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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
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FOG CUTTER CAPITAL GROUP INC.
FORM 10-Q
I N D E X
<Table>
<Caption>
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
</Table>
2
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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)
<Table>
<Caption>
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
========= =========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
3
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FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<Table>
<Caption>
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
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
4
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FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<Table>
<Caption>
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)
========== ========== ========= ========= ========== ============ ===========
<Caption>
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
============= ============
</Table>
- ----------
(1) Issued and outstanding.
The accompanying notes are an integral part of these consolidated financial
statements.
5
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FOG CUTTER CAPITAL GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(DOLLARS IN THOUSANDS)
<Table>
<Caption>
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 $ -
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<Page>
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
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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
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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
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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
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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
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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
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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
<Page>
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:
<Table>
<Caption>
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%
=============
</Table>
- ----------
(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.
<Table>
<Caption>
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%
=============
</Table>
- ----------
(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
<Page>
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.
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<Page>
At March 31, 2002, securities available for sale were as follows:
<Table>
<Caption>
Gross Gross
Amortized Unrealized Unrealized
Cost (1) Gains Losses Fair Value
-------------- --------------- --------------- -------------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities $ 56,548 $ 3,451 $ - $ 59,999
============== =============== =============== =============
</Table>
- ----------
(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
<Page>
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
<Page>
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.
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<Page>
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.
<Table>
<Caption>
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)
</Table>
- ----------
(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
<Page>
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)
<Table>
<Caption>
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
===============================================================================================================
</Table>
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.
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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):
<Table>
<Caption>
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%
</Table>
- ----------
(1) Real estate property holdings are not considered interest rate sensitive.
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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
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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.
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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
<Page>
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
<Page>
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
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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