**SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

 
| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**For thequarterly period ended September 30, 2002**

 

**OR**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**CommissionFile No. 0-23911**

 

**Fog Cutter Capital Group Inc.**

(Exact name of registrantas specified in its charter)

 

| **Maryland**                                                     |   | **52-2081138**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **1410 SW Jefferson Street  Portland, OR  97201**           |
| (Address of principal  executive offices) (Zip Code)             |
|                                                             |   |                                  |
| **(503) 721-6500**                                               |
| (Registrant’s telephone  number, including area code)       |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has been subjectto such filing requirements for the past 90 days.  Yes ý  No o

 

**APPLICABLE ONLY TO CORPORATE ISSUERS:**

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

 
| **Class**                                 |   | **Outstanding  at November 1, 2002** |   |
|-------------------------------------------|--------|--------------------------------------|--------|
| Common Stock, par value $0.0001 per share |   | 9,639,760 shares                     |   |

 

 

 

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FOG CUTTER CAPITAL GROUPINC.

 

FORM 10-Q

 

I N D E X

 
| **PART I—FINANCIAL  INFORMATION**                                                                     |
|------------------------------------------------------------------------------------------------------------|
|                                                                                                       |
| Item 1.  Interim Financial Statements (Unaudited):                                                    |
|                                                                                                       |
| Consolidated  Statements of Financial Condition                                                            |
|                                                                                                       |
| Consolidated  Statements of Operations                                                                     |
|                                                                                                       |
| Consolidated  Statement of Changes in Stockholders’ Equity                                            |
|                                                                                                       |
| Consolidated  Statements of Cash Flows                                                                     |
|                                                                                                       |
| Notes to  Consolidated Financial Statements                                                                |
|                                                                                                       |
| Item  2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations |
|                                                                                                       |
| Item  3.  Quantitative and Qualitative  Disclosures about Market Risk                                 |
|                                                                                                       |
| Item 4.  Controls and Procedures                                                                      |
|                                                                                                       |
| **PART  II—OTHER INFORMATION**                                                                        |
|                                                                                                       |
| Item 1.  Legal Proceedings                                                                            |
|                                                                                                       |
| Item  2.  Changes in Securities and Use of  Proceeds                                                  |
|                                                                                                       |
| Item 3.  Defaults Upon Senior Securities                                                              |
|                                                                                                       |
| Item  4.  Submission of Matters to a Vote of  Security Holders                                        |
|                                                                                                       |
| Item 5.  Other Information                                                                            |
|                                                                                                       |
| Item 6.  Exhibits and Reports on Form 8-K                                                             |
|                                                                                                       |
| Signatures                                                                                                 |

 

2

----

 

**PART I – FINANCIAL INFORMATION**

 

**ITEM 1.   INTERIM FINANCIAL STATEMENTS**

 

FOG CUTTER CAPITAL GROUPINC.

CONSOLIDATED STATEMENTSOF FINANCIAL CONDITION

*(dollars in thousands, except share data)*

 
|                                                                                                                                                                                          |   | **September  30,  2002** |    | **December  31,  2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-------------------------|--------|
|                                                                                                                                                                                          |   | **(Unaudited)**          |    |                    |   |
| **Assets**                                                                                                                                                                                    |   |                     |    |                    |   |
|                                                                                                                                                                                          |   |                     |    |                    |   |
| Cash and cash  equivalents                                                                                                                                                                    |   | $                        | 17,733  |                    | $      | 6,753 |   |
| Securities  available for sale, at estimated fair value                                                                                                                                       |   | 62,624                   |    | 51,783                  |   |
| Loans                                                                                                                                                                                         |   | 2,156                    |    | 4,819                   |   |
| Investments in  real estate held for sale                                                                                                                                                     |   | 4,426                    |    | 4,471                   |   |
| Investments in  WFSG                                                                                                                                                                          |   | —                   |    | 5,893                   |   |
| Investment in  BEP                                                                                                                                                                            |   | 6,032                    |    | 5,195                   |   |
| Other assets  (see Note 4)                                                                                                                                                                    |   | 9,367                    |    | 3,143                   |   |
| Total assets                                                                                                                                                                                  |   | $                        | 102,338 |                    | $      | 82,057 |   |
|                                                                                                                                                                                          |   |                     |    |                    |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                |   |                     |    |                    |   |
|                                                                                                                                                                                          |   |                     |    |                    |   |
| Liabilities:                                                                                                                                                                                  |   |                     |    |                    |   |
| Borrowings                                                                                                                                                                                    |   | $                        | 39,508  |                    | $      | 37,966 |   |
| Income taxes  payable                                                                                                                                                                         |   | 6,213                    |    | —                  |   |
| Accounts payable  and accrued liabilities                                                                                                                                                     |   | 5,109                    |    | 5,292                   |   |
| Total  liabilities                                                                                                                                                                            |   | 50,830                   |    | 43,258                  |   |
|                                                                                                                                                                                          |   |                     |    |                    |   |
| Commitments and  Contingencies (see Note 5)                                                                                                                                                   |   |                     |    |                    |   |
|                                                                                                                                                                                          |   |                     |    |                    |   |
| Temporary  Equity:                                                                                                                                                                            |   |                     |    |                    |   |
| Common stock  subject to put options                                                                                                                                                          |   | 3,878                    |    | —                  |   |
|                                                                                                                                                                                          |   |                     |    |                    |   |
| Stockholders’  Equity:                                                                                                                                                                   |   |                     |    |                    |   |
| Preferred stock,  $.0001 par value; 25,000,000 shares authorized; no shares issued and  outstanding                                                                                           |   | —                   |    | —                  |   |
| Common stock,  $.0001 par value; 200,000,000 shares authorized; 11,512,100 shares issued in  2002 and 11,500,100 issued in 2001; 9,638,260 shares outstanding in 2002 and  10,507,413 in 2001 |   | 167,012                  |    | 166,981                 |   |
| Treasury stock;  1,873,840 common shares in 2002 and 992,687 common shares in 2001, at cost                                                                                                   |   | (4,436                   | )       | (2,171                  | )      |
| Common stock  subject to put options                                                                                                                                                          |   | (3,131                   | )       | —                  |   |
| Accumulated  deficit                                                                                                                                                                          |   | (120,147                 | )       | (128,131                | )      |
| Recourse loans  to officers to acquire stock                                                                                                                                                  |   | —                   |    | (171                    | )      |
| Accumulated  other comprehensive income                                                                                                                                                       |   | 8,332                    |    | 2,291                   |   |
| Total  stockholders’ equity                                                                                                                                                              |   | 47,630                   |    | 38,799                  |   |
| Total  liabilities and stockholders’ equity                                                                                                                                              |   | $                        | 102,338 |                    | $      | 82,057 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

3

----

 

FOG CUTTER CAPITAL GROUPINC.

CONSOLIDATED STATEMENTSOF OPERATIONS

(Unaudited)

*(dollars in thousands, except share data)*

 
|                                                                                                            |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                                                            |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
| Net interest  income:                                                                                           |   |                                  |   |                                 |   |   |   |   |   |
| Loans                                                                                                           |   | $                                     | 67     |                                 | $      | 673 |   | $ | 259 |   | $ | 2,199 |   |
| Securities                                                                                                      |   | 1,445                                 |   | 1,715                                |   | 4,489 |   | 5,865 |   |
| Other  investments                                                                                              |   | 156                                   |   | 31                                   |   | 295 |   | 177 |   |
| Total interest  income                                                                                          |   | 1,668                                 |   | 2,419                                |   | 5,043 |   | 8,241 |   |
| Interest expense                                                                                                |   | 578                                   |   | 1,054                                |   | 1,686 |   | 3,895 |   |
| Net interest  income                                                                                            |   | 1,090                                 |   | 1,365                                |   | 3,357 |   | 4,346 |   |
|                                                                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Real estate  operations:                                                                                        |   |                                  |   |                                 |   |   |   |   |   |
| Operating income                                                                                                |   | —                                |   | 679                                  |   | — |   | 1,885 |   |
| Operating expense                                                                                               |   | (9                                    | )      | (111                                 | )      | (39 | ) | (339 | ) |
| Interest expense                                                                                                |   | (27                                   | )      | (343                                 | )      | (83 | ) | (1,046 | ) |
| Depreciation                                                                                                    |   | (17                                   | )      | (133                                 | )      | (50 | ) | (400 | ) |
| Total real  estate operations                                                                                   |   | (53                                   | )      | 92                                   |   | (172 | ) | 100 |   |
|                                                                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Other operating  income (loss):                                                                                 |   |                                  |   |                                 |   |   |   |   |   |
| Equity in (loss)  earnings of BEP                                                                               |   | (352                                  | )      | (361                                 | )      | 1,697 |   | (1,163 | ) |
| Gain on sale of  loans and securities                                                                           |   | 3,526                                 |   | 452                                  |   | 13,827 |   | 1,002 |   |
| Market valuation  losses and impairments                                                                        |   | —                                |   | (4,619                               | )      | — |   | (8,700 | ) |
| Loan origination  fees                                                                                          |   | 793                                   |   | —                               |   | 1,299 |   | — |   |
| Other revenue                                                                                                   |   | (496                                  | )      | 110                                  |   | (748 | ) | (6 | ) |
| Total other  operating income (loss)                                                                            |   | 3,471                                 |   | (4,418                               | )      | 16,075 |   | (8,867 | ) |
|                                                                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Operating  expenses:                                                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Compensation and  employee benefits                                                                             |   | 1,514                                 |   | 672                                  |   | 3,254 |   | 2,932 |   |
| Professional  fees                                                                                              |   | 476                                   |   | 222                                  |   | 1,421 |   | 781 |   |
| Other                                                                                                           |   | 868                                   |   | 573                                  |   | 1,978 |   | 1,996 |   |
| Total operating  expenses                                                                                       |   | 2,858                                 |   | 1,467                                |   | 6,653 |   | 5,709 |   |
|                                                                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Net income  (loss) before provision for income taxes and cumulative effect of a change in  accounting principle |   | 1,650                                 |   | (4,428                               | )      | 12,607 |   | (10,130 | ) |
| Provision for  income taxes                                                                                     |   | —                                |   | —                               |   | (800 | ) | — |   |
| Net income  (loss) before cumulative effect of a change in accounting principle                                 |   | 1,650                                 |   | (4,428                               | )      | 11,807 |   | (10,130 | ) |
| Cumulative  effect of a change in accounting principle                                                          |   | —                                |   | —                               |   | — |   | (1,021 | ) |
| Net income (loss)                                                                                               |   | $                                     | 1,650  |                                 | $      | (4,428 | ) | $ | 11,807 |   | $ | (11,151 | ) |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

4

----

 
|                                                                                            |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|-------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                                            |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
| Basic net income  (loss) per share before cumulative effect of a change in accounting principle |   | $                                     | 0.17   |                                 | $      | (0.42 | ) | $ | 1.18 |   | $ | (0.96 | ) |
| Cumulative  effect of a change in accounting principle per share                                |   | —                                |   | —                               |   | — |   | (.10 | ) |
| Basic net income  (loss) per share                                                              |   | $                                     | 0.17   |                                 | $      | (0.42 | ) | $ | 1.18 |   | $ | (1.06 | ) |
|                                                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Weighted average  shares outstanding                                                            |   | 9,764,343                             |   | 10,507,413                           |   | 9,997,472 |   | 10,507,413 |   |

 

 
|                                                                                               |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                                               |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** |   |
|                                                                                               |   |                                   |   |                                  |   |   |   |   |   |
| Diluted net  income (loss) per share before cumulative effect of a change in accounting  principle |   | $                                      | 0.17   |                                  | $      | (0.42 | ) | $ | 1.17 |   | $ | (0.96 | ) |
| Cumulative  effect of a change in accounting principle per share                                   |   | —                                 |   | —                                |   | — |   | (.10 | ) |
| Diluted net  income (loss) per share                                                          |   | $                                      | 0.17   |                                  | $      | (0.42 | ) | $ | 1.17 |   | $ | (1.06 | ) |
|                                                                                               |   |                                   |   |                                  |   |   |   |   |   |
| Diluted weighted  average shares outstanding                                                       |   | 9,907,564                              |   | 10,507,413                            |   | 10,121,512 |   | 10,507,413 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

5

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FOG CUTTER CAPITAL GROUPINC.

CONSOLIDATED STATEMENT OFCHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

*(dollars in thousands, except share data)*

 
|                                                                          |   |              |   |                |    |                                       |                     |       |   |   |                                        |   |   | **Recourse  Loans to  Officers to  Acquire  Stock** |   |     |   |   |   |
|-------------------------------------------------------------------------------|--------|-------------------|--------|---------------------|---------|--------------------------------------------|--------------------------|------------|--------|--------|---------------------------------------------|--------|--------|-----------------------------------------------------|--------|----------|--------|--------|--------|
|                                                                          |   |              |   |                |    | **Common  Stock Subject  to Put  Options** |                     |       |   |   | **Accumulated  Other Comprehensive Income** |   |   |                                                |
|                                                                          |   |              |   |                |    |                                       |                     |       |   |   |                                        |   |
|                                                                          |   | **Common  Stock** |   | **Treasury  Stock** |    |                                       | **Accumulated  Deficit** |       |   |   |                                        |   |
|                                                                          |   | **Shares(1)**     |   | **Amount**          |    | **Shares**                                 |                     | **Amount** |   |   |                                        |   |   | **Total**                                           |   |
|                                                                          |   |              |   |                |    |                                       |                     |       |   |   |                                        |   |   |                                                |   |     |   |   |   |
| Balance at January 1, 2002                                                    |   | 10,507,413        |   | $                   | 166,981 |                                       | 992,687                  |       | $      | (2,171 | )                                           | $      | — |                                                | $      | (128,131 | )      | $      | (171   | ) | $ | 2,291 |   | $ | 38,799 |   |
| Comprehensive income:                                                         |   |              |   |                |    |                                       |                     |       |   |   |                                        |   |   |                                                |   |     |   |   |   |
| Net income                                                                    |   | —            |   | —              |    | —                                     |                     | —     |   | — |                                        | 11,807 |   | —                                              |   | —   |   | 11,807 |   |
| Other comprehensive income:                                                   |   |              |   |                |    |                                       |                     |       |   |   |                                        |   |   |                                                |   |     |   |   |   |
| Foreign currency translation                                                  |   | —            |   | —              |    | —                                     |                     | —     |   | — |                                        | — |   | —                                              |   | 550      |   | 550    |   |
| Unrealized holding gains on securities available for sale                     |   | —            |   | —              |    | —                                     |                     | —     |   | — |                                        | — |   | —                                              |   | 7,791    |   | 7,791  |   |
| Reclassification adjustment for net gainson securities included innet  income |   | —            |   | —              |    | —                                     |                     | —     |   | — |                                        | — |   | —                                              |   | (2,300   | )      | (2,300 | )      |
| Total comprehensive income                                                    |   |              |   |                |    |                                       |                     |       |   |   |                                        |   |   |                                                |   |     |   | 17,848 |   |
| Common stock issued pursuant to exercise of stock options                     |   | 12,000            |   | 31                  |    | —                                     |                     | —     |   | — |                                        | — |   | —                                              |   | —   |   | 31     |   |
| Net change in recourse loans to officers to acquire stock                     |   | —            |   | —              |    | —                                     |                     | —     |   | — |                                        | — |   | 171                                                 |   | —   |   | 171    |   |
| Dividends declared                                                            |   | —            |   | —              |    | —                                     |                     | —     |   | — |                                        | (3,823 | )      | —                                              |   | —   |   | (3,823 | )      |
| Transfer to temporary equity:                                                 |   |              |   |                |    |                                       |                     |       |   |   |                                        |   |   |                                                |   |     |   |   |   |
| Put option agreements                                                         |   | —            |   | —              |    | —                                     |                     |       |   | (3,131 | )                                           | — |   | —                                              |   |     |   | (3,131 | )      |
| Treasury stock acquired                                                       |   | (881,153          | )      | —              |    | 881,153                                    |                     | (2,265     | )      | — |                                        | — |   | —                                              |   | —   |   | (2,265 | )      |
| Balance at September 30, 2002                                                 |   | 9,638,260         |   | $                   | 167,012 |                                       | 1,873,840                |       | $      | (4,436 | )                                           | $      | (3,131 | )                                                   | $      | (120,147 | )      | $      | — |   | $ | 8,332 |   | $ | 47,630 |   |

 

----

(1)  Issued andoutstanding.

 

The accompanying notesare an integral part of these consolidated financial statements.

 

6

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FOG CUTTER CAPITAL GROUPINC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

*(dollars in thousands)*

 
|                                                                           |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|--------------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                           |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** |   |
|                                                                           |   |                                   |   |                                  |   |   |   |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                          |   |                                   |   |                                  |   |   |   |   |   |
|                                                                           |   |                                   |   |                                  |   |   |   |   |   |
| Net income  (loss)                                                             |   | $                                      | 1,650  |                                  | $      | (4,428 | ) | $ | 11,807 |   | $ | (11,151 | ) |
| Adjustments to  reconcile net income to net cash used in operating activities: |   |                                   |   |                                  |   |   |   |   |   |
| Depreciation                                                                   |   | 64                                     |   | 183                                   |   | 203 |   | 549 |   |
| Market valuation  losses and impairments                                       |   | —                                 |   | 4,619                                 |   | — |   | 8,700 |   |
| Loss on foreign  currency translation                                          |   | (6                                     | )      | —                                |   | (20 | ) | 116 |   |
| Gain on sale of  securities available for sale                                 |   | (3,357                                 | )      | (452                                  | )      | (14,061 | ) | (452 | ) |
| Gain on sale of  real estate                                                   |   | —                                 |   | (141                                  | )      | (17 | ) | (141 | ) |
| Gain on sale of  loans                                                         |   | (169                                   | )      | —                                |   | 234 |   | (550 | ) |
| Loss on  sale of other assets                                             |   | —                                 |   | 31                                    |   | — |   | 31 |   |
| Equity in losses  (earnings) in BEP                                            |   | 352                                    |   | 361                                   |   | (1,697 | ) | 1,163 |   |
| Cumulative  effect of a change in accounting principle                         |   | —                                 |   | —                                |   | — |   | 1,021 |   |
| Other                                                                          |   | 380                                    |   | —                                |   | 729 |   | — |   |
| Change in:                                                                     |   |                                   |   |                                  |   |   |   |   |   |
| Accrued interest  receivable                                                   |   | 14                                     |   | (135                                  | )      | (123 | ) | 94 |   |
| Other assets                                                                   |   | 179                                    |   | (298                                  | )      | 214 |   | (17 | ) |
| Accounts payable  and accrued liabilities                                      |   | (2,272                                 | )      | (293                                  | )      | (2,355 | ) | (1,024 | ) |
| Net cash used in  operating activities                                         |   | (3,165                                 | )      | (553                                  | )      | (5,086 | ) | (1,661 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                         |   |                                   |   |                                  |   |   |   |   |   |
| Repayments of  securities available for sale                                   |   | 1,512                                  |   | 160                                   |   | 4,362 |   | 1,006 |   |
| Purchase of  securities available for sale                                     |   | —                                 |   | —                                |   | (8,250 | ) | (695 | ) |
| Proceeds from  sale of loans                                                   |   | —                                 |   | —                                |   | — |   | 7,304 |   |
| Proceeds from  sale of securities available for sale                           |   | 2,604                                  |   | 5,017                                 |   | 25,139 |   | 7,361 |   |
| Purchase of  loans and discounted loans                                        |   | (2,102                                 | )      | (100                                  | )      | (2,128 | ) | (1,293 | ) |
| Principle  repayments on loans and discounted loans                            |   | 38                                     |   | 11                                    |   | 2,789 |   | 38 |   |
| Proceeds from  sale of real estate                                             |   | —                                 |   | 1,441                                 |   | — |   | 1,539 |   |
| Loans to  executives                                                           |   | (2,000                                 | )      | —                                |   | (2,750 | ) | — |   |
| Repayment of  loans to executives                                              |   | 100                                    |   | —                                |   | 134 |   | — |   |
| Transfers from  restricted cash                                                |   | 2,579                                  |   | —                                |   | — |   | — |   |
| Proceeds from  investment in BEP                                               |   | —                                 |   | —                                |   | 1,381 |   | — |   |
| Payments made in  connection with acquisition of subsidiary                    |   | —                                 |   | —                                |   | (1,850 | ) | — |   |
| Purchase of  treasury stock                                                    |   | (432                                   | )      | —                                |   | (432 | ) | — |   |
| Other                                                                          |   | (82                                    | )      | (21                                   | )      | (106 | ) | (69 | ) |
| Net cash  provided by investing activities                                     |   | 2,217                                  |   | 6,508                                 |   | 18,289 |   | 15,191 |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                         |   |                                   |   |                                  |   |   |   |   |   |
| Proceeds from  borrowings                                                      |   | —                                 |   | 1,028                                 |   | 10,508 |   | 1,488 |   |
| Repayments on  borrowings                                                      |   | (1,412                                 | )      | (7,496                                | )      | (8,968 | ) | (14,472 | ) |
| Payment of  dividends                                                          |   | (1,275                                 | )      | —                                |   | (3,823 | ) | (1,366 | ) |
| Other                                                                          |   | —                                 |   | —                                |   | 31 |   | (858 | ) |
| Net cash used in  financing activities                                         |   | (2,687                                 | )      | (6,468                                | )      | (2,252 | ) | (15,208 | ) |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                       |   | 27                                     |   | 1                                     |   | 29 |   | (14 | ) |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                          |   | (3,608                                 | )      | (512                                  | )      | 10,980 |   | (1,692 | ) |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                              |   | 21,341                                 |   | 2,214                                 |   | $ | 6,753 |   | 3,394 |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                    |   | $                                      | 17,733 |                                  | $      | 1,702 |   | $ | 17,733 |   | $ | 1,702 |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                            |   |                                   |   |                                  |   |   |   |   |   |
| Cash paid for  interest                                                        |   | $                                      | 594    |                                  | $      | 1,455 |   | $ | 1,768 |   | $ | 5,050 |   |
| Cash paid for  Taxes                                                           |   | $                                      | — |                                  | $      | — |   | $ | — |   | $ | — |   |
| Sale of loan in  exchange for treasury stock                                   |   | $                                      | — |                                  | $      | — |   | $ | 1,833 |   | $ | — |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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FOG CUTTER CAPITAL GROUPINC.

NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1 - BASIS OF PRESENTATION

 

The accompanying interim consolidated financialstatements of Fog Cutter Capital Group Inc. and Subsidiaries (“FCCG” or the“Company”) are unaudited and have been prepared in conformity with therequirements of Regulation S-X promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”), particularly Rule 10-01 thereof, whichgoverns the presentation of interim financial statements.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements.  The accompanying interim consolidatedfinancial statements should be read in conjunction with the Company’s 2001Annual Report on Form 10-K.  A summaryof the Company’s significant accounting policies is set forth in Note 2 to theconsolidated financial statements in the 2001 Annual Report on Form 10-K.

 

In the Company’s opinion, all adjustments, comprisedof normal recurring accruals necessary for the fair presentation of the interimfinancial statements, have been included in the accompanying consolidatedfinancial statements.  Operating resultsfor the nine months ended September 30, 2002 are not necessarily indicative ofthe results that may be expected for the year ending December 31, 2002.

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires theCompany to make estimates and assumptions that affect the reported amounts ofassets and liabilities and disclosures of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates.  Certain items in the previously reportedconsolidated financial statements were reclassified to conform to the September30, 2002 presentation, none of which affect previously reported results ofoperations.

 

At September 30, 2002, certain Company officers anddirectors controlled, directly or indirectly, the significant voting majorityof the Company.

 

 

NOTE 2 -SIGNIFICANT TRANSACTIONS

 

In February 2002, theCompany purchased 100% of the outstanding senior securities of Bear StearnsStructured Products Series Trust 2000-3 (“BSSPT 2000-3”) from third partyinvestors for a purchase price of $8.2 million.  The Company had previously acquired the subordinate securitiesand, as a result of this transaction, became the beneficial owner of 100% ofBSSPT 2000-3.  The acquisition wasfinanced with repurchase agreements in the amount of $7.4 million.  In order to provide for the orderlyliquidation of its investment in these securities, in March 2002, the Companyelected to liquidate BSSPT 2000-3 and took direct ownership of the 67underlying residential mortgage-backed securities owned by the trust.  The Company has subsequently sold 23 of the67 mortgage-backed securities, which had a carrying value of $8.6 million.  The net proceeds from the sales totaled$14.2 million.  The Company repaid $7.0million of short-term indebtedness collateralized by mortgage-backed securitiesand recorded a $7.3 million gain on the sales.

 

The Company has declared and paid a $0.13 per sharecash dividend for each calendar quarter to date during 2002.

 

On March 6, 2002, theCompany purchased a total of 713,043 shares of its common stock from entitiesaffiliated with Jordan D. Schnitzer, a former member of the Company’s Board ofDirectors (“Schnitzer Entities”). The shares were purchased in exchange for a46.60% participation interest in the unpaid principal balance (as of December31, 2001) of the French American International School Loan (the “FAS Loan”),which was held by the Company.  Theparties valued the transaction at approximately $2.175 million, or $3.05 pershare.  On March 6, 2002, the closingprice of the Company’s stock as listed on NASDAQ was $2.57 per share.  The $0.4 million difference between the$2.57 per share closing price of

 

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the stock and the carrying value of the 46.60% interest in the loan wasincluded in the Statement of Operations as a reduction in gains on sale ofloans and securities.

 

The Company also granted an option (the “StockholderPut Option”) to the Schnitzer Entities, which entitled the Schnitzer Entitiesto require the Company to purchase an additional 713,042 shares of FCCG commonstock for $3.05 per share, less any dividends paid by the Company on the sharesbetween March 6, 2002 and the option closing date, plus interest accrued on thenet option price at a rate equal to 10.00% per annum.  In the event the Stockholder Put Option was exercised, paymentfor the shares was to be made by delivery of an additional 46.60% participationinterest in the FAS Loan, plus 46.60% of all principal payments received by theCompany on the FAS Loan since December 31, 2001, plus interest on the netoption price at a rate equal to 10.00% per annum, less any dividends paid bythe Company on the shares between March 6, 2002 and the option closing date.

 

On April 2, 2002, the FASLoan receivable, with a carrying value (net of the 46.6% participationagreement with Schnitzer) of $2.5 million, was paid in full by theborrower.  Net proceeds from therepayment totaled $2.6 million.  Theloan receivable had served as collateral for a $3 million line of credit, whichat the time of the repayment had no borrowings outstanding. Future drawsagainst the line of credit will not be available to the Company unless thelender agrees to accept substituted collateral.

 

The Schnitzer Entities exercised the Stockholder PutOption on September 12, 2002.  Prior tothe exercise, the Company had assigned its obligation to purchase 544,932shares to certain third parties, including Donald Berchtold, an officer of theCompany and the father-in-law of CEO Andrew Wiederhorn.  Mr. Berchtold agreed to purchase 7,000shares for his own account, and 31,099 shares as custodian for certain minorchildren, including Mr. Wiederhorn’s minor children.  All of the other assignments were to non-affiliatedassignees.  The Company purchased theremaining 168,110 shares under the Stockholder Put Option for $0.5million.  Of this amount, $0.4 million(representing the market price of the shares as quoted on NASDAQ on the grantdate) was recorded as treasury stock, and the remaining $0.1 million wasrecorded as a charge to earnings during the nine months ended September 30,2002.

 

The Company had granted an option (the “StockholderProperty Option”) to Jordan D. Schnitzer and Edward P. Borst (collectively the“Stockholder”), which entitled the Stockholder to require the Company topurchase an additional 727,235 shares of FCCG common stock for $0.3 million incash, plus delivery of the Company’s interest in approximately 10.9 acres ofland in Wilsonville, Oregon, less any dividends paid by the Company on theshares between March 6, 2002 and the option closing date.  At the same time, the Company also receivedan option (the “Company Property Option”) from the Stockholder, which entitledthe Company to require the Stockholder to purchase the Company’s interest inapproximately 10.9 acres of land in Wilsonville, Oregon, subject to certainconditions, for $1.9 million, plus any cash dividends paid on 623,265 shares ofFCCG common stock owned by the Stockholder.

 

On July 17, 2002, the Company and the Stockholderterminated the Company Property Option, and amended the Stockholder PropertyOption.  The parties agreed to cancelthe option agreement with respect to 484,235 shares of FCCG common stock andthe Company assigned its obligation to purchase the remaining 243,000 shares tocertain third parties, including Donald Berchtold, an officer of the Companyand the father-in-law of CEO Andrew Wiederhorn, who agreed to purchase 40,000of the shares from the Stockholder.  Asa result of the assignment and cancellation, the Stockholder Property Optionhad no effect on the earnings or equity of the Company at September 30, 2002.

 

On May 13, 2002, the Company and two of itsexecutives, Andrew Wiederhorn and Lawrence Mendelsohn, announced that they hadreached a settlement with the claimants in a series of lawsuits (the “CCLLawsuits”) relating to the receivership of Capital Consultants, L.L.C.(“CCL”).  Under the terms of the settlement,the Company and Messrs. Wiederhorn and Mendelsohn are released and dischargedfrom any and all claims, losses or damages arising or in any way related to CCLor any matters raised, or which could have been raised in the CCLLawsuits.  The agreement also providesprotection against potential claims which may be made by parties who are notparticipants in the settlement.

 

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The settlement agreement and the payment madethereunder are made in compromise of disputed claims and are not an admissionof any liability of any kind.  Thesettlement has an effective date of May 13, 2002, but it is subject to a numberof conditions before any funds can be distributed, including, among otherthings, court approval and the entry of a claims bar order in each of the CCLLawsuits pending before the United States District Court for the District ofOregon.  The court approved thesettlement and issued the claims bar order at a hearing on June 19, 2002.  The Company’s portion of the settlementpayment was made on July 10, 2002 and did not have a material impact on itsfinancial position or results of its operations due to the previouslyestablished settlement reserve.

 

Mr. Mendelsohn resigned for personal reasons asPresident and as a director of the Company on August 30, 2002.

 

On May 15, 2002, the Company made a $2.3 millioncapital investment in a newly formed, wholly owned subsidiary, Fog CapCommercial Lending Inc. (“FCCL”).  FCCLthen acquired a 51% ownership interest in Fog Cap GEMB Holdings LLC (“GEMB Holdings”).  GEMB Holdings subsequently purchased all ofthe assets and certain identified liabilities of George Elkins Mortgage BankingCompany, L.P. (“GEMB L.P.”), a California mortgage banking operation, which providesbrokerage services related to the production of commercial real estatemortgages.  FCCL also purchased a 51%ownership interest in SJGP, Inc.  SJGP,Inc., as the manager of GEMB Holdings, will act as a broker of commercialmortgages through four Southern California branches doing business as GeorgeElkins Mortgage Banking Company. The primary reason for the acquisition was topursue special situation lending opportunities through Elkins’ distributionplatform and to increase its loan brokerage volume and profitability throughthe development of additional lender relationships.

 

The acquisition price for the assets and certainidentified liabilities of GEMB L.P. was $0.4 million.  In conjunction with the acquisition, certain former employees ofGEMB L.P. entered into long-term employment agreements with SJGP, Inc.  The Company advanced deferred compensationpayments to these employees in the amount of $1.9 million, which are includedin other assets in the accompanying statement of financial position.  The Company began reporting the operationsof GEMB Holdings and SJGP, Inc. on a consolidated basis beginning May 15, 2002.

 

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The following supplemental pro forma informationdiscloses the results of operations for the quarters ended September 30, 2002and 2001, and for the nine months ended September 30, 2002 and 2001 as thoughthe acquisition had been completed as of the beginning of the period beingreported:

 
|                                                                                                    |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|---------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                                                    |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** |   |
|                                                                                                    |   | **(*dollars in thousands*)**           |   |
|                                                                                                    |   |                                   |   |                                  |   |   |   |   |   |
| Net interest income                                                                                     |   | $                                      | 1,090  |                                  | $      | 1,365 |   | $ | 3,357 |   | $ | 4,346 |   |
| Real estate operations                                                                                  |   | (53                                    | )      | 92                                    |   | (172 | ) | 100 |   |
| Other operating income                                                                                  |   | 3,471                                  |   | (3,835                                | )      | 16,576 |   | (7,118 | ) |
| Operating expenses                                                                                      |   | (2,858                                 | )      | (2,137                                | )      | (7,159 | ) | (7,719 | ) |
| Net income (loss) before provision for taxes and  cumulative effect of a change in accounting principle |   | 1,650                                  |   | (4,515                                | )      | 12,602 |   | (10,391 | ) |
| Provision for income taxes                                                                              |   | —                                 |   | —                                |   | (800 | ) | — |   |
| Net income (loss) before cumulative effect of a change in  accounting principle                         |   | 1,650                                  |   | (4,515                                | )      | 11,802 |   | (10,391 | ) |
| Cumulative  effect of a change in accounting principle                                                  |   | —                                 |   | —                                |   | — |   | (1,021 | ) |
| Net income (loss)                                                                                       |   | $                                      | 1,650  |                                  | $      | (4,515 | ) | $ | 11,802 |   | $ | (11,412 | ) |
|                                                                                                    |   |                                   |   |                                  |   |   |   |   |   |
| Basic net income  (loss) per share before cumulative effect of a change in accounting principle         |   | $                                      | 0.17   |                                  | $      | (0.43 | ) | $ | 1.18 |   | $ | (0.99 | ) |
| Cumulative  effect of a change in accounting principle per share                                        |   | —                                 |   | —                                |   | — |   | (0.10 | ) |
| Basic net income  (loss) per share                                                                      |   | $                                      | 0.17   |                                  | $      | (0.43 | ) | $ | 1.18 |   | $ | (1.09 | ) |

 

In May 2002, the Company sold, through severalbrokerage transactions to third parties, its entire holdings of approximately2.9 million shares of the common stock of Wilshire Financial Services Group,Inc. (“WFSG”).  The sales were promptedby improved market conditions surrounding WFSG and resulted in cash to theCompany of $9.9 million.  The salestransactions resulted in a net increase in stockholders’ equity of $3.2million.  With the disposal of itsentire interest in WFSG, the Company withdrew its application for change incontrol of a bank holding company (Form H-(e)1), which had been filed with theOffice of Thrift Supervision on March 29, 2002.

 

On July 9, 2002, the Company loaned Mr. Wiederhorn$2.0 million.  This loan is fully recourseto Mr. Wiederhorn and is secured by trust deeds on two residences located inOregon.  The loan is due on August 1,2007 and bears interest at 8.5% per annum, payable monthly.  The Company believes these terms arecomparable to, or more favorable to the Company than, loans available fromunaffiliated third parties negotiated in arms-length transactions.  The Board of Directors, with Mr. Wiederhornabstaining, approved this transaction. The loan was approved and funded prior to the enactment of the Sarbanes– Oxley Act of 2002.

 

On July 25, 2002, the Company purchased two GreatBritain pound (“GBP”) put options as a partial currency hedge on its investmentin the United Kingdom.  The firstcontract entitles the Company to sell GBP 1.0 million for U.S. dollars (“USD”)at an exchange rate of 1.46 USD per one GBP. The option expires on September 26, 2003.  The second contract entitles the Company to sell GBP 7.5 millionfor USD at an exchange rate of 1.46 USD per one GBP.  The option expires on December 26, 2003.  The fair value of the option contracts atSeptember 30, 2002 was $0.2 million and is included in other assets.

 

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On August 8, 2002, the Company entered into anagreement (the “Assignment”), effective July 31, 2002, in which the Companyaccepted the assignment of the obligations of the grantor under a put optiongranted by Andrew A. Wiederhorn to Lawrence A. Mendelsohn, (“Mendelsohn”), anindividual, MFLP, L.P. (“MFLP”), RPM Capital, LLC (“RPM”), AIM Capital, LLC(“AIM”), S&S Investors, LLC (“S&S”), and Joyce Mendelsohn (togetherwith Mendelsohn, MFLP, RPM, AIM and S&S, each, a “Stockholder”), each ofwhom is a stockholder of the Company, pursuant to a Stock Option and VotingAgreement dated October 16, 2001.  Mr.Wiederhorn is the Chairman of the Board and Chief Executive Officer of theCompany.  At the time of the assignment,Mr. Mendelsohn was the President and a member of the Board of Directors of theCompany.  Mr. Mendelsohn resigned fromthe Company on August 30, 2002.

 

Under the Assignment, the Stockholders have the option(the “Put Option”) to require the Company to purchase up to 1,044,760 shares ofthe Company’s common stock (the “Option Shares”) at a price per share equal toeighty percent (80%) of the book value per share of the Company as of the endof the most recent calendar month preceding the delivery of the exercise notice(the “Evaluation Date”).  The optionprice per share is reduced by any dividends paid (or declared with a recorddate) between the Evaluation Date and the settlement of shares purchased as aresult of the exercise of the Put Option.

 

The Stockholders’ right to require the Company topurchase the Option Shares commenced on July 31, 2002 and will expire onOctober 16, 2006 (such period, the “Exercise Period”).  At any time during the Exercise Period,Mendelsohn, acting as agent for the Stockholders, may exercise the Put Optionto require the Company to purchase any or all of the Option Shares.  In the event that an exercise notice isdelivered, the Put Option shall lapse with respect to any Option Shares notspecified as shares included in the exercise notice.  One third of the purchase price for any shares purchased underthe Option Agreement will be paid to the Stockholders at closing.  The remaining purchase price will be paid inaccordance with a promissory note which matures 11 months following the closingdate and which bears interest at 0% for the first 90 days and 12% per annumthereafter.  The note may be prepaid atany time without penalty or premium.

 

In accordance with SEC Accounting Series Release 268,the assumption of the Assignment resulted in the Company recording $3.9 millionin Temporary Equity on the Statement of Financial Condition as of September 30,2002.  Of this amount, $3.1 million wasdeducted from permanent Stockholders’ Equity. The remaining $0.8 million, representing the difference between thestrike price of the option shares and the quoted price of the Option Shares onNASDAQ on the assumption date, was recorded as a charge to earnings.

 

On August 14, 2002, the Company acquired approximately$6.7 million in outstanding debt of DAC International, Inc. (“DAC”) for apurchase price of approximately $2.0 million. DAC produces and markets lens manufacturing equipment.  The debt is evidenced by a new promissorynote, which bears interest at the greater of the Prime Rate plus 2% or theFederal Funds Rate plus 2.5%.  The noterequires monthly principal and interest payments and matures on August 1, 2004.  The note is secured by substantially all ofthe assets of DAC.  As of September 30,2002, DAC had made all of the required payments under the note.

 

 

NOTE 3 – VALUATION OFMORTGAGE-BACKED SECURITIES

 

The fair value of theCompany’s investment in mortgage-backed securities is determined at eachreporting date either through lender/broker quotes or by calculating thepresent value of the anticipated cash flows from the underlying collateralusing certain assumptions.  Theseassumptions include:  (i) future rate ofprepayment; (ii) discount rate used to calculate present value; and (iii)default rates and loss severity on loan pools underlying the mortgage-backedsecurities.  At September 30, 2002, therange of key economic assumptions used to determine the fair value of thesecurities was as follows: an annual prepayment speed ranging from 19% to 30%;a monthly constant default rate ranging from 0.11% to 0.48%; a loss severityranging from 40% to 55%; and a discount rate of 13% for the BB-rated securities,18% for the B-rated securities and 20% for the unrated securities.

 

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The Company evaluates, on an ongoing basis, thecarrying value of its securities portfolio, which is accounted for asavailable-for-sale.  To the extentdifferences between the book basis of the securities and their current marketvalues are deemed to be temporary in nature, such unrealized gains or lossesare reflected directly in equity as “other comprehensive income or loss.”  Declines in fair value are consideredother-than-temporary when: (i) the carrying value of the beneficial interestsexceeds the fair value of such beneficial interests using current assumptions,and (ii) the timing and/or extent of cash flows expected to be received on thebeneficial interests has adversely changed from the previous valuationdate.  To the extent declines in fairvalue are considered other-than-temporary, a write-down is recorded in “MarketValuation Losses and Impairments” in the consolidated statement of operations.

 

During the three months ended September 30, 2002, nomarket valuation losses and impairments were recorded.  However, during the 2001 period, marketvaluation and impairment losses of $4.6 million relative to mortgage-backedsecurities were charged against earnings.

 

 

NOTE 4 – OTHER ASSETS

 

At September 30, 2002, the Company’s other assets consisted of thefollowing:

 
| Loans to  executives                  |   | $         | 3,732,000 |   |
|---------------------------------------|--------|-----------|-----------|--------|
| Capitalized  deferred compensation    |   | 1,711,000 |      |
| Proceeds due  from sale of securities |   | 1,766,000 |      |
| Capitalized  financing fees           |   | 787,000   |      |
| Prepaid  insurance                    |   | 327,000   |      |
| Other                                 |   | 1,044,000 |      |
| Total                                 |   | $         | 9,367,000 |   |

 

 

NOTE 5 – COMMITMENTS,CONTINGENCIES & OFF-BALANCE SHEET RISK

 

The Company and two of its senior officers had beennamed, among other defendants, in a series of civil lawsuits related to thereceivership of an unaffiliated investment company.  In their claims, multiple plaintiffs allege several theories ofliability, including knowing participation in fiduciary breach and prohibitedtransactions under the Employee Retirement Income Security Act of 1974.  On May 13, 2002, the Company and its two topexecutives, Andrew Wiederhorn and Lawrence Mendelsohn, announced that they hadreached a settlement with the claimants in these civil lawsuits (see Part II,Item 1 – Legal Proceedings).  Based uponthe progress of mediation, the Company made a provision for litigation of $2million during the three months ended December 31, 2001.  The reserve was adequate to absorb thepayment of the litigation settlement made in 2002.  Mr. Mendelsohn resigned from the Company on August 30, 2002.

 

Certain current and former employees of the Company orof firms that were previously affiliated with the Company have been named asparties or have been requested to respond to discovery requests and/orgovernment investigations regarding the collapse of CCL.  Several of these individuals have requestedindemnity from the Company for the costs of their defense.  At this time, it is not possible todetermine the extent of liability, if any, the Company may face with regard tosuch indemnity claims.  The Company hasnot agreed to any such indemnity requests. Also, Wilshire Financial Services Group, Inc. (WFSG), which hasindemnity obligations to Messrs. Wiederhorn and Mendelsohn, has informed theCompany that it is reserving the right to claim contribution from the Companyfor a portion of the indemnification payments WFSG has made and may be requiredto pay in the future for the benefit of Messrs. Wiederhorn and Mendelsohn.  WFSG has not made a claim for a specificdollar amount.  The Company has notagreed to any such request for contribution

 

The Company is involved in various other legalproceedings occurring in the ordinary course of business, which the Companybelieves will not have a material adverse effect on the consolidated financialcondition or operations of the Company.

 

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The Company may utilize a wide variety of off-balancesheet financial techniques to manage its interest rate risk.  In hedging the interest rate and/or exchangerate exposure of a foreign currency denominated asset or liability, the Companymay enter into hedge transactions to counter movements in the differentcurrencies, as well as interest rates in those currencies.  These hedges may be in the form of currencyand interest rate swaps, options, and forwards, or combinations thereof.  At September 30, 2002, the Company’s openhedging positions consisted of two Great Britain pound (“GBP”) put options as apartial currency hedge on its investment in the United Kingdom.  The first contract entitles the Company tosell GBP 1.0 million for U.S. dollars (“USD”) at an exchange rate of 1.46 USDper one GBP.  The option expires onSeptember 26, 2003.  The second contractentitles the Company to sell GBP 7.5 million for USD at an exchange rate of1.46 USD per one GBP.  The optionexpires on December 26, 2003.  The valueof the option contracts at September 30, 2002 was $0.2 million.  At September 30, 2002, the Company also hadan open hedging investment consisting of the short sale, for November 2002delivery, of $5.0 million in FNMA 30-year, 6% bonds.  The Company elected not to utilize optional hedge accountingtreatment at this time for the hedging activities.

 

 

NOTE 6 – RECENTLYISSUED ACCOUNTING STANDARDS

 

In July 2001, FASB issued FAS No. 141, Accounting forBusiness Combinations and FAS No. 142, Accounting for Goodwill and IntangibleAssets. FAS No. 141 eliminates the ability to utilize the pooling of interestsmethod of accounting for business combination transactions initiated after June30, 2001.  The purchase method ofaccounting is now required.  FAS No. 142eliminates the existing requirement to amortize goodwill through a periodiccharge to earnings.  For existinggoodwill, the elimination of the amortization requirement is effectivebeginning January 1, 2002. As of that date, and at least annually thereafter,goodwill must be evaluated for impairment based on estimated fair value.  The Company adopted these statements onJanuary 1, 2002, and there was no impact on the Company’s financial position oroperating results upon adoption.

 

In June 2001, FASB issued FAS No. 143, Accounting forAsset Retirement Obligations, which requires that the fair value of a liabilityfor an asset retirement obligation be recognized in the period in which it isincurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs wouldbe capitalized as part of the carrying amount of the long-lived asset anddepreciated over the life of the asset. The liability is accreted at the end of each period through charges tooperating expense.  If the obligation issettled for other than the carrying amount of the liability, the Company willrecognize a gain or loss on settlement. The provisions of FAS No. 143 are effective for fiscal years beginningafter June 15, 2002.  Management has notyet determined the impact, if any, of adoption of FAS No. 143.

 

In August 2001, FASB issued Statement No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets (FAS No. 144).FAS No. 144 retains the fundamental provisions in FAS No. 121 for recognizingand measuring impairment losses on long-lived assets held for use andlong-lived assets to be disposed of by sale, while also resolving significantimplementation issues associated with FAS No. 121. For example, FAS No. 144provides guidance on how a long-lived asset that is used as a part of a groupshould be evaluated for impairment, establishes criteria for when a long-livedasset is held for sale, and prescribes the accounting for a long-lived assetthat will be disposed of other than by sale. FAS No. 144 also retains the basic provisions of Opinion 30 on how topresent discontinued operations in the income statement but broadens thatpresentation to include a component of an entity (rather than a segment of abusiness).  The Company adopted thisstatement on January 1, 2002, and there was no impact on the Company’sfinancial position or operating results upon adoption.

 

 

NOTE 7 – SUBSEQUENT EVENTS

 

On October 10, 2002, the Company paid $1.4 million toacquire the leasehold interests in 109 free-standing retail stores locatedthroughout the United States.  Thepurchase was made through the Company’s wholly-owned subsidiary, Fog Cap RetailInvestors LLC.  The leases coverapproximately

 

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500,000 square feet of retail space located in 25 states. The storesare free-standing, retail locations ranging from 4,500-7,000 square feeteach.  Leaseholds are, in general, 25-30years, and cover a broad tenant mix including convenience stores, shoe stores,pawn shops, carpet retailers and other small businesses.

 

On October 18, 2002, the Company announced a dividenddistribution of one right (a “Right”) to purchase one-tenth of a share of thecommon stock of the Company for each outstanding share of common stock, payableto the stockholders of record on October 28, 2002 (the “Record Date”).  Rights will also be attached to each commonshare issued after the Record Date. Generally, each Right entitles the registered holder to purchaseone-tenth of a common share from the Company at a price of $15 per whole commonshare.

 

The Rights are intended to protect the Company’sincome tax loss carryforward from the limitations imposed under the InternalRevenue Code if there is a change in control of the Company.  Under certain circumstances, individualsattempting to acquire a 5% ownership interest in the Company (or individualsattempting to increase their existing holdings in excess of 5% by more than 1%)will have their interests immediately diluted through distributions of stock toall other Right holders.  The descriptionand terms of the Rights are set forth in a Rights Agreement (the “RightsAgreement”) between the Company and The Bank of New York, as Rights Agent,dated as of October 18, 2002.  TheCompany filed a summary of the Rights Agreement with the Securities andExchange Commission on Form 8-K on October 18, 2002.

 

On October 31, 2002, the Company sold fourteenmortgage-backed securities having a combined carrying value at September 30,2002 of $53.2 million.  The sales pricewas $53.2 million and the transaction is expected to result in the recognitionof gain on sale of securities during the fourth quarter of approximately $13.0million, all of which is reflected in the Accumulated Other ComprehensiveIncome (“OCI”) section of Stockholders’ Equity at September 30, 2002.  Estimated income taxes payable of $4.3million and estimated bonuses payable of $2.4 million, relating to theunrealized appreciation of these bonds, were deducted from OCI at September 30,2002.  The transaction is expected toclose on November 15, 2002 and will result in net cash proceeds (before relatedbonus payments) of $19.5 million, net of the repayment of $33.1 million inrelated debt.

 

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**ITEM2.   MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Thefollowing discussion and analysis should be read in conjunction with theInterim Consolidated Financial Statements of Fog Cutter Capital Group Inc. andthe notes thereto included elsewhere in this filing.  References in this filing to “Fog Cutter Capital Group Inc.,”“we,” “our,” and “us” refer to Fog Cutter Capital Group Inc. and itssubsidiaries unless the context indicates otherwise.*

 

**GENERAL**

 

Fog Cutter Capital Group Inc. (“FCCG” or the“Company”) is a Nasdaq-listed corporation, which focuses on the acquisition ofassets where its expertise in intensive asset management, mortgage and realestate credit analysis and financial structuring can create value.  The Company maintains its headquarters inPortland, Oregon and also has executive offices in New York, Los Angeles andLondon.  The Company invests primarilyin the following types of assets:

 

**Mortgage-backed Securities -**The Company invests in mortgage-backedsecurities through its wholly owned subsidiary, Fog Cutter Capital MarketsInc.  We typically focus on thesubordinated classes of these securities, due to the opportunity for higherrisk-adjusted returns.  We buy and sellthese securities for our own account and utilize creative structuring to add valueto these products.  At September 30,2002, we had total mortgage-backed securities of approximately $62.6 million,which were subject to $38.5 million of non-recourse financing.

 

**Real Estate -**The Company invests in real estate-related assets either directly orindirectly through debt or equity positions in entities that own or operatereal estate.  At September 30, 2002,direct holdings include three properties located in Oregon and California.  In addition, we own 26% of the outstandingcapital stock of Bourne End Properties Plc (“BEP”), a specialist investor inretail shopping centers located in the United Kingdom.  In December 2000, we organized and led agroup of investors, including Merrill Lynch (Jersey) Holdings Limited (asubsidiary of Merrill Lynch & Co., Inc.) to purchase all of the outstandingcapital stock of BEP.  At September 30,2002, our investment in real estate, including the investment in BEP, totaled$10.5 million.  Total indebtednessrelating to these investments at September 30, 2002 was $1.0 million.

 

**Loans and Mortgage Banking -**The Company owns a 51% interest in themortgage banking operation of George Elkins Mortgage Banking Company(“Elkins”).  Headquartered in LosAngeles, with offices in Santa Barbara, San Diego and Newport Beach, Elkinsrenders brokerage services in connection with the origination of commercialmortgages, primarily for their life insurance correspondents.  Elkins specializes in commercial real estateloans in a variety of property types and loan amounts.  The mortgage banking operation also servicesin excess of $700 million of commercial mortgages for various investors.  In addition to the mortgage bankingoperation, we invest directly in special situation loans, including charged offor distressed commercial debt.  AtSeptember 30, 2002, our investment in loans and Elkin’s mortgage bankingactivities was $4.0 million.

 

**Other Investments -**The Company’s other investments consist of cash deposits and other assetsnot included in the classifications described above.  At September 30, 2002, our investments in other investmentstotaled $25.2 million, of which $17.7 million was in unrestricted cashdeposits.

 

16

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The contribution to netincome (loss) for each category of investment for the quarters ended September30, 2002 and 2001 are detailed below. Indirect general and administrative expenses are allocated based uponthe percentage of total assets invested in a category.

** **
|                                         |   | **Three  Months Ended September 30, 2002** |   |
|----------------------------------------------|--------|--------------------------------------------|--------|
|                                         |   | **Mortgage-  backed  Securities**          |   | **Real  Estate** |   | **Loans and  Mortgage  Banking** |   | **Other  Investments** |   | **Total** |   |
|                                         |   | **(*dollars in thousands*)**               |   |
| Interest income                              |   | $                                          | 1,445  |   | $ | — |   | $ | 133 |   | $ | 90 |   | $ | 1,668 |   |
| Interest expense                             |   | (578                                       | )      | — |   | — |   | — |   | (578 | ) |
| Net interest income                          |   | 867                                        |   | — |   | 133 |   | 90 |   | 1,090 |   |
|                                         |   |                                       |   |   |   |   |   |   |   |   |   |
| Other income                                 |   | 3,357                                      |   | (405 | ) | 962 |   | (496 | ) | 3,418 |   |
| Other expense                                |   | (1,083                                     | )      | (180 | ) | (1,156 | ) | (439 | ) | (2,858 | ) |
| Net income before provision for income taxes |   | 3,141                                      |   | (585 | ) | (61 | ) | (845 | ) | 1,650 |   |
| Provision for income taxes                   |   | —                                     |   | — |   | — |   | — |   | — |   |
| Net income (loss)                            |   | $                                          | 3,141  |   | $ | (585 | ) | $ | (61 | ) | $ | (845 | ) | $ | 1,650 |   |

 

 
|                                         |   | **Three  Months Ended September 30, 2001** |   |
|----------------------------------------------|--------|--------------------------------------------|--------|
|                                         |   | **(*dollars in thousands*)**               |   |
|                                         |   | **Mortgage-  backed  Securities**          |   | **Real  Estate** |   | **Loans and  Mortgage  Banking** |   | **Other  Investments** |   | **Total** | ** ** |
| Interest income                              |   | $                                          | 1,715  |   | $ | — |   | $ | 673 |   | $ | 31 |   | $ | 2,419 |   |
| Interest expense                             |   | (796                                       | )      | — |   | (248 | ) | (10 | ) | (1,054 | ) |
| Net interest income                          |   | 919                                        |   | — |   | 425 |   | 21 |   | 1,365 |   |
|                                         |   |                                       |   |   |   |   |   |   |   |   |   |
| Other income                                 |   | (3,917                                     | )      | (312 | ) | — |   | (97 | ) | (4,326 | ) |
| Other expense                                |   | (926                                       | )      | (173 | ) | (86 | ) | (282 | ) | (1,467 | ) |
| Net income before provision for income taxes |   | (3,924                                     | )      | (485 | ) | 339 |   | (358 | ) | (4,428 | ) |
| Provision for income taxes                   |   | —                                     |   | — |   | — |   | — |   | — |   |
| Net income (loss)                            |   | $                                          | (3,924 | ) | $ | (485 | ) | $ | 339 |   | $ | (358 | ) | $ | (4,428 | ) |

 

 

17

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The contribution to netincome (loss) for each category of investment for the nine months endedSeptember 30, 2002 and 2001 are detailed below. Indirect general andadministrative expenses are allocated based upon the percentage of total assetsinvested in a category.

** **
|                                                                                                    |   | **Nine  Months Ended September 30, 2002** |   |
|---------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                    |   | **Mortgage-  backed  Securities**         |   | **Real  Estate** |   | **Loans and  Mortgage  Banking** |   | **Other  Investments** |   | **Total** |   |
|                                                                                                    |   | **(*dollars in thousands*)**              |   |
| Interest income                                                                                         |   | $                                         | 4,489  |   | $ | — |   | $ | 371 |   | $ | 183 |   | $ | 5,043 |   |
| Interest expense                                                                                        |   | (1,686                                    | )      | — |   | — |   | — |   | (1,686 | ) |
| Net interest income                                                                                     |   | 2,803                                     |   | — |   | 371 |   | 183 |   | 3,357 |   |
|                                                                                                    |   |                                      |   |   |   |   |   |   |   |   |   |
| Other income                                                                                            |   | 7,770                                     |   | 1,542 |   | 1,085 |   | 5,506 |   | 15,903 |   |
| Other expense                                                                                           |   | (3,393                                    | )      | (567 | ) | (1,318 | ) | (1,375 | ) | (6,653 | ) |
| Net income before provision for income taxes and cumulative effect of a  change in accounting principle |   | 7,180                                     |   | 975 |   | 138 |   | 4,314 |   | 12,607 |   |
| Provision for income taxes                                                                              |   | (455                                      | )      | (62 | ) | (9 | ) | (274 | ) | (800 | ) |
| Net income before cumulative effect of a change in accounting principle                                 |   | 6,725                                     |   | 913 |   | 129 |   | 4,040 |   | 11,807 |   |
| Cumulative effect of a change in accounting principle                                                   |   | —                                    |   | — |   | — |   | — |   | — |   |
| Net income                                                                                              |   | $                                         | 6,725  |   | $ | 913 |   | $ | 129 |   | $ | 4,040 |   | $ | 11,807 |   |

 

 
|                                                                                                    |   | **Nine  Months Ended September 30, 2001** |   |
|---------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                    |   | **Mortgage-  backed  Securities**         |   | **Real  Estate** |   | **Loans and  Mortgage  Banking** |   | **Other  Investments** |   | **Total** |   |
|                                                                                                    |   | **(*dollars in thousands*)**              |   |
| Interest income                                                                                         |   | $                                         | 5,865  |   | $ | — |   | $ | 2,199 |   | $ | 177 |   | $ | 8,241 |   |
| Interest expense                                                                                        |   | (2,948                                    | )      | — |   | (911 | ) | (36 | ) | (3,895 | ) |
| Net interest income                                                                                     |   | 2,917                                     |   | — |   | 1,288 |   | 141 |   | 4,346 |   |
|                                                                                                    |   |                                      |   |   |   |   |   |   |   |   |   |
| Other income                                                                                            |   | (7,999                                    | )      | (1,122 | ) | 550 |   | (196 | ) | (8,767 | ) |
| Other expense                                                                                           |   | (3,603                                    | )      | (672 | ) | (335 | ) | (1,099 | ) | (5,709 | ) |
| Net income before provision for income taxes and cumulative effect of a  change in accounting principle |   | (8,685                                    | )      | (1,794 | ) | 1,503 |   | (1,154 | ) | (10,130 | ) |
| Provision for income taxes                                                                              |   | —                                    |   | — |   | — |   | — |   | — |   |
| Net income before cumulative effect of a change in accounting principle                                 |   | (8,685                                    | )      | (1,794 | ) | 1,503 |   | (1,154 | ) | (10,130 | ) |
| Cumulative effect of a change in accounting principle                                                   |   | (1,021                                    | )      | — |   | — |   | — |   | (1,021 | ) |
| Net income (loss)                                                                                       |   | $                                         | (9,706 | ) | $ | (1,794 | ) | $ | 1,503 |   | $ | (1,154 | ) | $ | (11,151 | ) |

 

18

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**CriticalAccounting Policies**

 

Management’s Discussion andAnalysis of Financial Condition and Results of Operations discusses ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States.  The preparation of these financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Management bases its estimates and judgmentson historical experience and on various other factors that are believed to bereasonable under the circumstances. Actual results may differ from these estimates under differentassumptions or conditions.  Managementbelieves the following critical accounting policies, among others, affect itsmore significant judgments and estimates used in the preparation of itsfinancial statements.

 

***Valuation***

 

At September 30, 2002, ourlargest asset was our portfolio of mortgage-backed securities.  When available, we use listed market pricesor dealer/lender value opinions to determine the fair value of the securitiesin our portfolio.  However, in theabsence of these third-party quotations, fair values for these securities aredetermined by us, using a third-party valuation model and internally developedassumptions.

 

Valuation models andassumptions impact the carrying value of our mortgage-backed securities and theamount and timing of gains and losses recognized.  The use of different valuation models or assumptions couldproduce different financial results. Changes in the fixed-income markets and the actual performance of ourmortgage-backed securities may impact our estimates of fair value in thefuture, potentially affecting, positively or negatively, our future operatingresults and equity.

 

Our key valuationassumptions include default rates and loss severity, which account for theanticipated credit losses in the pools of loans underlying our mortgage-backedsecurities.  Other key valuation assumptionsinclude prepayment rates and discount rates. Our internal valuation methodology calls for developing the keyvaluation assumptions of credit losses and prepayment speeds based upon theobservable recent history of performance, generally averaged across the latestthree to six months, subject to general economic and marketconsiderations.  Our key valuationassumption of discount rates is developed based on the assessment of thecurrent yields required by investors for similar classes of fixed incomeinstruments.  We apply our valuationmethodology consistently and believe that the resulting fair value estimatesare reasonable; however, these estimated values may differ from those realizedin a bona fide sale transaction, given the judgmental nature of the values ofthese assets.

 

During the years endedDecember 31, 2001, 2000, and 1999, we incurred significant losses of $8.7million, $21.4 million, and $19.6 million, respectively, due to decreases invalue of our mortgage-backed securities. These losses resulted from the worsening credit and prepaymentperformance of our mortgage-backed securities as well as increases in themarket yields for investments in such high-risk assets.  We believe our assumptions and the resultingestimated values of the mortgage-backed securities at September 30, 2002 areconservative, based on the facts and circumstances as of that date; however,there can be no assurance that there will be no future losses on thesesecurities due to changes in their performance or overall market conditions.

 

***Sale Recognition***

 

During 2002, we carried outseveral significant sales of mortgage-backed securities, WFSG stock andloans.  Our accounting policy calls forthe recognition of sales of financial instruments, including mortgage-backedsecurities and loans, only when we have irrevocably surrendered control overthese assets.  We do not retain anyrecourse or performance obligations with respect to our sales of assets.  Our sales were cash sales, and the cashproceeds were not contingent upon any future event.

 

19

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**RESULTSOF OPERATIONS****3⁄4 NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TONINE MONTHS ENDED SEPTEMBER 30, 2001**

 

NET (LOSS) INCOME. Our net income for the nine months ended September 30, 2002, was $11.8million, or $1.18 per share, compared with net loss of $11.2 million, or $1.06per share, for the nine months ended September 30, 2001.  The net income for the 2002 period isprimarily attributable to net interest income of $3.4 million, gain on sale ofloans and securities of $13.8 million, and equity in earnings of BEP of $1.7million, partially offset by other operating expenses of $6.7 million andprovision for income taxes of $0.8 million. The net loss for the 2001 period is attributable to net interest incomeof $4.3 million, gain on sale of loans and securities of $1.0 million andincome from real estate operations of $0.2 million, offset by market valuationlosses and impairments of $8.7 million, equity in the losses of BEP of $1.2million, the cumulative effect of a change in accounting principle of $1.0million and operating expenses of $5.7 million.

 

NET INTEREST INCOME. Our net interest income for the nine months ended September 30, 2002,was $3.4 million, compared with $4.3 million for the nine months endedSeptember 30, 2001.  The decrease isprimarily attributable to a reduction of assets (reflecting our sales ofmortgage-backed securities and loans and paydowns of the related debtfacilities), resulting in decreases in interest income on securities and loansof $1.4 million, and $1.9 million, respectively, partially offset by a decreasein interest expense of $2.2 million. The following tables set forth information regarding the total amount ofincome from interest-earning assets and expense from interest-bearingliabilities and the resulting average yields and rates:

 

 
|                                                            |   | **For the  Nine Months Ended September 30, 2002** |   |
|-----------------------------------------------------------------|--------|---------------------------------------------------|--------|
|                                                            |   | **Average  Balance**                              |   | **Interest  Income (Expense)** |   | **Annualized  Yield/Rate** |   |
|                                                            |   | ***(dollars in thousands)***                      |   |
| Interest-Earning  Assets:                                       |   |                                              |   |   |   |   |   |
|                                                            |   |                                              |   |   |   |   |   |
| Loan portfolios                                                 |   | $                                                 | 1,863  |   | $ | 259 |   | 18.5 | % |
| Mortgage-backed  securities available for sale                  |   | 55,202                                            |   | 4,489 |   | 10.8 | % |
| Other  investments                                              |   | 16,111                                            |   | 295 |   | 2.4 | % |
| Total  interest-earning assets                                  |   | $                                                 | 73,176 |   | $ | 5,043 |   | 9.2 | % |
|                                                            |   |                                              |   |   |   |   |   |
| Interest-Bearing  Liabilities:                                  |   |                                              |   |   |   |   |   |
|                                                            |   |                                              |   |   |   |   |   |
| Borrowings(1)                                                   |   | $                                                 | 39,940 |   | $ | (1,686 | ) | 5.6 | % |
| Total  interest-bearing liabilities                             |   | $                                                 | 39,940 |   | $ | (1,686 | ) | 5.6 | % |
|                                                            |   |                                              |   |   |   |   |   |
| Net interest  income before provision for loan losses/spread(2) |   |                                              |   | $ | 3,357 |   | 3.6 | % |
| Net interest  margin(3)                                         |   |                                              |   |   |   | 6.1 | % |

 

----

(1)                                  Excludesborrowings related to investments in real estate.

(2)                                  Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

(3)                                  Netinterest margin represents net interest income divided by averageinterest-earning assets.

 

20

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|                                                                   |   | **For the  Nine Months Ended September 30, 2001** |   |
|------------------------------------------------------------------------|--------|---------------------------------------------------|--------|
|                                                                   |   | **Average  Balance**                              |   | **Interest  Income (Expense)** |   | **Annualized  Yield/Rate** |   |
|                                                                   |   | ***(dollars in thousands)***                      |   |
| Interest-Earning  Assets:                                              |   |                                              |   |   |   |   |   |
|                                                                   |   |                                              |   |   |   |   |   |
| Loan portfolios                                                        |   | $                                                 | 30,589 |   | $ | 2,199 |   | 9.6 | % |
| Mortgage-backed  securities available for sale                         |   | 62,515                                            |   | 5,865 |   | 12.5 | % |
| Other  investments                                                     |   | 2,968                                             |   | 177 |   | 8.0 | % |
| Total  interest-earning assets                                         |   | $                                                 | 96,072 |   | $ | 8,241 |   | 11.4 | % |
|                                                                   |   |                                              |   |   |   |   |   |
| Interest-Bearing  Liabilities:                                         |   |                                              |   |   |   |   |   |
|                                                                   |   |                                              |   |   |   |   |   |
| Borrowings(1)                                                          |   | $                                                 | 68,398 |   | $ | (3,895 | ) | 7.6 | % |
| Total  interest-bearing liabilities                                    |   | $                                                 | 68,398 |   | $ | (3,895 | ) | 7.6 | % |
|                                                                   |   |                                              |   |   |   |   |   |
| Net interest  income before provision for loan   losses/spread(2) |   |                                              |   | $ | 4,346 |   | 3.8 | % |
| Net interest  margin(3)                                                |   |                                              |   |   |   | 6.0 | % |

 

----

(1)                                  Excludesborrowings related to investments in real estate.

(2)                                  Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

(3)                                  Netinterest margin represents net interest income divided by averageinterest-earning assets.

 

REAL ESTATE OPERATIONS.  Our real estate operations represent activity from our investmentin various office buildings, retail stores, and other commercial propertylocated in Oregon and California. During the nine months ended September 30, 2001, we realized net lossfrom real estate operations of approximately $0.2 million, compared with netincome of $0.1 million for the nine months ended September 30, 2001.  This decrease was primarily attributable tothe sale of office properties located in Portland, Oregon and the United Kingdomduring the prior period.

 

EQUITY IN EARNINGS OF BEP.   In December 2000, we organized and led a group of investors,including Merrill Lynch (Jersey) Holdings Limited (a subsidiary of MerrillLynch & Co., Inc.) to purchase all of the outstanding capital stock ofBEP.   During the nine months endedSeptember 30, 2002, we recognized our share of the earnings of BEP, amountingto $1.7 million.  During the comparableperiod of 2001, we recognized a loss of $1.2 million on BEP.

 

GAIN ON SALE OF LOANS AND SECURITIES.  During the nine months ended September 30,2002, we recognized $13.8 million in gains on the sale of loans and securities,primarily from the sale of our WFSG stock and mortgage-backed securities.  During the comparable period of 2001, werecognized gains on the sale of loans and securities of $1.0 million.

 

MARKET VALUATION LOSSES AND IMPAIRMENTS.  The term “Market Valuation Losses andImpairments” as used herein refers to impairment losses recognized primarily onour mortgage-backed securities and loan portfolios.  During the nine months ended September 30, 2002, no marketvaluation losses and impairments were recorded.  However, during the comparable period in 2001, we recorded marketvaluation losses and impairments of $8.7 million and recorded the cumulativeeffect of a change in accounting principle of $1.0 million relating tomortgage-backed securities.  This chargeto the portfolio of mortgage-backed securities primarily reflected higher thananticipated delinquencies, losses in loans underlying certain securities, andvarying prepayment speeds.

 

21

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OPERATING EXPENSES. During the nine months ended September 30, 2002, we incurred operatingexpenses of $6.7 million.  This was $0.9million higher than the comparable period in 2001.  The primary reason for the increase was $1.7 million in operatingexpenses associated with the acquisition and consolidation of GEMB Holdings andSJGP, Inc., partially offset by reductions in compensation expense as a resultof staff and salary reductions during the 2002 period.

 

 

**RESULTSOF OPERATIONS****3⁄4 THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPAREDTO QUARTER ENDED SEPTEMBER 30, 2001**

 

NET (LOSS) INCOME. Our net income for the three months ended September 30, 2002, was $1.7million, or $0.17 per share, compared with a net loss of $4.4 million, or $0.42per share, for the three months ended September 30, 2001.  The net income for the 2002 period isattributable to net interest income of $1.1 million and gain on sale of loansand securities of $3.5 million, partially offset by other operating expenses of$2.9 million.  The net loss for the 2001period is attributable to net interest income of $1.4 million, income from realestate operations of $0.2 million and gain on sale of loans and securities of$0.4 million, offset by market valuation losses and impairments of $4.6million, equity in losses of BEP of $0.3 million and operating expenses of $1.5million.

 

NET INTEREST INCOME. Our net interest income for the three months ended September 30, 2002,was $1.1 million, compared with $1.4 million for the three months endedSeptember 30, 2001.  The decrease isprimarily attributable to a reduction of assets (reflecting our sales ofmortgage-backed securities and loans and paydowns of the related debtfacilities), resulting in decreases in interest income on securities and loansof $0.3 million and $0.6 million, respectively, partially offset by a decreasein interest expense of $0.5 million. The following tables set forth information regarding the total amount ofincome from interest-earning assets and expense from interest-bearingliabilities and the resulting average yields and rates:

 
|                                                            |   | **For the  Three Months Ended September 30, 2002** |   |
|-----------------------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                            |   | **Average  Balance**                               |   | **Interest  Income (Expense)** |   | **Annualized  Yield/Rate** |   |
|                                                            |   | ***(dollars in thousands)***                       |   |
| Interest-Earning  Assets:                                       |   |                                               |   |   |   |   |   |
|                                                            |   |                                               |   |   |   |   |   |
| Loan portfolios                                                 |   | $                                                  | 1,443  |   | $ | 67 |   | 18.6 | % |
| Mortgage-backed  securities available for sale                  |   | 53,982                                             |   | 1,445 |   | 10.7 | % |
| Other  investments                                              |   | 21,933                                             |   | 156 |   | 2.8 | % |
| Total  interest-earning assets                                  |   | $                                                  | 77,358 |   | $ | 1,668 |   | 8.6 | % |
|                                                            |   |                                               |   |   |   |   |   |
| Interest-Bearing  Liabilities:                                  |   |                                               |   |   |   |   |   |
|                                                            |   |                                               |   |   |   |   |   |
| Borrowings(1)                                                   |   | $                                                  | 39,037 |   | $ | (578 | ) | 5.9 | % |
| Total  interest-bearing liabilities                             |   | $                                                  | 39,037 |   | $ | (578 | ) | 5.9 | % |
|                                                            |   |                                               |   |   |   |   |   |
| Net interest  income before provision for loan losses/spread(2) |   |                                               |   | $ | 1,090 |   | 2.7 | % |
| Net interest  margin(3)                                         |   |                                               |   |   |   | 5.6 | % |

 

----

(1)                                  Excludesborrowings related to investments in real estate.

(2)                                  Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

(3)                                  Netinterest margin represents net interest income divided by averageinterest-earning assets.

 

22

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|                                                                   |   | **For the  Three Months Ended September 30, 2001** |   |
|------------------------------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                                   |   | **Average  Balance**                               |   | **Interest  Income (Expense)** |   | **Annualized  Yield/Rate** |   |
|                                                                   |   | ***(dollars in thousands)***                       |   |
| Interest-Earning  Assets:                                              |   |                                               |   |   |   |   |   |
|                                                                   |   |                                               |   |   |   |   |   |
| Loan portfolios                                                        |   | $                                                  | 30,165 |   | $ | 673 |   | 8.9 | % |
| Mortgage-backed  securities available for sale                         |   | 54,942                                             |   | 1,715 |   | 12.5 | % |
| Other  investments                                                     |   | 1,588                                              |   | 31 |   | 7.8 | % |
| Total  interest-earning assets                                         |   | $                                                  | 86,695 |   | $ | 2,419 |   | 11.2 | % |
|                                                                   |   |                                               |   |   |   |   |   |
| Interest-Bearing  Liabilities:                                         |   |                                               |   |   |   |   |   |
|                                                                   |   |                                               |   |   |   |   |   |
| Borrowings(1)                                                          |   | $                                                  | 70,401 |   | $ | (1,054 | ) | 6.0 | % |
| Total  interest-bearing liabilities                                    |   | $                                                  | 70,401 |   | $ | (1,054 | ) | 6.0 | % |
|                                                                   |   |                                               |   |   |   |   |   |
| Net interest  income before provision for loan   losses/spread(2) |   |                                               |   | $ | 1,365 |   | 5.2 | % |
| Net interest  margin(3)                                                |   |                                               |   |   |   | 6.3 | % |

 

----

(1)                                  Excludesborrowings related to investments in real estate.

(2)                                  Netinterest spread represents the difference between the average rate oninterest-earning assets and the average cost of interest-bearing liabilities.

(3)                                  Netinterest margin represents net interest income divided by averageinterest-earning assets.

 

REAL ESTATE OPERATIONS.  Our real estate operations represent activity from our investmentin various office buildings, retail stores, and other commercial propertylocated in Oregon and California. During the three months ended September 30, 2002, we realized net lossfrom real estate operations of approximately $0.1 million (net of depreciationof $0.2 million), compared with net income of $0.1 million for the three monthsended September 30, 2001.  This decreasewas primarily attributable to the sale of real estate since the three monthsended September 30, 2001.

 

GAIN ON SALE OF LOANS AND SECURITIES.  During the three months ended September 30,2002, we recognized $3.5 million in gains on the sale of loans and securities,primarily from the sale of mortgage-backed securities.  During the comparable period of 2001, werecognized gains on the sale of loans and securities of $0.5 million.

 

MARKET VALUATION LOSSES AND IMPAIRMENTS.  The term “Market Valuation Losses andImpairments” as used herein refers to impairment losses recognized primarily onour mortgage-backed securities and loan portfolios.  During the three months ended September 30, 2002, no marketvaluation losses and impairments were recorded.  However, during the comparable period in 2001, we recorded marketvaluation losses and impairments of $4.6 million relating to mortgage-backedsecurities.  This charge to theportfolio of mortgage-backed securities primarily reflected higher thananticipated delinquencies, losses in loans underlying certain securities, andvarying prepayment speeds.

 

OPERATING EXPENSES. During the three months ended September 30, 2002, we incurred operatingexpenses of $2.9 million.  This was $1.4million higher than the comparable period in 2001.  The primary reason for the increase was $1.1 million in operatingexpenses associated with the acquisition and consolidation of GEMB Holdings andSJGP, Inc.  These expenses werepartially offset by $1.0 million of other operating income resulting from theacquisition.

 

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**CHANGES IN FINANCIAL CONDITION**

 

GENERAL.  Totalassets increased from approximately $82.1 million at December 31, 2001 toapproximately $102.3 million at September 30, 2002.  Total liabilities increased from approximately $47.6 million atDecember 31, 2001 to approximately $50.8 million at September 30, 2002.  Stockholders’ equity increased byapproximately $8.8 million to a balance at September 30, 2002 of $47.6 million.

 

SECURITIES AVAILABLE FOR SALE.  The balance of mortgage-backed securitiesavailable for sale increased from $51.8 million at December 31, 2001 to $62.6million at September 30, 2002.   Theincrease was primarily the result of the purchase of 100% of the outstanding senior mortgage-backed securities ofBear Stearns Structured Products Series Trust 2000-3 (“BSSPT 2000-3”) for apurchase price of $8.2 million and an increase in market value of $16.2million, which were partially offset by the sale of other mortgage-backedsecurities with a carrying value of $9.2 million and cash repayments ofsecurities of $4.4 million.

 

We mark our securities portfolio to estimated fairvalue at the end of each month.  Wedetermine the fair value of the securities through lender/broker quotes, whenavailable, and by modeling the anticipated cash flows using certain estimates(e.g. prepayment speeds, default rates, severity of losses, and discountrate).  As of each reporting period, weevaluate whether and to what extent any unrealized loss is to be recognized asother than temporary.

 

The Company has entered into an employment agreement,which entitles Robert G. Rosen to a bonuspayment equal to $350,000 plus 10% of the excess of the cumulative net proceedsfrom the sale of the Company’s mortgage-backed securities over a specifiedtarget amount (as defined in the employment agreement).  The unrealized holding gain on securitiesavailable for sale included in other comprehensive income has been adjusted toreflect the amount of the bonus payable to Mr. Rosen under his employmentagreement, assuming the Company had sold all of its mortgage-backed securitiesat a selling price equal to the carrying value at September 30, 2002.

 

At September 30, 2002, securities available for salewere as follows:

** **
|                        |   | **Amortized  Cost(1)**       |   | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair Value** |   |
|-----------------------------|--------|------------------------------|--------|------------------------------|--------|-------------------------------|--------|----------------|--------|
|                        |   | ***(dollars in thousands)*** |   |
|                        |   |                         |   |                         |   |                          |   |           |   |
| Mortgage-backed  securities |   | $                            | 46,386 |                         | $      | 16,341                        |   | $              | 103    |   | $ | 62,624 |   |
|                             |        |                              |        |                              |        |                               |        |                |        |  |  |  |  |

 

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(1)                                  Theamortized cost of the securities reflects prior market valuation losses andimpairments and excludes accrued interest of $0.2 million.

 

LOANS.  Duringthe nine months ended September 30, 2002, our loans decreased by approximately$2.7 million due primarily to the sale of a 46.6% participation interest in theFrench American International School loan in exchange for the Company’s stockand the subsequent repayment of the loan by the borrower.  This decrease was partially offset by theacquisition of distressed commercial loans.

 

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INVESTMENT IN WFSG. We sold our entire investment in Wilshire Financial Services Group Inc.(“WFSG”) common stock.  Prior to thesale, we had owned approximately 2.9 million shares, and as of December 31,2001 had been considered the second largest shareholder.  We had filed a change in control application(Form H-(e)1) with the Office of Thrift Supervision (the “OTS”) on March 29,2002.  On May 1, 2002 the OTS issued awritten request for additional information relating to the filing.  Following the sale of the stock, we withdrewthe Form H-(e)1 application with the OTS.

 

OTHER ASSETS. Our other assets increased by approximately $6.2 million during the ninemonths ended September 30, 2002.  Theincrease was primarily the result of the capitalization of $1.7 million indeferred compensation payments relating to the acquisition of GEMB, loans of$2.9 million to certain executives and an increase in proceeds due from thesale of securities of $1.7 million.  Asof September 30, 2002, our other assets consisted of capitalized deferredcompensation of $1.7 million, loans to executives of $3.7 million, capitalizedfinancing fees of $0.8 million, prepaid insurance of $0.5 million, proceeds duefrom the sale of securities of $1.8 million and other miscellaneous assetsof  $0.9 million.

 

BORROWINGS. Borrowings increased by approximately $1.5 million during the ninemonths ended September 30, 2002, primarily due to new borrowings in the amountof $10.5 million related to the purchase of mortgage-backed securities,partially offset by $9.0 million in principal repayments of the borrowings.

 

INCOME TAXES PAYABLE. Our income taxes payable increased to $6.2 million at September 30,2002.  This was the result of aprovision for income taxes of $0.8 million and the establishment of a taxliability of $5.4 million relating to unrealized appreciation on ourmortgage-backed securities portfolio. As of September 30, 2002, we had, for U.S. Federal tax purposes, a netoperating loss carryforward (“NOL”) of approximately $90 million, which beginsto expire in 2018.  The NOL maysignificantly reduce or eliminate the future payment of the taxliabilities.  However, U.S. taxregulations impose limitations on the use of loss carryforwards followingcertain changes in ownership.  If such achange occurs, the limitation could significantly reduce the amount of benefitsthat would be available to offset future taxable income each year, startingwith the year of ownership change.

 

STOCKHOLDERS’ EQUITY. Stockholders’ equity increased by approximately $8.8 million during thenine months ended September 30, 2002, primarily due to our net income of $11.8million and an increase in other comprehensive income of $6.0 million, whichwere partially offset by our dividend payment of $3.8 million, the transfer of$3.1 million to Temporary Equity relating to our assumption of the obligationunder certain put options (as described below) and our purchase of treasurystock of $2.3 million.

 

On August 7, 2002, we entered into an agreement (the“Assignment”), effective July 31, 2002, in which we accepted the assignment ofa put option granted by Andrew A. Wiederhorn to Lawrence A. Mendelsohn,(“Mendelsohn”), and others for whom Mendelsohn is acting as Agent (the“Stockholders”). Mr. Wiederhorn is the Chairman of the Board and ChiefExecutive Officer of the Company.  Atthe time of the Assignment, Mr. Mendelsohn was the President and a member ofthe Board of Directors of the Company.

 

Under the Assignment, the Stockholders have the option(the “Put Option”) to require us to purchase up to 1,044,760 shares of ourcommon stock at a price per share equal to eighty percent (80%) of the bookvalue per share of the Company as of the end of the most recent calendar monthpreceding the delivery of the exercise notice. As a result of the Assignment, the $3.9 million potential obligation topurchase stock under the Put Option has been transferred from Stockholders’Equity to Temporary Equity on the Consolidated Statements of Financial Positionas of September 30, 2002.  The $0.7million difference between the $3.71 per share option price on the shares andthe $3.00 per share NASDAQ closing price of the stock on the date of theAssignment, was deducted from Other Operating Income.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

Liquidity is a measurement of our ability to meetpotential cash requirements, including ongoing commitments to repay borrowings,fund investments, engage in loan acquisition and lending activities, meetcollateral calls and for other general business purposes.  The primary sources of funds for liquidityduring the nine months ended September 30, 2002, consisted of net cash providedby investing activities, including the cash repayments and sales related to ourmortgage-backed securities, investment in WFSG, and loan portfolios.  As of September 30, 2002, we held cash andcash equivalents totaling $17.7 million.

 

Our borrowings and the availability of furtherborrowings are substantially affected by, among other things, changes ininterest rates, changes in market spreads whereby the market value of thecollateral securing such borrowings may decline substantially, or decreases incredit quality of underlying assets.  Inthe event of declines in market value or credit quality, we may be required toprovide additional collateral for, or repay a portion of outstanding balancesof, our short-term borrowing facilities. During the quarter ending June 30, 2002, we repaid or refinanced all ofour remaining short-term fully-recourse repurchase agreements withnon-recourse, short-term repurchase agreements held in wholly-ownedsubsidiaries.  As a result, thepotential risk to the Company from collateral calls is limited to the equity inthe assets being financed, which at September 30, 2002 totaled $18.4million.  As of September 30, 2002, wehad no outstanding collateral calls. For additional information with respect to our monthly mark-to-market ofour securities available for sale portfolio, see “CHANGES IN FINANCIALCONDITION–SECURITIES AVAILABLE FOR SALE.”

 

Fluctuations in interest rates will continue to impactour net interest income to the extent our fixed-rate assets are funded byvariable-rate debt or our variable-rate assets reprice on a different scheduleor in relation to a different index than any floating-rate debt, which in turncould impact potential returns to shareholders.  See “Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK.”

 

At September 30, 2002, we had total consolidatedsecured indebtedness of $39.5 million, as well as $11.3 million of other liabilities.The consolidated secured indebtedness consisted of (i) $13.2 million ofnon-recourse repurchase agreements secured by $35.4 million of mortgage-backedsecurities and  (ii) $26.3 millionoutstanding of other borrowings maturing between 2003 and 2020, which aresecured by real estate and mortgage-backed securities.  Approximately $13.2 million of thisindebtedness had terms that allowed the lender to request additional collateralif the value of the underlying collateral declined.  However, due to the non-recourse nature of this debt, ourexposure to collateral calls is limited to the equity in the assets beingfinanced.

 

Our borrowings are established through both short-termand long-term financing facilities.  Ifinterest rates increase significantly, the borrowing cost under the financingfacility may also increase while the interest rate on the assets securing theloan may not increase at the same time or to the same degree.

 

We have historically financed acquisitions ofmortgage-backed securities through committed and uncommitted thirty-dayrepurchase agreements with major Wall Street investment banks.  Repurchase agreements are secured lendingarrangements that involve the borrower selling an asset to a lender at a fixedprice with the borrower having an obligation to repurchase the asset within aspecified period (generally 30 days) at a higher price reflecting the interestcost of the loan.  If the lender marksthe asset lower, the lender may request that the amount of the loan be reducedby cash payments from the borrower or additional collateral be provided by theborrower.  Mortgage-backed securitiessubject to repurchase agreements may periodically be revalued by the lender anda decline in the value (whether or not the lender recognizes the full fairvalue of the security) may result in the lender requiring us to provideadditional collateral to secure the indebtedness.

 

If we are unable to fund additional collateralrequirements or to repay, renew or replace maturing indebtedness on terms reasonablysatisfactory to us, we may be required to sell (potentially on short notice) aportion of our assets, and could incur losses as a result.  Furthermore, since from time to time thereis extremely limited liquidity in the market for subordinated and residualinterests in mortgage-related

 

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securities, there can be no assurance that we will beable to dispose of such securities promptly for fair value in such situations.

 

We consider the sale of assets to be a normal,recurring part of our operations and we are currently generating positive cashflow as a result of these transactions. However, excluding the sale of assets from time to time, we arecurrently operating with negative cash flow, since many of our assets do notgenerate current cash flows sufficient to cover current operatingexpenses.  We believe that our existingsources of funds will be adequate for purposes of meeting our liquidity needs,however, there can be no assurance that this will be the case.  Material increases in interest expense fromvariable-rate funding sources, collateral calls, or material decreases inmonthly cash receipts, generally would negatively impact our liquidity.  On the other hand, material decreases ininterest expense from variable-rate funding sources or an increase in marketvalue of our mark-to-market financial assets generally would positively affectour liquidity.

 

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**ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risk is the exposure to loss resulting fromchanges in interest rates, foreign currency exchange rates, commodity prices,and equity prices. Although the Company’s exposure to foreign currencyfluctuations has increased significantly over the past year, the primary marketrisk to which the Company is exposed is interest rate risk, which is highlysensitive to many factors, including governmental, monetary and tax policies,domestic and international economic and political considerations, and otherfactors beyond the control of the Company. Changes in the general level of interest rates can affect the Company’snet interest income, which is the difference between the interest income earnedon interest-earning assets and the interest expense incurred in connection withits interest-bearing liabilities, by affecting the spread between the Company’sinterest-earning assets and interest-bearing liabilities.  Changes in the level of interest rates alsocan affect, among other things, the ability of the Company to acquire loans,the value of the Company’s mortgage-backed securities and otherinterest-earning assets, and its ability to realize gains from the sale of suchassets.

 

It is the objective of the Company to attempt tocontrol risks associated with interest rate movements.  In general, the Company’s strategy is tolimit our exposure to earnings variations and variations in the value of assetsand liabilities as interest rates change over time.  Our asset and liability management strategy is formulated andmonitored regularly to review, among other things, the sensitivity of ourassets and liabilities to interest rate changes, the book and market values ofassets and liabilities, unrealized gains and losses, including thoseattributable to hedging transactions, purchase and securitization activity, andmaturities of investments and borrowings.

 

The following table quantifies the potential changesin net interest income and net portfolio value as of September 30, 2002 shouldinterest rates go up or down (shocked) by 100 to 200 basis points, assuming theyield curves of the rate shocks will be parallel to each other andinstantaneous.  Net portfolio value iscalculated as the present value of cash in-flows generated from interest-earningassets net of cash out-flows in respect of interest-bearing liabilities. Thecash flows associated with the loan portfolios and securities available forsale are calculated based on prepayment and default rates that vary by assetbut not by changes in interest rates. Projected losses, as well as prepayments,are generated based upon the actual experience with the subject pool, as wellas similar, more seasoned pools. To the extent available, loan characteristicssuch as loan-to-value ratio, interest rate, credit history and product typesare used to produce the projected loss and prepayment assumptions that areincluded in the cash flow projections of the securities.  The following table applies the U.S. Treasuryyield curve generally for assets and LIBOR for repurchase agreement liabilitiesand assume a uniform change in both rates. The tables assume that changes in interest rates occur  instantaneously.  The table also reflects the predicted effect of interest ratehedging positions in place at September 30, 2002 and demonstrates that theCompany has a significant exposure to LIBOR rates since its repurchaseagreement borrowings are generally based on LIBOR rates.  Actual results could differ significantlyfrom those estimated in the table.

 
| **Projected Percent Change In**   |   |
|-----------------------------------|--------|
| **Change in  Interest  Rates(1)** |   | **Net Interest  Income** |   | **Net Portfolio  Value** |   | **Change in Annual  Net  Interest Income** |   | **Change in Net  Portfolio  Value** |   |
| -200 Basis Points                 |   | 8.8 | % | 5.3 | % | $ | 32,000 |   | $ | 2,459,000 |   |
| -100 Basis Points                 |   | 4.1 | % | 2.6 | % | $ | 15,000 |   | $ | 1,234,000 |   |
| 0 Basis Points                    |   | 0.0 | % | 0.0 | % | $ | — |   | $ | — |   |
| 100 Basis Points                  |   | -4.7 | % | -2.0 | % | $ | (17,000 | ) | $ | (943,000 | ) |
| 200 Basis Points                  |   | -9.4 | % | -4.0 | % | $ | (35,000 | ) | $ | (1,852,000 | ) |

 

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(1)                                  Assumesthat uniform changes occur instantaneously in both the yield on 10-year U.S.Treasury notes and the interest rate applicable to U.S.  dollar deposits in the London interbankmarket.

 

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The following table setsforth information as to the type of funding used to finance the Company’sassets as of September 30, 2002.  Asindicated in the table, a large percentage of the Company’s fixed-rate assetsare financed by floating-rate liabilities and the Company’s variable-rate assetsare generally funded by variable-rate liabilities which use the same index.

 

Assets and Liabilities

As of September 30, 2002

(Dollars in thousands)

 
|                                      |   | **Assets** |    | **Interest** |   | **Liabilities** |   | **Interest** |   |
|-------------------------------------------|--------|------------|---------|--------------|--------|-----------------|--------|--------------|--------|
| Interest-Bearing  Assets                  |   |       |    |         |   |            |   |         |   |
| Fixed-Rate  Assets, Financed Floating     |   | $          | 62,624  |         | Fixed  |            | $      | 38,489       |   | LIBOR |   |
| Fixed-Rate  Assets, No Financing          |   | 2,205      |    | Fixed        |   | —          |   | None         |   |
| Variable-Rate  Assets, No Financing       |   | 3,683      |    | Prime        |   | —          |   | None         |   |
| Cash and Cash  Equivalents                |   | 17,733     |    | Fed Funds    |   | —          |   | None         |   |
| Subtotal                                  |   | 86,245     |    |         |   | 38,489          |   |         |   |
|                                      |   |       |    |         |   |            |   |         |   |
| Other Assets                              |   |       |    |         |   |            |   |         |   |
|                                      |   |       |    |         |   |            |   |         |   |
| Investments in  Real Estate               |   | 4,426      |    | N/A          |   | 1,019           |   | Fixed        |   |
| Investment in  BEP                        |   | 6,032      |    | N/A          |   | —          |   | None         |   |
| Other                                     |   | 5,635      |    | N/A          |   | —          |   | None         |   |
| Subtotal                                  |   | 16,093     |    |         |   | 1,019           |   |         |   |
|                                      |   |       |    |         |   |            |   |         |   |
| Liability Only                            |   |       |    |         |   |            |   |         |   |
|                                      |   |       |    |         |   |            |   |         |   |
| Income Taxes  Payable                     |   | —     |    |         |   | 6,213           |   |         |   |
| Accounts Payable  and Accrued Liabilities |   | —     |    |         |   | 5,109           |   | None         |   |
| Subtotal                                  |   | —     |    |         |   | 11,322          |   |         |   |
|                                      |   |       |    |         |   |            |   |         |   |
| Total                                     |   | $          | 102,338 |         |   |            | $      | 50,830       |   |   |   |

 

Asset and liability management involves managing thetiming and magnitude of the repricing of assets and liabilities.  It is the objective of the Company toattempt to control risks associated with interest rate movements.  Asset and liability management can utilize awide variety of off-balance sheet financial techniques to assist it in themanagement of interest rate risk.  Forexample, in hedging the interest rate and exchange rate exposure of a foreigncurrency denominated asset or liability, we may enter into hedge transactionsto counter movements in the different currencies as well as interest rates inthose currencies.  These hedges may bein the form of currency and interest rate swaps, options, and forwards, orcombinations thereof.  At September 30,2002, the Company had open hedging investments consisting of two Great Britainpound (“GBP”) put options as a partial currency hedge on its investment in theUnited Kingdom.  The first contractentitles the Company to sell GBP 1.0 million for U.S. dollars (“USD”) at anexchange rate of 1.46 USD per one GBP. The option expires on September 26, 2003.  The second contract entitles the Company to sell GBP 7.5 millionfor USD at an exchange rate of 1.46 USD per one GBP.  The option expires on December 26, 2003.  The value of these currency hedgingcontracts was $0.2 million at September 30, 2002.

 

At September 30, 2002, the Company also had an openinterest rate hedging investment consisting of the short sale, for November2002 delivery, of $5.0 million in FNMA 30-year, 6% bonds, which is hedging aportion of our mortgage-backed securities portfolio against a potential declinein value due to change in market interest rate.

 

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Methods for evaluating interest rate risk include ananalysis of the Company’s interest rate sensitivity “gap,” which is defined asthe difference between interest-earning assets and interest-bearing liabilitiesmaturing or repricing within a given time period.  A gap is considered positive when the amount of interest-ratesensitive assets exceeds the amount of interest-rate sensitiveliabilities.  A gap is considerednegative when the amount of interest-rate sensitive liabilities exceedsinterest-rate sensitive assets.  Duringa period of rising interest rates, a negative gap would tend to adversely affectnet interest income, while a positive gap would tend to result in an increasein net interest income.  During a periodof falling interest rates, a negative gap would tend to result in an increasein net interest income, while a positive gap would tend to affect net interestincome adversely.  Since different typesof assets and liabilities with the same or similar maturities may reactdifferently to changes in overall market rates or conditions, changes in interestrates may affect net interest income positively or negatively even if aninstitution were perfectly matched in each maturity category.

 

The following tables set forth the estimated maturityor repricing of the Company’s interest–earning assets andinterest-bearing liabilities at September 30, 2002 (dollars in thousands):

 
|                                                                                    |   | **Within  3 Months** |    | **4 to 12  Months** |   | **One Year  to  3 Years** |   | **More than  3 Years** |    | **TOTAL** |   |
|-----------------------------------------------------------------------------------------|--------|----------------------|---------|---------------------|--------|---------------------------|--------|------------------------|---------|-----------|--------|
| Interest-sensitive assets(1):                                                           |   |                 |    |                |   |                      |   |                   |    |      |   |
| Cash and cash equivalents                                                               |   | $                    | 17,733  |                | $      | —                    |   | $                      | —  |      | $      | — |   | $ | 17,733 |   |
| Securities available for sale                                                           |   | —               |    | —              |   | —                    |   | 62,624                 |    | 62,624    |   |
| Loans                                                                                   |   | 2,033                |    | —              |   | —                    |   | 123                    |    | 2,156     |   |
| Other assets                                                                            |   | —               |    | 1,732               |   | —                    |   | 2,000                  |    | 3,732     |   |
| Total rate-sensitive assets                                                             |   | $                    | 19,766  |                | $      | 1,732                     |   | $                      | —  |      | $      | 64,747 |   | $ | 86,245 |   |
|                                                                                    |   |                 |    |                |   |                      |   |                   |    |      |   |
| Interest-sensitive liabilities :                                                        |   |                 |    |                |   |                      |   |                   |    |      |   |
| Borrowings                                                                              |   | $                    | 38,489  |                | $      | 1,019                     |   | $                      | —  |      | $      | — |   | $ | 39,508 |   |
| Total rate-sensitive liabilities                                                        |   | $                    | 38,489  |                | $      | 1,019                     |   | $                      | —  |      | $      | — |   | $ | 39,508 |   |
|                                                                                    |   |                 |    |                |   |                      |   |                   |    |      |   |
| Interest rate sensitivity gap                                                           |   | $                    | (18,723 | )                   | $      | 713                       |   | $                      | —  |      | $      | 64,747 |   |   |   |
| Cumulative interest rate sensitivity Gap                                                |   | $                    | (18,723 | )                   | $      | (18,010                   | )      | $                      | (18,010 | )         | $      | 46,737 |   |   |   |
| Cumulative interest rate sensitivity gap as a percentage of total rate-sensitive assets |   | -22                  | %       | -21                 | %      | -21                       | %      | 54                     | %       |      |   |

 

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(1)  Real estate propertyholdings are not considered interest rate sensitive.

 

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**ITEM 4.   CONTROLS AND PROCEDURES**

 

As of September 30, 2002, an evaluation was performedunder the supervision and with the participation of the Company’s management,including the Chief Executive Officer (“CEO”) and Chief Financial Officer(“CFO”), of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEOand CFO, concluded that the Company’s disclosure controls and procedures wereeffective as of September 30, 2002. There have been no significant changes in the Company’s internalcontrols or in other factors that could significantly affect internal controlssubsequent to September 30, 2002.

 

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FORWARD-LOOKING STATEMENTS

 

CERTAIN STATEMENTS CONTAINED HEREIN AND CERTAINSTATEMENTS CONTAINED IN FUTURE FILINGS BY THE COMPANY WITH THE SEC MAY NOT BEBASED ON HISTORICAL FACTS AND ARE “FORWARD-LOOKING STATEMENTS” WITHIN THEMEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.  FORWARD-LOOKING STATEMENTS, WHICH ARE BASEDON VARIOUS ASSUMPTIONS (SOME OF WHICH ARE BEYOND THE COMPANY’S CONTROL), MAY BEIDENTIFIED BY REFERENCE TO A FUTURE PERIOD OR PERIODS, OR BY THE USE OFFORWARD-LOOKING TERMINOLOGY, SUCH AS “MAY,” “WILL,” “BELIEVE,” “EXPECT,”“ANTICIPATE,” “CONTINUE,” OR SIMILAR TERMS OR VARIATIONS ON THOSE TERMS, OR THENEGATIVE OF THOSE TERMS.  ACTUAL RESULTSCOULD DIFFER MATERIALLY FROM THOSE SET FORTH IN FORWARD-LOOKING STATEMENTS DUETO A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THEECONOMIC ENVIRONMENT, PARTICULARLY IN THE MARKET AREAS IN WHICH THE COMPANYOPERATES, THE FINANCIAL AND SECURITIES MARKETS AND THE AVAILABILITY OF ANDCOSTS ASSOCIATED WITH SOURCES OF LIQUIDITY, COMPETITIVE PRODUCTS AND PRICING,THE REAL ESTATE MARKET, FISCAL AND MONETARY POLICIES OF THE U.S.  GOVERNMENT, CHANGES IN PREVAILING INTERESTRATES, DEFAULT ASSUMPTIONS AND PREPAYMENT ASSUMPTIONS, ACQUISITIONS AND THEINTEGRATION OF ACQUIRED BUSINESSES, CREDIT RISK MANAGEMENT, ASSET/LIABILITYMANAGEMENT AND THE IMPACT OF ONGOING LITIGATION.  EXCEPT AS MAY BE REQUIRED BY LAW, THE COMPANY DOES NOT UNDERTAKE,AND SPECIFICALLY DISCLAIMS ANY OBLIGATION, TO PUBLICLY RELEASE THE RESULTS OFANY REVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS TO REFLECTTHE OCCURRENCE OF ANTICIPATED OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTERTHE DATE OF SUCH STATEMENTS.

 

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**PARTII — OTHER INFORMATION**

 

 

**Item1.   Legal Proceedings.**

 

The Company, Fog Cap L.P. (a subsidiary of the Companyand formerly known as Wilshire Real Estate Partnership L.P.), its top executiveAndrew Wiederhorn and former president Lawrence Mendelsohn, were named in aseries of civil lawsuits (the “CCL Lawsuits”) relating to the receivership ofCapital Consultants, L.L.C. (“CCL”). The CCL Lawsuits named multiple defendants in addition to the Companyand its executives.  In addition, theclaimants filed claims against a number of additional parties regarding thesame alleged losses, including a number of professional advisors to nameddefendants.

 

The cases were TOM HAZZARD, ET AL., V. CCL, ET AL.,U.S. District Court of Oregon, Civil No. CV 00-1338-HU (filed September 29,2000); MARK EIDEM, ET AL., V. TRUSTEES UNITED ASSN. UNION LOCAL 290, ET AL.,U.S. District Court of Oregon, Civil No. CV 00-1446-HA (filed October 26,2000); NANCY SCHULTZ, ET AL., V. GARY KIRKLAND, ET AL., U.S. District Court ofOregon, Civil No. CV 00-1377-HA (filed October 10, 2000); LARRY MILLER, ET AL.,V. LEE CLINTON, ET AL., U.S. District Court of Oregon, Civil No. CV00-1317-HA(filed September 26, 2000); SALVATORE J. CHILIA, ET AL., V. CCL, ET AL., U.S.District Court of Oregon, Civil No. CV 00-1633 JE (filed November 29, 2000);and MADOLE V. CAPITAL CONSULTANTS ET. AL., U.S. District Court of Oregon, CivilNo. CV 00-1600-HU (filed December 1, 2000). In the HAZZARD, CHILIA and MADOLE cases, the trustees of severalTaft-Hartley trusts filed suit against CCL and several individuals andorganizations CCL did business with (including the Company and Messrs.Wiederhorn and Mendelsohn).  In theEIDEM, SCHULTZ and MILLER cases, the trustees who were plaintiffs in HAZZARDwere in turn named as defendants in class action suits filed by beneficiariesof the Taft-Hartley trusts on which they served as plaintiff-trustees. In thecases in which the trustees were defendants, they filed third-party complaintsagainst several parties, including the Company and Messrs. Wiederhorn andMendelsohn.  In addition, a group ofinvestors that are not Taft-Hartley trusts filed a similar complaint againstthe same defendants, as well as other individuals not named in the priorcomplaints, in the case of AMERICAN FUNERAL & CEMETERY TRUST SERVICES ET.AL. v CAPITAL CONSULTANTS ET. AL., U.S. District Court of Oregon, Civil No.01-00609-HU (filed April 28, 2001).

 

The CCL Lawsuits were all virtually identical andincluded claims against the Company, Messrs. Wiederhorn and Mendelsohn allegingbreaches of fiduciary duties under the Employee Retirement Income Security Actof 1974 (“ERISA”); knowing participation in a fiduciary breach under ERISA;knowing participation in a prohibited transaction under ERISA; knowing transferof trust assets under ERISA; negligence; common law claim for breach offiduciary duty; tortious interference with contract; conversion; constructivetrust, restitution and unjust enrichment; fraud; state securities law claims;and breach of contract.  The CCLLawsuits also alleged claims against Messrs. Wiederhorn and Mendelsohn oftortious interference with business relationships between the Taft-Hartleytrusts and CCL, as well as violations of the Racketeering Influenced andCorrupt Organization provisions of the Organized Crime Control Act of 1970, 18U.S.C. Section 1961-1965 (“RICO”).

 

The claimants in the CCL Lawsuits claimed total lossesby the various plaintiffs against all defendants in the range of $400million.  Approximately $160 million ofthis amount arises from losses on investments, which plaintiffs alleged relatedto Messrs. Wiederhorn and Mendelsohn and companies with which they wereaffiliated, for which plaintiffs alleged the Company shares some unspecifiedportion of the liability.  Additionaldamages were claimed for prejudgment interest dating from the date of eachinvestment under securities law claims under which plaintiffs are seekingrescission remedies.  The RICO claimsinclude additional claims for triple damages and the tort claims include claimsfor punitive damages.  Attorneys’ fees werealso sought under the ERISA, RICO and securities law claims.  The claimants did not describe with anyspecificity, the proportion or share of losses that they claim wereattributable to the Company or its executives, as compared to the other partiesand other potential defendants.  Theoverall remedies sought against all defendants included claims for broad reliefunder the remedial provisions of ERISA, such as rescission of transactions andthe imposition of a constructive trust over any trust assets, which plaintiffsclaimed were obtained in violation of ERISA. Certain of the claims against the Company

 

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appeared to be covered by releases that were given by CCL to theCompany and Messrs. Wiederhorn and Mendelsohn. The claimants’ suits sought to rescind the transactions in which thereleases were granted.  The claimantsalso seek common law remedies such as damages and punitive damages.  However, certain of these common law claimsmay be preempted by ERISA.

 

CCL was placed in receivership by the Department ofLabor and the Securities and Exchange Commission in the cases of SEC V. CAPITALCONSULTANTS, L.L.C., et. al., U.S. District Court of Oregon, Case No.00-1290-KI, and HERMAN V. CAPITAL CONSULTANTS, L.L.C., et. al., U.S. DistrictCourt of Oregon, Case No. 001291-KI. When the receivership order was entered, the court stayed otherproceedings against CCL for several weeks. Once the stay was partially lifted, the parties deferred discovery anddelayed the filing of any answers or legal challenges to the sufficiency of thepleadings in order to facilitate a confidential global mediation process.  U.S. Circuit Court Judge Edward Leavy of theNinth Circuit Court of Appeals was selected as the mediator.  Discovery and motion practice was stayedpending the outcome of the mediation, excepting only a limited amount ofdocument production by all of the parties to the litigation.

 

In addition to the cases identified above, theclaimants also filed other actions relating to the collapse of CCL in whichneither the Company nor its officers have been named.  These cases include AFTCS-Preferred Endowment etc, et. al. v.Grayson, U.S. District Court of Oregon, Civil No. CV 01 1429 HA; Chilia et. al. v. StoelRives LLP, et. al., U.S. District Court of Oregon, Civil No. CV 01 1315 KI; Hazzard, et. al. v. StoelRives LLP, State of Oregon, Multnomah County, Case No. 0108-08975; Sheet MetalWorkers, etc. v. Stoel Rives LLP, U.S. District Court of Oregon, Civil No. CV01 1314 JO; Chilea v. O’Melveny, U.S. District Court of Oregon, Civil No. CV 011370 AS; Carpenters Health v. CCL, U.S. District Court of Oregon, Civil No. CV00 01660 AS; Lennon v. Moss Adams, U.S. District Court of Oregon, Civil No. 0100440 HA; Martinez v. Sesgal Advisors, Inc., U.S. District Court C.D.California, Civil No. 01 5723; Sheet Metal Workers, etc. v. O’Melveny &Meyers et. al., U.S. District Court of Oregon, Civil No. CV 01 1369 JE; Hazzardv. Moss Adams, State of Oregon, Multnomah County, Case No. 0103-03372;McPherson v. Eight District, U.S. District Court of Oregon, Civil No. CV 0001445 HA; Olson v. Larson, U.S. District Court of Oregon, Civil No. CV 01 00480BR; Hazzard v. Moss Adams, U.S. District Court of Oregon, Civil No. CV 01 00603 AS; Piet, et. al. v.Lontine, U.S. District Court of Colorado, Civil No. CV 01 WM 0698; and Madole,et. al. v. Deloitte & Touche, LLP, State of Oregon, Multnomah County, CaseNo. 0202-01882.

 

As a result of the mediation process, the claimantsand a group of the defendants, including the Company, its subsidiaries andMessrs. Wiederhorn and Mendelsohn reached a settlement, the terms of which areset forth in a settlement agreement. The claimants also entered into a series of settlements with severalother parties to the above referenced litigation.  The settlement agreement and the payments made thereunder weremade in compromise of disputed claims and were not an admission of anyliability of any kind.  The settlementhad an effective date of May 13, 2002, but was subject to a number ofconditions precedent before any funds could be distributed under the settlementagreement, including, among other things, court approval and the entry of  a bar order in each of the CCL Lawsuitspending before the United States District Court for the District of Oregon.  The court approved the settlement and enteredthe claims bar order on June 19, 2002.

 

The court approved settlement totaled in excess of$100 million.  Pursuant to thesettlement in which the Company is participating, the defendants and theirinsurers agreed to pay the claimants the sum of $40.0 million, which includesthe purchase for $10.5 million by one defendant of stock held by thereceiver.  The Company agreed to pay aportion of the settlement amount.  Dueto the reserves previously established by the Company, the Company’s settlementpayment did not have a material impact on the Company’s financial position orresults of operations.  The amounts paidby the Company  in connection with thesettlement will not be subject to reimbursement from the Company’s insurancecarriers.  The payment was made by theCompany on July 10, 2002.

 

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Pursuant to the terms of the settlement agreement, theclaimants and the receiver appointed for CCL released and discharged thesettling defendants and certain other related parties from any and all claims,losses, damages, attorney’s fees and costs, disgorgement of fees, fines andpenalties, whether accrued or not, whether already acquired or acquired in thefuture, whether known or unknown, arising or in any way related to CCL or anymatters raised, or which could have been raised in the CCL Lawsuits (the“Released Claims”).  The claimants alsoreleased the defendants and certain other related parties from all claims for indemnityand contribution, regardless of whether those claims are asserted under legaltheories, that in any way arise out of the transactions, occurrences, or anyseries of transactions or occurrences related to the CCL Lawsuits, or whicharise from matters raised, or which could have been raised, in the CCLLawsuits.  The claimants also covenantednot to sue the Company, its subsidiaries, Messrs. Wiederhorn and Mendelsohn andthe other defendants in the CCL Lawsuits based upon the Released Claims.  Each of the defendants released andcovenanted not to sue each other. Certain parties that may have contribution claims or indemnity rightsagainst the settling defendants, including the Company, are not entering intothe settlement agreement.  In order toinduce the settling defendants to enter into the settlement agreement andprotect them against claims by the non-settling parties, the parties to thesettlement agreement agreed as follows:

 

•                  the settlementagreement will require court approval and the entry of a bar order under whichany non-settling parties will receive credit for any loss they must pay toclaimants equal to the relative fault or responsibility of the settlingdefendants, including the Company; therefore if any cross claims are broughtagainst a settling defendant, each settling defendant will be deemed to havealready paid the full amount of its proportionate liability;

•                  the claimantswill reimburse the settling defendants from a defense fund of $2.0 million ofthe settlement funds, which are set aside to defend settling defendants fromany contribution claims made by non-settling parties;

•                  the claimantshave also agreed that with regard to any claims they pursue against otherparties, they will not seek recovery based on the alleged fault of the settlingdefendants, including the Company  (aspecial verdict form will be used in such cases to allocate proportionateliability between the party against whom a judgment is obtained and thesettling parties); and

•                  an additionalamount of $4.25 million will be set aside to cover potential administrativeclaims by the Department of Labor in the event the Department determines toadvance certain claims under ERISA.

 

Certain former employees of the Company or of firmsthat were previously affiliated with the Company have been named as parties orhave been requested to respond to discovery requests and/or governmentinvestigations regarding the collapse of CCL. Several of these individuals have requested indemnity from the Companyfor the costs of their defense.  At thistime, it is not possible to determine the extent of liability, if any, theCompany may face with regard to such indemnity claims because of thepreliminary nature of the underlying litigation.  The Company has not agreed to any such indemnity requests.  Also, Wilshire Financial Services Group,Inc. (WFSG), which has indemnity obligations to Messrs. Wiederhorn andMendelsohn, has informed the Company that it is reserving the right to claimcontribution from the Company for a portion of the indemnification paymentsWFSG has made and may be required to pay in the future for the benefit ofMessrs. Wiederhorn and Mendelsohn.  WFSGhas not made a claim for a specific dollar amount.  The Company has not agreed to any such request for contribution

 

In addition to the civil litigation, the CCL failurehas led to governmental investigations, including a criminal investigation,which criminal investigation is ongoing. Messrs. Wiederhorn and Mendelsohn have received letters from the UnitedStates Attorney’s office in Portland, Oregon, advising them that they are thetargets of a grand jury investigation into the failure of CCL.  At this stage, it is not possible to predictthe outcome of this investigation.  Messrs.Wiederhorn and Mendelsohn, pursuant to the terms of their respective employmentagreements with the Company, may be entitled to indemnity for litigationexpenses and personal losses from the Company in connection with suchinvestigations and any litigation related thereto.  Messrs. Wiederhorn and Mendelsohn have notified the Company thatthey are reserving their rights to seek such indemnity.  Messrs. Wiederhorn and Mendelsohn also maybe entitled to indemnification for litigation expenses and personal losses fromother defendants named in the CCL

 

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Lawsuits in connection with such investigations and any litigationrelated thereto.  At this time, it isnot possible to determine the extent of liability, if any, the Company may facewith regard to such indemnity claims because of the preliminary nature of theinvestigation.  The Company has notagreed to any such indemnity requests.

 

**Item 2.   Changes in Securities and Use of Proceeds.**

 

Not applicable.

 

**Item 3.   Defaults Upon Senior Securities.**

 

Not applicable.

 

**Item 4.   Submission of Matters to a Vote of Security Holders.**

 

None.

 

**Item5.   Other Information.**

 

**TRANSACTIONSWITH AFFILIATES**

 

**StockholderProperty Option; Company Property Option**

 

As discussed in “Note 2 –“Significant Transactions” in the notes to the financial statements, we agreedwith Edward P. Borst and Jordan D. Schnitzer, a former director of the Company(collectively, the “Stockholder”), to terminate our option to put our interestin a property located in Wilsonville, Oregon to them, due to difficultiesrelated to the timing of parceling the property as required by the CompanyProperty Option.  At the same time, theparties reached agreement with respect to the option of the Stockholder to put727,235 shares of the Company to us in exchange for the Wilsonville property.  The Stockholder decided to retain 484,235shares of our stock and the option with respect to those shares wasterminated.   We assigned our obligationto purchase the remaining shares to a number of other investors.  All of the other investors were unaffiliatedto us, except that Donald J. Berchtold, who is one of the Company’s officersand the father-in-law of CEO Andrew Wiederhorn, acquired 40,000 shares.

 

**StockholderPut Option**

 

As discussed in “Note 2 –Significant Transactions” in the notes to the financial statements, theSchnitzer Entities exercised the Stockholder Put Option on September 12,2002.  Prior to the exercise, theCompany had assigned its obligation to purchase 544,932 of the shares to certainthird parties, including Donald Berchtold, an officer of the Company and thefather-in-law of CEO Andrew Wiederhorn. Mr. Berchtold agreed to purchase 7,000 shares for his own account, and31,099 shares as custodian for certain minor children, including Mr.Wiederhorn’s minor children.  All of theother assignments were to non-affiliated assignees.  The Company purchased the remaining 168,110 shares under theStockholder Put Option for $0.5 million.

 

**MendelsohnPut Option**

 

As discussed in “Note 2 –Significant Transactions” in the notes to the financial statements, on August7, 2002, we entered into an agreement (the “Assignment”), effective July 31,2002, in which we accepted the assignment of a put option granted by Andrew A.Wiederhorn to Lawrence A. Mendelsohn (“Mendelsohn”), and others for whomMendelsohn is acting as Agent (the “Stockholders”). Mr. Wiederhorn is theChairman of the Board and Chief Executive Officer of the Company.  At the time of the Assignment, Mr.Mendelsohn was the President and a member of the Board of Directors of the Company.

 

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Under the Assignment, theStockholders have the option (the “Put Option”) to require us to purchase up to1,044,760 shares of our common stock at a price per share equal to eightypercent (80%) of the book value per share of the Company as of the end of themost recent calendar month preceding the delivery of the exercise notice.  As a result of the Assignment, the $3.9million potential obligation to purchase stock under the Put Option has been transferredfrom Stockholders’ Equity to Temporary Equity on the Consolidated Statements ofFinancial Position as of September 30, 2002. The $0.7 million difference between the $3.71 per share option price onthe shares and the $3.00 per share NASDAQ closing price of the stock on thedate of the Assignment, was deducted from Other Operating Income in theStatement of Operations during the three months ended September 30, 2002.

 

**StockPurchase Loans to Officers**

 

Historically, we havenegotiated employment agreements with senior executives, which allow theseexecutives to borrow from us, up to a specified maximum amount to purchaseshares of our common stock.  These loansare full recourse, secured loans bearing interest at the prime rate.  We believe that encouraging stock ownershipby our executives more closely aligns these executives’ interests with those ofthe shareholders.  These loans, and the$2 million loan to an executive officer described in the following section,were all made prior to the enactment of the Sarbanes-Oxley Act.  At September 30, 2002, in addition to the $2million loan to an executive officer referred to below, we had outstandingstock purchase loans to Messrs. Wiederhorn, and Rosen, including accruedinterest, of approximately $880,000, and $825,000, respectively.  The loans are described as follows:

 

*AndrewWiederhorn*.  OnFebruary 21, 2002, we loaned Mr. Wiederhorn $175,000 to finance the purchase ofour common stock.  This loan is fullyrecourse to Mr. Wiederhorn and is secured by all of Mr. Wiederhorn’s rightsunder his employment agreement.  We areentitled to net amounts payable by us under the employment agreement againstany amounts payable by Mr. Wiederhorn upon any default or at maturity of theloan.  At Mr. Wiederhorn’s direction (inaccordance with the terms of his employment agreement), on February 21, 2002,we loaned a limited partnership controlled by Mr. Wiederhorn’s spouse (the“LP”) $687,000 to finance the purchase of our common stock.  The loan is secured by the membershipinterests of two limited liability companies owned by the LP.  The limited liability companies each own aparcel of real property in Oregon and have no liabilities.  At the time of the loan, the real propertyhad an appraised value of $725,000.  Theloan is also guaranteed by Mr. Wiederhorn. The common stock purchased with the proceeds of these loans does notserve as security for the loans.

 

*RobertG. Rosen*.  On December27, 1999, we loaned Mr. Rosen $47,868 to finance the purchase of our common stock.  In September 2000, we loaned Mr. Rosen$798,000 to finance the purchase of our common stock.  These loans are fully recourse to Mr. Rosen and are secured byall of Mr. Rosen’s rights under his employment agreement.  We are entitled to net amounts payable by usunder the employment agreement against any amounts payable by Mr. Rosen uponany default or at maturity of the loans. As additional security for the payment of all amounts due under theloans, Mr. Rosen agreed (i) to deliver annual financial statements of hisfinancial condition to us during the period that the loans remainedoutstanding, (ii) that he would not create or incur any liens upon the whole orany part of his present of future assets without our prior written consent, and(iii) to deliver all of his shares of our stock to us, as custodian pursuant tothe terms of a custody agreement.

 

Further information onthese loans to executives is included in our annual proxy statement for 2001and prior years and these executives’ employment agreements have beenpreviously filed with the SEC.

 

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**Loan toExecutive Officer**

 

On July 9, 2002, weloaned Mr. Wiederhorn $2.0 million. This loan is fully recourse to Mr. Wiederhorn and is secured by trust deedson two residences located in Oregon. The loan is due on August 1, 2007 and bears interest at 8.5% per annum,payable monthly.  The Board of Directors(with Mr. Wiederhorn abstaining) concluded that the terms of the loan were atleast as favorable to the Company than arms length, third party transactionsand approved the loan on July 9, 2002.

 

**Item 6.   Exhibits and Reports on Form 8-K.**

 

(a)          Exhibits

 

4.2                                 TheRights Agreement between the Company the Bank of New York, incorporated byreference from Exhibit A to Form 8-A, filed with the Securities and ExchangeCommission on October 29, 2002.

 

11            Computation of Per Share Earnings

 

99.1                           ChiefExecutive Officer’s Certification pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

99.2                           ChiefFinancial Officer’s Certification pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)         Reports on Form 8-K:

 

A current report on Form 8-K was filed with the Securitiesand Exchange Commission by the Company on August 15, 2002 disclosing theassumption by the Company of the obligation of the grantor to purchase up to1,044,760 shares of the Company’s common stock pursuant to a Stock Option andVoting Agreement dated October 16, 2001 between Andrew A. Wiederhorn as grantorand Lawrence A Mendelsohn, et. al., as grantees.

 

A current report on Form 8-K was filed with theSecurities and Exchange Commission by the Company on September 3, 2002,disclosing the resignation of Lawrence A. Mendelsohn as President and as aDirector of the Company.

 

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**SIGNATURES**

 

Pursuant to the requirements of the exchange act, theregistrant has caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                    | FOG CUTTER CAPITAL GROUP INC. |
|-------------------------|-------------------------------|
|                    |                          |   |
|                    |                          |   |
|                    |                          | By:  /s/  Andrew A. Wiederhorn |   |
|                    |                          | Andrew A. Wiederhorn |
|                    |                          | Chairman and Chief Executive Officer |
|                    |                          |   |
|                    |                          |   |
|                    |                          | By:  /s/ R.  Scott Stevenson |   |
|                    |                          | R. Scott Stevenson |
|                    |                          | Senior Vice President and Chief Financial Officer |
|                    |                          |   |
|                    |                          |   |
|                    |                          |   |
| Date: November 14, 2002 |

 

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CERTIFICATION

 

I, Andrew A. Wiederhorn, Chairman of the Board of Directors and ChiefExecutive Officer of Fog Cutter Capital Group Inc. (the “Company”), certifythat:

 

1.             I have reviewedthis quarterly report on Form 10-Q of the Company;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

(a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

(b) evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this quarterly report (the “Evaluation Date”);and

 

(c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’sother certifying officer and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee of registrant’sboard of directors (or persons performing the equivalent function):

 

(a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(b) any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.             The registrant’sother certifying officer and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date: November 14, 2002 |                                                             |
|-------------------------|------------------------------------------------------------------|
|                    |                                                             |
|                    | /s/ ANDREW A. WIEDERHORN                                         |   |
|                    | Andrew A.  Wiederhorn                                            |
|                    | Chairman of the Board  of Directors  and Chief Executive Officer |

 

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CERTIFICATION

 

I, R. Scott Stevenson, Chief Financial Officer of Fog Cutter CapitalGroup Inc. (the “Company”), certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of the Company;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

(a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

(b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

(c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’sother certifying officer and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

(a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(b) any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.             The registrant’sother certifying officer and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date: November 14, 2002 |                     |
|-------------------------|--------------------------|
|                    |                     |
|                    | /s/ R. SCOTT STEVENSON   |   |
|                    | R. Scott  Stevenson      |
|                    | Chief Financial  Officer |

 

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