10-Q 1 a2080145z10-q.txt 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-23911 FOG CUTTER CAPITAL GROUP INC. (Exact name of registrant as specified in its charter) MARYLAND 52-2081138 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) 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) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No/ /. APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT MARCH 31, 2002 Common Stock, par value $0.0001 per share 9,794,370 shares ================================================================================ FOG CUTTER CAPITAL GROUP INC. FORM 10-Q I N D E X
Page No. PART I--FINANCIAL INFORMATION Item 1. Interim Financial Statements (Unaudited): Consolidated Statements of Financial Condition...............................................3 Consolidated Statements of Operations........................................................4 Consolidated Statement of Changes in Stockholders' Equity....................................5 Consolidated Statements of Cash Flows........................................................6 Notes to Consolidated Financial Statements...................................................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......12 Item 3. Quantitative and Qualitative Disclosures about Market Risk..................................19 PART II--OTHER INFORMATION Item 1. Legal Proceedings...........................................................................23 Item 2. Changes in Securities and Use of Proceeds...................................................26 Item 3. Defaults Upon Senior Securities.............................................................26 Item 4. Submission of Matters to a Vote of Security Holders.........................................26 Item 5. Other Information...........................................................................26 Item 6. Exhibits and Reports on Form 8-K............................................................26 Signatures ..........................................................................................27
2 PART I -- FINANCIAL INFORMATION ITEM 1. INTERIM FINANCIAL STATEMENTS FOG CUTTER CAPITAL GROUP INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
March 31, December 31, 2002 2001 ----------- ------------- (Unaudited) ASSETS Cash and cash equivalents .............................. $ 5,574 $ 6,753 Securities available for sale, at estimated fair value.. 59,999 51,783 Loans .................................................. 2,575 4,819 Investments in real estate held for sale ............... 4,460 4,471 Investments in WFSG .................................... 6,648 5,893 Investment in BEP ...................................... 5,066 5,195 Other assets ........................................... 2,776 3,143 --------- --------- Total assets ....................................... $ 87,098 $ 82,057 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Borrowings ............................................. $ 44,247 $ 37,966 Accounts payable and accrued liabilities ............... 4,042 5,292 --------- --------- Total liabilities .................................. 48,289 43,258 --------- --------- Commitments and Contingencies (see Note 4) Temporary Equity: Common stock subject to put options .................... 3,939 -- --------- --------- 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; 11,500,100 shares issued; 9,794,370 shares outstanding in 2002 and 10,507,413 in 2001 ........... 166,981 166,981 Treasury stock; 1,705,730 common shares in 2002 and 992,687 common shares in 2001, at cost ............... (4,004) (2,171) Common stock subject to put options .................... (3,547) -- Accumulated deficit .................................... (129,986) (128,131) Recourse loans to officers to acquire stock ............ (928) (171) Accumulated other comprehensive income ................. 6,354 2,291 --------- --------- Total stockholders' equity ......................... 34,870 38,799 --------- --------- Total liabilities and stockholders' equity ......... $ 87,098 $ 82,057 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 3 FOG CUTTER CAPITAL GROUP INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
Quarter Ended March 31, ---------------------------- 2002 2001 ------------ ------------ Net Interest Income: Loans ...................................... $ 131 $ 824 Securities ................................. 1,448 2,251 Other investments .......................... 31 60 ------------ ------------ Total interest income ................... 1,610 3,135 Interest expense ........................... 500 1,571 ------------ ------------ Net interest income before loan losses .. 1,110 1,564 ------------ ------------ Real Estate Operations: Operating income ........................... -- 597 Operating expense .......................... (16) (94) Interest expense ........................... (28) (355) Depreciation ............................... (16) (136) ------------ ------------ Total real estate operations .......... (60) 12 ------------ ------------ Other Operating (Loss) Income: Market valuation losses and impairments .... -- (4,081) Equity in losses of BEP .................... (28) (227) Gain on sale of loans and securities ....... 116 317 Other ...................................... (379) (110) ------------ ------------ Total other operating (loss) income ... (291) (4,101) ------------ ------------ Operating Expenses: Compensation and employee benefits ......... 633 1,201 Professional fees .......................... 274 318 Other ...................................... 433 747 ------------ ------------ Total operating expenses .............. 1,340 2,266 ------------ ------------ Net loss before provision for income taxes ..... (581) (4,791) Provision for income taxes ..................... -- -- ------------ ------------ Net loss ....................................... $ (581) $ (4,791) ============ ============ Basic and diluted net loss per share ........... $ (0.06) $ (0.46) Basic weighted average shares outstanding ...... 10,269,665 10,507,313 Diluted weighted average shares outstanding .... 10,535,578 10,507,313
The accompanying notes are an integral part of these consolidated financial statements. 4 FOG CUTTER CAPITAL GROUP INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
Recourse Common Loans to Common Stock Treasury Stock Stock Subject Officers to ------------------------- ---------------------- to Put Accumulated Aquire Shares (1) Amount Shares Amount Options Deficit Stock ----------- ------------ ----------- --------- -------------- -------------- ---------------- Balance at January 1, 2002 10,507,413 $ 166,981 992,687 $ (2,171) $ - $ (128,131) $ (171) Comprehensive income: Net loss - - - - - (581) - Other comprehensive income: Foreign currency translation - - - - - - - Unrealized holding gains on securities available for sale - - - - - - - Reclassification adjustment for net gains on securities included in net loss - - - - - - - Total comprehensive income Loans to officers, net - - - - - - (757) Dividends declared - - - - - (1,274) - Transfer to temporary equity: Put option agreements - - - - (3,547) - - Treasury stock acquired (713,043) - 713,043 (1,833) - - - ---------- ---------- --------- --------- ---------- ------------ ----------- Balance at March 31, 2002 9,794,370 $ 166,981 1,705,730 $ (4,004) $ (3,547) $ (129,986) $ (928) ========== ========== ========= ========= ========== ============ =========== Accumulated Other Comprehensive Income Total -------------- ------------- Balance at January 1, 2002 $ 2,291 $ 38,799 Comprehensive income: Net loss - (581) Other comprehensive income: Foreign currency translation (100) (100) Unrealized holding gains on securities available for sale 4,659 4,659 Reclassification adjustment for net gains on securities included in net loss (496) (496) ------------ Total comprehensive income 3,482 Loans to officers, net - (757) Dividends declared - (1,274) Transfer to temporary equity: Put option agreements - (3,547) Treasury stock acquired - (1,833) ------------- ------------ Balance at March 31, 2002 $ 6,354 $ 34,870 ============= ============
---------- (1) Issued and outstanding. The accompanying notes are an integral part of these consolidated financial statements. 5 FOG CUTTER CAPITAL GROUP INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (DOLLARS IN THOUSANDS)
Quarter Ended March 31, ----------------------- 2002 2001 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (581) $(4,791) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation 64 184 Market valuation losses and impairments - 4,081 Unrealized foreign currency losses 3 110 Gain on sale of loans and securities (116) (317) Equity in losses of BEP 28 227 Gain on sale of real estate (17) - Loss on grant of put options 392 - Change in: Accrued interest receivable (32) 171 Other assets 294 277 Accounts payable and accrued liabilities (1,252) 269 ------- ------- Net cash (used in) provided by operating activities (1,217) 211 ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of securities (8,250) (695) Repayments of securities available for sale 1,289 650 Proceeds from sale of securities available for sale 2,650 - Proceeds from sale of loans - 2,999 Principal repayments on loans 73 17 Proceeds from sale of real estate (5) - Other (725) (21) ------- ------- Net cash (used in) provided by investing activities (4,968) 2,950 ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings 7,467 - Dividend payment on common stock (1,273) - Repayments on borrowings (1,187) (3,031) ------- ------- Net cash provided by (used in) financing activities 5,007 (3,031) ------- ------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (1) (14) ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,179) 116 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,753 3,394 ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,574 $ 3,510 ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 520 $ 1,915 Cash paid for taxes $ - $ - NON-CASH FINANCING AND INVESTING ACTIVITIES: Treasury stock acquired in exchange for assets $ 1,833 $ -
The accompanying notes are an integral part of these consolidated financial statements. 6 FOG CUTTER CAPITAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying interim consolidated financial statements of Fog Cutter Capital Group Inc. and Subsidiaries ("FCCG" or the "Company") are unaudited and have been prepared in conformity with the requirements of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), particularly Rule 10-01 thereof, which governs the presentation of interim financial statements. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The accompanying interim consolidated financial statements should be read in conjunction with the Company's 2001 Annual Report on Form 10-K. A summary of the Company's significant accounting policies is set forth in Note 2 to the consolidated financial statements in the 2001 Annual Report on Form 10-K. In the Company's opinion, all adjustments, comprised of normal recurring accruals necessary for the fair presentation of the interim financial statements, have been included in the accompanying consolidated financial statements. Operating results for the three months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain items in the previously reported consolidated financial statements were reclassified to conform to the March 31, 2002 presentation, none of which affect previously reported results of operations. At March 31, 2002, certain former and present Company officers and directors controlled, directly or indirectly, the significant voting majority of the Company. NOTE 2 - SIGNIFICANT TRANSACTIONS In January 2002, the Company sold mortgage-backed securities with a basis of $2.2 million for $2.6 million. In February 2002, the Company purchased 100% of the outstanding senior mortgage-backed securities of Bear Stearns Structured Products Series Trust 2000-3 ("BSSPT 2000-3") from third party investors for a purchase price of $8.2 million. The Company had previously acquired the subordinate mortgage-backed securities and, as a result of this transaction, is now the beneficial owner of 100% of BSSPT 2000-3. The acquisition was financed with repurchase agreements in the amount of $7.4 million. In order to provide for the orderly liquidation of its investment in these mortgage-backed securities, in March 2002, the Company elected to collapse BSSPT 2000-3 and took direct ownership of the 67 underlying mortgage-backed securities owned by the trust. At March 31, 2002, the Company estimated the fair value of these securities and recorded an increase in unrealized holding gains, included in Stockholders' Equity, of $3.1 million. On February 22, 2002, the Company declared a cash dividend for the quarter ended March 31, 2002 of $0.13 per share. The dividend was paid on March 13, 2002 to shareholders of record as of March 8, 2002. On March 6, 2002, the Company purchased a total of 713,043 shares of its common stock from entities affiliated with Jordan D. Schnitzer, a former member of the Company's Board of Directors ("Schnitzer"). The shares were purchased in exchange for a 46.60% participation interest in the unpaid principal balance (as of December 31, 2001) of the French American International School Loan (the "FAS Loan"), which is held by the Company. The parties valued the transaction at approximately $2.175 million, or $3.05 per share. On March 6, 2002, the closing price 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 the stock and the carrying value of the 46.60% interest in the loan was included in the Statement of Operations as a reduction in gains on sale of loans and securities. 7 The Company also granted an option (the "Stockholder Put Option") to Schnitzer, which entitles Schnitzer to require the Company to purchase an additional 713,042 shares of FCCG common stock for $3.05 per share, less any dividends paid by the Company on the shares between March 6, 2002 and the option closing date, plus interest accrued on the net option price at a rate equal to 10.00% per annum. The Stockholder Put Option is exercisable from September 1, 2002 through September 10, 2002. In the event the Stockholder Put Option is exercised, payment for the shares will be made by delivery of an additional 46.60% participation interest in the FAS Loan, plus 46.60% of all principal payments received by the Company on the FAS Loan since December 31, 2001, plus interest on the net option price at a rate equal to 10.00% per annum, less any dividends paid by the Company on the shares between March 6, 2002 and the option closing date. In the event Schnitzer exercises the Stockholder Put Option, Schnitzer will also be required to purchase the remaining 6.80% participation interest in the FAS Loan at a price of $0.3 million. Upon purchase of the remaining 6.80% participation interest, Schnitzer will also receive 6.80% of all principal payments received by the Company on the FAS Loan since December 31, 2001. The Company was granted an option (the "Company Put Option") from Schnitzer, which entitles the Company to require Schnitzer to purchase the additional 46.60% participation interest in the FAS Loan at an exercise price of $2.175 million, plus any cash dividends paid on 713,042 shares of FCCG common stock owned by Schnitzer between March 6, 2002 and the option closing date, less interest accrued on the net option price at a rate equal to 10.00% per annum. The Company Put Option is exercisable from September 11, 2002 through September 20, 2002. In the event the Company Put Option is exercised, Schnitzer will receive the additional 46.60% participation interest in the FAS Loan, plus 46.60% of all principal payments received by the Company on the FAS Loan since December 31, 2001. In the event the Company exercises the Company Put Option, Schnitzer will also be required to purchase the remaining 6.80% participation interest in the FAS Loan at a price of approximately $0.3 million. Upon purchase of the remaining 6.80% participation interest, Schnitzer will receive 6.80% of all principal payments received by the Company on the FAS Loan since December 31, 2001. The Company also granted an option (the "Stockholder Property Option") to Schnitzer, which entitles Schnitzer to require the Company to purchase an additional 727,235 shares of FCCG common stock for $0.3 million in cash, plus delivery of the Company's interest in approximately 10.9 acres of land in Wilsonville, Oregon, less any dividends paid by the Company on the shares between March 6, 2002 and the option closing date. The Stockholder Property Option is exercisable from January 2, 2003 through January 10, 2003. The Company also received an option (the "Company Property Option") from Schnitzer, which entitles the Company to require Schnitzer to purchase its interest in approximately 10.9 acres of land in Wilsonville, Oregon, subject to certain conditions, for $1.9 million, plus any cash dividends paid on 623,265 shares of FCCG common stock owned by Schnitzer. This option is exercisable between January 11, 2003 and January 20, 2003. The Company has secured its performance under the various options by pledging 1,625,000 shares of common stock of Wilshire Financial Services Group Inc. and granting trust deeds on approximately 10.9 acres of land in Wilsonville, Oregon and certain property owned by the Company in Eugene, Oregon. Schnitzer has secured his performance under the various options by pledging 1,440,277 shares of FCCG common stock. In accordance with SEC Accounting Series Release 268, the grant of the Stockholder Put Option and a portion of the Stockholder Property Option resulted in the Company recording $3.9 million in Temporary Equity on the Statement of Financial Condition as of March 31, 2002. Of this amount, $3.5 million (representing the quoted price per share on NASDAQ at the grant date for the applicable option shares) was deducted from Stockholders' Equity. The remaining $0.4 million, representing the difference between the strike price of the applicable option shares and the quoted price of the Company's stock on NASDAQ at the grant date, was recorded as a charge to earnings for the quarter. The receipt of the Company Loan Option and the Company Put Option had no effect on the Statement of Operations or Statement of Financial Condition as of March 31, 2002. 8 NOTE 3 - VALUATION OF MORTGAGE-BACKED SECURITIES The fair value of the Company's investment in mortgage-backed securities is determined at each reporting date as the present value of the anticipated cash flows from the underlying collateral using certain assumptions. These assumptions include: (i) future rate of prepayment; (ii) discount rate used to calculate present value; and (iii) default rates and loss severity on loan pools underlying the mortgage-backed securities. At March 31, 2002, the range of key economic assumptions used to determine the fair value of the securities 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 severity ranging 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. The Company evaluates, on an ongoing basis, the carrying value of its securities portfolio, which is accounted for as available-for-sale. To the extent differences between the book basis of the securities and their current market values are deemed to be temporary in nature, such unrealized gains or losses are reflected directly in equity as "other comprehensive income or loss." Declines in fair value are considered other-than-temporary when: (i) the carrying value of the beneficial interests exceeds 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 the beneficial interests has adversely changed from the previous valuation date. To the extent declines in fair value are considered other-than-temporary, a write-down is recorded in "Market Valuation Losses and Impairments" in the consolidated statement of operations. During the quarter ended March 31, 2002, no market valuation losses and impairments were recorded. During the quarter ended March 31, 2001, market valuation losses and impairments of $4.1 million were recorded. These impairments related to the portfolio of mortgage-backed securities and reflected higher-than-anticipated delinquencies, losses in loans underlying certain securities and varying prepayment speeds. NOTE 4 - COMMITMENTS, CONTINGENCIES & OFF-BALANCE SHEET RISK The Company and two of its senior officers have been named, among other defendants, in a series of lawsuits related to the receivership of an unaffiliated investment company. In their claims, multiple plaintiffs allege several theories of liability, including knowing participation in fiduciary breach and prohibited transactions under the Employee Retirement Income Security Act of 1974. The plaintiffs have not described with any specificity the proportion or share of losses and related amounts, which they claim are attributable to the Company or its executives. Because the cases are still in early stages of the pleadings and because the amount of discovery has been limited, the ultimate financial loss to the Company cannot be reasonably estimated at this time. However, based upon the progress of mediation the Company made a provision for litigation of $2 million during the quarter ended December 31, 2001. The Company determined that this reserve was adequate at March 31, 2002. The Company and its executives have directed that these cases be defended against vigorously. Under their employment arrangements with the Company, the Company's senior officers may be entitled to indemnification by the Company. Due to the preliminary nature of the underlying litigation, the Company has not determined whether such indemnification will be granted, and accordingly, the Company does not believe it is possible to estimate the extent of liability, if any, related to such indemnification. On May 13, 2002, the Company and its two top executives, Andrew Wiederhorn and Larry Mendelsohn, announced that they have reached a settlement with the claimants in these lawsuits (see Part II, Item 1 - Legal Proceedings). The Company is involved in various other legal proceedings occurring in the ordinary course of business, which the Company believes will not have a material adverse effect on the consolidated financial condition or operations of the Company. The Company may utilize a wide variety of off-balance sheet financial techniques to manage its interest rate risk. In hedging the interest rate and/or exchange rate exposure of a foreign currency denominated asset or liability, the Company may enter into hedge transactions to counter movements in the different currencies, as well as interest rates in those currencies. These hedges may be in the form of currency and interest rate swaps, options, and forwards, or combinations thereof. At March 31, 2002, the Company had no outstanding derivative instruments held for trading or hedging purposes. 9 NOTE 5 - RECENTLY ISSUED ACCOUNTING STANDARDS In July 2001, FASB issued FAS No. 141, Accounting for Business Combinations and FAS No. 142, Accounting for Goodwill and Intangible Assets. FAS No. 141 eliminates the ability to utilize the pooling of interests method of accounting for business combination transactions initiated after June 30, 2001. The purchase method of accounting is now required. FAS No. 142 eliminates the existing requirement to amortize goodwill through a periodic charge to earnings. For existing goodwill, the elimination of the amortization requirement is effective beginning 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 on January 1, 2002, and there was no impact on the Company's financial position or operating results upon adoption. In June 2001, FASB issued FAS No. 143, Accounting for Asset Retirement Obligations, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs would be capitalized as part of the carrying amount of the long-lived asset and depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The provisions of FAS No. 143 are effective for fiscal years beginning after June 15, 2002. Management has not yet 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 recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with FAS No. 121. For example, FAS No. 144 provides guidance on how a long-lived asset that is used as a part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. FAS No. 144 also retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). The Company adopted this statement on January 1, 2002, and there was no impact on the Company's financial position or operating results upon adoption. NOTE 6 - SUBSEQUENT EVENTS On April 12, 2002, the Company sold eleven bonds which had been acquired through the liquidation of BSSPT 2000-3 and which had a carrying value of $7.0 million. The net proceeds from the sale were $9.8 million. Prior to the sale, the Company repaid $1.2 million of short-term indebtedness collateralized by the bonds. The Company recorded a $3.8 million gain on the sale, $1.1 million of which was transferred out of unrealized holding gains on securities included in Other Comprehensive Income. On April 2, 2002, the French American International School loan receivable, with a carrying value (net of the 46.6% participation agreement with Schnitzer) of $2.5 million, was paid in full by the borrower. Net proceeds from the repayment totaled $2.6 million. The loan receivable had served as collateral for a $3 million line of credit, which at the time of the repayment had no borrowings outstanding. Future draws against the line of credit will not be available to the Company unless the lender agrees to accept substituted collateral. On May 13, 2002 the Company and its two top executives, Andrew Wiederhorn and Larry Mendelsohn, announced that they have reached a settlement with the claimants in a series of lawsuits (the "CCL Lawsuits") 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 discharged from any and all claims, losses or damages arising or in any way related to CCL or any matters raised, or which could have been raised in the CCL Lawsuits. The agreement also provides protection against potential claims which may be made by parties who are not participants in the settlement. The settlement agreement and the payment to be made thereunder are made in compromise of disputed claims and are not an admission of any liability of any kind. The settlement has an effective date of May 13, 2002, but it is subject to a number of conditions before any funds may be distributed, including, among other things, court approval and the entry of a claims bar order in each of the CCL Lawsuits pending before the United States District Court for the District of Oregon. The court is expected to conduct a hearing on June 19, 2002. 10 If the settlement is approved by the court and implemented, the Company's portion of the settlement payment will not have a material impact on its financial position or results of its operations. On May 15, 2002, the Company made a $2.25 million capital investment in a newly formed, wholly owned subsidiary, Fog Cap Commercial Lending Inc. ("FCCL"). FCCL then acquired a 51% ownership interest in Fog Cap GEMB Holdings LLC ("GEMB Holdings"). GEMB Holdings subsequently purchased all of the assets and certain identified liabilities of George Elkins Mortgage Banking Company, L.P. ("GEMB L.P."), a California mortgage banking operation which produced approximately $500 million in commercial real estate mortgages in 2001. FCCL also purchased a 51% ownership interest in SJGP, Inc., the corporate general partner of GEMB L.P. SJGP, Inc., as the manager of GEMB Holdings, will originate commercial mortgages through four Southern California branches doing business as George Elkins Mortgage Banking Company. The Company expects to report the operations of GEMB Holdings and SJGP, Inc. on a consolidated basis beginning in the second quarter of 2002. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS OF FOG CUTTER CAPITAL GROUP INC. AND THE 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 ITS SUBSIDIARIES 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 of assets where its expertise in intensive asset management, mortgage and real estate credit analysis and financial structuring can create value. The Company maintains its headquarters in Portland Oregon, and also has executive offices in New York and London. The Company invests primarily in the following types of assets: - equity and debt in real estate-related corporations, - mortgage-backed securities, - mortgage loans, and - other opportunistic investments. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS - The operations of the Company consist primarily of the acquisition of pools of performing, sub-performing and non-performing residential and commercial mortgage loans, as well as commercial real estate and mortgage-backed securities. The Company's primary sources of revenue are from loans, mortgage-backed securities and real estate. PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements include the accounts of Fog Cutter Capital Group Inc. and its subsidiaries, including Fog Cap L.P. (formerly Wilshire Real Estate Partnership L.P.), WREP 1998-1 LLC, Fog Cutter Securities Corporation (formerly WREI Securities Corporation), Fog Cutter Servicing Inc. (formerly WREI Mortgage Inc.) and WREP Islands Limited. Intercompany accounts have been eliminated in consolidation. USE OF ESTIMATES IN THE PREPARATION OF THE CONSOLIDATED FINANCIAL STATEMENTS-The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Significant estimates include the determination of fair values of certain financial instruments for which there is no active market, the allocation of basis between assets sold and retained, and valuation allowances for loans and real estate owned. Estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS - For purposes of reporting the consolidated financial condition and cash flows, cash and cash equivalents include non-restricted cash and due from banks, repurchase agreements and securities with original maturities of 90 days or less. SECURITIES AVAILABLE FOR SALE - Securities available for sale include mortgage-backed securities and other securities that are designated as assets available for sale because the Company does not intend to hold them to maturity. Securities available for sale are carried at estimated fair values with the net unrealized gains or losses reported in accumulated other comprehensive loss, which is included as a separate component in stockholders' equity. The Company determines the fair value of its securities by discounting the anticipated cash flows using certain assumptions (e.g. prepayment speeds, default rates, severity of losses, and discount rate). As of each reporting period, the Company evaluates whether and to what extent any decline in the estimated fair values is to be recognized in earnings as other than temporary. Other than temporary declines in the carrying value of securities, if any, are charged to earnings and the basis of each security is adjusted, accordingly. At disposition, the realized net gain or loss is included in earnings on a specific identification basis. Actual prepayment experience, credit losses and the yields are reviewed at least quarterly. Declines in fair value are to be considered other than temporary and 12 the security is impaired when: (i) the carrying value of the beneficial interests exceeds 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 the beneficial interests has adversely changed from the previous valuation date. LOANS - Loans are designated as held-for-sale and are carried at the lower of cost or estimated market value. INVESTMENTS IN REAL ESTATE - Real estate purchased directly is originally recorded at the purchase price. Real estate acquired in settlement of loans is originally recorded at fair value less estimated costs to sell. Any excess of net loan cost basis over the fair value less estimated selling costs of real estate acquired through foreclosure is charged to the allowance for loan losses. Any subsequent operating expenses or income, reductions in estimated fair values, as well as gains or losses on disposition of such properties, are recorded in current operations. Depreciation on investments in real estate is computed using the straight-line method over the estimated useful lives of the assets as follows: Buildings and improvements............ 35 years Tenant improvements................... Lesser of lease term or useful life Expenditures for repairs and maintenance are charged to operations as incurred. Significant renovations are capitalized and amortized over their expected useful lives. Fees and costs incurred in the successful negotiation of leases are deferred and amortized on a straight-line basis over the terms of the respective leases. Rental revenue is reported on a straight-line basis over the terms of the respective leases. INVESTMENT IN BOURNE END PROPERTIES PLC ("BEP")-The equity method of accounting is used for investments in associated companies which are not controlled by the Company and in which the Company's interest is generally between 20% and 50%. The Company's share of earnings or losses of associated companies, in which at least 20% of the voting securities is owned, is included in the consolidated statement of operations. INCOME TAXES-The Company files its income tax returns with the relevant tax authorities in the United States on a consolidated basis. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is not probable that some portion or all of the deferred tax assets will be realized. NET LOSS PER SHARE-Basic EPS excludes dilution and is computed by dividing the net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. RESULTS OF OPERATIONS -- QUARTER ENDED MARCH 31, 2002 COMPARED TO QUARTER ENDED MARCH 31, 2001 NET INCOME. Our net loss for the quarter ended March 31, 2002 was $0.6 million, or $0.06 per share, compared with a net loss of $4.8 million, or $0.46 per share, for the quarter ended March 31, 2001. The net loss for the quarter ended March 31, 2002 is primarily attributable to operating expenses of $1.3 million, and losses recognized relating to the grant of certain put options in the Company's common stock of $0.4 million, partially offset by net interest income of $1.1 million. The net loss for the 2001 period is primarily attributable to market valuation losses and impairments of $4.1 million. NET INTEREST INCOME. Our net interest income for the quarter ended March 31, 2002 was $1.1 million, compared with $1.6 million for the quarter ended March 31, 2001. The decrease is primarily attributable to a reduction of assets (reflecting our sales of mortgage-backed securities and loans and paydowns 13 of the related debt facilities), resulting in decreases in interest income on securities and loans of $0.8 million and $0.7 million, respectively, partially offset by a decrease in interest expense of $1.0 million. The following tables set forth information regarding the total amount of income from interest-earning assets and expense from interest-bearing liabilities and the resulting average yields and rates:
For the Quarter Ended March 31, 2002 --------------------------------------------------- Average Interest Annualized Balance Income (Expense) Yield/Rate --------------- ------------------- ------------- (DOLLARS IN THOUSANDS) Interest-Earning Assets: Loan portfolios................................. $ 4,045 $ 110 10.9% Mortgage-backed securities available for sale... 57,409 1,448 10.1 Cash deposits and other investments............. 6,171 52 3.3 --------------- ------------------- ------------- Total interest-earning assets............... $ 67,625 $ 1,610 9.5% --------------- ------------------- ------------- Interest-Bearing Liabilities: Borrowings (1).................................. $ 42,171 (500) 4.7% --------------- ------------------- ------------- Total interest-bearing liabilities.......... $ 42,171 $ (500) 4.7% --------------- ------------------- ------------- Net interest income before provision for loan losses/spread (2)............................. $ 1,110 4.8% =================== ============= Net interest margin (3)........................ 6.6% =============
---------- (1) Excludes borrowings related to investments in real estate. (2) Net interest spread represents the difference between the average rate on interest-earning assets and the average cost of interest-bearing liabilities. (3) Net interest margin represents net interest income divided by average interest-earning assets.
For the Quarter Ended March 31, 2001 -------------------------------------------------------- Average Interest Annualized Balance Income (Expense) Yield/Rate ---------------- ------------------ ------------- (DOLLARS IN THOUSANDS) Interest-Earning Assets: Loan portfolios................................. $ 31,322 $ 824 10.2% Mortgage-backed securities available for sale... 72,151 2,251 12.5 Cash deposits and other investments............. 4,037 60 6.0 ---------------- ------------------ ------------- Total interest-earning assets............... $ 107,510 $ 3,135 11.7% ---------------- ------------------ ------------- Interest-Bearing Liabilities: Borrowings (1).................................. 69,207 (1,571) 9.1 ---------------- ------------------ ------------- Total interest-bearing liabilities.......... $ 69,207 $ (1,571) 9.1% ---------------- ------------------ ------------- Net interest income before provision for loan losses/spread (2).............................. $ 1,564 2.6% ================== ============= Net interest margin (3)........................ 5.8% =============
---------- (1) Excludes borrowings related to investments in real estate. (2) Net interest spread represents the difference between the average rate on interest-earning assets and the average cost of interest-bearing liabilities. (3) Net interest margin represents net interest income divided by average interest-earning assets. 14 REAL ESTATE OPERATIONS. Our real estate operations represent activity from our investment in commercial property located in Oregon and California. During the quarter ended March 31, 2002, we realized a net loss from real estate operations of $0.1 million, compared with break-even operations for the quarter ended March 31, 2001. MARKET VALUATION LOSSES AND IMPAIRMENTS. The term "Market Valuation Losses and Impairments" as used herein refers to impairment losses recognized primarily on our mortgage-backed securities and loan portfolios. During the quarter ended March 31, 2002, no market valuation losses and impairments were recorded. During the quarter ended March 31, 2001, market valuation losses and impairments of $4.1 million were recorded. These charges related to the portfolio of mortgage-backed securities primarily reflecting higher than anticipated delinquencies, losses in loans underlying certain securities and varying prepayment speeds. OPERATING EXPENSES. During the quarter ended March 31, 2002, operating expenses totaled $1.3 million and were comprised of compensation and employee benefits of $0.6 million, professional fees of $0.3 million and other costs of $0.4 million. For the quarter ended March 31, 2001, operating expenses totaled $2.2 million and were comprised of compensation and employee benefits of $1.2 million, professional fees of $0.3 million and other costs of $0.7 million. The decrease in expenses reflects a reduction in the number of Company employees; new employment agreements with our Chief Executive Officer, President and Executive Vice President; re-structuring of the compensation for our directors and our relocation to smaller executive offices. CHANGES IN FINANCIAL CONDITION GENERAL. Total assets increased from approximately $82.1 million at December 31, 2001 to approximately $87.1 million at March 31, 2002. Total liabilities increased from approximately $43.2 million at December 31, 2001 to approximately $48.3 million at March 31, 2002. Stockholders' equity decreased by approximately $3.9 million resulting primarily from a dividend payment of $1.3 million, the transfer of $3.9 million to Temporary Equity relating to the grant of the Stockholder Put Option, and the acquisition of treasury stock in the amount of $1.8 million, which were partially offset by increases in other comprehensive income of $4.1 million. SECURITIES AVAILABLE FOR SALE. The balance of mortgage-backed securities available for sale increased from $51.8 million at December 31, 2001 to $60.0 million at March 31, 2002. The increase was primarily the result of the purchase of 100% of the outstanding senior mortgage-backed securities of Bear Stearns Structured Products Series Trust 2000-3 ("BSSPT 2000-3") for a purchase price of $8.2 million and an increase in market value of $3.4 million, which were partially offset by the sale of other mortgage-backed securities with a carrying value of $2.2 million and cash repayments of securities of $1.2 million. We mark our securities portfolio to estimated fair value at the end of each month. We determine the fair value of the securities by modeling the anticipated cash flows using certain estimates (e.g. prepayment speeds, default rates, severity of losses, and discount rate). As of each reporting period, we evaluate whether and to what extent any unrealized loss is to be recognized as other than temporary. The Company has entered into an employment agreement which entitles Robert G. Rosen to a bonus payment equal to $350,000 plus 10% of the excess of the cumulative net proceeds from the sale of the Company's mortgage-backed securities over a specified target amount (as defined in the employment agreement). If the Company had sold all of its mortgage-backed securities at a selling price equal to their carrying value at March 31, 2002, the bonus payable to Mr. Rosen under the terms of his employment agreement would have been approximately $780,000. 15 At March 31, 2002, securities available for sale were as follows:
Gross Gross Amortized Unrealized Unrealized Cost (1) Gains Losses Fair Value -------------- --------------- --------------- ------------- (DOLLARS IN THOUSANDS) Mortgage-backed securities $ 56,548 $ 3,451 $ - $ 59,999 ============== =============== =============== =============
---------- (1) The amortized cost of the securities reflects the market valuation losses and impairments discussed above and excludes accrued interest of $0.1 million. LOANS. During the three months ended March 31, 2002, our loans decreased by approximately $2.2 million due primarily to the sale of a 46.6% participation interest in the French American International School loan in exchange for the Company's stock. INVESTMENT IN WFSG. The Company currently owns approximately 2.9 million shares (18.1%) of Wilshire Financial Services Group Inc. ("WFSG") common stock. Effective December 31, 2001, WFSG repurchased a total of 4,168,854 shares of its common stock from entities affiliated with American Express Financial Advisors Inc. (collectively, "AXP"). This transaction between WFSG and AXP resulted in the Company becoming the second largest shareholder of WFSG, which is a savings and loan holding company. The status of owning more than 10% and being one of the two largest shareholders of a savings and loan holding company creates a rebuttable presumption, for regulatory purposes, that such a shareholder "controls" the savings and loan holding company. As a result of the Company being one of the two largest shareholders of WFSG, a change in control application (Form H-(e)1) must be filed with the Office of Thrift Supervision ("OTS") within ninety days of achieving such status. In lieu of the Form H-(e)1, the Company may file a rebuttal of control application ("Rebuttal Application") in which the Company demonstrates (and makes related contractual commitments in a rebuttal of control agreement with the OTS) that its ownership of WFSG does not constitute "control". The Company filed a Form H-(e)1 with the OTS on March 29, 2002. On May 1, 2002 the OTS provided a written request for additional information relating to the filing. The Company has 30 days from the date of the request to provide the additional information. There can be no assurance that the OTS will approve the Form H-(e)1. If the Form H-(e)1 is not approved by the OTS, the Company may be required to sell a portion of its WFSG common stock in order to reduce its investment below the next largest shareholder. Such a forced divestiture may result in losses to the Company. The Company is continuing to consider what course of action might best maximize the value of its investment in WFSG. Any course of conduct (including retention of the Company's current position) needs to comply with requirements of the OTS, including those relating to the "control" of savings and loan holding companies such as WFSG. As a result, the Company may decide to sell some or all of its shares of WFSG or retain its current ownership position. The Company does not believe, at this time, that it would seek to increase its ownership of WFSG shares, which would require specific OTS approval. BORROWINGS. Borrowings increased by approximately $6.3 million during the three months ended March 31, 2002, primarily due to new borrowings in the amount of $7.4 million related to the purchase of mortgage-backed securities, partially offset by scheduled principal payments. STOCKHOLDERS' EQUITY. Stockholders' equity decreased by approximately $3.9 million during the three months ended March 31, 2002 primarily due to our dividend payment of $1.3 million, the transfer of $3.9 million to Temporary Equity relating to the grant of the Stockholder Put Option, and our 16 purchase of treasury stock of $1.8 million. These decreases were partially offset by increases in other comprehensive income. On March 6, 2002, The Company granted put options to entities affiliated with Jordan D. Schnitzer, a former member of the Company's Board of Directors ("Schnitzer"), which entitles Schnitzer to require the Company to purchase certain shares of FCCG common stock at a specified price. As a result, a $3.9 million obligation to purchase approximately 1.4 million shares under the put option agreements has been transferred from Stockholders' Equity to Temporary Equity on the Consolidated Statements of Financial Position as of March 31, 2002. The $0.4 million difference between the $3.05 per share purchase option price on certain of the shares and the $2.57 per share NASDAQ closing price of the stock on the date of grant, was included in Other Operating Loss in the Statement of Operations as of March 31, 2002. LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund investments, engage in loan acquisition and lending activities, meet collateral calls and for other general business purposes. The primary sources of funds for liquidity during the quarter ended March 31, 2002 consisted of net cash provided by investing activities, including the cash repayments and sales related to our mortgage-backed securities and loan portfolios. Our borrowings and the availability of further borrowings are substantially affected by, among other things, changes in interest rates, changes in market spreads whereby the market value of the collateral securing such borrowings may decline substantially, or decreases in credit quality of underlying assets. In the event of declines in market value or credit quality, we may be required to provide additional collateral for, or repay a portion of outstanding balances of, our short-term borrowing facilities. As of March 31, 2002, we had no outstanding collateral calls. For additional information with respect to our monthly mark-to-market of our securities available for sale portfolio, see "CHANGES IN FINANCIAL CONDITION-SECURITIES AVAILABLE FOR SALE." Fluctuations in interest rates will continue to impact our net interest income to the extent our fixed-rate assets are funded by variable-rate debt or our variable-rate assets reprice on a different schedule or in relation to a different index than any floating-rate debt which in turn could impact potential returns to shareholders. See "Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK." At March 31, 2002, we had total consolidated secured indebtedness of $44.3 million, as well as $3.9 million of other liabilities. The consolidated secured indebtedness consisted of (i) $15.3 million of repurchase agreements secured by $19.8 million of mortgage-backed securities and (ii) $29.0 million outstanding of other borrowings maturing between 2003 and 2020, which are secured by real estate and mortgage-backed securities. Approximately $15.2 million of this indebtedness had terms that allowed the lender to request additional collateral if the value of the underlying collateral declined (including financing facilities for both mortgage-backed securities and loans). Our borrowings are established through both short-term and long-term financing facilities. If the value of the assets securing our borrowings declines as determined by the lender, the lender may request that the amount of the loan be reduced by cash payments or that additional collateral be provided by the borrower (generally known as "collateral calls"). Accordingly, in an environment where lenders consistently mark down the value of the underlying assets, a borrower can become subject to collateral calls, which can have a significant impact on liquidity. Similarly, if interest rates increase significantly, the borrowing cost under the financing facility may also increase while the interest rate on the assets securing the loan may not increase at the same time or to the same degree. We have historically financed acquisitions of mortgage-backed securities through committed and uncommitted thirty-day repurchase agreements with major Wall Street investment banks. Repurchase agreements are secured lending arrangements that involve the borrower selling an asset to a lender at a 17 fixed price with the borrower having an obligation to repurchase the asset within a specified period (generally 30 days) at a higher price reflecting the interest cost of the loan. If the lender marks the asset lower, the lender may request that the amount of the loan be reduced by cash payments from the borrower or additional collateral be provided by the borrower. Mortgage-backed securities which are subject to repurchase agreements may periodically be revalued by the lender, and a decline in the value (whether or not the lender recognizes the full fair value of the security) may result in the lender requiring us to provide additional collateral to secure the indebtedness. If we are unable to fund additional collateral requirements or to repay, renew or replace maturing indebtedness on terms reasonably satisfactory to us, we may be required to sell (potentially on short notice) a portion of our assets, and could incur losses as a result. Furthermore, since from time to time there is extremely limited liquidity in the market for subordinated and residual interests in mortgage-related securities, there can be no assurance that we will be able to dispose of such securities promptly for fair value in such situations. Excluding the sale of assets from time to time, we are currently operating with negative cash flow, since many of our assets do not generate current cash flows sufficient to cover current operating expenses. We believe that our existing sources of funds will be adequate for purposes of meeting our short-term liquidity needs, however, there can be no assurance that this will be the case. Material increases in interest expense from variable-rate funding sources, collateral calls, or material decreases in monthly cash receipts, generally would negatively impact our liquidity. On the other hand, material decreases in interest expense from variable-rate funding sources or an increase in market value of our mark-to-market financial assets generally would positively affect our liquidity. 18 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices, and equity prices. Although the Company's exposure to foreign currency fluctuations has increased significantly over the past year, the primary market risk to which the Company is exposed is interest rate risk, which is highly sensitive to many factors, including governmental, monetary and tax policies, domestic and international economic and political considerations, and other factors beyond the control of the Company. Changes in the general level of interest rates can affect the Company's net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with its interest-bearing liabilities, by affecting the spread between the Company's interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect, among other things, the ability of the Company to acquire loans, the value of the Company's mortgage-backed securities and other interest-earning assets, and its ability to realize gains from the sale of such assets. It is the objective of the Company to attempt to control risks associated with interest rate movements. In general, the Company's strategy is to limit our exposure to earnings variations and variations in the value of assets and liabilities as interest rates change over time. Our asset and liability management strategy is formulated and monitored regularly to review, among other things, the sensitivity of our assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, including those attributable to hedging transactions, purchase and securitization activity, and maturities of investments and borrowings. The following tables quantify the potential changes in net interest income and net portfolio value as of March 31, 2002 should interest rates go up or down (shocked) by 100 to 200 basis points, assuming the yield curves of the rate shocks will be parallel to each other and instantaneous. Net portfolio value is calculated as the present value of cash in-flows generated from interest-earning assets net of cash out-flows in respect of interest-bearing liabilities. The cash flows associated with the loan portfolios and securities available for sale are calculated based on prepayment and default rates that vary by asset but not by changes in interest rates. Projected losses, as well as prepayments, are generated based upon the actual experience with the subject pool, as well as similar, more seasoned pools. To the extent available, loan characteristics such as loan-to-value ratio, interest rate, credit history and product types are used to produce the projected loss and prepayment assumptions that are included in the cash flow projections of the securities. The following tables apply the U.S. Treasury yield curve generally for assets and LIBOR for repurchase agreement liabilities and assume a uniform change in both rates. The tables assume that changes in interest rates occur instantaneously. The tables also reflect that the Company has a significant exposure to LIBOR rates since its repurchase agreement borrowings are generally based on LIBOR rates. Actual results could differ significantly from those estimated in the tables.
Projected Percent Change In ------------------------------------------------------------------------------------------------------------- Change in Monthly Change in Net Change in Interest Rates(1) Net Interest Income Net Portfolio Value Interest Rates Portfolio Value --------------------------- ------------------- ------------------- ----------------- --------------- -200 Basis Points 16.9% 4.4% $ 61,000 $ 1,644,000 -100 Basis Points 8.5% 2.4% $ 30,000 $ 906,000 0 Basis Points 0.0% 0.0% $ - $ - 100 Basis Points -8.5% -3.6% $ (30,000) $ (1,372,000) 200 Basis Points -16.9% -7.9% $ (61,000) $ (2,983,000)
---------- (1) Assumes that 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 interbank market. 19 The following table sets forth information as to the type of funding used to finance the Company's assets as of March 31, 2002. As indicated in the table, a large percentage of the Company's fixed-rate assets are financed by floating-rate liabilities and the Company's variable-rate assets are generally funded by variable-rate liabilities which use the same index. Assets and Liabilities As of March 31, 2002 (Dollars in thousands)
Assets Interest Liabilities Interest ------ -------- ----------- -------- INTEREST-BEARING ASSETS Fixed-Rate Assets, Financed Floating $ 59,999 Fixed $ 43,216 LIBOR Fixed-Rate Assets, No Financing 2,575 Fixed - None Cash and Cash Equivalents 5,574 Fed Funds - None --------------- --------------- Subtotal 68,148 43,216 OTHER ASSETS Investments in Real Estate 4,460 N/A 1,031 Fixed Investments in WFSG and affiliates 6,648 N/A - None Investment in BEP 5,066 N/A - None Other 2,776 N/A - None --------------- --------------- Subtotal 18,950 1,031 LIABILITY ONLY Accounts Payable and Accrued Liabilities - 4,042 None --------------- --------------- Subtotal - 4,042 --------------------------------------------------------------------------------------------------------------- Total $ 87,098 $ 48,289 ===============================================================================================================
Asset and liability management involves managing the timing and magnitude of the repricing of assets and liabilities. It is the objective of the Company to attempt to control risks associated with interest rate movements. Asset and liability management can utilize a wide variety of off-balance sheet financial techniques to assist it in the management of interest rate risk. For example, in hedging the interest rate and exchange rate exposure of a foreign currency denominated asset or liability, we may enter into hedge transactions to counter movements in the different currencies as well as interest rates in those currencies. These hedges may be in the form of currency and interest rate swaps, options, and forwards, or combinations thereof. No such techniques were in use during the quarter ended and at March 31, 2002. Methods for evaluating interest rate risk include an analysis of the Company's interest rate sensitivity "gap," which is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Since different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category. 20 The following tables set forth the estimated maturity or repricing of the Company's interest-earning assets and interest-bearing liabilities at March 31, 2002 (dollars in thousands):
Within 4 to 12 One Year to More than 3 Months Months 3 Years 3 Years TOTAL ------------- ------------ ------------ ------------ ------------ INTEREST-SENSITIVE ASSETS(1): Cash and cash equivalents $ 5,574 $ - $ - $ - $ 5,574 Securities available for sale - - - 59,999 59,999 Loans - - - 2,575 2,575 ------------- ------------ ------------ ------------ ------------ Total rate-sensitive assets $ 5,574 $ - $ - $ 62,574 $ 68,148 ============= ============ ============ ============ ============ INTEREST-SENSITIVE LIABILITIES: Borrowings $ 43,216 $ 1,031 $ - $ - $ 44,247 ------------- ------------ ------------ ------------ ------------ Total rate-sensitive liabilities $ 43,216 $ 1,031 $ - $ - $ 44,247 ============= ============ ============ ============ ============ Interest rate sensitivity gap $ (37,642) $ (1,031) $ - $ 62,574 Cumulative interest rate sensitivity gap $ (37,642) $ (38,673) $ (38,673) $ 23,901 Cumulative interest rate sensitivity gap as a percentage of total rate- sensitive assets -55% -57% -57% 35%
---------- (1) Real estate property holdings are not considered interest rate sensitive. 21 FORWARD-LOOKING STATEMENTS CERTAIN STATEMENTS CONTAINED HEREIN AND CERTAIN STATEMENTS CONTAINED IN FUTURE FILINGS BY THE COMPANY WITH THE SEC MAY NOT BE BASED ON HISTORICAL FACTS AND ARE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. FORWARD-LOOKING STATEMENTS WHICH ARE BASED ON VARIOUS ASSUMPTIONS (SOME OF WHICH ARE BEYOND THE COMPANY'S CONTROL) MAY BE IDENTIFIED BY REFERENCE TO A FUTURE PERIOD OR PERIODS, OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS "MAY," "WILL," "BELIEVE," "EXPECT," "ANTICIPATE," "CONTINUE," OR SIMILAR TERMS OR VARIATIONS ON THOSE TERMS, OR THE NEGATIVE OF THOSE TERMS. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN FORWARD-LOOKING STATEMENTS DUE TO A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THE ECONOMIC ENVIRONMENT, PARTICULARLY IN THE MARKET AREAS IN WHICH THE COMPANY OPERATES, THE FINANCIAL AND SECURITIES MARKETS AND THE AVAILABILITY OF AND COSTS 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 INTEREST RATES, ACQUISITIONS AND THE INTEGRATION OF ACQUIRED BUSINESSES, CREDIT RISK MANAGEMENT, ASSET/LIABILITY MANAGEMENT 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 OF ANY REVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT THE OCCURRENCE OF ANTICIPATED OR UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS. 22 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The Company, Fog Cap L.P. (a subsidiary of the Company and formerly known as Wilshire Real Estate Partnership L.P.) and its two top executives, Andrew Wiederhorn and Lawrence Mendelsohn, have been named in a series of lawsuits (the "CCL Lawsuits") relating to the receivership of Capital Consultants, L.L.C. ("CCL"). The CCL Lawsuits name multiple defendants in addition to the Company and its executives. In addition, the claimants have filed claims against a number of additional parties regarding the same alleged losses, including a number of professional advisors to named defendants. The cases are 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 of Oregon, 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, Civil No. CV 00-1600-HU (filed December 1, 2000). In the HAZZARD, CHILIA and MADOLE cases, the trustees of several Taft-Hartley trusts filed suit against CCL and several individuals and organizations CCL did business with (including the Company and Messrs. Wiederhorn and Mendelsohn). In the EIDEM, SCHULTZ and MILLER cases, the trustees who are plaintiffs in HAZZARD are in turn named as defendants in class action suits filed by beneficiaries of the Taft-Hartley trusts on which they serve as plaintiff-trustees. In the cases in which the trustees are defendants, they have filed third-party complaints against several parties, including the Company and Messrs. Wiederhorn and Mendelsohn. In addition, a group of investors that are not Taft-Hartley trusts have filed a similar complaint against the same defendants, as well as other individuals not named in the prior complaints, 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 are all virtually identical and include claims against the Company, Messrs. Wiederhorn and Mendelsohn alleging breaches of fiduciary duties under the Employee Retirement Income Security Act of 1974 ("ERISA"); knowing participation in a fiduciary breach under ERISA; knowing participation in a prohibited transaction under ERISA; knowing transfer of trust assets under ERISA; negligence; common law claim for breach of fiduciary duty; tortious interference with contract; conversion; constructive trust, restitution and unjust enrichment; fraud; state securities law claims; and breach of contract. The CCL Lawsuits also allege claims against Messrs. Wiederhorn and Mendelsohn of tortious interference with business relationships between the Taft-Hartley trusts and CCL, as well as violations of the Racketeering Influenced and Corrupt Organization provisions of the Organized Crime Control Act of 1970, 18 U.S.C. Section 1961-1965 ("RICO"). The claimants in the CCL Lawsuits claim total losses by the various plaintiffs against all defendants in the range of $400 million. Approximately $160 million of this amount arises from losses on investments, which plaintiffs allege relate to Messrs. Wiederhorn and Mendelsohn and companies with which they were affiliated, for which plaintiffs allege the Company shares some unspecified portion of the liability. Additional damages are claimed for prejudgment interest dating from the date of each investment under securities law claims under which plaintiffs are seeking rescission remedies. The RICO claims include additional claims for triple damages and the tort claims include claims for punitive damages. Attorneys' fees are also sought under the ERISA, RICO and securities law claims. The claimants have not described with any specificity the proportion or share of losses which they claim are attributable to the Company or its executives, as compared to the other parties and other potential defendants. The overall remedies sought against all defendants include claims for broad relief under the remedial provisions of ERISA, such as rescission of transactions and the imposition of a constructive trust over any trust assets which plaintiffs claim were obtained in violation of ERISA. Certain of the claims against the Company appear to be covered by releases that were given by CCL to the Company and Messrs. Wiederhorn and Mendelsohn. 23 The claimants' suits seek to rescind the transactions in which the releases were granted. The claimants also seek common law remedies such as damages and punitive damages. However, certain of these common law claims may be preempted by ERISA. CCL was placed in receivership by the Department of Labor and the Securities and Exchange Commission in the cases of SEC V. CAPITAL CONSULTANTS, 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. District Court of Oregon, Case No. 001291-KI. When the receivership order was entered, the court stayed other proceedings against CCL for several weeks. Once the stay was partially lifted, the parties deferred discovery and delayed the filing of any answers or legal challenges to the sufficiency of the pleadings in order to facilitate a confidential global mediation process. U.S. Circuit Court Judge Edward Leavy of the Ninth Circuit Court of Appeals has been selected as the mediator. Discovery and motion practice has been stayed pending the outcome of the mediation, excepting only a limited amount of document production by all of the parties to the litigation. In addition to the cases identified above, the claimants have also filed other actions relating to the collapse of CCL in which neither 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. Stoel Rives LLP, et. Al., U.S. District Court of Oregon, Civil No. CV 01 1315 KI; Hazzard, et. al. V. Stoel Rives LLP, State of Oregon, Multnomah County, Case No. 0108-08975; Sheet Metal Workers, etc. v. Stoel Rives LLP, U.S. District Court of Oregon, Civil No. CV 01 1314 JO; Chilea v. O'Melveny, U.S. District Court of Oregon, Civil No. CV 01 1370 AS; Carpenters Health v. CCL, U.S. District Court of Oregon, Civil No. CV 00 01660 AS; Lennon v. Moss Adams, U.S. District Court of Oregon, Civil No. 01 00440 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; Hazzard v. Moss Adams, State of Oregon, Multnomah County, Case No. 0103-03372; McPherson v. Eight District, U.S. District Court of Oregon, Civil No. CV 00 01445 HA; Olson v. Larson, U.S. District Court of Oregon, Civil No. CV 01 00480 BR; 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, Case No. 0202-01882. As a result of the mediation process, the claimants and a group of the defendants, including the Company, its subsidiaries and Messrs. Wiederhorn and Mendelsohn have reached a settlement, the terms of which are set forth in a settlement agreement. The claimants have also entered into a series of settlements with several other parties to the above referenced litigation. The settlement agreement and the payments to be made thereunder are made in compromise of disputed claims and are not an admission of any liability of any kind. The settlement has an effective date of May 13, 2002, but it is subject to a number of conditions precedent before any funds may be distributed under the settlement agreement, including, among other things, court approval and the entry of a bar order in each of the CCL Lawsuits pending before the United States District Court for the District of Oregon. The court is expected to conduct a hearing on June 19, 2002. Claimants have filed motions for approval of settlements totaling in excess of $100 million. Pursuant to the settlement agreement in which the Company is participating, the defendants and their insurers have agreed to pay the claimants the sum of $40.0 million, which includes the purchase for $10.5 million by one defendant of stock held by the receiver. The Company has agreed to pay a portion of the settlement amount. If the settlement is approved by the court and implemented, due to the reserves previously established by the Company, the Company's settlement payment will not have a material impact on the Company's financial position or results of operations. Any amounts paid by the Company in connection with the settlement will not be subject to reimbursement from the Company's insurance carriers. Pursuant to the terms of the settlement agreement, the claimants and the receiver appointed for CCL released and discharged the settling defendants and certain other related parties from any and all claims, losses, damages, attorney's fees and costs, disgorgement of fees, fines and penalties, whether accrued or not, whether already acquired or acquired in the future, whether known or unknown, arising or in any way related to CCL or any matters raised, or which could have been raised in the CCL Lawsuits (the "Released 24 Claims"). The claimants also released the defendants and certain other related parties from all claims for indemnity and contribution, regardless of whether those claims are asserted under legal theories, that in any way arise out of the transactions, occurrences, or any series of transactions or occurrences related to the CCL Lawsuits, or which arise from matters raised, or which could have been raised, in the CCL Lawsuits. The claimants also covenanted not to sue the Company, its subsidiaries, Messrs. Wiederhorn and Mendelsohn and the other defendants in the CCL Lawsuits based upon the Released Claims. Each of the defendants released and covenanted not to sue each other. Certain parties that may have contribution claims or indemnity rights against the settling defendants, including the Company, are not entering into the settlement agreement. In order to induce the settling defendants to enter into the settlement agreement and protect them against claims by the non-settling parties, the parties to the settlement agreement agreed as follows: - the settlement agreement will require court approval and the entry of a bar order under which any non-settling parties will receive credit for any loss they must pay to claimants equal to the relative fault or responsibility of the settling defendants, including the Company; therefore if any cross claims are brought against a settling defendant, each settling defendant will be deemed to have already paid the full amount of its proportionate liability; - the claimants will reimburse the settling defendants from a defense fund of $2.0 million of the settlement funds, which are set aside to defend settling defendants from any contribution claims made by non-settling parties; - the claimants have also agreed that with regard to any claims they pursue against other parties, they will not seek recovery based on the alleged fault of the settling defendants, including the Company (a special verdict form will be used in such cases to allocate proportionate liability between the party against whom a judgment is obtained and the settling parties); and - an additional amount of $4.25 million will be set aside to cover potential administrative claims by the Department of Labor in the event the Department determines to advance certain claims under ERISA. Certain former employees of the Company or of firms that were previously affiliated with the Company have been named as parties or have been requested to respond to discovery requests and/or government investigations regarding the collapse of CCL. Several of these individuals have requested indemnity from the Company for the costs of their defense. At this time, it is not possible to determine the extent of liability, if any, the Company may face with regard to such indemnity claims because of the preliminary nature of the underlying litigation. The Company has not agreed to any such indemnity requests. In addition to the civil litigation, the CCL failure has led to governmental investigations, including a criminal investigation, which criminal investigation is ongoing. Messrs. Wiederhorn and Mendelsohn have received letters from the United States Attorney's office in Portland, Oregon, advising them that they are the subjects of a grand jury investigation into the failure of CCL. At this stage, it is not possible to predict the outcome of this investigation. Messrs. Wiederhorn and Mendelsohn, pursuant to the terms of their respective employment agreements with the Company, may be entitled to indemnity for litigation expenses and personal losses from the Company in connection with such investigations and any litigation related thereto. Messrs. Wiederhorn and Mendelsohn have notified the Company that they are reserving their rights to seek such indemnity. Messrs. Wiederhorn and Mendelsohn also may be entitled to indemnification for litigation expenses and personal losses from other defendants named in the CCL Lawsuits in connection with such investigations and any litigation related thereto. At this time, it is not possible to determine the extent of liability, if any, the Company may face with regard to such indemnity claims because of the preliminary nature of the investigation. The Company has not agreed to any such indemnity requests. 25 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. ITEM 5. OTHER INFORMATION. Not Applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 11 Computation of Per Share Earnings (b) Reports on Form 8-K: A Form 8-K was filed with the Securities and Exchange Commission by the Company on March 7, 2002 announcing the resignation of Jordan D. Schnitzer as a member of the Board of Directors. A Form 8-K was filed with the Securities and Exchange Commission by the Company on March 8, 2002 announcing the acquisition of treasury stock by the Company in exchange for a 46.6% participation interest in a loan owned by the Company and certain option arrangements with Jordan D. Schnitzer, a former member of the Board of Directors. 26 SIGNATURES Pursuant to the requirements of the exchange act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Fog Cutter Capital Group Inc. By: /s/ Lawrence A. Mendelsohn ---------------------------------------------------- Lawrence A. Mendelsohn President By: /s/ R. Scott Stevenson ---------------------------------------------------- R. Scott Stevenson Senior Vice President and Chief Financial Officer Date: May 15, 2002 27