreements. MORTGAGE INVESTMENT OPERATIONS WFSG conducts its Mortgage Investment Operations through WFC, our
wholly-owned investment subsidiary. Some of WFCs activities are conducted with
a co-investor which has participation interests in the returns generated by the
assets that serve as collateral for the loans. The share of such activities
held by this co-investor is reflected as Investor participation interest in
the Companys consolidated statements of operations. The following table compares WFCs income before taxes for the quarters
ended March 31, 2004 and 2003. Quarter Ended March 31,Increase2004
    
    2003
    
    (Decrease)(Dollars in thousands)Interest income
    
    $
    560
    
    
    $
    1,041
    
    
    $
    (481
    )Realized gains
    
    
    47
    
    
    
    5
    
    
    
    42Other loss, net
    
    
    (138
    )
    
    
    (78
    )
    
    
    (60
    )Total revenues
    
    
    469
    
    
    
    968
    
    
    
    (499
    )Interest expense
    
    
    10
    
    
    
    28
    
    
    
    (18
    )Provision for loan losses
    
    
    114
    
    
    
    30
    
    
    
    84Compensation and employee benefits expense
    
    
    
    
    
    
    205
    
    
    
    (205
    )Other expenses
    
    
    3
    
    
    
    128
    
    
    
    (125
    )Total provisions and expenses
    
    
    127
    
    
    
    391
    
    
    
    (264
    )Income before taxes
    
    $
    342
    
    
    $
    577
    
    
    $
    (235
    )
 Interest Income and Interest Expense WFCs interest income was approximately $0.6 million for the quarter ended
March 31, 2004, compared with $1.0 million for the quarter ended March 31,
2003. The decrease was due 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 decreased slightly from the first quarter of 2003
to the first quarter of 2004. This decrease was due to a lower average balance
of borrowings outstanding in the current period as a result of WFCs repayments
of debt facilities, and also reflects the continuing decline in interest rates. 24




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##### Table of Contents



Other Loss, Net The components of WFCs other loss are reflected in the following table: Quarter EndedMarch 31,2004
    
    2003(Dollars in thousands)Other loss:Real estate owned, net
    
    $
    
    
    
    $
    (15
    )Investor participation interest
    
    
    (90
    )
    
    
    (66
    )Other, net
    
    
    (48
    )
    
    
    3Total other loss
    
    $
    (138
    )
    
    $
    (78
    )
 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 quarter of 2004. As part of the Companys reallocation of operating
expenses among its business segments, certain employees compensation was
transferred to WCC from WFC, commencing in the second quarter of 2003. Those
employees will remain 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 ended March
31, 2004, compared with $0.1 million for the quarter ended March 31, 2003. The
decrease was primarily due to the reallocation of certain assets and expense
categories from WFC to WFSG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
March 31, 2004 and December 31, 2003: March 31,
    
    December 31,2004
    
    2003(Dollars in thousands)ASSETS:Cash and cash equivalents
    
    $
    104
    
    
    $
    37Mortgage-backed securities available for sale, at fair value
    
    
    555
    
    
    
    862Discounted loans, net
    
    
    3,174
    
    
    
    3,817Real estate owned, net
    
    
    35
    
    
    
    Intercompany receivables
    
    
    18,512
    
    
    
    17,911Other assets
    
    
    675
    
    
    
    627Total assets
    
    $
    23,055
    
    
    $
    23,254LIABILITIES:Investment financing
    
    $
    638
    
    
    $
    681Other liabilities
    
    
    1,879
    
    
    
    2,055Total liabilities
    
    
    2,517
    
    
    
    2,736NET WORTH
    
    
    20,538
    
    
    
    20,518Total liabilities and net worth
    
    $
    23,055
    
    
    $
    23,254
 Mortgage-Backed Securities Available for Sale.WFCs portfolio of
mortgage-backed securities available for sale decreased by approximately $0.3
million during the first quarter of 2004 as a result of continuing paydowns on
the underlying loan portfolio. WFC received $0.25 million in principal and
interest repayments in the current year 25




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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 $0.6 million for the quarter ended March 31, 2004, as a result of
$0.5 million of principal repayments and a loan loss provision of approximately
$0.1 million. Intercompany Receivables.Intercompany receivables increased by
approximately $0.6 million during the quarter ended March 31, 2004. This
increase was primarily due to the ongoing transfer of funds from WFC to WFSG to
meet the holding companys operating costs. Investment Financing.WFCs investment financing liability decreased
slightly during the first quarter of 2004, as a result of repayments of a debt
facility with the co-investor. Liquidity and Capital Resources WFCs sources of cash flow include whole loan sales, net interest income,
and borrowings from a co-investor. WFCs liquidity is actively managed on a
daily basis and is periodically reviewed by our Board of Directors. This
process is intended to ensure the maintenance of sufficient funds to meet 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. We no longer own subordinated mortgage-backed securities backed by loan
pools serviced by unaffiliated third parties, and currently hold subordinated
mortgage-backed securities only where WCC has acted as servicer of the loan
pools backing these securities. At March 31, 2004 WFC held approximately $0.6
million of such mortgage-backed securities. HOLDING COMPANY AND MISCELLANEOUS OPERATIONS Our Holding Company and Miscellaneous Operations consist of other
operating revenues and expenses not directly attributable to our Banking, Loan
Servicing or Mortgage Investment Operations, and also 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. WFSG will continue to depend on its
non-Bank subsidiaries to meet its liquidity needs. 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 26




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##### Table of Contents



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 March 31,
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. 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. 27




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##### Table of Contents




    
    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 peer benchmark 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 March 31, 2004 we had a total deferred tax asset of
approximately $47.7 million. This asset represents the tax effect of future
deductible or taxable amounts and is attributable to carryforwards, such as net
operating losses and capital losses, and also to temporary differences between
amounts that have been recognized in the financial statements and amounts that
have been recognized in the Companys income tax returns. In accounting for the
deferred tax asset, we apply Statement of Financial Accounting Standards No.
109, Accounting for Income Taxes, which requires that deferred tax assets be
reduced by a valuation allowance if it is more likely than not that some
portion or all of the deferred tax asset will not be realized. We evaluate the
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, $17.6 million, is reported as an asset in our consolidated statement
of financial condition as of March 31, 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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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 investment committee of the Company and the
asset and liability committee of the Bank (the Committees) which meet to
review, among other things, the sensitivity of our assets and liabilities to
interest rate changes, the book and market values of assets and liabilities,
unrealized gains and losses (including those attributable to hedging
transactions), purchase activity, and maturities of investments and borrowings.
FBBHs Asset and Liability Committee establishes rate sensitivity tolerances
(within regulatory guidelines) which are approved by the Banks Board of
Directors, and coordinates with the Banks Board with respect to overall asset
and liability composition. The Committees are authorized to utilize off-balance sheet financial
techniques to assist them in the management of interest rate risk. These
techniques include interest rate swap agreements, pursuant to which the parties
exchange the difference between fixed-rate and floating-rate interest payments
on a specified principal amount (referred to as the notional amount) for a
specified period without the exchange of the underlying principal amount. The
Bank has entered into a $35 million notional principal amount interest rate
swap agreement, which became effective in December 2002 and matures in December
2004. Pursuant to the agreement, the Bank will pay interest at a fixed rate of
2.22% and receive quarterly interest payments at the three-month LIBOR rate. We continually monitor the interest rate sensitivity of our portfolios of
interest-earning assets and interest-bearing liabilities in conjunction with
the current interest rate environment. When a new pool of loans, securities or
mortgage servicing rights is acquired, we will assess the incremental change in
our sensitivity to interest rates, and determine accordingly whether or not to
hedge. In addition, as required by OTS regulations, the Banks Asset and
Liability Committee also regularly reviews interest rate risk by forecasting
the impact of alternative interest rate environments on the interest rate
sensitivity of Net Portfolio Value (NPV), which is defined as the net present
value of an institutions existing assets, liabilities and off-balance sheet
instruments. The Committee further evaluates such impacts against the maximum
tolerable change in interest income that is authorized by the Board of
Directors of the Bank. The following table quantifies the potential changes in the Companys net
portfolio value (excluding WCCs assets and liabilities) at March 31, 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
    
    Change(Dollars in thousands)Change in Rates+300bp
    
    $
    80,879
    
    
    $
    (28,302
    )
    
    
    (26
    )%
    
    
    7.36
    %
    
    
    (204
    )bp+200bp
    
    
    91,875
    
    
    
    (17,306
    )
    
    
    (16
    )
    
    
    8.19
    
    
    
    (121
    )bp+100bp
    
    
    101,734
    
    
    
    (7,447
    )
    
    
    (7
    )
    
    
    8.90
    
    
    
    (50
    )bp0bp
    
    
    109,181
    
    
    
    
    
    
    
    

    
    
    
    9.40
    
    
    
    -100bp
    
    
    105,946
    
    
    
    (3,235
    )
    
    
    (3
    )
    
    
    9.05
    
    
    
    (35
    )bp-200bp
    
    
    98,577
    
    
    
    (10,604
    )
    
    
    (10
    )
    
    
    8.39
    
    
    
    (101
    )bp-300bp
    
    
    95,623
    
    
    
    (13,558
    )
    
    
    (12
    )
    
    
    8.13
    
    
    
    (127
    )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 30




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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. 
 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. Within the 90 days prior to the date of this report, we
carried out an evaluation, under the supervision and with the participation of
our management, including the individual then 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-14
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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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 on Form 8-K.  (a)
    
    Exhibits.  10.1
    
    Amended and Restated Stock Purchase Agreement dated April 30, 2004 by
and between the Company and Merrill Lynch Mortgage Capital Inc.
(incorporated by reference to the Companys Current Report on Form
8-K dated April 30, 2004)31
    
    Certification by the Principal Executive Officer and Principal
Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.32
    
    Certification by the Principal Executive Officer and Principal
Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.  (b)
    
    Current Report on Form 8-K dated January 16, 2004, reporting
that the Company had entered into an agreement to sell its
wholly-owned mortgage servicing subsidiary, Wilshire Credit
Corporation, to Merrill Lynch Mortgage Capital Inc., a
division of Merrill Lynch & Co., New York, NY.Current Report on Form 8-K dated March 5, 2004, reporting
that the Companys application for listing of its common
stock on the Nasdaq National Market had been approved and
that trading would commence on March 10, 2004.Current Report on Form 8-K dated March 30, 2004, reporting
the Companys earnings results for the year ended December
31, 2003.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. 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: May 24, 2004
    By:
    /s/   STEPHEN P. GLENNONStephen P. GlennonPrincipal Executive Officer and
Principal Financial Officer 33