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WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
COMMISSION FILE NUMBER 000-21673
AUTOBOND ACCEPTANCE CORPORATION
(Exact name of registrant as specified in its charter)
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TEXAS 75-2487218
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
100 CONGRESS AVENUE, AUSTIN, TEXAS 78701
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (512) 435-7000
Securities registered pursuant to Section 12(b) of the Act:
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Title of class Name of each exchange on which registered
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COMMON STOCK, NO PAR VALUE PER SHARE AMERICAN STOCK EXCHANGE
15% SERIES A CUMULATIVE PREFERRED STOCK,
NO PAR VALUE PER SHARE AMERICAN STOCK EXCHANGE
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes ___X___ No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
Form 10-K. [x]
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The aggregate market value of the voting stock held by non-affiliates of
the registrant on March 29, 1999 (based on the closing price on such date as
reported on the American Stock Exchange) was $1,841,396.1
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FOOTNOTE: 1 Calculated by excluding all shares that may be deemed to be
beneficially owned by executive officers, directors and five percent,
shareholders of the registrant, without conceding that all such persons are
"affiliates" of the registrant for purposes of the Federal securities laws.
As of March 31, 1999, there were 6,531,311 shares of the registrant's
Common Stock, no par value, and 1,125,000 of the registrant's 15% Series A
Cumulative Preferred Stock, no par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III - Portions of the registrant's definitive Proxy Statement with respect
to the registrant's 1999 Annual Meeting of Shareholders, to be filed not later
that 120 days after the close of the registrant's fiscal year.
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TABLE OF CONTENTS
PART I 1
Item 1. Business 1
Item 2. Properties 17
Item 3. Legal Proceedings 18
Item 4. Submission Of Matters To A Vote Of Security Holders 20
PART II 21
Item 5. Market For Registrants' Common Equity And Related Stockholder Matters 21
Item 6. Selected Financial Data 22
Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of
Operations 23
item 7a Quantitative and qualitative disclosures about market risk 41
Item 8. Financial Statements And Supplementary Data 41
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 42
PART III 43
Item 10. Directors And Executive Officers Of The Registrant 43
Item 11. Executive Compensation 43
Item 12. Security Ownership of Certain Beneficial Owners and Management 43
Item 13. Certain Relationships And Related Transactions 43
PART IV 44
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 44
SIGNATURES 48
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PART I
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ITEM 1. BUSINESS
GENERAL
AutoBond Acceptance Corporation (the "Company") is a specialty consumer
finance company engaged in underwriting, acquiring, servicing and selling or
securitizing retail installment contracts ("finance contracts") originated by
franchised automobile dealers in connection with the sale of used and, to a
lesser extent, new vehicles to selected consumers with limited access to
traditional sources of credit ("sub-prime consumers"). Sub-prime consumers
generally are borrowers unable to qualify for traditional financing due to one
or more of the following reasons: negative credit history (which may include
late payments, charge-offs, bankruptcies, repossessions or unpaid judgments);
insufficient credit; employment or residence histories; or high debt-to-income
or payment-to-income ratios (which may indicate payment or economic risk).
The Company acquires finance contracts generally from franchised automobile
dealers, makes credit decisions using its own underwriting guidelines and credit
personnel and performs the collection function for finance contracts using its
own collections department. The Company also acquires finance contracts from
third parties other than dealers for which the Company reunderwrites and
collects such finance contracts in accordance with the Company's standard
guidelines. The Company sells or securitizes portfolios of these retail
automobile installment contracts to efficiently utilize limited capital to allow
continued growth and to achieve sufficient finance contract volume to allow
profitability. The Company markets a single finance contract acquisition program
with five pricing tiers to automobile dealers which adheres to consistent
underwriting guidelines involving the purchase of primarily late-model used
vehicles. This has enabled the Company to securitize those contracts into
investment grade securities with similar terms from one issue to another
providing consistency to investors. For the period of inception through December
31, 1998, the Company acquired 33,604 finance contracts with an aggregate
current outstanding principal balance of $221 million. Since inception, the
Company has completed 8 securitizations pursuant to which it privately placed
$205 million in finance contract-backed securities. The Company has also placed
$170 million in finance contract-backed securities with Dynex Capital, Inc.
("Dynex") through January 29, 1999.
RECENT DEVELOPMENTS
Included in this report is the report of Deloitte & Touche LLP
("Deloitte"), the Company's independent accountants, with respect to their
examination of the Company's financial statements for the year ended December
31, 1998. As stated in Deloitte's report:
The accompanying consolidated financial statements for
the year ended December 31, 1998 have been prepared assuming
that the Company will continue as a going concern. As discussed
in Note 1 to the consolidated financial statements, the termination
of the Company's primary source of funding for its acquisition of
finance contracts, the ability of a lender to accelerate a debt
obligation, the possibility of certain trustees removing the
company as servicer on certain transactions, and litigation brought
against the company by a preferred stock holder raise substantial
doubt about its ability to continue as a going concern. Management's
plans concerning these matters are also described in Note 1. The
financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
On March 31, 1999, when the Company filed its notification of late filing of
this report as well as an earnings release, the Company had not received the
opinion of Deloitte. Prior to the issuance of Deloitte's opinion the Company
received notice of the preferred shareholder lawsuit discussed below.
Since June 1998, the Company's primary source of funding finance contracts
has been Dynex. Shortly after execution of the parties' various agreements, and
from time to time thereafter, Dynex requested that the Company agree to
renegotiate the terms of the transaction, including the reduction of the
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advance rate on funded loans from 105% to 104% of the principal balance of the
loan, and then again down to 88% (with the 16% difference to be paid to the
Company by December 31, 1998). The Company accommodated Dynex on these requests,
but rejected others, including the request by Dynex on October 12, 1998 that the
Company lend $6 million to Dynex. On December 7, 1998, the President of Dynex
threatened that Dynex would assign its funding obligations to an insolvent
affiliate that would then file for bankruptcy. On December 14, 1998, the
President of Dynex presented this threat to the Company in writing, along with
two other "alternatives": (a) no acquisition of the Company, but funding to
continue through February 28, 1999, only upon certain conditions, including the
ability of Dynex to obtain financing and a reduction in the advance rate; or (b)
the acquisition of the Company, but with a material reduction from the $6 per
share previously agreed pursuant to an existing stock option agreement (the
"Stock Option") offered by Dynex Holding, Inc. ("Dynex Holding"), an affiliate
of Dynex, for the Company's common stock, along with numerous other unacceptable
conditions. The Company's management rejected these "alternatives", since none
of them could be justified to its shareholders, and management believed that
Dynex would ultimately choose to honor its contractual commitments. Despite
Dynex' apparent liquidity pressures, the Company believed, that given Dynex'
reported shareholders' equity, Dynex would have the ability to sell assets or
take other necessary actions to generate the requisite liquidity. To be safe,
the Company's management did request Dynex to allow the Company to seek
alternative funding sources, but Dynex refused this request.
In addition to Dynex' requests to renegotiate the terms of its strategic
alliance with the Company, throughout the latter part of 1998, Dynex was
habitually slow in honoring funding requests. On December 31, 1998, Dynex,
claiming inadequate cash resources, defaulted on its obligation to pay
$6,573,107.44 to the Company for the funding accommodations mentioned above. The
full amount was not received until February 2, 1999. The January funding
requests were filled by Dynex either after the contractually required time
period or not at all. No February funding requests were honored. On December 31,
1998, the Company was informed by Dynex that it had determined to have its
affiliate Dynex Holding exercise its option to acquire the Company and in
connection therewith would visit the Company during January 1999 in order to
perform final due diligence. The ensuing two-week due diligence review was
extensive and comprehensive, included a review of loan files and servicing
records, and was completed on January 21, 1999. On January 26, 1999, Dynex
Holding, an affiliate of Dynex and holder of the Stock Option, filed a
Notification and Report Form under the Hart-Scott-Rodino Antitrust Improvements
Act of 1976 (the "Hart-Scott filing"). The Hart-Scott filing contained a
description of the Stock Option and included an affidavit wherein the President
of Dynex swore to the Federal Trade Commission that "[Dynex Holding] intends, in
good faith, to make the acquisition referred to in the attached notice."
Concurrently, the President of Dynex sent a letter to the Company stating that
"[Dynex Holding] intends to acquire 5,474,500 shares of Common Stock of AutoBond
which will represent all securities of AutoBond owned by [Dynex Holding]
subsequent to the acquisition." While apparently misleading the Company and the
government by its Hart-Scott filing, Dynex requested and received a waiver, for
potential violations, from Daiwa Finance Corporation ("Daiwa") on its credit
facility supporting the Company's loans, prior to informing the Company of any
breaches by the Company. Dynex apparently knew enough to request a waiver from
Daiwa, and yet at no time informed the Company during this time of any problems.
It was not until the first week of February 1999 that Dynex' management
notified the Company that Dynex was refusing to make additional fundings of
finance contracts, based upon the purported findings of its consultants with
respect to the Company's breach of representations regarding loan origination
standards. However, a refusal to fund by Dynex is not the prescribed remedy for
such breaches; rather, a repurchase provision applies, allowing a 30-day grace
period for cure. The Company's management pleaded with Dynex throughout this
week for the information necessary to analyze this assertion, but Dynex refused
to provide any substantive information. Over the weekend of February 5 through
7, representatives of Dynex and the Company met at the Company's offices to
review the finance contracts against the origination criteria. The Company
determined that Dynex' January due diligence utilized a flawed "grid",
reflecting criteria inconsistent with the Company's written guidelines
previously provided to Dynex. After reaching apparent agreement on the correct
criteria, the Dynex team changed its mind on underwriting the following day,
insisting on grading the loans against criteria that differed materially from
the criteria that had been previously agreed-upon and employed by the Company in
accordance with its written guidelines. It should be noted that actual credit
performance of the loans in question is such that (a) Dynex'
overcollateralization has increased through the application of available cash
flow and (b) there have been no defaults in the amounts owed to Dynex under the
Credit Agreement.
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At this juncture, it became clear to the Company that Dynex was not really
interested in objectively appraising the Company's performance, but in
concocting reasons for refusing to fund. The Company believes that Dynex fully
utilized its funding line with Daiwa, and had no funding line for its future
funding commitments. Through March 1, 1999, Dynex had breached commitments
totaling at least $30 million owed to the Company. On March 3, 1999, Dynex
announced its intent to pay dividends on its preferred stock, thereby further
hindering and delaying the payments owed to the Company and possibly other Dynex
creditors. Having attempted to cripple the Company (through termination of
funding as well as litigation) and in order to pay off its line with Daiwa,
Dynex apparently believes it would be easier to securitize or finance the
approximately $140 million in outstanding paper by removing the Company as
servicer for those finance contracts. Accordingly, on February 22, 1999, Dynex
purported to terminate the Company as servicer based on a false allegation of a
servicing termination event. On March 1, 1999, Dynex' attempt to obtain a
temporary restraining order to force the relinquishment of servicing by the
Company was defeated by a federal district court in New York. See "Legal
Proceedings".
Since early February 1999, the Company's management has been attempting to
procure alternative sources of funding and other strategic alternatives, in
order to mitigate the situation with Dynex. The Company is currently in
discussions with several investment bankers and direct sources regarding such
alternatives which may include joint ventures, or changes in control of the
Company. While management hopes that an alternative opportunity will be
consummated, the Company has suspended acquisitions and dispositions of finance
contracts until alternative funding sources are obtained, however, there can be
no assurance that such funding will be obtained. As a consequence, the Company
expects to report a loss for the first quarter of 1999 and will not pay the
quarterly dividend on its preferred stock otherwise payable on March 31, 1999.
Unless financing or other strategic alternatives are found the Company may not
continue its business of originating loans and would take steps to reduce its
personnel and operating expenses associated with such activities. Also, parties
to the Company's various securitization transactions could request that the
Company surrender servicing, although management does not believe such parties
have the right to terminate servicing under the respective agreements. See
"Funding/Securitization of Finance Contracts, Securitization Program". The
Company expects to continue its servicing operations. Management believes the
Company has sufficient liquidity to meet its obligations and continue its
servicing activities for a reasonable period of time.
In February 1997 the Company discovered certain breaches of representations
and warranties by certain dealers with respect to finance contracts sold into a
securitization. The Company honored its obligations to the securitization trust
and repurchased finance contracts totaling $619,520 from that trust during the
three months ended March 31, 1997. Of the total amount of these finance
contracts, $190,320 were purchased from one dealer. Although the Company
requested that this dealer repurchase such contracts, the dealer refused. After
such dealer's refusal to repurchase, the Company commenced an action in the
157th Judicial District Court for Harris County, Texas against Charlie Thomas
Ford, Inc. to compel such repurchase. In February 1999, the Company reached a
favorable settlement agreement with the defendants. The Company has received
funds related to such settlement sufficient to reimburse it for the repurchased
finance contracts.
On March 31, 1999, a suit naming the Company and William O. Winsauer,
Adrian Katz and John S. Winsauer (in their capacities as controlling
shareholders of the Company) as defendants was filed in the federal district
court for the Western District of Texas by a holder of the Company's 15% Series
A Cumulative Preferred Stock. See "Legal Proceedings."
GROWTH AND BUSINESS STRATEGY
The Company's growth strategy anticipates the acquisition of an increasing
number of finance contracts contingent upon finding financing for such
transactions The key elements of this strategy include: (i) increasing the
number of finance contracts acquired per automobile dealer; (ii) expanding the
Company's presence within existing markets; (iii) penetrating new markets that
meet the Company's economic, demographic and business criteria and (iv)
securitizing or otherwise monetizing portfolios of acquired finance contracts.
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To foster its growth and increase profitability, the Company will continue
to pursue a business strategy based on the following principles:
Targeted Market and Product Focus-The Company has targeted the sub-prime
auto finance market because it believes that sub-prime finance presents greater
opportunities than does prime lending. This greater opportunity stems from a
number of factors, including the relative newness of sub-prime auto finance, the
range of finance contracts that various sub-prime auto finance companies
provide, the relative lack of competition compared to traditional automotive
financing and the potential returns sustainable from large interest rate
spreads. The Company focuses on late model used rather than new vehicles, as
management believes the risk of loss is lower on used vehicles due to lower
depreciation rates, while interest rates are typically higher than on new
vehicles. For the period from inception through December 31, 1998, new vehicles
and used vehicles represented 7.1 % and 92.9%, respectively, of the finance
contract portfolio. In addition, the Company concentrates on acquiring finance
contracts from dealerships franchised by major automobile manufacturers because
they typically offer higher quality vehicles, are better capitalized, and have
better service facilities than used car dealers.
Efficient Funding Strategies-Through warehouse facilities and a periodic
securitization program, the Company increases its liquidity, redeploys its
capital and reduces its exposure to interest rate fluctuations. The strategy of
the Company's funding and securitization program has been to provide more
proceeds than the Company's acquisition costs, resulting in positive revenue
cash flow and lower overall costs of funding, and permitting loan volume to
increase with limited additional equity capital.
Uniform Underwriting Criteria-To manage the risk of delinquency or defaults
associated with sub-prime consumers, the Company has utilized since inception
underwriting criteria which are uniformly applied in evaluating credit
applications. This evaluation process is conducted on a centralized basis
utilizing experienced personnel. These uniform underwriting criteria create
consistency in the securitization portfolios of finance contracts that make them
more easily analyzed by the rating agencies and more marketable and permit
static pool analysis of loan defaults to optimally structure securitizations.
See "Management's Discussion and Analysis-Repossession Experience-Static Pool
Analysis".
Centralized Operating Structure-While the Company establishes and maintains
relationships with dealers through sales representatives located in the
geographic markets served by the Company, all of the Company's day-to-day
operations are centralized at the Company's offices in Austin, Texas. This
centralized structure allows the Company to closely monitor its marketing,
funding, underwriting and collections operations and eliminates the expenses
associated with full-service branch or regional offices.
Experienced Management Team-The Company actively recruits and retains
experienced personnel at the executive, supervisory and managerial levels. The
senior operating management of the Company consists of seasoned automobile
finance professionals with substantial experience in underwriting, collecting
and financing automobile finance contracts.
Intensive Collection Management-The Company believes that intensive
collection efforts are essential to ensure the performance of sub-prime finance
contracts and to mitigate losses. The Company's collections managers contact
delinquent accounts frequently, working cooperatively with customers to get full
or partial payments, but will initiate repossession of financed vehicles no
later than the 90th day of delinquency. As of December 31, 1998, a total of$28.6
million or 13.56%, of the Company's active finance contract portfolio were
between 30 and 89 days past due and $ 5.2 million, or approximately 2.47%, of
the Company's active finance contracts outstanding were 90 days past due or
greater. The aforementioned percentages and amounts include finance contracts in
the Company's portfolio where the Company has discontinued collection efforts,
such as where the underlying vehicle has been repossessed, the borrower is in
bankruptcy, the dealer is to buy back the loan, or an insurance claim has been
filed, but a final loss has not been recorded. From inception through December
31, 1998, the Company repossessed 7,966 (approximately 23.9%) of its financed
vehicles, and the Company had
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completed the disposal and recovery process of 4,457 vehicles, resulting in an
average loss per repossession of approximately $ 2,682 per vehicle. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Net Loss Per Repossession".
Limited Loss Exposure-To reduce its potential losses on defaulted finance
contracts, the Company historically has insured each finance contract it funds
against damage to the financed vehicle through a vendor's comprehensive single
interest physical damage insurance policy (a "VSI Policy"). In addition, in
connection with certain of the Company's warehouse financing and securitizations
through December 31, 1997, the Company purchased credit default insurance
through a deficiency balance endorsement ("Credit Endorsement") to the related
VSI Policy. The Credit Endorsement reimburses the Company for the difference
between the unpaid contract finance balance and the net proceeds received in
connection with the sale of the repossessed vehicle. Moreover, the Company
limits loan-to-value ratios and applies a purchase price discount to the finance
contracts it acquires. The Company's combination of underwriting criteria,
intensive collection efforts and the VSI Policy and Credit Endorsement has
resulted in net charge-offs (after receipt of liquidation and insurance
proceeds) of 21.91% (excluding repossession costs) of the principal balance
outstanding on disposed repossessed vehicles for which the liquidation process
has been completed as of December 31, 1998. For its 1997-B and 1997-C
securitizations, the Company purchased credit default insurance from Progressive
Northern Insurance Company. See "Legal Proceedings", "Insurance" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Net Loss per Repossession".
As discussed, the Company's business strategy depends on its ability to
increase the rate of revenue growth more rapidly than the rate of expenses,
which would involve a reversal of an adverse trend experienced through much of
1997 and 1998. Thus, continued growth in revenues is important for the Company
to succeed in its business strategy. Unless a comprehensive solution to the
liquidity problems caused by the Dynex situation is reached, the future
viability of the Company's business of originating loans is threatened. The
Company expects to continue its servicing operations for the foreseeable future.
BORROWER CHARACTERISTICS
Borrowers under finance contracts in the Company's finance contract
portfolio are generally sub-prime consumers. Sub-prime consumers are purchasers
of financed vehicles with limited access to traditional sources of credit and
are generally individuals with weak or no credit histories.
CONTRACT PROFILE
From inception to December 31, 1998, the Company acquired 33,371 finance
contracts with an aggregate initial principal balance of $ 389 million. Of the
finance contracts acquired, approximately 7.1% have related to the sale of new
automobiles and approximately 92.9% have related to the sale of used
automobiles. The average age of used finance vehicles was approximately two
years at the time of sale. The finance contracts had, upon acquisition, an
average initial principal balance of $11,556; a weighted average APR of 19.87%;
and a weighted average contractual maturity of 53.5 months. As of December 31,
1998, the finance contracts in the finance contract portfolio had a weighted
average remaining maturity of 43 months.
DEALER NETWORK
General Description. The Company acquires finance contracts originated by
automobile dealers in connection with the sale of late-model used and, to a
lesser extent, new cars to sub-prime borrowers. Accordingly, the Company's
business development strategy depends on enrolling and promoting active
participation by automobile dealers in the Company's financing program. Dealers
are selected on the basis of geographic location, financial strength, experience
and integrity of management, stability of ownership, quality of used car
inventory, participation in sub-prime financing programs, and the anticipated
quality and quantity of finance contracts which they originate. The Company
principally targets dealers operating
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under franchises from major automobile manufacturers, rather than independent
used car dealers. The Company believes that franchised dealers are generally
more stable and offer higher quality vehicles than independent dealers. This is
due, in part, to careful initial screening and ongoing monitoring by the
automobile manufacturers and to the level of financial commitment necessary to
secure and maintain a franchise. As of December 31, 1998, the Company was
licensed or qualified to do business in 40 states. Over the near term, the
Company intends to focus its proposed geographic expansion on states in the
Midwest and Mid-Atlantic regions.
Location of Dealers. Approximately 34 % of the Company's dealer network
consists of dealers located in Texas, where the Company has operated since 1994.
DEALER SOLICITATION
Marketing Representatives. As of December 31, 1998, the Company utilized 41
marketing representatives, 40 of whom were individuals employed by the Company
and one of whom were marketing organizations serving as independent
representatives. These representatives have an average of ten years' experience
in the automobile financing industry. The marketing representatives reside in
the region for which they are responsible. Marketing representatives are
compensated on the basis of a salary plus commissions based on the number of
finance contracts purchased by the Company in their respective areas. The
Company maintains an exclusive relationship with the independent marketing
representatives and compensates such representatives on a commission basis. All
marketing representatives undergo training and orientation at the Company's
Austin headquarters.
The Company's marketing representatives establish financing relationships
with new dealerships, and maintain existing dealer relationships. Each marketing
representative endeavors to meet with the managers of the finance and insurance
("F&I") departments at each targeted dealership in his or her territory to
introduce and enroll dealers in the Company's financing program, educating the
F&I managers about the Company's underwriting philosophy, its practice of using
experienced underwriters (rather than computerized credit scoring) to review
applications, and the Company's commitment to a single lending program that is
easy for dealers to master and administer. The marketing representatives offer
training to dealership personnel regarding the Company's program guidelines,
procedures and philosophy.
After each dealer relationship is established, a marketing representative
continues to actively monitor that relationship with the objective of maximizing
the volume of applications received from the dealer that meet the Company's
underwriting standards. Due to the non-exclusive nature of the Company's
relationships with dealers, the dealers retain discretion to determine whether
to seek financing from the Company or another financing source. Each
representative submits a weekly call report describing contacts with prospective
and existing dealers during the preceding week and a monthly competitive survey
relating to the competitive situation and possible opportunities in the region.
The Company provides each representative with a weekly report detailing
applications received and finance contracts purchased from all dealers in the
region. The marketing representatives regularly telephone and visit F&I managers
to remind them of the Company's objectives and to answer questions. To increase
the effectiveness of these contacts, the marketing representatives can obtain
real-time information from the Company's newly installed management information
systems, listing by dealership the number of applications submitted, the
Company's response to such applications and the reasons why a particular
application was rejected. The Company believes that the personal relationships
its marketing representatives establish with the F&I managers are an important
factor in creating and maintaining productive relationships with its dealership
customer base.
The role of the marketing representatives is generally limited to marketing
the Company's financing program and maintaining relationships with the Company's
dealer network. The marketing representatives do not negotiate, enter into or
modify dealer agreements on behalf of the Company, do not participate in credit
evaluation or loan funding decisions and do not handle funds belonging to the
Company or its dealers. The Company intends to develop notable finance contract
volume in each state in which it initiates coverage. The Company has elected not
to establish full service branch offices, believing that the expense and
administrative burden of such offices are generally unjustified. The Company has
concluded that the ability to closely monitor the critical functions of finance
contract approval and contract administration and collection are best performed
and controlled on a centralized basis from its Austin facility.
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Dealer Agreements. Each dealer with which the Company establishes a
financing relationship enters into a non-exclusive written dealer agreement (a
"Dealer Agreement") with the Company, governing the Company's acquisition of
finance contacts from such dealer. A Dealer Agreement generally provides that
the dealer shall indemnify the Company against any damages or liabilities,
including reasonable attorney's fees, arising out of (i) any breach of a
representation or warranty of the dealer set forth in the Dealer Agreement or
(ii) any claim or defense that a borrower may have against a dealer relating to
financing contract. Representations and warranties in a Dealer Agreement
generally relate to matters such as whether (a) the financed automobile is free
of all liens, claims and encumbrances except the Company's lien, (b) the down
payment specified in the finance contract has been paid in full and whether any
part of the down payment was loaned to the borrower by the dealer and (c) the
dealer has complied with applicable law. If the dealer violates the terms of the
Dealer Agreement with respect to any finance contract, the dealer is obligated
to repurchase such contract on demand for an amount equal to the unpaid balance
and all other indebtedness due to the Company from the borrower.
FINANCING PROGRAM
Unlike certain competitors who offer numerous marketing programs that the
Company believes serve to confuse dealers and borrowers, the Company markets a
single financing contract acquisition program with five pricing tiers to its
dealers. The Company believes that by focusing on a single program, it realizes
consistency in achieving its contract acquisition criteria, which aids the
funding and securitization process. The finance contracts purchased by the
Company must meet several criteria, including that each contract: (i) meets the
Company's underwriting guidelines; (ii) is secured by a new or late-model used
vehicle of a type on the Company's approved list; (iii) was originated in a
jurisdiction in the United States in which the Company was licensed or qualified
to do business, as appropriate; (iv) provides for level monthly payments
(collectively, the "Scheduled Payments") that fully amortize the amount financed
over the finance contract's original contractual term; (v) has an original
contractual term from 24 to 60 months; (vi) provides for finance charges at an
APR of at least 14%; (vii) provides a verifiable down payment of 10% or more of
the cash selling price; and (viii) is not past due or does not finance a vehicle
which is in repossession at the time the finance contract is presented to
Company for acquisition. Although the Company has in the past acquired a
substantial number of finance contracts for which principal and interest are
calculated according to the "Rule of 78s," the Company's present policy is to
acquire primarily finance contracts calculated using the simple interest method.
The amount financed with respect to a finance contract will generally equal
the aggregate amount advanced toward the purchase price of the financed vehicle,
which equals the net selling price of the vehicle (cash selling price less down
payment and trade-in), plus the cost of permitted automotive accessories (e.g.,
air conditioning, standard transmission, etc.), taxes, title and license fees,
credit life, accident and health insurance policies, service and warranty
contracts and other items customarily included in retail automobile installment
contracts and related costs. Thus, the amount financed may be greater than the
Manufacturer's Suggested Retail Price ("MSRP") for new vehicles or the market
value quoted for used vehicles. Down payments must be in cash, real value of
traded-in vehicles, or rebates. Dealer-assisted or deferred down payments are
not permitted.
The Company's current purchase criteria limit acceptable finance contracts
to a maximum of the (a) net selling price of 112% of wholesale book value (or
dealer invoice for new vehicles) or (b) amount financed of 120% of retail book
value in the case of a used vehicle, or 120% of MSRP in the case of a new
vehicle.
The credit characteristics of an application approved by the Company for
acquisition generally consist of the following: (i) stability of applicant's
employment, (ii) stability of applicant's residence history, (iii) sufficient
borrower income, (iv) credit history, and (v) amount of down payment.
All of the Company's finance contracts are prepayable at any time. Finance
contracts acquired by the Company must prohibit the sale or transfer of the
financed vehicle without the Company's prior consent and provide for
acceleration of the maturity of the finance contract in the absence of such
consent. For an approved finance contract, the Company will agree to acquire
such finance contract from the originating dealer at a non-refundable contract
acquisition discount of approximately 0% to 10% of the amount financed.
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<PAGE>
CONTRACT ACQUISITION PROCESS
General. Having selected an automobile for purchase, the sub-prime consumer
typically meets with the dealership's F&I manager to discuss options for
financing the purchase of the vehicle. If the sub-prime consumer elects to
finance the vehicle's purchase through the dealer, the dealer will typically
submit the borrower's credit application to a number of potential financing
sources to find the most favorable terms. In general, an F&I department's
potential sources of financing will include banks, thrifts, captive finance
companies and independent finance companies.
For the year ended December 31, 1998, 129,461 credit applications were
submitted to the Company. Of these 129,461 applications, approximately 36.3%
were approved and 8%, or 10,176 contracts, were acquired by the Company. The
difference between the number of applications approved and the number of finance
contracts acquired is attributable to a common industry practice in which
dealers often submit credit applications to more than one finance company and
select on the basis of the most favorable terms offered. The prospective
customer may also decide not to purchase the vehicle notwithstanding approval of
the credit application.
Contract Processing. Dealers send credit applications along with other
information to the Company's Credit Department in Austin via facsimile. Upon
receipt, the credit application and other relevant information is entered into
the Company's computerized contract administration system by the Company's
credit verification personnel and a paper-based file where the original
documents are created. Once logged into the system, the applicant's credit
bureau reports are automatically accessed and retrieved directly into the
system. At this stage, the computer assigns the credit application to the
specific credit manager assigned to the submitting dealer for credit evaluation.
Credit Evaluation. In evaluating the applicant's creditworthiness the
credit underwriter reviews each application in accordance with the Company's
guidelines and procedures, which take into account, among other things, the
individual's stability of residence, employment history, credit history, ability
to pay, income, discretionary income and debt ratio. In addition, the credit
underwriter evaluates the applicant's credit bureau report in order to determine
if the applicant's (i) credit quality is deteriorating, (ii) credit history
suggests a high probability of default or (iii) credit experience is too limited
for the Company to assess the probability of performance. The Company also
assesses the value and useful life of the automobile that will serve as
collateral under the finance contract. Moreover, the credit underwriters
consider the suitability of a proposed loan under its financing program in light
of the (a) proposed contract term and (b) conformity of the proposed collateral
coverage to the Company's underwriting guidelines.
Verification of certain applicant-provided information is required before
the Company funds the contract. Such verification typically requires submission
of supporting documentation, such as a paycheck stub or other substantiation of
income, or a telephone bill evidencing a current address.
The Company's underwriting standards are applied uniformly by experienced
credit underwriters with a personal analysis of each application, utilizing
experienced judgment. These standards have been developed and refined by the
Company's senior credit and collections management who, on average, possess more
than 20 years of experience in the automobile finance industry. The Company
believes that having its credit underwriters personally review and communicate
to the submitting dealership the decision with respect to each application,
including the reasons why a particular application may have been declined,
enhances the Company's relationship with such dealers. This practice encourages
F&I managers to submit contracts meeting the Company's underwriting standards,
thereby increasing the Company's operating efficiency by eliminating the need to
process applications unlikely to be approved.
The Company's Credit Department personnel undergo ongoing internal training
programs are attended by such personnel depending on their responsibilities. All
of these personnel are located in the Company's offices in Austin where they are
under the supervision of the Vice President-Credit. The Vice President-Credit
has of more than 20 years of experience in the automobile finance business. In
addition, the Company reviews all repossessions to identify factors that might
require refinements in the Company's credit evaluation procedures.
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<PAGE>
Approval Process. The time from receipt of application to final credit
approval is a significant competitive factor, and the Company seeks to complete
its funding approval decision in an average of two to three hours. When the
Company approves the purchase of a finance contract, the credit manager notifies
the dealer by facsimile or telephone. Such notice specifies all pertinent
information relating to the terms of approval, including the interest rate, the
term, information about the automobile to be sold and the amount of discount
that the Company will deduct from the amount financed prior to remitting the
funds to the dealer. The discount is not refundable to the dealer.
Contract Purchase and Funding. Upon final confirmation of the terms by the
borrower, the dealer completes the sale of the automobile to the borrower. After
the dealer delivers all required documentation (including an application for
title or a dealer guaranty of title, naming the Company as lienholder) to the
Company, the Company remits funds to the dealer via overnight delivery service
within a commercially reasonable time of having received the complete loan
funding package. As a matter of policy, the Company takes such measures as it
deems necessary to obtain a perfected security interest in the related financed
vehicles under the laws of the states in which such vehicles are originated.
This generally involves taking the necessary steps to obtain a certificate of
title which names the Company as lienholder. Each finance contract requires that
the automobile be adequately insured and that the Company be named as loss
payee, and compliance with these requirements is verified prior to the
remittance of funds to the dealer.
From time to time, the Company also acquires bulk portfolios from other
originators. In this event, the Company reunderwrites such contracts to ensure
appropriate credit standards are maintained. The Company acquired approximately
$14.8 million in finance contracts in 1996 from Greenwich Capital Financial
Products which were originated by First Fidelity Acceptance Corp. During the
first quarter of 1997, the Company acquired approximately $12.8 million in
finance contracts from Credit Suisse First Boston Mortgage Capital LLC ("CSFB")
which were originated by Jefferson Capital Corporation. During the third quarter
of 1997, the Company acquired a total of $7.9 million in finance contracts from
three originators. During the fourth quarter of 1997, the Company acquired a
total of $7.4 million in finance contracts from third party originators and,
from CSFB, approximately $12.5 million in finance contracts, which were
originated by several third parties. CSFB also provided acquisition financing
for the purchase.
CONTRACT SERVICING AND COLLECTION
Contract servicing includes contract administration and collection. Because
the Company believes that an active collection program is essential to success
in the sub-prime automobile financing market, the Company retains responsibility
for finance contract servicing and collection. Prior to December 1997, the
Company engaged CSC Logic/MSA L.L.P. (a Texas limited liability partnership
doing business as "Loan Servicing Enterprise" ("LSE")) to provide contract
administration for its warehouse arrangements and securitizations.
Contract Administration. The Company, as servicer, performs certain
contract administration functions in connection with finance contracts
warehoused or sold to securitization trusts, including payment processing,
statement rendering, insurance tracking, data reporting and customer service for
finance contracts. The Company inputs newly originated finance contracts on the
contract system daily. The servicer then mails a welcome letter to the borrower
and subsequently mails monthly billing statements to each borrower approximately
ten days prior to each payment due date. All borrower remittances are directed
to a lock box. Remittances received are then posted to the proper account on the
system. The Company also handles account inquiries from borrowers, performs
insurance tracking services and sends out notices to borrowers for instances
where proper collateral insurance is not documented.
Contract Collection. As collection agent, the Company is responsible for
pursuing collections from delinquent borrowers. The Company utilizes proactive
collection procedures, which include making early and frequent contact with
delinquent borrowers, educating borrowers as to the importance of maintaining
good credit, and employing a consultative and customer service approach to
assist the borrower in meeting his or her obligations. The Company's ability to
monitor performance and collect payments owed by contract obligors is a function
of its collection approach and support systems. The Company's approach to the
collection of delinquent contracts is to minimize repossessions and charge-offs.
The Company maintains a computerized collection system specifically designed to
service sub-prime automobile finance contracts. The Company believes that if
problems are identified early, it is possible to correct many delinquencies
before they deteriorate further.
The Company has invested in equipment and training for a predictive dialer
system. This system will allow for more effective and efficient collection
efforts. Employees have been trained to manage the benefits allowing fewer
collection representatives to handle a higher volume of calls. The Company
believes that it has already, and will continue to see improvements in
delinquencies as a direct result of the predictive dialer system.
As of December 31, 1998, the Company employed 227 people full-time,
including 63 collection specialists and other support personnel, in the
Collections Department. Each employee is devoted exclusively to collection
functions. The Collections Department is managed by the Vice President -
Collections, who possesses 30 years experience in the automotive and finance
industry. The Company hires additional collection specialists in advance of need
to ensure adequate staffing and training.
Accounts reaching five days past due are assigned to collectors who have
specific responsibility for those accounts. These collectors contact the
customer frequently, both by phone and in writing. Accounts that reach 60 days
past due are assigned to senior collectors who handle those accounts until
resolved. To facilitate collections from borrowers, the Company has increased
its utilization of Western Union's "Quick Collect," which allows borrowers to
pay from remote locations, with a confirmation printed at the Company's office
Payment extensions may be granted if, in the opinion of the collection
department, such extension is warranted. An extension fee is generally paid by
the customer prior to the extension. Generally, there can be only one extension
during the first 18 months of a finance contract and two for the term of the
contract. Payment due dates can be modified during the term of the contract to
facilitate current payment by the customer.
Repossessions and Recoveries. If a delinquency exists and a default is
deemed inevitable or the collateral is in jeopardy, and in no event later than
the 90th day of delinquency (as required by the applicable VSI Policy), the
Company's Collections Department will initiate the repossession of the financed
vehicle. Bonded, insured outside repossession agencies are used to secure
involuntary repossessions. In most jurisdictions, the Company is required to
give notice to the borrower of the Company's intention to sell the repossessed
vehicle, whereupon the borrower may exercise certain rights to cure his or her
default or redeem the automobile. Following the expiration of the legally
required notice period, the repossessed vehicle is sold at a wholesale auto
auction (or in limited circumstances, through dealers), usually within 60 days
of the repossession. The Company closely monitors the condition of vehicles set
for auction, and procures an appraisal under the applicable VSI Policy prior to
sale. Liquidation proceeds are applied to the borrower's outstanding obligation
under the finance contract and loss deficiency claims under the VSI Policy and,
if applicable, any deficiency balance policy are then filed. See "-Insurance".
INSURANCE
Each finance contract requires the borrower to obtain comprehensive and
collision insurance with respect to the related financed vehicle with the
Company named as a loss payee. The Company relies on representation from the
selling dealer and independently verifies that a borrower in fact has such
insurance in effect when it purchases contracts. Each finance contract acquired
by the Company prior to December 31, 1996 is covered by the Interstate VSI
Policy, including the Credit Endorsement. The Interstate VSI Policy has been
issued to the Company by Interstate Fire & Casualty Company ("Interstate").
Interstate is an indirect wholly-owned subsidiary of Fireman's Fund Insurance
Company. Certain finance contracts acquired by the Company after December 31,
1996 are covered by either the Interstate VSI Policy, including the Credit
Endorsement, another VSI Policy (which does not include a Credit Endorsement),
or the VSI Policy and deficiency balance endorsement (the "Progressive Policy")
issued by Progressive Northern Insurance Company ("Progressive").
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<PAGE>
Physical Damage and Loss Coverage. The Company initially relies on the
requirement, set forth in its underwriting criteria, that each borrower obtain
adequate levels of physical damage loss coverage on the respective financed
vehicle prior to funding. The Company tracks the physical damage insurance of
borrowers and notifies borrowers in the event of a lapse in coverage or
inadequate documentation. Moreover, the VSI Policies insure against: (i) all
risk of physical loss or damage from any external cause to financed vehicles
which the Company holds as collateral; (ii) any direct loss which the Company
may sustain by unintentionally failing to record or file the instrument
evidencing each contract with the proper public officer or public office, or by
failing to cause the proper public officer or public office to show the
Company's encumbrance thereon, if such instrument is a certificate of title;
(iii) any direct loss sustained during the term of the applicable VSI Policy, by
reason of the inability of the Company to locate the borrower or the related
financed vehicle, or by reason of confiscation of the financed vehicle by a
public officer or public office; and (iv) all risk of physical loss or damage
from any external cause to a repossessed financed vehicle for a period of 60
days while such financed vehicle is (subject to certain exceptions) held by or
being repossessed by the Company.
The physical damage provisions of a VSI Policy generally provide coverage
for losses sustained on the value of the financed vehicle securing a contract,
but in no event is the coverage to exceed: (i) the cost to repair or replace the
financed vehicle with material of like kind and quality; (ii) the actual cash
value of the financed vehicle at the date of loss, less its salvage value; (iii)
the unpaid balance of the contract; (iv) $40,000 per financed vehicle (or, in
the case of losses or damage sustained on repossessed financed vehicles, $25,000
per occurrence), or $50,000 in the case of the Progressive Policy; or (v) the
lesser of the amounts due the Company under clauses (i) through (iv) above, less
any amounts due under all other valid insurance on the damaged financed vehicle
less its salvage value. No assurance can be given that the insurance will cover
the amount financed with respect to a financed vehicle.
All claim settlements for physical damage and loss coverage under the
Interstate Policy are subject to a $500 deductible per loss ($250 for the
Progressive Policy). There is no aggregate limitation or other form of cap on
the number of claims under the VSI Policy. Coverage on a financed vehicle is for
the term of the related contract and is noncancellable. Each VSI Policy requires
that, prior to filing a claim, a reasonable attempt be made to repossess the
financed vehicle and, in the case of claims on skip losses, every professional
effort be made to locate the financed vehicle or the related borrower.
Deficiency Balance Endorsements. In addition to physical damage and loss
coverage, the Interstate VSI Policy contains a Credit Endorsement which provides
that Interstate shall indemnify the Company for certain losses incurred due to a
deficiency balance following the repossession and resale of financed vehicles
securing defaulted finance contracts eligible for coverage. Coverage under the
Credit Endorsement is strictly conditioned upon the Company's maintaining and
adhering to the credit underwriting criteria set forth in the Credit
Endorsement. Losses on each eligible contract are covered in an amount equal to
the deficiency balance resulting from the Net Payoff Balance (as defined below)
less the sum of (I) the Actual Cash Value (as defined below) of the financed
vehicle plus (ii) the total amount recoverable from all other applicable
insurance, including refunds from cancelable add-on products. The maximum
coverage under the Credit Endorsement is $15,000 per contract.
"Actual Cash Value" for the purposes of the Credit Endorsement only, means
the greater of (i) the price for which the subject financed vehicle is sold or
(ii) the wholesale market value at the time of the loss as determined by an
automobile guide approved by Interstate applicable to the region in which the
financed vehicle is sold.
"Net Payoff Balance" for the purposes of the Credit Endorsement, means the
outstanding principal balance as of the default date plus late fees and
corresponding interest no more than 90 days after the date of default. In no
event shall Net Payoff Balance include non-approved fees, taxes, penalties or
assessments included in the original instrument, or repossession, disposition,
collection or remarketing expenses and fees or taxes incurred.
The Progressive Policy contains a Deficiency Balance Endorsement (the
"DBE"), pursuant to which Progressive will insure the Company's interest in the
Financed Vehicles against direct loss incurred due to the Company's inability to
recover one hundred percent (100%) of the balance due under an instrument
representing a finance contract. Under the DBE, Progressive will cover such
impairment of the Company's interest in the financed vehicle, measured as the
Net Payoff Amount, reduced by (a) claim settlements from other insurance
policies, (b) claim settlements due under other coverage provisions of the
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<PAGE>
VSI Policy or its other endorsements, and (c) monies recoverable under any other
recourse or repurchase agreement or through any dealer hold-back, or any other
source. The maximum liability under the DBE is Five Thousand Dollars ($5,000)
for any financed contract. Claims payments may not exceed, on a monthly basis,
88% of the premiums paid, however, any unpaid claims in a given month are
carried over for payment in succeeding months. Progressive stopped paying claims
under the Progressive Policy in April 1998. See "Legal Proceedings".
MANAGEMENT INFORMATION SYSTEMS
Management believes that a high level of real-time information flow and
analysis is essential to manage the Company's informational and reporting needs
and to enhance the Company's competitive position. Throughout 1998, the Company
handled in-house major servicing and reporting functions which had been
out-sourced in the past, relying heavily on its significant investment in
in-house technology. This has allowed the Company to realize significant savings
in servicing fees, as well as to provide improved service and responsiveness to
its customers and investors.
The Company had, in 1998, and will continue to have certain expenses
associated with maintaining and supporting its in-house technology. While these
expenses increased from 1997 to 1998 due to the increased in-house technology
needs, the Company does not anticipate a significant increase in this area for
1999.
The Company has, in 1998, continued its investment expanding its in-house
technology capabilities, and such investments are expected to continue, albeit
at a reduced rate as the major technology contributions have already been
realized. The Company has invested in equipment and training for a predictive
dialer system. This system will allow for more effective and efficient
collection efforts. Employees have been trained to manage the benefits allowing
fewer collections representatives to handle a higher volume of calls. The
Company believes that it has already, and will continue to see improvements in
delinquencies as a direct result of the predictive dialer system.
Management feels that the technology the Company has in place is sufficient
to handle its current and future needs, and feels that only a modest additional
investment in extending and enhancing its capabilities are needed to solidify it
in-house technology needs.
In addition, management feels that neither the Company nor its customers or
investors should expect any significant adverse impact relating to the 'Year
2000' bug. This is based on a number of considerations, such as in-house
testing; the fact that the recently designed in-house technology was written to
cater to the year 2000 bug; and the fact that many key year 2000 issues have
already past (e.g., loan maturity dates). Management thus feels that the Company
is 'Year 2000 Compliant'. See "Management's Discussion and Analysis, Year 2000
Compliance".
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<PAGE>
FUNDING/SECURITIZATION OF FINANCE CONTRACTS
Warehouse Credit Facilities. The Company obtains a substantial portion of
its working capital for the acquisition of finance contracts through warehouse
credit facilities. Under a warehouse facility, the lender generally advances
amounts requested by the borrower on a periodic basis, up to an aggregate
maximum credit limit for the facility, for the acquisition and servicing of
finance contracts or other similar assets. Until proceeds from a securitization
transaction are used to pay down outstanding advances, as principal payments are
received on the finance contracts, the principal amount of the advances may be
paid down incrementally or reinvested in additional finance contracts on a
revolving basis.
The Company and its wholly owned subsidiary, AutoBond Funding Corporation
II, entered into a $50 million revolving warehouse facility (the "Daiwa
Facility") with Daiwa Finance Corporation ("Daiwa") effective as of February 1,
1997. Advances under the Daiwa Facility matured as of March 31, 1998. The
proceeds from the borrowings under the Daiwa Facility were used to acquire
finance contracts and to make deposits to a reserve account. Interest was
payable at the lesser of (x) 30 day LIBOR plus 1.15% or (y) 11% per annum. The
Company paid a non-utilization fee of .25% per annum on the unused amount of the
line of credit. These notes were repaid on July 1, 1998 through the Funding
Agreement with Dynex.
On December 31, 1997, the Company entered into a warehouse/securitization
arrangement with Credit Suisse First Boston Mortgage Capital L.L.C. ("CSFB"),
whereby $12.5 million of finance contracts were sold to a qualifying
unconsolidated special purpose subsidiary, AutoBond Master Funding Corporation
II. These finance contracts secured variable funding notes, in the initial
amount of $11.3 million, which were repaid on June 30, 1998 through the Funding
Agreement with Dynex.
On March 31, 1998, the Company entered into a warehouse/securitization
arrangement with Infinity Investors Limited ("Infinity"), whereby $7.2 million
of finance contracts were sold to a qualifying unconsolidated special purpose
subsidiary, AutoBond Master Funding Corporation IV. These finance contracts
collateralized variable funding notes bearing interest at 10% per annum through
May 31, 1998 and thereafter at 17% per annum. In connection with the transaction
with Infinity, the Company issued a warrant to purchase up to 100,000 shares of
Common Stock, at an exercise price of $8.73 per share. These notes were repaid
on June 30, 1998 through the Funding Agreement with Dynex.
On June 9, 1998, the Company and Dynex entered into an arrangement whereby
the Company obtained a commitment from Dynex to purchase all currently
warehoused and future automobile finance contract acquisitions through at least
May 31, 1999 (the "Credit Agreement") The terms of the Credit Agreement were
modified on June 30, October 20, and October 28, 1998. Under the prior terms of
the Credit Agreement, the Company transferred finance contracts to AutoBond
Master Funding Corporations V ("Master Funding V"), a qualified unconsolidated
special purpose subsidiary, and Dynex provided warehouse credit facilities in
the amount equal to 104% of the unpaid principal balance of the finance
contracts (the "Advance Rate"), with the proceeds of such fundings received by
the Company. Under the modified terms of the Credit Agreement, the Advance Rate
was reduced from 104% to 88% for an interim period (the "Interim Period") ending
on the earlier of (a) December 31, 1998 and (b) the settlement date of a
securitization by Dynex of any finance contracts originated by the Company. At
the end of the Interim Period, the Advance Rate reverted to 104% and Dynex
agreed to advance the Company an additional amount equal to 16% of the unpaid
principal balance of finance contracts financed by Dynex during the Interim
Period, less any amounts that otherwise would have been paid as principal on the
Notes (as defined below) during such period. Advances under the Credit
Agreement are limited to $25 million per month after June 1998 until the
commitment termination date. Under the modified terms of the Funding Agreement,
the commitment terminates on July 31, 1999 (provided that 90 days' prior written
notice from Dynex is given), or if such notice is not given, July 31, 2000. At
the Company's option the commitment termination date can be extended an
additional four months to November 30, 1999 (provided that 90 days' prior
written notice from Dynex is given), or if such notice is not given, November
30, 2000. Advances under the Credit Agreement are evidenced by Class A and
Class B Notes (collectively, the "Notes") issued by Master Funding V to Dynex.
The Class A Notes are issued in a principal amount equal to 94.0% of the unpaid
principal balance of the finance contracts (88.0% for advances funded during the
Interim Period) and bear interest at a rate equal to 190 basis points over the
corporate bond equivalent yield on the three-year Treasury note on the closing
date for each such advance (equal to an average of 7.02% as of December 31,
1998); provided however, that during the Interim Period, the interest rate on
the Company's Class A
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<PAGE>
Notes equaled one-month LIBOR plus 1.50%. The Class B Notes are issued in a
principal amount equal to 10.0% of the unpaid principal balance of the finance
contracts (0.0% for advances funded during the Interim Period) and bear interest
at a rate equal to 16% per annum. The Company retains a subordinated interest
in the pooled finance contracts. Transfers of finance contracts to Master
Funding V have been recognized as sales under SFAS No. 125. At December 31,
1998, advances under the Dynex Credit Agreement totaled $155 million. During the
first week of February, 1999, Dynex' management informed the Company that Dynex
was refusing to make additional fundings of finance contracts. See "Recent
Developments" and "Legal Proceedings".
At December 31, 1998, the Company had no outstanding balance on a $10.0
million revolving credit facility (the "Sentry Facility") with Sentry Financial
Corporation ("Sentry"), which expires on December 31, 2000. The proceeds from
borrowings under the Sentry Facility are used to acquire finance contracts, to
pay applicable credit default insurance premiums and to make deposits to a
reserve account with Sentry. The Company pays a utilization fee of up to 0.21%
per month on the average outstanding balance under the Sentry Facility. The
Sentry Facility also requires the Company to pay up to 0.62% per quarter on the
average unused balance. Interest is payable monthly and accrues at a per annum
rate of prime plus 1.75%. The Sentry Facility contains certain conditions and
imposes certain requirements, including, among other things, minimum net worth
and cash and cash equivalent balances in the reserve accounts. The Sentry
Facility was amended in May 1998 to add additional representations, covenants, a
general release of Sentry, the guarantee of William O. Winsauer, and the right
of Sentry to refuse future advances at its sole discretion. Management has no
current plans to request an advance under the Sentry Facility.
The Company's ability to obtain warehouse facilities or similar financing
will depend on, among other things, the willingness of financial organizations
to participate in funding subprime finance contracts and the Company's financial
condition and results of operations. The Company's growth is dependent upon its
ability to obtain sufficient financing under warehouse credit facilities, at
rates and upon terms acceptable to the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources".
Securitization Program. The periodic securitization of finance contracts
has been an integral part of the Company's business. Securitizations enable the
Company to monetize its assets and redeploy its capital resources and warehouse
credit facilities for the purchase of additional finance contracts. To date, the
Company has completed 8 securitizations and the sales to Dynex involving
approximately $360 million in aggregate principal amount of finance contracts.
In its securitization transactions through December 31, 1996, the Company
sold pools of finance contracts to a special purpose subsidiary, which then
assigned the finance contracts to a trust in exchange for cash and certain
retained beneficial interests in the trust. The trust issued two classes of
fixed income investor certificates: Class A Certificates which were sold to
investors, generally at par with a fixed coupon, and subordinated excess spread
certificates (representing a senior interest in excess spread cash flows from
the finance contracts) which were retained by the Company's securitization
subsidiary and which collateralize borrowings on a non-recourse basis. The
Company also funded a cash reserve account that provides credit support to the
Class A Certificates. The Company's securitization subsidiaries also retained an
interest in the trust that is subordinate to the interest of the investor
certificate holders. The retained interests entitle the Company to receive the
future excess spread cash flows from the trust after payment to investors,
absorption of losses, if any, that arise from defaults on the transferred
finance contracts and payment of the other expenses and obligations of the
trust. In accounting for its securitization transactions after December 31, 1996
the Company followed the provisions of SFAS 125. In these securitizations the
Company sold pools of finance contracts to a special purpose subsidiary, which
then issued notes under a trust indenture secured by such finance contracts. The
special purpose corporations may issue multiple classes of secured notes,
including subordinated excess spread notes. The Company also funded a cash
reserve account that provides credit support to the senior notes. The Company's
securitization subsidiaries also have retained an interest in the finance
contracts that is subordinate to the interest of the note holders. The retained
interests entitle the Company to receive the future excess spread cash flows
from the trust estate after payment to investors, absorption of losses, if any,
that arise from defaults on the transferred finance contracts and payment of the
other expenses and obligations of the trust estate.
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<PAGE>
Securitization transactions impact the Company's liquidity in two primary
ways. First, the application of proceeds toward payment of the outstanding
advances on warehouse credit facilities makes additional borrowing available, to
the extent of such proceeds, under those facilities for the acquisition of
additional finance contracts. Second, additional working capital is obtained
through the Company's practice of borrowing, through the issuance of
non-recourse debt, against the value of the senior interest in the retained
excess spread. If the structure of the securitizations was changed, it could
impact the Company's ability to generate liquidity. See "Recent Developments".
Upon each securitization, the Company recognizes the sale of finance
contracts and records a non-cash gain or loss in an amount which takes into
account the amounts expected to be received as a result of its retained
interests. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Revenues - Gain on Sale of Finance Contracts." At
December 31, 1998, the Company held retained interest in securitizations of
$13,873,351, a portion of which had been pledged to secure non-recourse notes
payable of $3,185,050.
If the Company were unable to securitize and/or sell its contracts in a
financial reporting period, the Company would incur a significant decline in
total revenues and net income or report a loss for such period. If the Company
were unable to securitize its contracts and did not have sufficient credit
available, either under its warehouse credit facilities or from other sources,
the Company would have to sell portions of its portfolio directly to investors
or curtail its finance contract acquisition activities. See "Recent
Developments" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources".
The securitization trust agreements and the servicing agreement contain
certain events of administrator termination, the occurrence of which entitles
the trustee to terminate the Company's right to act as collection agent and
administrator. Events of administrator termination typically include: (i)
defaults in payment obligations under the trust agreements; (ii) unremedied
defaults in the performance of certain terms or covenants under the trust
agreements, the servicing agreements or related documents; (iii) the institution
of certain bankruptcy or liquidation proceedings against the Company; (iv)
material breaches by the Company of representations and warranties made by it
under the servicing agreements and the sale agreements pursuant to which it has
sold the securitized finance contracts; (v) the occurrence of a trigger event
whereby the ratio of delinquent finance contracts to total securitized finance
contracts for each transaction exceeds the percentage set forth in the servicing
agreements; or (vi) any of the rating agencies rating the securitization
transactions determines that the Company's serving as collection agent under the
related servicing agreement would prevent such agency from maintaining the
required ratings on such transactions, or would result in such transactions
being placed on negative review suspension or downgrade.
The trust agreements contain amortization events, the occurrence of any of
which may affect the Company's rights to receive payments in respect of the
future excess spread cash flows otherwise payable to it until principal and
interest payments due the holders of all investor certificates are paid in full.
Such amortization events include:
(i) defaults in certain payments or repurchase obligations under the trust
agreements; (ii) unremedied defaults in the performance of any covenants or
terms of the trust agreements by a securitization subsidiary; (iii) the
occurrence of certain bankruptcy or insolvency events of a securitization
subsidiary; (iv) unremedied material breaches of representations or warranties
of a securitization subsidiary; (v) occurrence of an event of administrator
termination; (vi) failure of a securitization subsidiary to transfer certain
required amounts of unpaid principal balance of finance contracts to each
securitization trust or to retain the resulting shortfall in the collection
accounts; (vii) failure of any transfer under the trust agreements to create, or
failure of any investor certificates to evidence, a valid and perfected first
priority undivided ownership or
-- 14 --
<PAGE>
security interest in the pool of securitized finance contracts and related
collateral; (viii) failure of the Company to own, directly or indirectly, 100%
of the outstanding shares of common stock of any securitization subsidiary; (ix)
entry of unpaid and unstayed judgments aggregating in excess of $25,000 are
entered against any securitization subsidiary; or (x) occurrence of a "change in
control" with respect to the Company.
COMPETITION
The sub-prime credit market is highly fragmented, consisting of many
national, regional and local competitors, and is characterized by relative ease
of entry and the recent arrival of a number of well capitalized publicly-held
competitors. Existing and potential competitors include well-established
financial institutions, such as banks, savings and loan associations, small loan
companies, industrial thrifts, leasing companies and captive finance companies
owned by automobile manufacturers and others. Many of these financial
organizations do not consistently solicit business in the sub-prime credit
market. The Company believes that captive finance companies generally focus
their marketing efforts on this market only when inventory control and/or
production scheduling requirements of their parent organizations dictate a need
to enhance sales volumes and exit the market once such sales volumes are
satisfied. The Company also believes that increased regulatory oversight and
capital requirements imposed by market conditions and governmental agencies have
limited the activities of many banks and savings and loan associations in the
sub-prime credit market. In many cases, those organizations electing to remain
in the automobile finance business have migrated toward higher quality customers
to allow reductions in their overhead cost structures.
As a result, the sub-prime credit market is primarily serviced by smaller
finance organizations that solicit business when and to the extent their capital
resources permit. The Company believes no one of its competitors or group of
competitors has a dominant presence in the market. The Company's strategy is
designed to capitalize on the market's relative lack of major national financing
sources. Nonetheless, several of these competitors have greater financial
resources than the Company and may have a significantly lower cost of funds.
Many of these competitors also have long-standing relationships with automobile
dealerships and may offer dealerships or their customers other forms of
financing or services not provided by the Company. The Company's ability to
compete successfully depends largely upon its relationships with dealerships and
the willingness of dealerships to offer finance contracts to the Company that
meet the Company's underwriting criteria. There can be no assurance that the
Company will be able to continue successfully in the markets it serves. See
"Recent Developments".
REGULATION
The Company's business is subject to regulation and licensing under various
federal, state and local statues and regulations. As of December 31, 1998, the
Company was licensed to conduct business operations with dealers located in 40
states, and, accordingly, the laws and regulations of such states govern the
Company's operations. Most states where the Company operates (i) limit the
interest rates, fees and other charges that may be imposed by, or prescribe
certain other terms of, the finance contracts that the Company purchases and
(ii) define the Company's rights to repossess and sell collateral. In addition,
the Company is required to be licensed or registered to conduct its finance
operations in certain states in which the Company purchases finance contracts.
As the Company expands its operations into other states, it will be required to
comply with the laws of such states.
Numerous federal and state consumer protection laws and related regulations
impose substantive disclosure requirements upon lenders and servicers involved
in automobile financing. Some of the federal laws and regulations include the
Truth-in-Lending Act, the Equal Credit Opportunity Act, the Federal Trade
Commission Act, the Fair Credit Reporting Act, the Fair Credit Billing Act, the
Fair Debt Collection Practices Act, the Magnuson-Moss Warranty Act, the Federal
Reserve Board's Regulations B and Z and the Soldiers' and Sailors' Civil Relief
Act.
-- 15 --
<PAGE>
In addition, the Federal Trade Commission ("FTC") has adopted a
holder-in-due-course rule which has the effect of subjecting persons that
finance consumer credit transactions (and certain related lenders and their
assignees) to all claims and defenses which the purchaser could assert against
the seller of the goods and services. With respect to used automobiles
specifically, the FTC's Rule on Sale of Used Vehicles requires that all sellers
of used automobiles prepare, complete and display a Buyer's Guide which explains
the warranty coverage for such automobiles. The Credit Practices Rules of the
FTC impose additional restrictions on sales contract provisions and credit
practices.
The Company believes that it is in substantial compliance with all
applicable material laws and regulations. Adverse changes in the laws or
regulations to which the Company's business is subject, or in the interpretation
thereof, could have a material adverse effect on the Company's business. In
addition, due to the consumer-oriented nature of the industry in which the
Company operates and the unclear application of various truth-in-lending laws
and regulations to certain products offered by companies in the industry,
industry participants are sometimes named as defendants in litigation involving
alleged violations of federal and state consumer lending or other similar laws
and regulations. A significant judgment against the Company or within the
industry in connection with any litigation could have a material adverse effect
on the Company's financial condition and results of operations.
In the event of default by a borrower under a finance contract, the Company
is entitled to exercise the remedies of a secured party under the Uniform
Commercial Code ("UCC"). The UCC remedies of a secured party include the right
to repossession by self-help means, unless such means would constitute a breach
of the peace. Unless the borrower voluntarily surrenders a vehicle, self-help
repossession by an independent repossession agent engaged by the Company is
usually employed by the Company when a borrower defaults. Self-help repossession
is accomplished by retaking possession of the vehicle. If a breach of the peace
is likely to occur, or if applicable state law so requires, the Company must
obtain a court order from the appropriate state court and repossess the vehicle
in accordance with that order.
In most jurisdictions, the UCC and other state laws require a secured party
to provide an obligor with reasonable notice of the date, time and place of any
public sale or the date after which any private sale of collateral may be held.
Unless the obligor waives his rights after default, the obligor in most
circumstances has a right to redeem the collateral prior to actual sale (i) by
paying the secured party all unpaid installments on the obligation, plus
reasonable expenses for repossessing, holding and preparing the collateral for
disposition and arranging for its sale, plus in some jurisdictions, reasonable
attorneys' fees or (ii) in some states, by paying the secured party past-due
installments. Repossessed vehicles are generally resold by the Company through
wholesale auctions, which are attended principally by dealers.
EMPLOYEES
As of December 31, 1998, the Company employed 227 persons, none of whom was
covered by a collective bargaining agreement. The Company believes that its
relationship with its employees is satisfactory.
ITEM 2. PROPERTIES
PROPERTIES AND FACILITIES
The Company has leased approximately 40,530 square feet of office space at
a monthly rent of $46,863 plus operating expense of $28,100 for a term of seven
years following the initial commencement date on June 1, 1998. The Company's
headquarters contain the Company's executive offices as well as those related to
automobile finance contract acquisition. The Company does not maintain any
regional office facilities, although its securitization subsidiaries are
incorporated and maintain an office in Nevada.
-- 16 --
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
In the normal course of its business, the Company is from time to time made
a party to litigation involving consumer-law claims. These claims typically
allege improprieties on the part of the originating dealer and name the Company
and/or its assignees as subsequent holders of the finance contracts. To date,
none of these actions have resulted in the payment of damages or any judgments
therefor, by the Company or its assignees, nor have any actions been certified
as eligible for class-action status.
On February 8, 1999, the Company, AutoBond Master Funding Corporation V, a
wholly-owned subsidiary of the Company ("Master Funding"), William O. Winsauer,
the Chairman and Chief Executive Officer of the Company, John S. Winsauer, a
Director and the Secretary of the Company, and Adrian Katz, the Vice-Chairman,
Chief Financial Officer and Chief Operating Officer of the Company
(collectively, the "Plaintiffs") commenced an action in the District Court of
Travis County, Texas (250th Judicial District) against Dynex and James Dolph
(collectively, the "Defendants"). This action is hereinafter referred to as the
"Texas Action". The Company and the other Plaintiffs assert in the Texas Action
that Dynex breached the terms of the Credit Agreement (the "Credit Agreement"),
dated June 9, 1998, by and among the Company, Master Funding and Dynex. Such
breaches include chronic delays and shortfalls in funding the advances required
under the Credit Agreement and ultimately the refusal by Dynex to fund any
further advances under the Credit Agreement. Plaintiffs also allege that Dynex
and Mr. Dolph conspired to misrepresent and mischaracterize the Company's credit
underwriting criteria and its compliance with such criteria with the intention
of interfering with and causing actual damage to the Company's business,
prospective business and contracts. The Plaintiffs assert that Dynex' funding
delays and ultimate breach of the Credit Agreement were intended to force the
Plaintiffs to renegotiate the terms of their various agreements with Dynex and
related entities. Specifically, the Plaintiffs assert that Dynex intended to
force the Company to accept something less than Dynex' full performance of its
obligations under the Credit Agreement. Further, Dynex intended to force the
controlling shareholders of the Company to agree to sell their stock in the
Company to Dynex or an affiliate at a share price substantially lower than the
$6.00 per share price specified in the Stock Option Agreement, dated as of June
9, 1998, by and among Messrs. William O. Winsauer, John S. Winsauer and Adrian
Katz (collectively, the "Shareholders") and Dynex Holding, Inc. Plaintiffs in
the Texas Action request declaratory judgement that (a) Dynex has breached and
is in breach of its various agreements and contracts with the Plaintiffs, (b)
Plaintiffs have not and are not in breach of their various agreements and
contracts with Defendants, (c) neither the Company nor Master Funding has
substantially or materially violated or breached any representation or warranty
made to Dynex, including but not limited to the representation and warranty that
all or substantially all finance contracts funded or to be funded by Dynex
comply in full with, and have been acquired by the Company in accordance with,
the Company's customary underwriting guidelines and procedures; and (d) Dynex is
obligated to fund the Company in a prompt and timely manner as required by the
parties' various agreements. In addition to actual, punitive and exemplary
damages, the Plaintiffs also seek injunctive relief compelling Dynex to fund
immediately all advances due to the Company under the Credit Agreement.
On March 1, 1999, the Company and the other Plaintiffs filed an application
in the Texas Action for a temporary injunction joining Dynex (a) from continuing
to suspend or withhold funding pursuant to the Credit Agreement, (b) from
removing or attempting to remove the Company as servicer, and (c) from making
any further false or defamatory public statements regarding the Plaintiffs. A
hearing is scheduled for mid-April,1999 to consider this application. Dynex has
yet to file any responsive pleadings in the Texas Action.
On February 9, 1999, Dynex commenced an action against the Company in the
United States District Court for the Eastern District of Virginia (Richmond
District) (the "Virginia Action") seeking declaratory relief that Dynex is (a)
not obligated to advance funds to Master Funding under the Credit Agreement
because the conditions to funding set forth in the Credit Agreement have not
been met, and (b) entitled to access to all books, records and other documents
of Master Funding, including all finance contract files. Specifically, Dynex
alleges that as a result of a partial inspection of certain finance contract
files by Mr. Dolph and Virgil Baker & Associates in January 1999, Dynex
concluded that a significant number of such contracts contained material
deviations from the applicable credit criteria and procedures, an apparent
breach of the Credit Agreement. Dynex also alleges that on February 8, 1999, the
Company refused to permit Mr. Dolph and representatives from Dynex access to the
books, records and finance contract files of the Company. Dynex concludes that
as a result of such alleged breaches, it is not obligated to provide advances
under the Credit Agreement. The Company, Messrs. William O. Winsauer, John S.
-- 17 --
<PAGE>
Winsauer and Adrian Katz filed a responsive pleading on March 25, 1999. The
Company intends to seek dismissal of the Virginia Action on the basis that these
matters are being litigated in the previously filed Texas Action.
On February 22, 1999, the same day that Dynex notified the Company of a
purported servicing termination, Dynex filed another action against the Company
in the United States District Court for the Southern District of New York (the
"New York Action"), seeking damages and injunctive relief for the Company's
alleged breaches under the servicing agreement among the Company, Dynex and
Master Funding. The Company was not notified of the New York Action until March
1, 1999, when Dynex sought a temporary restraining order against the Company.
After hearing argument from counsel for both sides, the temporary restraining
order was denied. On March 23, 1999, the court issued an order transferring the
action to the federal district court in the Eastern District of Virginia. To be
clear, notwithstanding Dynex' assertion in past statements, the Company remains
the servicer, is performing in its capacity as servicer, and has not hit any
triggering event thresholds, as defined in the servicing agreement.
In March 1998, after Progressive Northern Insurance purported to cancel the
VSI and deficiency balance insurance policies issued in favor of the Company,
the Company sued Progressive, its affiliate United Financial Casualty Co. and
their agent in Texas, Technical Risks, Inc. in the district court of Harris
County, Texas. The action seeks declaratory relief confirming the Company's
interpretation of the policies, as discussed under "Business -- Recent
Developments", as well as claims for damages based upon breach of contract, bad
faith and fraud. The Company has not yet received the defendants' answers.
Also in March 1998, the Company commenced an action in Travis County, Texas,
against Loan Servicing Enterprise, alleging LSE's contractual breach of its
servicing obligations on a continuing basis. LSE has commenced an action
against the Company in Illinois State court seeking recovery from the Company of
putative termination fees in connection with LSE's termination as servicer. The
Company expects the two actions to be consolidated.
The Company's carrier for the credit deficiency insurance obtained through
1996, Interstate Fire & Casualty Co. ("Interstate") determined in late 1996 to
no longer offer such coverage to the auto finance industry, including the
Company. In connection with Interstate's attempt to no longer offer credit
deficiency coverage for contracts originated after December 1996, the Company
commenced an action in the United States District Court for the Western District
of Texas, Austin Division, seeking a declaratory judgment that (a) the Company
was entitled to 180 days' prior notice of cancellation and (b) Interstate was
not entitled to raise premiums on finance contracts for which coverage was
obtained prior to the effectiveness of such cancellation, as well as seeking
damages for Interstate's alleged deficiencies in paying claims. Prior to
receiving the Company's complaint in the Texas action, Interstate commenced a
similar action for declaratory relief in the United States Court for the
Northern District of Illinois. While settlement discussions are ongoing,
Interstate and the Company have to date acted on the basis of a cancellation
date of May 12, 1997 (i.e., no finance contracts presented after that date will
be eligible for credit deficiency coverage by Interstate, although all existing
contracts for which coverage was obtained will continue to have the benefits of
such coverage), no additional premiums having been demanded or paid, and the
claims-paying process having been streamlined. In particular, in order to speed
the claims-paying process, Interstate has paid lump sums to the Company as an
estimate of claims payable prior to completion of processing. Pending the
Company's determination of the appropriate beneficiary for such claims payments,
the Company has deposited and will continue to deposit such funds into a
segregated account.
In February 1997 the Company discovered certain breaches of representations
and warranties by certain dealers with respect to finance contracts sold into a
securitization. The Company honored its obligations to the securitization trust
and repurchased finance contracts totaling $619,520 from that trust during the
three months ended March 31, 1997. Of the total amount of these finance
contracts, $190,320 were purchased from one dealer. Although the Company has
requested that this dealer repurchase such contracts, the dealer has refused.
After such dealer's refusal to repurchase, the Company commenced an action in
the 157th Judicial District Court for Harris County, Texas against Charlie
Thomas Ford, Inc. to compel such repurchase. On favorable terms, the Company has
reached a settlement agreement with Charlie Thomas Ford, Inc. The Company has
received funds related to such settlement.
On March 31, 1999, a suit naming the Company and William O. Winsauer,
Adrian Katz and John S. Winsauer (in their capacities as controlling
shareholders of the Company) as defendants (the "Defendants") was filed in the
United States District Court for the Western District of Texas (Austin Division)
by Bruce Willis (the "Plaintiff"), a holder of the Company's 15% Series A
Cumulative Preferred
-- 18 --
<PAGE>
Stock. The suit alleges, among other things, that the Defendants violated
Section 10(b) of the Securities and Exchange Act of 1934 (and Rule 10b-5
promulgated thereunder) in failing to disclose adequately and in causing
misstatements concerning the nature and condition of the Company's financing
sources. The suit also alleges that such actions constituted statutory fraud
under the Texas Business Corporation Act, common law fraud and negligent
misrepresentation. The Plaintiff seeks class action certification. The
Plaintiff also seeks, among other things, actual, special, consequential, and
exemplary damages in an unspecified sum, as well as costs and expenses incurred
in connection with pursuing the action against the Company. While the Company
has yet to file a responsive pleading, the Company nevertheless believes that it
has consistently and accurately informed the public of its business and
operations, including the viability of its funding sources, and, as a
consequence believes the suit to be without merit and intends to vigorously
defend against this action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
-- 19 --
<PAGE>
--------
PART II
--------
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
On November 8, 1996, the Company's Common Stock was listed for quotation
and began trading on NASDAQ National Market ("NASDAQ") under the symbol "ABND".
Prior to such date, the Company's stock was closely held and not traded on any
regional or national exchange. On February 27, 1998, the Company's common stock
listing was transferred to the American Stock Exchange and began trading under
the symbol "ABD".
<TABLE>
<CAPTION>
HIGH AND LOW SALE PRICES BY PERIOD
<S> <C> <C>
QUARTER ENDED. . . HIGH LOW
- ------------------ -------- --------
December 31, 1996. $ 11 $ 9 1/4
March 31, 1997 . . $ 10 3/8 $ 4
June 30, 1997. . . $ 4 3/4 $ 2 1/4
September 30, 1997 $ 5 1/8 $3 13/16
December 31, 1997. $ 4 1/2 $ 2 5/8
March 31, 1998 . . $ 8 7/8 $2 13/16
June 30, 1998. . . $ 8 1/4 $ 5 1/8
September 30, 1998 $7 15/16 $ 5 3/8
December 31, 1998. $ 5 3/8 $ 3
</TABLE>
The transfer agent and registrar for the Common Stock is American Stock
Transfer & Trust Company. As of December 31, 1998, the Company had approximately
16 stockholders of record, exclusive of holders who own their shares in "street"
or nominee names.
The Company has not paid and does not presently intend to pay cash
dividends on its common stock. The Company anticipates that its earnings for the
foreseeable future will be retained for use in operation and expansion of
business. Payment of cash dividends, if any, in the future will be at the sole
discretion of the Company's Board of Directors and will depend upon the
Company's financial condition, earnings, current and anticipated capital
requirements, terms of indebtedness and other factors deemed relevant by the
Company's Board of Directors. See "Recent Developments" and "Liquidity and
Capital Resources".
-- 20 --
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the
Company and its subsidiaries for the periods and at the dates indicated. The
selected financial data were derived from the financial statements and
accounting records of the Company. The data presented below should be read in
conjunction with the consolidated financial statements, related notes and other
financial information included herein. (Dollars in thousands, except for per
share amounts.)
<TABLE>
<CAPTION>
Year Ended December 31,
1994(2) 1995 1996 1997 1998
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Statement of operations data:
Interest income . . . . . . . . . . . . . . . . . . . . $ 38 $ 2,881 $ 2,520 $ 4,119 $ 1,499
Gain on sale of finance contracts . . . . . . . . . . . - 4,086 12,820 18,667 17,985
Servicing fee income. . . . . . . . . . . . . . . . . . - - 658 1,131 3,222
Other income (loss) . . . . . . . . . . . . . . . . . . - - 388 (173) 348
----------- ----------- ----------- ----------- -----------
Total revenues. . . . . . . . . . . . . . . . . . . . . 38 6,967 16,386 23,743 $ 23,054
----------- ----------- ----------- ----------- -----------
Provision for credit losses . . . . . . . . . . . . . . 45 49 412 613 100
Interest expense. . . . . . . . . . . . . . . . . . . . 19 2,100 2,383 3,880 3,117
Salaries and benefits . . . . . . . . . . . . . . . . . 226 1,320 4,529 7,357 10,472
General and administrative. . . . . . . . . . . . . . . 245 1,463 2,331 6,075 6,782
Impairment of retained interest in securitizations. . . - - 1,312 9,932
Other operating expenses. . . . . . . . . . . . . . . . 48 963 1,120 2,005 3,422
----------- ----------- ----------- ----------- -----------
Total expenses. . . . . . . . . . . . . . . . . . . . . 543 5,895 10,775 21,242 33,825
----------- ----------- ----------- ----------- -----------
Income (loss) before taxes and extraordinary loss . . . (545) 1,072 5,611 2,501 (10,771)
Provision for income taxes. . . . . . . . . . . . . . . - 199 1,926 888 (3,626)
Extraordinary loss, net of tax benefit. . . . . . . . . - - (100) - -
----------- ----------- ----------- ----------- -----------
Net income (loss) . . . . . . . . . . . . . . . . . . . $ (545) $ 873 $ 3,585 $ 1,613 (7,145)
----------- ----------- ----------- ----------- -----------
Net income (loss) attributable to common shareholders . (545) 873 3,585 1,613 (8,584)
Earnings per share before extraordinary item. . . . . . $ (0.11) $ 0.17 $ 0.64 $ 0.25 ($1.31)
Earnings per share-diluted. . . . . . . . . . . . . . . $ (0.11) $ 0.17 $ 0.62 $ 0.25 ($1.31)
Weighted average shares outstanding-diluted . . . . . . 5,118,753 5,190,159 5,809,157 6,965,877 6,531,311
Cash flow data:
Cash provided by (used in) operating activities . . . . (2,514) (5,458) (5,730) (14,455) 4,721
Cash provided by (used in) investing activities . . . . (16) (442) 421 513 80
Cash provided by financing activities . . . . . . . . . 2,530 5,992 9,337 9,980 211
Balance sheet data:
Cash and cash equivalents . . . . . . . . . . . . . . . $ - $ 93 $ 4,121 $ 159 $ 5,171
Restricted funds. . . . . . . . . . . . . . . . . . . . - 1,683 2,982 6,904 -
Finance contracts held for sale, net. . . . . . . . . . 2,361 3,355 228 1,366 867
Retained interests in securitization. . . . . . . . . . - 4,206 16,943 32,017 13,873
Total assets. . . . . . . . . . . . . . . . . . . . . . 2,500 11,065 26,133 43,210 30,331
Revolving credit agreement. . . . . . . . . . . . . . . 2,055 1,150 - 7,639 -
Notes payable & non-recourse debt . . . . . . . . . . . - 2,675 10,175 9,841 13,352
Repurchase agreement. . . . . . . . . . . . . . . . . . - 1,061 - - -
Total debt. . . . . . . . . . . . . . . . . . . . . . . 2,055 4,886 10,175 17,480 13,352
Shareholders' equity. . . . . . . . . . . . . . . . . . (109) 3,026 12,142 15,348 15,552
Asset quality data:
Delinquencies as a percentage of principal balance of
finance contract portfolio serviced (end of period) (1)
30-59 days past due . . . . . . . . . . . . . . . . . . - 4.69% 7.55% 11.48% 9.81%
60+ days past due . . . . . . . . . . . . . . . . . . . - 2.32% 4.63% 5.85% 3.75%
<FN>
1 Includes the Company's entire finance contract portfolio of contracts held and contracts securitized. Excluded are
loans that are repossessed, with total loss insurance claim paid, charged-off, or identified to be repurchased by dealer
(or seller).
2 The Company was incorporated on June 15, 1993 and commenced operations on August 1994.
</TABLE>
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the preceding "Selected
Financial Data" and the Company's Consolidated Financial Statements and Notes
thereto and the other financial data included herein. Certain of the financial
information set forth below has been rounded in order to simplify its
presentation. However, the ratios and percentages set forth below are calculated
using the detailed financial information contained in the Financial Statements
and the Notes thereto, and the financial data included elsewhere in this Form
10-K.
The Company is a specialty consumer finance company engaged in
underwriting, acquiring, servicing and securitizing retail installment contracts
("finance contracts") originated by franchised automobile dealers in connection
with the sale of used and, to a lesser extent, new vehicles to selected
consumers with limited access to traditional sources of credit ("sub-prime
consumers"). Sub-prime consumers generally are borrowers unable to qualify for
traditional financing due to one or more of the following reasons: negative
credit history (which may include late payments, charge-offs, bankruptcies,
repossessions or unpaid judgments); insufficient credit; employment or residence
histories; or high debt-to-income or payment-to-income ratios (which may
indicate payment or economic risk).
The Company acquires finance contracts generally from franchised automobile
dealers, makes credit decisions using its own underwriting guidelines and credit
personnel and performs the collection function for finance contracts using its
own collections department. The Company also acquires finance contracts from
third parties other than dealers, for which the Company reunderwrites and
collects such finance contracts in accordance with the Company's standard
guidelines. The Company securitizes portfolios of these retail automobile
installment contracts to efficiently utilize limited capital to allow continued
growth and to achieve sufficient finance contract volume to allow profitability.
The Company markets a single finance contract acquisition program to automobile
dealers, which adheres to consistent underwriting guidelines involving the
purchase of primarily late-model used vehicles. The Company has experienced
significant growth in its finance contract portfolio since it commenced
operations in August 1994.
The continued acquisition and servicing of sub-prime finance contracts by
an independent finance company under current market conditions is a capital and
labor intensive enterprise. Capital is needed to fund the acquisition of finance
contracts and to effectively securitize them so that additional capital is made
available for acquisition activity. While a portion of the Company's financing
has been obtained with investment grade ratings at relatively low interest
rates, the remainder is difficult to obtain and requires the Company to pay high
coupons, fees and other issuance expenses, with a negative impact on earnings.
The underwriting and servicing of a growing sub-prime finance contract portfolio
requires a higher level of experienced personnel than that required for a
portfolio of higher credit-quality consumer loans. Accordingly, the Company's
growth in finance contract volume since inception has corresponded with a
significant increase in expenses related to building the infrastructure
necessary for effective underwriting and servicing. Although the Company's
assumption of all servicing functions in late 1997 has increased servicing
income, and the Company began to realize overall improvements in net income as
the growth in acquisition volume continued through January 1999, in view of the
Dynex situation and the high cost of capital, the Company does not expect to see
profitability until alternate funding is obtained.
REVENUES
The Company's primary sources of revenues consist of three components:
interest income, gain on sale of finance contracts and servicing fee income.
Interest Income. Interest income consists of the sum of two primary
components: (i) interest income earned on finance contracts held for sale by the
Company and (ii) interest income earned on retained interests in
securitizations. Other factors influencing interest income during a given
fiscal period include (a) the annual percentage rate of the finance contracts
acquired, (b) the aggregate principal balance of finance contracts acquired and
funded through the Company's warehouse and other credit facilities prior to
securitization, and (c) the length of time such contracts are funded by the
warehouse and other credit facilities.
-- 22 --
<PAGE>
Gain on Sale of Finance Contracts. The Company implemented Statement of
Financial Accounting Standards No. 125 "Transfer and Servicing of Financial
Assets and Extinguishment of Liabilities" ("SFAS No. 125") as of January 1,
1997. SFAS No. 125 provides new accounting and reporting standards for transfers
and servicing of financial assets and extinguishment of liabilities. This
statement also provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings and
requires that liabilities and derivatives incurred or obtained by transferors as
part of a transfer of financial assets be initially measured at fair value. For
transfers that result in the recognition of a sale, SFAS No. 125 requires that
the newly created assets obtained and liabilities incurred by the transferors as
a part of a transfer of financial assets be initially measured at fair value.
Interests in the assets that are retained are measured by allocating the
previous carrying amount of the assets (e.g. finance contracts) between the
interests sold (e.g. investor certificates) and interests retained based on
their relative fair values at the date of the transfer. The amounts initially
assigned to these financial components is a determinant of the gain or loss from
a securitization transaction under SFAS No. 125.
The retained interests in securitizations available for sale are carried at
estimated fair value with unrealized gains (losses) recorded in stockholders'
equity as part of accumulated other comprehensive income and those classified as
trading are carried at estimated fair value with unrealized gain (losses)
recorded currently in income. The fair value of the retained interests in
securitizations is determined by discounting expected cash flows at a rate based
on assumptions that market participants would use for similar financial
instruments subject to prepayment, default, collateral value and interest rate
risks. The Company's retained interests are subordinated to other trust
securities, consequently cash flows are paid by the securitization trustee to
the investor security holders until such time as all accrued interest together
with principal have been paid in full. Subsequently, all remaining cash flows
are paid to the Company.
An impairment review of the retained interest in securitizations is
performed quarterly by calculating the net present value of the expected future
excess spread cash flows after giving effect to changes in assumptions due to
market and economic changes and the performance of the loan pool to date.
Impairment is determined on a disaggregated basis consistent with the risk
characteristics of the underlying finance contracts as well as the performance
of the pool to date. To the extent that the Company deems the asset to be
permanently impaired, the Company would record a charge against earnings and
write down the asset accordingly. The Company recorded a charge to income of
$9,932,169 during the year ended December 31, 1998 as a result of the impairment
review. See Notes 2 and 5 to the Consolidated Financial Statements.
The Company's cost basis in finance contracts sold has varied from
approximately 92% to 103% of the value of the principal balance of such finance
contracts. This portion of recognized gain on sale varies based on the Company's
cost of insurance covering the finance contracts and the discount obtained upon
acquisition of the finance contracts. Generally, the Company has acquired
finance contracts from dealers at a greater discount than with finance contracts
acquired from third parties. Additionally, costs of sale reduce the total gain
recognized.
Further, the retained interest component of recognized gain is affected by
various factors, including most significantly, the coupon on the senior investor
securities and the age of the finance contracts in the pool, as the excess
spread cash flow from a pool of aged, as opposed to new, finance contracts is
less. The aging (capture of excess spread prior to securitization) necessarily
results in less available excess spread cash flow from the securitization.
The gain on sale of finance contracts is affected by the aggregate
principal balance of contracts securitized and the gross interest spread on
those contracts. The following table illustrates the gross interest spread for
each of the Company's securitizations through December 31, 1998(dollars in
thousands):
-- 23 --
<PAGE>
<TABLE>
<CAPTION>
Finance Contracts(1) Senior Investor Certificates
-------------------- ----------------------------
Principal Weighted Balance
Amount Average December 31, Gross
Securitization Securitized Rate 1998 Rate Spread(2)
- ----------------------------- ------------ --------- ------------- ------- ---------
<S> <C> <C> <C> <C> <C>
AutoBond Receivables
Trust 1995-A. . . . . . . . . $ 26,261,009 18.9% $ 6,019,329 7.2% 11.7%
Trust 1996-A. . . . . . . . . 16,563,366 19.7% 5,416,372 7.2% 12.5%
Trust 1996-B. . . . . . . . . 17,832,885 19.7% 6,671,800 7.7% 12.0%
Trust 1996-C. . . . . . . . . 22,296,719 19.7% 10,436,867 7.5% 12.2%
Trust 1996-D. . . . . . . . . 25,000,000 19.5% 12,446,374 7.4% 12.1%
Trust 1997-A (4). . . . . . . 28,037,167 20.8% 13,862,448 7.8% 13.0%
Trust 1997-B. . . . . . . . . 34,725,196 19.9% 22,936,843 7.7% 12.2%
Trust 1997-C. . . . . . . . . 34,430,079 20.0% 24,455,075 7.6% 12.4%
AutoBond Master Funding
Corporation V Trust(Dynex)(3) 137,772,888 20.0% 110,049,311 7.4%(3) 12.6%
------------ -------------
Total . . . . . . . . . . . . $342,919,309 $ 212,294,419
============ =============
<FN>
1 Refers only to balances on senior investor certificates.
2 Difference between weighted average contract rate and senior certificate rate.
3 Includes $26 million of finance contracts from securitizations previously retired
4 Weighted average of senior investor coupon rates
</TABLE>
Servicing Fee Income. The Company earns substantially all of its servicing
fee income on the contracts it services on behalf of securitization trusts.
Servicing fee income consists of: (i) contractual administrative fees received
through securitizations, equal to $7.00 per month per contract included in each
trust (excluding amounts paid to third-party servicers by the trust); and (ii)
contractual servicing fees received through securitizations, equal to $8.00 per
month per contract included in each trust; and (iii) fee income earned as
servicer for such items as late charges and documentation fees, which are earned
whether or not a securitization has occurred.
FINANCE CONTRACT ACQUISITION ACTIVITY
The following table sets forth information about the Company's finance
contract acquisition activity (dollars in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1998
------------ ------------
<S> <C> <C>
Number of finance contracts acquired . . . . . . 13,189 10,176
Principal balance of finance contracts acquired $148,931,331 $119,166,628
Number of active dealerships 1. . . . . . . . . 1,060 1,064
Number of enrolled dealerships. . . . . . . . . 1,621 2,254
<FN>
1 Dealers who have sold at least one finance contract to the Company during the
period.
</TABLE>
-- 24 --
<PAGE>
RESULTS OF OPERATIONS
Period-to-period comparisons of operating results may not be meaningful,
and results of operations from prior periods may not be indicative of future
results. The following discussion and analysis should be read in conjunction
with the Company's Consolidated Financial Statements and the Notes thereto.
Year Ended December 31, 1998 Compared To Year Ended December 31, 1997
Net Income
In the year ended December 31, 1998, net income decreased $8,757,476 to a
net loss of $7,144,423 from $1,613,053 for the year ended December 31, 1997. The
decrease in net income was primarily attributable to an increase in
infrastructure costs to support higher anticipated finance contract acquisition
and servicing volumes, impairment charges on retained interest in
securitizations, and actual decreases in acquisition volume. The principal
balance of finance contracts acquired decreased due to the delay between the
expiration of the Daiwa warehouse facility on March 31, 1998 and the
implementation of the Dynex funding agreement in June 1998. This delay forced
the Company to slow its acquisition of finance contracts in the second quarter.
Third quarter acquisitions improved over the second quarter, but nonetheless had
not yet returned to earlier levels. Growth continued throughout the fourth
quarter with a finance contract origination volume of $48.1 million. Increased
hiring of qualified personnel, as they became available during the past year
added to the growth in salary and benefit expenses.
Total Revenues
Total revenues decreased $688,883 to $23,054,478 for the year ended
December 31, 1998 from $23,743,361 for the year ended December 31, 1997. The
decrease was due primarily from the volume of finance activity for the first two
quarters. Originations and sales accelerated in the later part of the third
quarter and continued through the fourth quarter.
Interest Income. Interest income decreased $2,619,810 to $1,498,985 for the
year ended December 31, 1998 from $4,118,795 for the year ended December 31,
1997 due to the timing of finance contract acquisitions and the period held
before securitization.
Gain on Sale of Finance Contracts. The Company realized gain on sale
totaling $17,985,045 on finance contracts carried at $111.17 million (16.10%)
during the year ended December 31, 1998. The Company realized gain on sale
totaling $18,666,570 on finance contracts carried at $136.4 million (13.7%)
during the year ended December 31, 1997. The increased profitability is the
result of the arrangement with Dynex which provided higher cash proceeds upon
sale.
Servicing Fee Income. The Company reports servicing fee income only with
respect to finance contracts that are securitized. For the year ended December
31, 1998, servicing fee income was $3,222,669, consisting of contractual
administrative fees and servicer fees. Servicing fee income increased by
$2,091,527 from the year ended December 31, 1997 as a result of the Company
assuming servicer functions in December 1997.
Other Income (Loss). For year ended December 31, 1998, other income (loss)
amounted to $347,779, compared with a loss of $173,146 for the comparable 1997
period. The increase was mainly attributable to recoveries on loans that had
previously been written-off.
-- 25 --
<PAGE>
Total Expenses
Total expenses of the Company increased $12,583,132 to $33,825,270 for year
ended December 31, 1998 from $21,242,138 for the year ended December 31, 1997,
due primarily to impairment of retained interest in securitizations of
$9,932,169 for the year ended December 31, 1998, as well as increases in
salaries and benefits and other expenses. The Company moved to larger facilities
in June 1998 thereby increasing occupancy costs.
Provision for Credit Losses. Provision for credit losses on finance
contracts decreased $512,715 to $100,000 for the year ended December 31, 1998
from $612,715 for the year ended December 31, 1997. The decrease was the result
of a reduction in the number and amount of finance contracts held for sale.
Interest Expense. Interest expense decreased $762,332 to $3,117,211 for the
year ended December 31, 1998 from $3,879,543 for the year ended December 31,
1997. The decrease resulted from a lower average balance outstanding relating to
revolving credit facilities.
Salaries and Benefits. Salaries and benefits increased $3,114,331 to
$10,471,615 for the year ended December 31, 1998 from $7,357,284 the year ended
December 31, 1997. This increase was due primarily to an increase in the number
of the Company's employees necessary to handle the increased contract
acquisition volume and the servicing and collection activities on a growing
portfolio of finance contracts. As of December 1, 1997 the Company completed the
transfer of certain servicing functions from LSE to in-house personnel and
equipment.
General and Administrative Expenses. General and administrative expenses
increased $706,890 to $6,782,015 for the year ended December 31, 1998 from
$6,075,125 the year ended December 31, 1997. In anticipation of expansion of its
operations the Company relocated its offices to a larger facility. The
associated increased rent was the major reason for the increase. Rent increased
$401,130 to $647,255 for the year ended December 31, 1998 compared with $246,125
for the year ended December 31, 1997.
Impairment of Retained Interest in Securitizations. The Company
periodically reviews the fair value of the retained interest in securitizations.
The Company recorded a charge against earnings for impairment of these assets of
$9,932,169 for the year ended December 31, 1998. This impairment reflects the
revaluation of expected future cash flows to the Company from securitizations.
As the Company assumed all servicing functions, it accelerated the rate of
charge-offs as compared with previous periods, thereby allocating additional
cash collections and reserve account balances to paying down the senior investor
securities. The effect of this was to stop payments of interest on subordinated
securities issued in the securitizations, thereby causing accretion in the
principal balances of such securities, resulting in reduced residual cash flows
to the Company. See Note 5 to the Notes to Consolidated Financial Statements.
See "Legal Proceedings".
Other Operating Expenses. Other operating expenses (consisting principally
of servicer fees, credit bureau reports, communications and insurance) increased
$1,417,023 to $3,422,260 for the year ended December 31, 1998 from $2,005,237
for the year ended December 31, 1997. This increase was due mainly to increases
in finance contract acquisition and payment of insurance premiums.
Year Ended December 31, 1997 Compared To Year Ended December 31, 1996
Net Income
In the year ended December 31, 1997, net income decreased $1,971,833 to
$1,613,053 from $3,584,886 for the year ended December 31, 1996. The decrease in
net income was primarily attributable to an increase in infrastructure costs to
support higher finance contract acquisition and servicing volume, as more fully
discussed under "Total Expenses" below. The principal balance of finance
contracts acquired increased $62.4 million to $148.9 million for the year ended
December 31, 1997 from $86.5 million for the year ended December 31, 1996. Due
to weakened competitors, the Company more aggressively added qualified personnel
as they became available in the year ended December 31, 1997, and this added to
the growth in salary and benefit expenses.
-- 26 --
<PAGE>
Total Revenues
Total revenues increased $7,356,821 to $23,743,361 for the year ended
December 31, 1997 from $16,386,540 for the year ended December 31, 1996 due to
expansion of the Company's finance contract acquisition and securitization
activities.
Interest Income. Interest income increased $1,599,183 to $4,118,795 for the
year ended December 31, 1997 from $2,519,612 for the year ended December 31,
1996 due the growth and timing of finance contract acquisitions. The Company
acquired finance contracts totaling $148.9 million during the year ended
December 31, 1997 compared to $86.5 million in the comparable 1996 period.
Accretion on retained interest in securitizations increased $392,478 from the
respective 1996 period to $546,507 during the year ended December 31, 1997.
Gain on Sale of Finance Contracts. The Company realized gain on sale
totaling $18,666,570 on finance contracts carried at $136.4 million (13.7%)
during the year ended December 31, 1997. Gain on sale amounted to $12,820,700 on
finance contracts carried at $85.0 million (15.1%) in the comparable 1996
period. Accordingly, gain on sale of finance contracts rose $5,845,870 during
the year ended December 31, 1997 over the comparable 1996 period.
Servicing Fee Income. The Company reports servicing fee income only with
respect to finance contracts that are securitized. For the year ended December
31, 1997, servicing fee income was $1,131,142, primarily collection agent fees.
Servicing fee income increased by $473,192 from the year ended December 31, 1996
as a result of increased securitization activity by the Company. The ratio of
servicing fee income to the average principal balance of finance contracts
outstanding declined from 1.0% for the year ended December 31, 1996 to .7%
during the year ended December 31, 1997, as the Company waived $149,415 in
servicing fees during the later period. The Company waived these servicing fees
to enhance the liquidity of specific outstanding securitization trusts during
1997, increasing the rate of repayment of non-recourse notes. The result of such
waiver is the deferral and subordination of the Company's ultimate receipt of
such waived fees.
Other Income (Loss). For year ended December 31, 1997, other income (loss)
amounted to ($173,146) compared with $388,278 for the comparable 1996 period
Total Expenses
Total expenses of the Company increased $10,467,037 to $21,242,138 for year
ended December 31, 1997 from $10,775,101 for the year ended December 31, 1996.
As of December 1, 1997 the Company completed the transfer of certain servicing
functions from LSE to in-house personnel and equipment. The Company incurred
significant expenses in the hiring and training of personnel as well as the
acquisition and leasing of equipment primarily to facilitate the servicing
transfer during the year ended December 31, 1997.
Provision for Credit Losses. Provision for credit losses on finance
contracts increased $200,328 to $612,715 for the year ended December 31, 1997
from $412,387 for the year ended December 31, 1996 due to an evaluation of the
owned finance contracts portfolio.
Interest Expense. Interest expense rose to $3,879,543 for the year ended
December 31, 1997 from $2,382,818 for the year ended December 31, 1996. Interest
expense increased by $1,496,725 due to higher borrowing volumes outstanding
under the revolving credit facilities, along with increased debt issuance costs
amortization of $320,985.
Salaries and Benefits. Salaries and benefits increased $2,828,278 to
$7,357,284 for the year ended December 31, 1997 from $4,529,006 the year ended
December 31, 1996. This increase was due primarily to an increase in the number
of the Company's employees necessary to handle the increased contract
acquisition volume and the collection activities on a growing portfolio of
finance contracts. As of December 1, 1997 the Company completed the transfer of
certain servicing functions from LSE to in-house personnel and equipment. The
Company incurred significant expenses in the hiring and training of personnel as
well as the acquisition and leasing of equipment to facilitate the servicing
transfer during the year ended December 31, 1997. The number of employees of the
Company increased by 75 to 191 employees at December 31, 1997, compared to 116
employees at December 31, 1996.
-- 27 --
<PAGE>
General and Administrative Expenses. General and administrative expenses
increased $3,743,879 to $6,075,125 for the year ended December 31, 1997 from
$2,331,246 the year ended December 31, 1996. This increase was due primarily to
growth in the Company's operations. General and administrative expenses consist
principally of office, furniture and equipment leases, professional fees,
non-employee marketing commissions, communications and office supplies, and are
expected to increase as the Company continues to grow and also due to the costs
of operating as a public company.
Impairment of retained interest in securitization: Impairment of retained
interest in securitization increased $1,312,234 to $1,312,234 as a result a
review of the estimate of the timing and ultimate receipt of cash flows.
Other Operating Expenses. Other operating expenses (consisting principally
of servicer fees, credit bureau reports and insurance) increased $885,593 to
$2,005,237 for the year ended December 31, 1997 from $1,119,644 for the year
ended December 31, 1996. This increase was due to increased finance contract
acquisition volume.
FINANCIAL CONDITION
Restricted Cash. Restricted cash decreased $6.9 million to none at December
31, 1998 from $6.9 million at December 31, 1997, reflecting the elimination of
cash reserve accounts in the new funding agreement with Dynex. In accordance
with the Company's previous revolving credit facilities, proceeds advanced by
the lender for purchase of finance contracts were held by a trustee until the
Company delivered qualifying collateral to release the funds, normally in a
matter of days. The Company was also required to maintain a cash reserve with
its lenders up to 10% of the proceeds received from the lender for the
origination of the finance contracts. Access to these funds was restricted by
the lender.
Finance Contracts Held for Sale. Finance contracts held for sale, net of
allowance for credit losses, decreased $0.5 million to $0.9 million at December
31, 1998, from $1.4 million at December 31, 1997. The number and principal
balance of contracts held for sale are largely dependent upon the timing and
size of the Company's securitizations. The Company securitized finance contracts
on a regular basis through the Dynex funding agreement. Future securitizations
are uncertain.
Retained Interest in Securitizations. An impairment review of the retained
interest in securitizations is performed quarterly by calculating the net
present value of the expected future cash flows after giving effect to changes
in assumptions due to market and economic changes and the performance of the
loan pool to date. The discount rate used is an estimated market rate, currently
15% to 17%. To the extent that the Company deems the asset to be permanently
impaired, the Company records a charge against earnings. The Company recorded a
charge against earnings of $9,932,169 during the year ended December 31, 1998 as
a result of the impairment review.
Finance contracts are continuously acquired and sold and therefore the
retained interest in securitizations can demonstrate increases while realizing
impairments. The reduction of the Company's retained interest in securitizations
at December 31, 1998 versus the prior periods is primarily as a result of
increased monetization through the Dynex warehouse facility.
The following table presents the valuation and recorded impairment of the
Company's retained interest in securitizations for the year ended December 31,
1998, by quarter:
<TABLE>
<CAPTION>
March 31, 1998 June 30, 1998 September 30, 1998 December 31, 1998
--------------- -------------- ------------------- ------------------
<S> <C> <C> <C> <C>
Valuations of
retained interest
in securitizations $ 35,643,756 $ 33,043,626 $ 17,000,966 $ 13,873,351
Impairment . . . . $ 288,022 $ 5,589,802 $ 1,637,191 $ 2,417,154
--------------- -------------- ------------------- ------------------
</TABLE>
-- 28 --
<PAGE>
Prior to the Dynex funding agreement, at the time a securitization closes,
the Company's securitization subsidiary was required to fund a cash reserve
account within the trust to provide additional credit support for the senior
investor securities. Additionally, depending on the structure of the
securitization, a portion of the future excess spread cash flows from the trust
is required to be deposited in the cash reserve account to increase the initial
deposit to a specified level. A portion of excess spread cash flows will
increase such reserves until they reach a target reserve level (initially 6%) of
the outstanding balance of the senior investor certificates. The trust
receivables are ultimately payable to the Company as owner of retained interests
and are included in the estimated cash flow of such retained interests. (i.e.
the "cash out" method).
The cash reserve deposits for the Company's securitizations follow:
<TABLE>
<CAPTION>
Certificate Initial Reserve Reserve Balance
Securitization Amount (1) Deposit Dec. 31, 1998
- --------------------------------- ------------- ---------------- ----------------
<S> <C> <C> <C>
AutoBond Receivables Trust 1995-A $ 26,261,009 $ 525,220 $ 320,000
AutoBond Receivables Trust 1996-A 16,563,366 331,267 207,042
AutoBond Receivables Trust 1996-B 17,833,885 356,658 223,000
AutoBond Receivables Trust 1996-C 22,297,719 445,934 278,700
AutoBond Receivables Trust 1996-D 25,000,000 500,000 312,500
AutoBond Receivables Trust 1997-A 28,037,167 560,744 350,464
AutoBond Receivables Trust 1997-B 34,725,196 868,130 -
AutoBond Receivables Trust 1997-C 34,430,079 860,752 61,114
- --------------------------------- ------------- ---------------- ----------------
<FN>
1 Refers only to balances on senior Investor certificates upon issuance.
</TABLE>
DELINQUENCY EXPERIENCE
The following table reflects the delinquency experience of the Company's
finance contract portfolio:
<TABLE>
<CAPTION>
December 31, 1997 (2) December 31, 1998
--------------------- -----------------
<S> <C> <C> <C> <C>
Principal balance of finance contracts outstanding $187,098,957 $210,947,939
Delinquent finance contracts (1):
Two payments past due. . . . . . . . . . . . . . . 21,484,450 11.48% 20,689,671 9.81%
Three payments past due. . . . . . . . . . . . . . 10,941,753 5.85% 7,901,166 3.75%
Four or more payments past due . . . . . . . . . . 8,368,493 4.47% 5,214,162 2.47%
Total. . . . . . . . . . . . . . . . . . . . . . . $ 40,794,696 21.80% $ 33,804,999 16.03%
<FN>
1 Percentage based upon outstanding balance. Delinquency balances outstanding excludes finance
contracts where the underlying vehicle is repossessed, where a dealer (seller) buyback is
expected, where a skip claim is paid and where a primary insurance claim is filed.
2 As of December 31, 1997, aging was calculated based on number of days past due using
categories 30-59 days past due, 60-89 days past due, and 90 days past due and over.
</TABLE>
-- 29 --
<PAGE>
CREDIT LOSS EXPERIENCE
An allowance for credit losses is maintained for contracts held for sale.
The Company reports a provision for credit losses on finance contracts held for
sale. Management evaluates the reasonableness of the assumptions employed by
reviewing credit loss experience, delinquencies, repossession trends, the size
of the finance contract portfolio and general economic conditions and trends. If
necessary, assumptions will be changed in the future to reflect historical
experience to the extent it deviates materially from that which was assumed.
-- 30 --
<PAGE>
If a delinquency exists and a default is deemed inevitable or the
collateral is in jeopardy, and in no event later than the 90th day of
delinquency, the Company's Collections Department will initiate the repossession
of the financed vehicle. Bonded, insured outside repossession agencies are used
to secure involuntary repossessions. In most jurisdictions, notice to the
borrower of the Company's intention to sell the repossessed vehicle is required,
whereupon the borrower may exercise certain rights to cure his or her default
and redeem the automobile. Following the expiration of the legally required
notice period, the repossessed vehicle is sold at a wholesale auto auction (or
in limited circumstances, through dealers), usually within 60 days of the
repossession. The Company closely monitors the condition of vehicles set for
auction, and procures an appraisal under the relevant VSI policy prior to sale.
Liquidation proceeds are applied to the borrower's outstanding obligation under
the finance contract and insurance claims under the VSI policy and, if
applicable, the deficiency balance policy are then filed.
Because of the Company's limited operating history, its finance contract
portfolio is somewhat unseasoned. This effect on the delinquency statistics can
be observed in the comparison of 1998 versus 1997 delinquency percentages since
the portfolio is tangibly more seasoned as of December 31, 1998. Accordingly,
delinquency and charge-off rates in the portfolio may not fully reflect the
rates that may apply when the average holding period for finance contracts in
the portfolio is longer. Increases in the delinquency and/or charge-off rates in
the portfolio would adversely affect the Company's ability to obtain credit or
securitize its receivables.
REPOSSESSION EXPERIENCE - STATIC POOL ANALYSIS
Because the Company's finance contract portfolio is continuing to grow,
management does not manage losses on the basis of a percentage of the Company's
finance contract portfolio, because percentages can be favorably affected by
large balances of recently acquired finance contracts. Management monitors
actual dollar levels of delinquencies and charge-offs and analyzes the data on a
"static pool" basis.
The following tables provide static pool repossession frequency analysis in
dollars of the Company's portfolio from inception through December 31, 1998. All
finance contracts have been segregated by quarter of acquisition. All
repossessions have been segregated by the quarter in which the repossessed
contract was originally acquired by the Company. Cumulative repossessions equals
the ratio of repossessions as a percentage of finance contracts acquired for
each segregated quarter. Annualized repossessions equals an annual equivalent of
the cumulative repossession ratio for each segregated quarter. This table
provides information regarding the Company's repossession experience over time.
For example, recently acquired finance contracts demonstrate very few
repossessions because properly underwritten finance contracts to sub-prime
consumers generally do not normally default during the initial term of the
contract. Between approximately one year and 18 months of seasoning, frequency
of repossessions on an annualized basis appear to reach a plateau. Based on
industry statistics and the performance experience of the Company's finance
contract portfolio, the Company believes that finance contracts seasoned in
excess of approximately 18 months will start to demonstrate declining
repossession frequency. The Company believes this may be due to the fact that
the borrower perceives that he or she has equity in the vehicle. The Company
also believes that the finance contracts generally amortize more quickly than
the collateral depreciates, and therefore losses and/or repossessions will
decline over time.
-- 31 --
<PAGE>
<TABLE>
<CAPTION>
ALL INCLUSIVE(3)
Repossession Frequency
----------------------
Year and Principal Balance at
Quarter of Default of Failed Loans by Cumulative Annualized Principal Balance of
Acquisition Quarter Acquired Percentage (1) Percentage (2) Contracts Acquired
----------- -------------------------- -------------- -------------- --------------------
<C> <S> <C> <C> <C> <C>
1994
1 Q3. . . . . 22,046 21.79% 4.84% 101,161
2 Q4. . . . . 631,460 25.90% 6.10% 2,437,674
1995
3 Q1. . . . . 1,860,450 29.48% 7.37% 6,310,421
4 Q2. . . . . 1,796,859 29.03% 7.74% 6,190,596
5 Q3. . . . . 2,185,377 30.19% 8.62% 7,239,813
6 Q4. . . . . 4,110,940 33.73% 10.38% 12,188,863
1996
7 Q1. . . . . 5,159,590 33.37% 11.12% 15,460,823
8 Q2. . . . . 6,515,618 35.18% 12.79% 18,520,410
9 Q3. . . . . 7,376,986 26.25% 10.50% 28,098,899
10 Q4. . . . . 7,904,067 32.34% 14.37% 24,442,500
1997
11 Q1. . . . . 10,860,604 31.14% 15.57% 34,875,869
12 Q2. . . . . 10,014,174 28.36% 16.21% 35,305,817
13 Q3. . . . . 7,843,269 22.65% 15.10% 34,629,616
14 Q4. . . . . 7,045,633 15.97% 12.78% 44,120,029
1998
15 Q1. . . . . 3,555,380 11.94% 11.94% 29,775,406
16 Q2. . . . . 1,928,715 8.42% 11.22% 22,916,849
17 Q3. . . . . 596,547 2.54% 5.07% 23,518,889
18 Q4. . . . . 72,917 0.17% 0.68% 43,185,824
----------- -------------------------- -------------- -------------- --------------------
<FN>
(1) For each quarter, cumulative loss frequency equals the gross principal loss divided by
the gross amount financed of the contracts acquired during that quarter.
(2) Annualized loss frequency converts cumulative loss frequency into an annual
equivalent (e.g. for Q4 1997, principal balance of $7,045,633 in losses divided by
$44,120,029 in amount financed of the contracts acquired, divided by 5 quarters
outstanding times 4 equals an annual loss frequency of 12.78%).
(3) Included are the loan that were repossessed, paid by customers' primary insurance, paid by
skip claim, paid by dealer and charged off due to certain reasons.
</TABLE>
-- 32 --
<PAGE>
<TABLE>
<CAPTION>
REPO AND SKIP(3)
Repossession Frequency
----------------------
Year and Principal Balance at
Quarter of Default of Failed Loans Cumulative Annualized Original Principal Balance of
Acquisition by Quarter Acquired Percentage (1) Percentage (2) Contracts Acquired
----------- ----------------------- -------------- -------------- -----------------------------
<C> <S> <C> <C> <C> <C>
1994
1 Q3. . . . . 22,046 21.79% 4.84% 101,161
2 Q4. . . . . 618,987 25.39% 5.97% 2,437,674
1995
3 Q1. . . . . 1,697,362 26.90% 6.72% 6,310,421
4 Q2. . . . . 1,670,219 26.98% 7.19% 6,190,596
5 Q3. . . . . 1,977,491 27.31% 7.80% 7,239,813
6 Q4. . . . . 3,732,028 30.62% 9.42% 12,188,863
1996
7 Q1. . . . . 4,754,416 30.75% 10.25% 15,460,823
8 Q2. . . . . 5,891,044 31.81% 11.57% 18,520,410
9 Q3. . . . . 6,495,843 23.12% 9.25% 28,098,899
10 Q4. . . . . 7,146,990 29.24% 13.00% 24,442,500
1997
11 Q1. . . . . 9,722,823 27.88% 13.94% 34,875,869
12 Q2. . . . . 9,024,012 25.56% 14.61% 35,305,817
13 Q3. . . . . 6,953,128 20.08% 13.39% 34,629,616
14 Q4. . . . . 6,207,960 14.07% 11.26% 44,120,029
1998
15 Q1. . . . . 3,063,194 10.29% 10.29% 29,775,406
16 Q2. . . . . 1,687,608 7.36% 9.82% 22,916,849
17 Q3. . . . . 476,224 2.02% 4.05% 23,518,889
18 Q4. . . . . 14,594 0.03% 0.14% 43,185,824
----------- ----------------------- -------------- -------------- -----------------------------
<FN>
(1) For each quarter, cumulative loss frequency equals the gross principal loss divided by
the gross amount financed of the contracts acquired during that quarter.
(2) Annualized loss frequency converts cumulative loss frequency into an annual
equivalent (e.g. for Q4 1997, principal balance of $6,207,960 in losses divided by
$44,120,029 in amount financed of the contracts acquired, divided by 5 quarters
outstanding times 4 equals an annual loss frequency of 11.26%).
(3) Included are the loan that were repossessed, and paid by skip claim
</TABLE>
NET LOSS PER REPOSSESSION
Upon initiation of the repossession process, it is the Company's intent to
complete the liquidation process as quickly as possible. The majority of
repossessed vehicles are sold at wholesale auction. The Company is responsible
for the costs of repossession, transportation and storage. The Company's net
charge-off per repossession equals the unpaid balance less the auction proceeds
(net of associated costs) and less proceeds from insurance claims. As less of
the Company's finance contracts are acquired with credit deficiency insurance,
the Company expects its net loss per repossession to increase. The following
table demonstrates the net charge-off per repossessed automobile since
inception.
-- 33 --
<PAGE>
<TABLE>
<CAPTION>
Loans
Loans with Without
From August 1, 1994 (Inception) to December 31, 1998 Default Default
Insurance Insurance All Loans
------------ ------------ ------------
<S> <C> <C> <C>
Number of finance contracts acquired 33,371
Number of vehicles repossessed . . . . . . . . . . . . . . . . . 5,829 2,137 7,966
Repossessed units disposed of. . . . . . . . . . . . . . . . . . 3,220 1,237 4,457
Repossessed units awaiting disposition (1) . . . . . . . . . . . 2,609 900 3,509
Cumulative gross charge-offs (2) . . . . . . . . . . . . . . . . $32,348,617 $12,981,206 $45,329,823
Costs of repossession (2). . . . . . . . . . . . . . . . . . . . 1,481,622 537,234 2,018,856
Proceeds from auction, physical damage insurance and refunds (2) 18,655,226 7,716,412 26,371,361
------------ ------------ ------------
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15,175,013 $ 5,802,028 $20,977,317
Deficiency insurance settlement received (2) . . . . . . . . . . 9,024,588 0 9,024,588
------------ ------------ ------------
Net charge-offs (2). . . . . . . . . . . . . . . . . . . . . . . $ 6,150,425 $ 5,802,028 $11,952,730
=========== ========== ============
Net charge-offs per unit disposed. . . . . . . . . . . . . . . . $ 1,910 $ 4,691 $ 2,682
Net loss as a percentage of cumulative gross charge-offs . . . . 46.91% 44.70% 46.28%
Recoveries as a percentage of cumulative gross charge-offs (3) . 80.99% 55.30% 73.63%
- ---------------------------------------------------------------- ------------ ------------ ------------
<FN>
1 The vehicles may have been sold at auction; however The Company might not have received all insurance
proceeds as of December 31, 1998.
2 Amounts are based on actual liquidation and repossession proceeds (including insurance proceeds)
received on units for which the repossession process had been completed as of December 31, 1998.
3 Not including the costs of repossession which are reimbursed by the securitization trusts.
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company requires access to significant sources and amounts of cash to
fund its operations and to acquire and securitize finance contracts. The
Company's primary operating cash requirements include the funding of (i) the
acquisition of finance contracts prior to securitization, (ii) the initial cash
deposits to reserve accounts in connection with the warehousing and
securitization of contracts in order to obtain such sources of financing, (iii)
fees and expenses incurred in connection with the warehousing and securitization
of contracts and (iv) ongoing administrative and other operating expenses. The
Company has traditionally obtained these funds in three ways: (a) loans and
warehouse financing arrangements, pursuant to which acquisition of finance
contracts are funded on a temporary basis; (b) securitizations or sales of
finance contracts, pursuant to which finance contracts are funded on a permanent
basis; and (c) general working capital, which if not obtained from operations,
may be obtained through the issuance of debt or equity. Failure to procure
funding from all or any one of these sources could have a material adverse
effect on the Company.
Since early February 1999, the Company's management has been attempting to
procure alternative sources of funding and other strategic alternatives, in
order to mitigate the situation with Dynex. The Company is currently in
discussions with several investment bankers and direct sources regarding such
alternatives which may include joint ventures, or changes in control of the
Company. While management hopes that an alternative opportunity will be
consummated, the Company has suspended acquisitions and dispositions of finance
contracts until alternative funding sources are obtained, however, there can be
no assurance that such funding will be obtained. As a consequence, the Company
expects to report a loss for the first quarter of 1999 and will not pay the
quarterly dividend on its preferred stock otherwise payable on March 31, 1999.
Unless financing or other strategic alternatives are found the Company may not
continue its business of originating loans and would take steps to reduce its
personnel and operating expenses associated with such activities. Also, parties
to the Company's various securitization transactions could request that the
Company surrender servicing, although management does not believe such parties
have the right to terminate servicing under the respective agreements. The
Company expects to continue its servicing operations.
-- 34 --
<PAGE>
Management believes the Company has sufficient liquidity to meet its
obligations and continue its servicing activities for a reasonable period of
time.
Cash Flows. Significant cash flows related to the Company's operating
activities include the use of cash for purchases of finance contracts, and cash
provided by payments on finance contracts, collections on retained interests and
sales of finance contracts. Net cash provided by operating activities totaled
$4.9 million during the year ended December 31, 1998.
Significant activities comprising cash flows from investing activities
include proceeds from disposal of collateral. Cash flows from financing
activities include reduction of revolving credit facilities $7.6 million,
proceeds from borrowings $10.5 million, and public offering of preferred stock
$9.6 million.
Revolving Credit Facilities. The Company historically obtained a
substantial portion of its working capital for the acquisition of finance
contracts through revolving credit facilities. Under a warehouse facility, the
lender generally advances amounts requested by the borrower on a periodic basis,
up to an aggregate maximum credit limit for the facility, for the acquisition
and servicing of finance contracts or other similar assets. Until proceeds from
a securitization transaction are used to pay down outstanding advances, as
principal payments are received on the finance contracts, the principal amount
of the advances may be paid down incrementally or reinvested in additional
finance contracts on a revolving basis.
On June 10, 1998, the Company and Dynex Capital, Inc., ("Dynex") entered
into an arrangement whereby the Company obtained a commitment from Dynex to
purchase all currently warehoused and future automobile finance contract
acquisitions through at least May 31, 1999 (the "Funding Agreement"). The terms
of the Funding Agreement were modified on June 30, October 20, and October 28,
1998. Under the prior terms of the Funding Agreement, the Company transferred
finance contracts to AutoBond Master Funding Corporation V ("Master Funding
V"), a qualified unconsolidated special purpose subsidiary, and Dynex provided
credit facilities in the amount equal to 104% of the unpaid principal balance of
the finance contracts (the "Advance Rate"), the proceeds of such facilities are
received by the Company. Under the modified terms of the Funding Agreement, the
Advance Rate was reduced from 104% to 88% for an interim period (the "Interim
Period") ending on the earlier of (a) December 31, 1998 and (b) the settlement
date of a securitization by Dynex of any finance contracts originated by the
Company. At the end of the Interim Period, the Advance Rate will revert to 104%
and Dynex was to advance to Master Funding V an additional amount equal to 16%
of the unpaid principal balance of finance contracts financed by Dynex during
the Interim Period, less any amounts that otherwise would have been paid as
principal on the Notes (as defined below) during such period. Advances under
the Funding Agreement were limited to $25 million per month after June 1998
until the commitment termination date. Under the modified terms of the Funding
Agreement, the commitment terminates on July 31, 1999 (provided that 90 days'
prior written notice from Dynex is given), or if such notice is not given, July
31, 2000. At the Company's option the commitment termination date can be
extended an additional four months to November 30, 1999 (provided that 90 days'
prior written notice to Dynex is given), or if such notice is not given,
November 30, 2000. Advances under the Funding Agreement are evidenced by Class
A and Class B Notes (collectively, the "Notes") issued by Master Funding V to
Dynex. The Class A Notes were issued in a principal amount equal to 94.0% of
the unpaid principal balance of the finance contracts (88.0% for advances funded
during the Interim Period) and bear interest at a rate equal to 190 basis points
over the corporate bond equivalent yield on the three-year Treasury note on the
closing date for each such advance (equal to an average of 7.02% as of December
31, 1998); provided however, that during the Interim Period, the interest rate
on the Company's Class A Notes will equal One-Month LIBOR plus 1.50%. The Class
B Notes are issued in a principal amount equal to 10.0% of the unpaid principal
balance of the finance contracts (0.0% for advances funded during the Interim
Period) and bear interest at a rate equal to 16% per annum. The Company retains
a subordinated interest in the pooled finance contracts. Transfers of finance
contracts to the qualified special purpose entities have been recognized as
sales under SFAS No. 125. At December 31, 1998, advances by Dynex under the
Funding Agreement totaled $ 155 million. See "Recent Developments" and "Legal
Proceedings".
-- 35 --
<PAGE>
William O. Winsauer, Chief Executive Officer and Chairman of the Board of
Directors of the Company (the "Board"), Adrian Katz, Chief Operating Officer,
Chief Financial Officer and Vice Chairman of the Board and John S. Winsauer,
Secretary and a member or the Board (collectively, the "Shareholders"), entered
into a Stock Option Agreement (the "Option Agreement") with Dynex Holding
wherein the Shareholders granted to Dynex Holding the Option to purchase all of
the shares of the Company's common stock owned by the Shareholders,
(approximately 85% of the Company's current outstanding common stock) at a price
of $6.00 per share. The Option may be exercised in whole and not in part at
anytime up to and including July 31, 1999. If the Company elects to exercise its
option to extend the commitment termination date, the expiration date of the
Option shall be extended to match the commitment termination date. In the event
that Dynex Holding exercises its Option, the exercise price of the Option will
be payable in shares of a newly issued series of convertible preferred stock of
Dynex ("Dynex Preferred"). The number of Dynex Preferred shares to be issued
will be equal to the product of the number of shares of the Company's common
stock subject to the Option and $6.00, divided by 115% of the average of the
closing prices per share of the common stock of Dynex ("Dynex Common") for the
ten consecutive trading days ending immediately prior to the exercise of the
Option. Upon exercise of the Option, Dynex Holding will deliver to each of the
Shareholders 80% of his pro rata share of the Dynex Preferred shares, with the
balance to be held by Dynex Holding subject to certain terms and conditions
contained in the Option Agreement and in each Shareholder's employment agreement
with Dynex. The Dynex Preferred will pay dividends at 9% per annum and be
convertible into shares of Dynex Common at an Initial conversion rate of one to
one. See "Recent Developments" and "Legal Proceedings"
The Company and its wholly owned subsidiary, AutoBond Funding Corporation
II, entered into a $50 million revolving warehouse facility (the "Daiwa
Facility") with Daiwa Finance Corporation ("Daiwa") effective as of February 1,
1997. Advances under the Daiwa Facility matured on the earlier of 120 days
following the date of the advance or March 31, 1998. The proceeds from the
borrowings under the Daiwa Facility were used to acquire finance contracts and
to make deposits to a reserve account. The Daiwa Facility was collateralized by
the finance contracts acquired with the outstanding advances. Interest was
payable upon maturity of the advances and accrued at the lesser of (x) 30 day
LIBOR plus 1.15% or (y) 11% per annum. The Company had no credit availability
under the Daiwa facility after March 31, 1998 and the total amount outstanding
was repaid in July 1998 through the Dynex funding agreement.
On December 31, 1997, the Company entered into a similar
warehouse/securitization arrangement with Credit Suisse First Boston Mortgage
Capital L.L.C. ("CSFB"), whereby $12.5 million of finance contracts were sold to
a qualifying unconsolidated special purpose subsidiary, AutoBond Master Funding
Corporation II. These finance contracts secured variable funding notes in the
initial amount of $11.3 million, which were repaid through the Dynex funding
agreement on June 30, 1998.
On March 31, 1998, the Company entered into a warehouse/securitization
arrangement with Infinity Investors Limited ("Infinity"), whereby $7.2 million
of finance contracts were sold to a qualifying unconsolidated special purpose
subsidiary, AutoBond Master Funding Corporation IV. These finance contracts
secured variable funding notes in the initial amount of $6.5 million, increasing
up to $10 million. These variable funding notes bore interest at 10% per annum
through May 31, 1998 and thereafter at 17% per annum. These notes were repaid
through the Dynex funding agreement on June 30, 1998. In connection with the
transaction with Infinity, the Company issued a warrant to purchase up to
100,000 shares of common stock, at an exercise price of $8.73 per share.
-- 36 --
<PAGE>
Notes Payable and Non-Recourse Debt
<TABLE>
<CAPTION>
The following amounts are included in notes payable and non-recourse debt as of:
December 31, December 31,
1997 1998
------------- -------------
<S> <C> <C>
Non-recourse notes payable, collateralized by Class B Certificates $ 7,783,219 $ 3,185,050
Subordinated notes payable . . . . . . . . . . . . . . . . . . . . - 7,143,628
Convertible notes payable. . . . . . . . . . . . . . . . . . . . . 2,000,000 3,000,000
Other notes payable. . . . . . . . . . . . . . . . . . . . . . . . 57,824 23,342
------------- -------------
$ 9,841,043 $ 13,352,020
------------- -------------
</TABLE>
Pursuant to an agreement (the "Securities Purchase Agreement") entered into
on June 30, 1997, the Company issued by private placement $2,000,000 in
aggregate principal amount of senior secured convertible notes ("convertible
notes"). Interest is payable quarterly at a rate of 18% per annum until maturity
on June 30, 2000. The convertible notes, collateralized by the retained interest
in securitizations from the Company's first four securitizations, are
convertible into shares of common stock of the Company upon the earlier to occur
of (x) an event of default on the convertible notes and (y) June 30, 1998,
through the close of business on June 30, 2000, subject to prior redemption. The
Company paid off the convertible notes in February 1998. Also pursuant to the
Securities Purchase Agreement, the Company issued warrants which upon exercise
allow the holders to purchase up to 200,000 shares of common stock at $4.225 per
share. The warrants are exercisable to the extent the holders thereof purchase
up to $10,000,000 of the Company's subordinated asset-backed securities before
June 30, 1998. The holders purchased $5,800,000 of subordinated asset-backed
securities. The total value assigned to these warrants was approximately
$154,000 which is included as an adjustment of the gain (loss) on sale of the
related finance contracts.
In January 1998, the Company privately placed with BancBoston Investments,
Inc. ("BancBoston") $7,500,000 in aggregate principal amount of its 15% senior
subordinated convertible notes (the "Subordinated Notes"). Interest on the
Subordinated Notes is payable quarterly until maturity on February 1, 2001. The
Subordinated Notes are convertible at the option of the holder for up to 368,462
shares of common stock of the Company, at a conversion price of $3.30 per share,
subject to adjustment under standard anti-dilution provisions. In the event of a
change of control transaction, the holder of the Subordinated Notes may require
the Company to repurchase the Subordinated Notes at 100% of the principal amount
plus accrued interest. The Subordinated Notes are redeemable at the option of
the Company on or after July 1, 1999 at redemption prices starting at 105% of
the principal amount, with such premium reducing to par on and after November 1,
2000, plus accrued interest. The Subordinated Notes were issued pursuant to an
Indenture, dated as of January 30, 1998 (the "Indenture") between the Company
and BankBoston, N.A., as agent. The Indenture contains certain restrictive
covenants including (i) a consolidated leveraged ratio not to exceed 2 to 1
(excluding non-recourse warehouse debt and securitization debt), (ii)
limitations on restricted payments such as dividends (but excluding, so long as
no event of default has occurred under the Indenture, dividends or distributions
on the preferred stock of the Company), (iii) limitations on sales of assets
other than in the ordinary course of business and (iv) certain financial
covenants, including a minimum consolidated net worth of $12 million (plus
proceeds from equity offerings), a minimum ratio of EBITDA to interest of 1.5
to 1, and a maximum cumulative repossession ratio of 27%. Events of default
under the Indenture include failure to pay, breach of covenants, cross-defaults
in excess of $1 million or material breach of representations or covenants under
the purchase agreement with BancBoston. Net proceeds from the sale of the
subordinated notes were used to pay short-term liabilities, with the remainder
available to provide for the repayment of the Company's 18% Convertible Secured
Notes and for working capital. The Company capitalized debt issuance costs of
$594,688, and recorded a discount of $507,763 on the debt representing the value
of the warrants issued. The debt issuance cost and discount is being amortized
as interest expense on the interest method through February 2001.
-- 37 --
<PAGE>
Due principally to the impairment of the Company's interest in
securitizations, the Company was in breach, as of September 30, 1998, of the
minimum net worth and the minimum ratio of earnings to interest covenants
contained in the Indenture. On November 13, 1998, the Company received a waiver
of such covenants from BankBoston, N.A. At December 31, 1998 the Company did
not meet certain of its financial covenants, which failure constitutes an event
of Default on the Subordinate Notes. The ability of the company to meet such
covenants is dependant upon future earnings. The Company has made all payments
due on its Subordinated Notes and expects to continue to meet such obligations.
The Subordinated Notes have not been formally accelerated by BankBoston; however
if such acceleration were made, BankBoston could declare such amounts
immediately due.
On June 10, 1998, the Company sold to Dynex at par $3 million of the
Company's 12% Convertible Senior Notes due 2003 (the "Senior Notes"). Interest
on the Senior Notes is payable quarterly in arrears, with the principal amount
due on June 9, 2003. The Senior Notes may be converted at the option of Dynex on
or before May 31, 1999 into shares of the Company's common stock at a conversion
price of $6.00 per share. Demand and "piggyback" registration rights with
respect to the underlying shares of common stock were granted. Dynex claims that
the Senior Notes are now in default due, among other things, to the impairment
of the Stock Option, an assertion which the Company disputes. The Company has
made all payments due on the Senior Notes and expects to continue to meet such
obligations. See "Recent Developments".
Securitization Program. In its securitization transactions through the end
of 1996, the Company sold pools of finance contracts to a special purpose
subsidiary, which then assigned the finance contracts to a trust in exchange for
cash and certain retained beneficial interests in future excess spread cash
flows. The trust issued two classes of fixed income investor certificates:
"Class A Certificates" which were sold to investors, generally at par with a
fixed coupon, and subordinated excess spread certificates ("Class B
Certificates"), representing a senior interest in excess spread cash flows from
the finance contracts, which were typically retained by the Company's
securitization subsidiary and which collateralize borrowings on a non-recourse
basis. The Company also funded a cash reserve account that provides credit
support to the Class A Certificates. The Company's securitization subsidiaries
also retained a "Transferor's Interest" in the contracts that is subordinate to
the interest of the investor certificate holders.
In the Company's March 1997, August 1997 and October 1997 securitization
transactions, the Company sold a pool of finance contracts to a special purpose
subsidiary, which then assigned the finance contracts to an indenture trustee.
Under the trust indenture, the special purpose subsidiary issued three classes
of fixed income investor notes, which were sold to investors, generally at par,
with fixed coupons. The subordinated notes represent a senior interest in
certain excess spread cash flows from the finance contracts. In addition, the
securitization subsidiary retained rights to the remaining excess spread cash
flows. The Company also funded cash reserve accounts that provide credit support
to the senior class or classes.
The retained interests entitle the Company to receive the future cash flows
from the trust after payment to investors, absorption of losses, if any, that
arise from defaults on the transferred finance contracts and payment of the
other expenses and obligations of the trust.
The Company has relied significantly on a strategy of periodically selling
finance contracts through asset-backed securitizations. The Company's ability to
access the asset-backed securities market is affected by a number of factors,
some of which are beyond the Company's control and any of which could cause
substantial delays in securitization including, among other things, the
requirements for large cash contributions by the Company into securitizations,
conditions in the securities markets in general, conditions in the asset-backed
securities market and investor demand for sub-prime auto paper. Additionally,
gain on sale of finance contracts represents a significant portion of the
Company's total revenues and, accordingly, net income. If the Company were
unable to sell finance contracts or account for any securitization as a sale
transaction in a financial reporting period, the Company would likely incur a
significant decline in total revenues and net income or report a loss for such
period. Moreover, the Company's ability to monetize excess spread cash flows has
been an important factor in providing the Company with substantial liquidity. If
the Company were unable to sell its finance contracts and did not have
sufficient credit available, either under warehouse credit facilities or from
other sources, the Company would have to sell portions of its portfolio directly
to whole loan buyers or curtail its finance contract acquisition activities.
-- 38 --
<PAGE>
On May 19, 1998, Moody's announced that the ratings on the senior
securities issued in the Company's term securitization were reduced to Bal (B2
for the 1997B and 1997C transactions), expressing concerns including (1) the
alleged non-adherence to the transaction documents with regard to charge-off
policy and the calculation of delinquency and loss triggers, (2) the Company's
procedures for allocating prepaid insurance among the trusts, (3) instances of
the Company waiving fees and making cash contributions to the transactions to
enhance their performance, and (4) "instances of commingled collections." While
the Company was not requested by Moody's to provide legal guidance as to whether
or not these factors would as a matter of law "increase the uncertainty" with
respect to the transactions, the Company does note the following: (1) with the
transfer of servicing from Loan Servicing Enterprise ("LSE") now completed, the
Company believes that it is servicing in accordance with the documentation; (2)
the transaction documents did not contemplate the allocation of prepaid
insurance claims, a phenomenon brought about by the Company's prevailing upon
Interstate to speed up the payment of claims for the benefit of the trusts in a
manner the Company believes is fair to the trusts; (3) the transaction documents
do not prohibit fee waivers and explicitly permit the Company to make voluntary
capital contributions to the trusts; and (4) at the insistence of the former
servicer, collections have always been directed to omnibus lockboxes in the name
of, and under the control of the former servicer and the transaction trustees
and, the trustee is holding cash that is to be paid to certificate holders upon
reconciliation instructions from LSE.
The Company has engaged counsel who is presently performing the
deal-by-deal analysis of the structural and legal integrity of these
transactions and resolve the concerns raised by Moody's. In the meantime, the
Company has been notified by the trustees on certain of the securitizations that
the action of Moody's and the alleged causes constituted events of servicer
termination under such transactions. The trustees have threatened to remove the
Company as servicer on certain transactions, and have withheld servicing fees
due to the Company. Since the Company is of the view that no events of
servicing termination have occurred and that the transactions documents did not
intend for servicing compensation to the Company to be cut off where the cause
of an event of default is due to the actions of Progressive and LSE (the former
servicer), the Company is seeking to resolve those issues to the satisfaction of
all parties.
Equity Offerings. In February 1998, the Company completed the underwritten
public offering of 1,125,000 shares of its 15% Series A Cumulative Preferred
Stock (the "Preferred Stock"), with a liquidation preference of $10 per share.
The price to public was $10 per share, with net proceeds to the Company of
approximately $10,386,000. Such net proceeds have been utilized for working
capital purposes, including the funding of finance contracts. Dividends on the
Preferred Stock are cumulative and payable quarterly on the last day of March,
June, September and December of each year, commencing on June 30, 1998, at the
rate of 15% per annum. After three years from the date of issuance, the Company
may, at its option, redeem one-sixth of the Preferred Stock each year, in cash
at the liquidation price per share (plus accrued and unpaid dividends), or, if
in Common Stock, that number of shares equal to $10 per share of Preferred Stock
to be redeemed, divided by 85% of the average closing sale price per share for
the Common Stock for the 5 trading days prior to the redemption date. The
Preferred Stock is not redeemable at the option of the holder and has no stated
maturity.
If dividends on the Preferred Stock are in arrears for two quarterly
dividend periods, holders of the Preferred Stock will have the right to elect
two additional directors to serve on the Company's Board until such dividend
arrearage is eliminated. In addition, certain changes that could materially
affect the holders of Preferred Stock, such as a merger of the Company, cannot
be made without the affirmative vote of the holders of two-thirds of the shares
of Preferred Stock, voting as a separate class. The Preferred Stock ranks senior
to the Common Stock with respect to the payment of dividends and amounts upon
liquidation, dissolution or winding up. As of December 31, 1998, Preferred
Stock dividends were current, but the dividend will not be paid for the first
quarter of 1999.
On May 20, 1998, the Company and Promethean Investment Group, L.L.C.
("Promethean") entered into a common stock investment agreement (the "Investment
Agreement") and related registration rights agreement whereby Promethean agreed
to purchase from the Company, on the terms and conditions outlined below, up to
$20 million (subject to increase up to $25 million at Promethean's option) of
the Company's common stock. The Company must deliver a preliminary notice of its
intention to require Promethean to purchase its common shares at least ten but
not more than thirty days prior to the Company's delivery of its final notice.
The Company may only deliver such final notice if (i) the dollar volume-
-- 39 --
<PAGE>
weighted price of its common stock reported on the business day of such final
notice is at least $3.25 per share, (ii) at all times during the period
beginning on the date of delivery of the preliminary notice and ending on and
including the closing date (a) a registration statement covering the resale of
no less than 150% of the shares to be sold to Promethean under the Investment
Agreement has been declared and remains effective and (b) shares of the
Company's common stock are at such time listed on a major national securities
exchange, and (iii) the Company has not delivered another final notice to
Promethean during the preceding twenty-five business days preceding delivery of
such final notice. Following receipt of a final notice, Promethean's purchase
obligation will equal the lowest of: (i) the amount indicated in such final
notice, (ii) $5,000,000 and (iii) 20% of the aggregate of the daily trading
dollar volume on the twenty consecutive business days following delivery of the
put notice. Promethean may, in its sole discretion, increase the amount
purchasable in the preceding sentence by 125%. Promethean must conclude all
required purchases of common shares within twenty-five business days of receipt
of the final notice. The purchase price for the Company's shares will be equal
to 95% of the lowest daily dollar volume-weighted average price during the six
consecutive trading days ending on and including the date of determination.
Promethean's obligation to purchase shares under the Investment Agreement shall
end either upon the mutual consent of the parties or automatically upon the
earliest of the date (a) on which total purchases by Promethean under the
Investment Agreement total $20,000,000, (b) which is two years after the
effective date of the registration statement relating to the common stock
covered by the Investment Agreement, or (c) which is twenty-seven months from
the date of the Investment Agreement. In consideration of Promethean's
obligations under the Investment Agreement, the Company paid $527,915 in cash on
August 19, 1998, which was treated as an investment in a common stock agreement.
The statements contained in this document that are not historical facts are
forward looking statements. Actual results may differ from those projected in
the forward looking statements. These forward looking statements involve risks
and uncertainties, including but not limited to the following risks and
uncertainties: changes in the performance of the financial markets, in the
demand for and market acceptance of the Company's loan products, and in general
economic conditions, including interest rates, presence of competitors with
greater financial resources and the impact of competitive products and pricing;
the effect of the Company's policies; and the continued availability to the
Company of adequate funding sources. Investors are also directed to other risks
discussed in documents filed by the Company with the Securities and Exchange
Commission.
Impact of Inflation and Changing Prices
Although the Company does not believe that inflation directly has a
material adverse effect on its financial condition or results of operations,
increases in the inflation rate generally are associated with increased interest
rates. Because the Company borrows funds on a floating rate basis during the
period leading up to a securitization, and in many cases purchases finance
contracts bearing a fixed rate nearly equal but less than the maximum interest
rate permitted by law, increased costs of borrowed funds could have a material
adverse impact on the Company's profitability. Inflation also can adversely
affect the Company's operating expenses.
Impact of New Accounting Pronouncements
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires
than an entity recognize all derivatives as either assets or liabilities in its
balance sheet and that it measure those instruments at fair value. The
accounting for changes in the fair value of a derivative (that is, gains and
losses) is dependent upon the intended use of the derivative and the resulting
designation. SFAS No. 133 generally provides for matching the timing of gain or
loss recognition on the hedging instrument with the recognition of (1) the
changes in the fair value of the hedged asset or liability that are attributable
to the hedged risk or (2) the earnings effect of the hedged forecast
transaction. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999, although earlier application is encouraged. The
Company plans to comply with the provisions of SFAS No. 133 upon its initial use
of derivative instruments. As of December 31, 1998, no such instruments were
being utilized by the Company.
-- 40 --
<PAGE>
The Company does not believe the implementation of SFAS No. 133 will have a
material effect on its consolidated financial statements.
YEAR 2000 COMPLIANCE
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Computer programs
containing date-sensitive code could recognize a date ending with the digits
"00" as the year 1900 instead of the year 2000. This could result in a system
failure or in miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal activities.
As a specialty consumer finance company, the Company substantially depends
on its computer systems and proprietary software applications in underwriting,
acquiring, servicing and securitizing finance contracts. As a result of
initiatives undertaken in the development of its proprietary software systems,
all of the Company's systems and software applications have been formatted with
a full, four-digit date code in the database management and cash flow evaluation
software. The efficacy of certain of the Company's systems and software
applications in handling Year 2000 issues has been demonstrated repeatedly in
the system's ability to calculate payments streams accurately on finance
contracts with maturity dates that extend beyond December 31, 1999. Based on
its review of the likely impact of the Year 2000 on its business, the Company
believes that it is working constructively toward making its critical and
operational applications Year 2000 compliant.
Nevertheless, the Company may be exposed to the risk that other service
providers may not be in compliance. While the Company does not foresee that the
Year 2000 will pose significant operational problems, the failure of its
vendors, customers or financial institutions to become Year 2000 compliant could
have a material adverse effect on the Company's business, financial condition
and results of operations. To date, the Company has not formulated any
contingency plans to address such consequences.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument as a result of
fluctuations in interest and currency exchange rates and in equity and commodity
prices. Market risk is inherent to both derivative and non-derivative financial
instruments. The Company's market risk management procedures include all market
risk sensitive financial instruments. The Company has no derivative financial
instruments, exposure to currency exchange rates nor commodity risk exposure.
The Company's debt is all fixed rate and the Company's earnings and cash
flows from retained interests in securitization and finance contracts, which are
at fixed rates, are not impacted by changes in market interest rates. The
Company manages market risk by striving to balance its finance contract
origination activities with its ability to sell such contracts in a short period
of time. Changes in market value of its finance contracts and retained interests
may increase or decrease due to pre-payments and defaults influenced by changes
in market conditions and the borrowers' financial condition.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements are set forth in this report beginning at page F-1.
-- 41 --
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Please refer to the discussion contained in the Company's quarterly report
on Form 10-Q for the quarter ended June 30, 1998.
-- 42 --
<PAGE>
--------
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is hereby incorporated above reference
thereto.
No person who, at any time during the fiscal year ended December 31, 1998,
was a director, officer, beneficial owner of more than ten percent of any class
of equity securities of the Company registered pursuant to Section 12 of the
Exchange Act, or any other person subject to Section 16 of the Exchange Act with
respect to the Company because of the requirements of Section 30 of the
Investment Company Act ("reporting person") has failed to file or is delinquent
in filing the forms and reports required by Section 16(a) of the Exchange Act
during the fiscal year ended December 31, 1998 or prior fiscal years.
ITEM 11. EXECUTIVE COMPENSATION
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual Meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is hereby incorporated by reference
thereto.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual Meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is hereby incorporated by reference
thereto.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information will be contained in the Company's definitive Proxy
Statement with respect to the Company's Annual Meeting of Shareholders, to be
filed with the Securities and Exchange Commission within 120 days following the
end of the Company's fiscal year, and is hereby incorporated by reference
thereto.
-- 43 --
<PAGE>
-------
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM
8-K
The following documents are filed as part of this Form 10-K:
1. Financial Statements
Report of Independent Accountants - Deloitte & Touche LLP
Report of Independent Accountants - Coopers & Lybrand, LLP
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Income
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
-- 44 --
<PAGE>
<TABLE>
<CAPTION>
2. Exhibits
<S> <C>
EXHIBIT NO.. DESCRIPTION OF EXHIBIT
- ------------ ------------------------------------------------------------------------------------------
3.1 (1). . . Restated Articles of Incorporation of the Company
3.2 (1). . . Amended and restated Bylaws of the Company
4.1 (1). . . Specimen Common Stock Certificate
10.1 (1) . . Amended and Restated Loan Origination, Sale and Contribution Agreement dated as of
December 15, 1995 by and between the Company and AutoBond Funding Corporation I
10.2 (1) . . Security Agreement dated as of May 21, 1996 among AutoBond Funding Corporation II,
the Company and Norwest Bank Minnesota, National Association
10.3 (1) . . Credit Agreement and Side Agreement, dated as of May 21, 1996 among AutoBond
Funding Corporation II, the Company and Peoples Life Insurance Company
10.4 (1) . . Servicing Agreement dated as of May 21, 1996 among AutoBond Funding Corporation II,
CSC Logic/MSA L.L.P., doing business as "Loan Servicing Enterprise", the Company
and Norwest Bank Minnesota, National Association
10.5 (1) . . Loan Acquisition Sale and Contribution Agreement dated as of May 21, 1996 by and
between the Company and AutoBond Funding Corporation II
10.6 (1) . . Second Amended and Restated Secured Revolving Credit Agreement dated as of July 31,
1995 between Sentry Financial Corporation and the Company
10.7 (1) . . Management Administration and Services Agreement dated as of January 1, 1996 between
the Company and AutoBond, Inc.
10.8 (1) . . Employment Agreement dated November 15, 1995 between Adrian Katz and the Company
10.9 (1) . . Employment Agreement effective as of May 1, 1996 between William O. Winsauer and the
Company
10.10 (1). . Vender's Comprehensive Single Interest Insurance Policy and Endorsements, issued by
Interstate Fire & Casualty Company
10.11 (1). . Warrant to Purchase Common Stock of the Company dated March 12, 1996
10.12 (1). . Employee Stock Option Plan
10.13 (1). . Dealer Agreement dated November 9, 1994, between the Company and Charlie Thomas
Ford, Inc.
10.14 (1). . Automobile Loan Sale Agreement, dated as of September 30, 1996, among the Company,
First Fidelity Acceptance Corp., and Greenwich Capital Financial Products, Inc.
10.15 (2). . Servicing Agreement, dated as of January 29, 1997, between CSC LOGIC/MSA L.P.P.,
doing business as "Loan Servicing Enterprise" and the Company
10.16 (2). . Credit Agreement, dated as of February 1, 1997, among AutoBond Funding Corporation II,
the Company and Daiwa Finance Corporation
10.17 (2). . Security Agreement, dated as of February 1, 1997, by and among AutoBond Funding
Corporation II, the Company and Norwest Bank Minnesota, National Association
10.18 (2). . Automobile Loan Sale Agreement, dated as of March 19, 1997, by and between Credit
Suisse First Boston Mortgage Capital L.L.C., a Delaware limited liability company, and the
Company
10.19 (3). . Automobile Loan Sale Agreement, dated as of March 26, 1997, by and between Credit
Suisse First Boston Mortgage Capital L.L.C., a Delaware limited liability company, and the
Company
10.20 (4). . Credit Agreement, dated as of June 30, 1997, by and among AutoBond Master Funding
Corporation, the Company and Daiwa Finance Corporation
10.21 (4). . Amended and Restated Trust Indenture, dated as of June 30, 1997, among AutoBond
Master Funding Corporation, AutoBond Acceptance Corporation and Norwest Bank
Minnesota, National Association.
10.22 (4). . Securities Purchase Agreement, dated as of June 30, 1997, by and among the Company,
Lion Capital Partners, L.P. and Infinity Emerging Opportunities Limited.
10.23 (6). . Credit Agreement, dated as of December 31, 1997, by and among AutoBond Master
Funding Corporation II, the Company and Credit Suisse First Boston Mortgage Capital
L.L.C
10.24 (6). . Trust Indenture, dated as of December 31, 1997, among AutoBond Master Funding
Corporation II, the Company and Manufacturers & Traders Trust Company
10.25 (6). . Receivables Purchase Agreement, dated as of December 31, 1997, between Credit Suisse
First Boston Mortgage Capital L.L.C and the Company
10.26 (6). . Servicing Agreement, dated as of December 31, 1997, among the Company, AutoBond
Master Funding Corporation II and Manufacturers & Traders Trust Company
10.27 (6). . Indenture and Note, dated January 30, 1998, between the Company and Bank Boston, N.A.
10.28 (6). . Warrant, dated January 30, 1998, issued to BancBoston Investments, Inc.
10.29 (6). . Purchase Agreement, dated January 30, 1998, between the Company and BancBoston
Investments, Inc.
10.30 (5). . Warrant, dated February 2, 1998, issued to Dresner Investments Services, Inc.
10.31 (5). . Warrant Agreement, dated February 2, 1998, issued to Tejas Securities Group, Inc.
10.32 (5). . Consulting and Employment Agreement, dated as of January 1, 1998 between Manuel A.
Gonzalez and the Company
10.33 (5). . Severance Agreement, dated as of February 1, 1998 between Manuel A. Gonzalez and the
Company
10.34 (7). . 1998 Stock Option Plan
10.35 (7). . Third Amendment to the Secured Revolving Credit Agreement dated May 5, 1998 between
Sentry Financial Corporation and the Company
10.36 (7). . Warrant, dated March 31, 1998, issued to Infinity Investors Limited
10.37 (7). . Credit Agreement, dated as of June 9, 1998, by and among AutoBond Master Funding
Corporation V, the Company, and Dynex Capital, Inc.
10.38 (8). . Servicing Agreement, dated as of June 9, 1998, by and among AutoBond Master Funding
Corporation V, the Company, and Dynex Capital, Inc.
10.39 (8). . Trust Indenture, dated as of June 9, 1998, by and among AutoBond Master Funding
Corporation V, the Company and Dynex Capital, Inc.
10.40 (9). . Letter Agreement, dated June 30, 1998 by and between the Company and Dynex Capital,
Inc.
10.41 (9). . Letter Agreement dated October 20, 1998 by and between the Company and Dynex Capital,
Inc.
10.42 (9). . Letter Agreement dated October 28, 1998 by and between the Company, Dynex Holding,
Inc., and Dynex Capital, Inc.
21.1 (4) . . Subsidiaries of the Company
21.2 (6) . . Additional Subsidiaries of the Company
21.3 . . . . Additional Subsidiaries of the Company
27.1 . . . . Financial Data Schedule
- ------------
<FN>
1 Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No.
333-05359).
2 Incorporated by reference to the Company's 1996 annual report on Form 10-K for the year ended December
31, 1996.
3 Incorporated by reference to the Company's quarterly report on Form 10-Q for the quarter ended March
31, 1997.
4 Incorporated by reference to the Company's quarterly report on Form 10-Q for the quarter ended June
30, 1997.
5 Incorporated by reference to the Company's 1997 annual report on Form 10-K for the year ended December
31, 1997
6 Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No.
333-41257).
7 Incorporated by reference to the Company's quarterly report on Form 10-Q for the quarter ended March
31, 1998
8 Incorporated by reference to the Company's report on Form 8-K filed on June 24, 1998
9 Incorporated by reference to the Company's quarterly report on form 10-Q for the quarter ended
September 30, 1998
- --------------------------------------------------------------------------------------------------------
</TABLE>
-- 45 --
<PAGE>
(b) Reports of Form 8-K
The Company filed no reports on Form 8-K during the quarter ended December
31, 1998.
-- 46 --
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, hereunto duly authorized.
AUTOBOND ACCEPTANCE CORPORATION
By: /s/ William O. Winsauer
----------------------------
William O. Winsauer, Chairman of the Board
and Chief Executive Officer
Date: April 15, 1999
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the registrant in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ William O. Winsauer Chairman of the Board and April 15, 1999
Chief Executive Officer
William O. Winsauer
- -----------------------
/s/ Adrian Katz Vice Chairman of the Board and April 15, 1999
Chief Operating Officer and
Adrian Katz Chief Financial Officer
- -----------------------
/s/ John S. Winsauer Secretary and Director April 15, 1999
John S. Winsauer
- -----------------------
/s/ Thomas Blinten Director April 15, 1999
Thomas Blinten
- -----------------------
/s/Brian O'Neil Vice President April 15, 1999
(Principal Accounting Officer)
Brian O'Neil
- -----------------------
</TABLE>
-- 47 --
<PAGE>
<TABLE>
<CAPTION>
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
<S> <C>
Reports of Independent Accountants F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 F-4
Consolidated Statements of Operations and Comprehensive Income (loss)for the Years Ended F-5
December 31, 1996, 1997 and 1998
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1996, 1997 F-6
and 1998
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1997 and 1998 F-8
Notes to Consolidated Financial Statements F-9
</TABLE>
All schedules are omitted as the required information is not applicable or
the information is presented in the consolidated financial statements, related
notes, or other schedules.
-- F-1 --
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders
AutoBond Acceptance Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of AutoBond
Acceptance Corporation and Subsidiaries as of December 31, 1998 and the related
consolidated statements of operations and comprehensive income (loss),
shareholders' equity and cash flows for the year ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of AutoBond
Acceptance Corporation and Subsidiaries as of December 31, 1998 and the results
of their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.
The accompanying consolidated financial statements for the year ended
December 31, 1998 have been prepared assuming that the Company will continue as
a going concern. As discussed in Note 1 to the consolidated financial
statements, the termination of the Company's primary source of funding for its
acquisition of finance contracts, the ability of a lender to accelerate a debt
obligation, the possibility of certain trustees removing the company as servicer
on certain transactions, and litigation brought against the company by a
preferred stock holder raise substantial doubt about its ability to continue as
a going concern. Management's plans concerning these matters are also described
in Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Deloitte & Touche LLP
Dallas, Texas
March 30, 1999 (Except for Note 1 and the last paragraph of Note 14 as to which
the date is April 7, 1999)
-- F-2 --
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders
AutoBond Acceptance Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of AutoBond
Acceptance Corporation and Subsidiaries as of December 31, 1996 and 1997 and the
related consolidated statements of income and comprehensive income,
shareholders' equity and cash flows for the years ended December 31, 1996 and
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
The Company's most significant warehouse and securitization facility, which
expires March 31, 1998, has been extended to April 30, 1998. The Company is
currently in negotiations with other parties for additional warehouse and
securitzation facilities.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of AutoBond
Acceptance Corporation and Subsidiaries as of December 31, 1996 and 1997, and
the consolidated results of their operations and their cash flows for each of
the years ended December 31, 1995, 1996 and 1997, in conformity with generally
accepted accounting principles.
As described in Note 2, the Company implemented Statement of Financial
Accounting Standards ("SFAS") No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" as of January 1, 1997. The
Company implemented SFAS No. 130, "Reporting Comprehensive Income," for the
period ended December 31, 1997.
Coopers & Lybrand, L.L.P.
Austin, Texas
March 30, 1998
-- F-3 --
<PAGE>
<TABLE>
<CAPTION>
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
--------------
1997 1998
-------------- ------------
<S> <C> <C>
ASSETS
- ------
Cash and cash equivalents $ 159,293 $ 5,170,969
Restricted funds 6,904,264 -
Receivable from Dynex - 6,573,107
Finance contracts held for sale, net 1,366,114 867,070
Collateral acquired, net 150,908 70,957
Retained interest in securitizations - Trading 7,878,306 4,586,908
Retained interest in securitizations - Available for sale 24,138,343 9,286,443
Debt issuance costs 605,847 729,206
Due from affiliates 176,963 396,015
Property, plant, and equipment, net 1,148,559 1,187,421
Other assets 681,851 1,463,046
-------------- ------------
Total assets $ 43,210,448 $30,331,142
============== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Liabilities:
Notes payable $ 2,057,824 $10,166,969
Non-recourse debt 7,783,219 3,185,050
Revolving credit facilities 7,639,201 -
Payables and accrued liabilities 3,386,685 1,324,951
Bank overdraft 2,936,883 -
Payable to affiliates 554,233 -
Deferred income taxes 3,504,249 101,800
-------------- ------------
Total liabilities $ 27,862,294 $14,778,770
-------------- ------------
Commitments and contingencies (Notes 1 and 14 )
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares authorized; $ - $10,856,000
1,125,000 shares of 15% Series A cumulative preferred
stock, $10 liquidation preference, issued and outstanding,
at December 31, 1998
Common stock, no par value; 25,000,000 shares authorized, 1,000 1,000
6,531,311 shares issued and outstanding
Capital in excess of stated capital 8,781,669 8,291,481
Due from shareholders (10,592) (10,592)
Accumulated other comprehensive income 1,049,256 -
Retained earnings (accumulated deficit) 5,526,821 (3,057,602)
Investment in common stock agreement - (527,915)
-------------- ------------
Total shareholders' equity 15,348,154 15,552,372
-------------- ------------
Total liabilities and shareholders' equity $ 43,210,448 $30,331,142
============== ============
<FN>
The accompanying notes are an integral part of the consolidated financial statements
</TABLE>
-- F-4 --
<PAGE>
<TABLE>
<CAPTION>
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
Years Ended December 31,
------------------------
1996 1997 1998
------------ ------------ --------------
<S> <C> <C> <C>
Revenues:
Interest income . . . . . . . . . . . . . . . . . . . . . $ 2,519,612 $ 4,118,795 $ 1,498,985
Gain on sale of finance contracts . . . . . . . . . . . . 12,820,700 18,666,570 17,985,045
Servicing income. . . . . . . . . . . . . . . . . . . . . 657,950 1,131,142 3,222,669
Other income (loss) . . . . . . . . . . . . . . . . . . . 388,278 (173,146) 347,779
------------ ------------ --------------
Total revenues. . . . . . . . . . . . . . . . . 16,386,540 23,743,361 23,054,478
------------ ------------ --------------
Expenses:
Provision for credit loss . . . . . . . . . . . . . . . . 412,387 612,715 100,000
Interest expense. . . . . . . . . . . . . . . . . . . . . 2,382,818 3,879,543 3,117,211
Salaries and benefits . . . . . . . . . . . . . . . . . . 4,529,006 7,357,284 10,471,615
General and administrative. . . . . . . . . . . . . . . . 2,331,246 6,075,125 6,782,015
Impairment of retained interest in securitizations. . . . - 1,312,234 9,932,169
Other operating expenses. . . . . . . . . . . . . . . . . 1,119,644 2,005,237 3,422,260
------------ ------------ --------------
Total expenses. . . . . . . . . . . . . . . . . 10,775,101 21,242,138 33,825,270
------------ ------------ --------------
Income (loss) before income taxes. . . . . . . . . . . . . . . 5,611,439 2,501,223 (10,770,792)
Provision (benefit) for income taxes . . . . . . . . . . . . . 1,926,553 888,170 (3,626,369)
------------ ------------ --------------
Income (loss) before extraordinary loss. . . . . . . . . . . . 3,684,886 1,613,053 ( 7,144,423)
Extraordinary loss, net of tax . . . . . . . . . . . . . . . . (100,000) - -
------------ ------------ --------------
Net income. . . . . . . . . . . . . . . 3,584,886 1,613,053 ( 7,144,423)
Preferred Stock Dividend. . . . . . . . - - (1,440,000)
------------ ------------ --------------
Net income (loss) available to common shareholders. . . . . . . $ 3,584,886 $ 1,613,053 ($8,584,423)
============ ============ ==============
Weighted average number of common shares:
Basic . . . . . . . . . . . . . . . . . . . . . 5,791,189 6,516,056 6,531,311
Diluted . . . . . . . . . . . . . . . . . . . . 5,809,157 6,965,877 6,531,311
Earnings (loss) per common share:
Basic . . . . . . . . . . . . . . . . . . . . . $ 0.62 $ 0.25 ($1.31)
Diluted . . . . . . . . . . . . . . . . . . . . $ 0.62 $ 0.25 ($1.31)
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . $ 3,584,886 $ 1,613,053 ($7,144,423)
Other comprehensive income, net of tax:
Unrealized gain (loss) on retained interest in
securitizations . . . . . . . . . . . . . . . . - 1,049,256 (1,049,256)
------------ ------------ --------------
Other comprehensive income (loss). . . . . . . . . . . . . . . - 1,049,256 (1,049,256)
------------ ------------ --------------
Comprehensive income (loss). . . . . . . . . . . . . . . . . . $ 3,584,886 $ 2,662,309 ($8,193,679)
============ ============ ==============
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
-- F-5 --
<PAGE>
<TABLE>
<CAPTION>
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Year Ended December 31,
1996 1997 1998
----------- ----------- -------------
<S> <C> <C> <C>
Preferred stock (Shares):
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . - - -
Issuance of preferred stock in public offering . . - - 1,250,000
----------- ----------- -------------
Ending balance . . . . . . . . . . . . . . . . . . - - 1,250,000
- ---------------------------------------------------- ----------- ----------- -------------
Common stock (Shares):
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . 5,118,753 6,512,500 6,531,311
Stock issued pursuant to employee contract . . . . 568,747 - -
Issuance of common stock in public offering . . . 825,000 - -
Exercise of common stock warrants. . . . . . . . . - 18,811 -
----------- ----------- -------------
Ending balance . . . . . . . . . . . . . . . . . . 6,512,500 6,531,311 6,531,311
- ---------------------------------------------------- ----------- ----------- -------------
Preferred stock:
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . - - -
Issuance of preferred stock in public offering . . - - 10,856,000
----------- ----------- -------------
Ending balance. . . . . . . . . . . . . . . . . . - - $ 10,856,000
- ---------------------------------------------------- ----------- ----------- -------------
Common stock (stated capital):
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . 1,000 1,000 1,000
----------- ----------- -------------
Ending balance . . . . . . . . . . . . . . . . . . $ 1,000 $ 1,000 $ 1,000
- ---------------------------------------------------- ----------- ----------- -------------
Capital in excess of stated capital:
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . 2,912,603 8,617,466 8,781,669
Issuance cost of preferred stock . . . . . . . . . - - (1,201,451)
Issuance of common stock in public offering. . . . 5,704,863 - -
Issuance of common stock warrants. . . . . . . . . - 164,203 711,263
----------- ----------- -------------
Ending balance . . . . . . . . . . . . . . . . . . $8,617,466 $8,781,669 $ 8,291,481
- ---------------------------------------------------- ----------- ----------- -------------
Deferred compensation:
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . . (62,758) (11,422) -
Amortization of deferred compensation. . . . . . . . 51,336 11,422 -
----------- ----------- -------------
Ending Balance . . . . . . . . . . . . . . . . . . . $ (11,422) - -
- ---------------------------------------------------- ----------- ----------- -------------
Due from shareholders:
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . . (153,359) (378,618) (10,592)
Payments from(to) shareholders . . . . . . . . . . . (225,259) 368,026 -
----------- ----------- -------------
Ending balance . . . . . . . . . . . . . . . . . . . ($378,618) ($10,592) ($10,592)
- ---------------------------------------------------- ----------- ----------- -------------
Accumulated other comprehensive income, net of tax:
- ----------------------------------------------------
Beginning balance. . . . . . . . . . . . . . . . . . - - 1,049,256
Other comprehensive income (loss) . . . . . . . . - 1,049,256 (1,049,256)
----------- ----------- -------------
Ending balance . . . . . . . . . . . . . . . . . . . - 1,049,256 -
- ---------------------------------------------------- ----------- ----------- -------------
Accumulated deficit:
- ----------------------------------------------------
Beginning balance . . . . . . . . . . . . . . . . 328,882 3,913,768 5,526,821
Dividends. . . . . . . . . . . . . . . . . . . . . . - - (1,440,000)
Net income(loss) . . . . . . . . . . . . . . . . . . 3,584,886 1,613,053 (7,144,423)
----------- ----------- -------------
Ending balance . . . . . . . . . . . . . . . . . . . $3,913,768 $5,526,821 ($3,057,602)
- ---------------------------------------------------- ----------- ----------- -------------
</TABLE>
-- F-6 --
<PAGE>
<TABLE>
<CAPTION>
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(CONTINUED)
<S> <C> <C> <C>
Investment in common stock agreement:
- -------------------------------------
Beginning balance . . . . . . . . . . - - -
Investment in common stock agreement. - - (527,915)
----------- ----------- ------------
Ending balance. . . . . . . . . . . . - - (527,915)
----------- ----------- ------------
Total shareholders' equity. . . . . . $12,142,194 $15,348,154 $15,552,372
=========== =========== ============
<FN>
The accompanying notes are an integral part of the consolidated
financial statements.
</TABLE>
-- F-7 --
<PAGE>
<TABLE>
<CAPTION>
AUTOBOND ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED
-------------
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net Income (Loss). . . . . . . . . . . . . . . . . . . . . . . . . $ 3,584,886 $ 1,613,053 $ (7,144,423)
Reconcile net income (loss) to net cash from operating activities
Amortization of finance contract acquisition discount and. . . . (358,949) (11,472) (126,215)
insurance
Amortization of debt issuance costs and discounts. . . . . . . . 497,496 818,481 794,840
Accretion of retained interest in securitization . . . . . . . . (154,029) (546,507) (127,980)
Provision for credit loss. . . . . . . . . . . . . . . . . . . . 412,387 612,715 100,000
Depreciation and amortization. . . . . . . . . . . . . . . . . . 51,336 300,300 484,237
Impairment of retained interests in securitizations. . . . . . . - 1,312,234 9,932,169
Gain on sale of finance contracts. . . . . . . . . . . . . . . . (12,820,700) (18,666,570) (17,985,045)
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . 1,876,552 888,171 (2,861,923)
Restricted funds . . . . . . . . . . . . . . . . . . . . . . . . (1,298,613) (3,922,814) 6,904,264
Finance contracts held for sale, net . . . . . . . . . . . . . . 16,127,169 16,607,446 18,510,304
Retained interest in securitizations . . . . . . . . . . . . . . (12,981,441) (14,250,024) 6,749,327
Receivable from Dynex. . . . . . . . . . . . . . . . . . . . . . - - (6,573,107)
Due from affiliates. . . . . . . . . . . . . . . . . . . . . . . 14,899 25,300 (219,052)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . (329,747) (1,435,334) (1,100,794)
Payables and accrued liabilities . . . . . . . . . . . . . . . . (361,495) 1,912,098 (2,061,734)
Payable to affiliates. . . . . . . . . . . . . . . . . . . . . . 10,401 288,235 (554,233)
------------- ------------- -------------
CASH PROVIDED (USED) BY OPERATIONS . . . . . . . . . . . . . . . . (5,729,848) (14,454,688) 4,720,635
------------- ------------- -------------
INVESTING ACTIVITIES:
Proceeds from disposal of collateral . . . . . . . . . . . . . . 646,600 321,870 79,951
Decrease (increase) in due from shareholder. . . . . . . . . . . (225,259) 191,062 -
------------- ------------- -------------
CASH PROVIDED BY INVESTING . . . . . . . . . . . . . . . . . . . . 421,341 512,932 79,951
------------- ------------- -------------
FINANCING ACTIVITIES:
Net (payments) on revolving credit facilities. . . . . . . . . . (1,150,421) 7,639,201 (7,639,201)
Payments for debt issue costs. . . . . . . . . . . . . . . . . . (794,834) (426,990) (608,170)
Proceeds from notes payable. . . . . . . . . . . . . . . . . . . 12,575,248 2,015,150 10,500,000
Payments on notes payable. . . . . . . . . . . . . . . . . . . . (5,075,212) (2,348,740) (7,162,148)
Repurchase agreements. . . . . . . . . . . . . . . . . . . . . . (1,061,392) - -
Decrease in bank overdraft . . . . . . . . . . . . . . . . . . . (861,063) 2,936,883 (2,936,883)
Proceeds from public offering of preferred stock, net. . . . . . 5,704,863 - 9,631,407
Dividends paid on preferred stock. . . . . . . . . . . . . . . . - - (1,440,000)
Proceeds from issuance of common stock warrants. . . . . . . . . - 164,203 394,000
Investment in common stock agreement . . . . . . . . . . . . . . - - (527,915)
------------- ------------- -------------
CASH PROVIDED BY (USED IN) FINANCING. . . . . . . . . . . . . . . 9,337,189 9,979,707 211,090
------------- ------------- -------------
INCREASE (DECREASE) IN CASH. . . . . . . . . . . . . . . . . . . . 4,028,682 (3,962,049) 5,011,676
BEGINNING CASH BALANCE . . . . . . . . . . . . . . . . . . . . . . 92,660 4,121,342 159,293
------------- ------------- -------------
ENDING CASH BALANCE. . . . . . . . . . . . . . . . . . . . . . . . $ 4,121,342 $ 159,293 $ 5,170,969
============= ============= =============
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
-- F-8 --
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Termination of Dynex Funding Agreement
AutoBond Acceptance Corporation (the "Company") was incorporated in June
1993 and commenced operations August 1, 1994. The Company and its wholly-owned
subsidiaries, AutoBond Funding Corp I ("ABF I"), AutoBond Funding Corp II ("ABF
II"), and AutoBond Funding Corp III ("ABF III") (collectively, the "Company"),
engage primarily in the business of acquiring, selling or securitizing and
servicing automobile installment sale contracts ("finance contracts") originated
by franchised automobile dealers. The Company specializes in contracts to
consumers who generally have limited access to traditional financing, such as
that provided by commercial banks or captive finance companies of automobile
manufacturers. The Company purchases contracts directly from automobile dealers
or from other originators, with the intent to resell them.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As discussed
herein, the Company's primary source of funding for its acquisition of finance
contracts terminated funding in February 1999. In addition, the Company did not
meet certain of its financial covenants, which may give a lender the ability to
accelerate a debt obligation (see Note 7). Also, as further discussed in Note
14, trustees on certain of the Company's securitizations have notified the
Company of alleged events which may constitute events of servicer termination
under certain securitization transactions. The trustees have threatened to
remove the Company as servicer on certain transactions and, at December 31,
1998, have withheld certain servicing fees due the Company. Also, as discussed
in Note 14, the Company has filed litigation against a former deficiency balance
insurer concerning unpaid claims for reimbursement of losses incurred by the
Company on securitized finance contracts and the Company has been named in
litigation brought by a 15% Series A Cumulative Preferred stockholder. These
factors among others may indicate that the Company will be unable to continue as
a going concern for a reasonable period of time.
The financial statements do not include any adjustments relating to the
recoverability of recorded asset amounts or the amounts of liabilities that
might be necessary should the Company be unable to continue as a going concern.
The Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
comply with the terms and covenants of its financing agreements, to obtain
additional financing or refinancing as may be required, and ultimately to attain
successful operations. Management is continuing its efforts to obtain
additional funds so that the Company can sustain such operations as further
described below.
The Company's primary source for funding its finance contracts during 1998
was Dynex Capital, Inc. ("Dynex"). The Company, at Dynex' request, amended the
original financing agreements to accommodate certain of Dynex' liquidity issues.
The terms were last modified on October 28, 1998. With respect to new financing
requests, since the fourth quarter of 1998 a number of these requests have been
funded slower than the prescribed timeframe (2 days) in the financing
agreements. The last filled financing request was January 29, 1999. In February
1999, Dynex informed the Company that no further fundings would be made. As a
result of Dynex' failure to fund the Company's finance contracts, the Company
filed suit in District Court of Travis County demanding performance. Dynex also
has purported to accelerate the $3 million Senior Note payable by the Company.
The Company disputes the validity of such acceleration.
Since early February 1999, the Company's management has been attempting to
procure alternative sources of funding and other strategic alternatives, in
order to mitigate the situation with Dynex. The Company is currently in
discussions with several investment bankers and direct sources regarding such
alternatives which may include joint ventures, or changes in control of the
Company. While management hopes that an alternative opportunity will be
consummated, the Company has suspended acquisitions and
-- F-9 --
<PAGE>
dispositions of finance contracts until alternative funding sources are
obtained, however, there can be no assurance that such funding will be obtained.
As a consequence, the Company expects to report a loss for the first quarter of
1999 and will not pay the quarterly dividend on its preferred stock otherwise
payable on March 31, 1999. Unless financing or other strategic alternatives are
found the Company may not continue its business of originating loans and would
take steps to reduce its personnel and operating expenses associated with such
activities. Also, parties to the Company's various securitization transactions
could request that the Company surrender servicing, although management does not
believe such parties have the right to terminate servicing under the respective
agreements. The Company expects to continue its servicing operations.
Management believes the Company has sufficient liquidity to meet its
obligations and continue its servicing activities for a reasonable period of
time.
2. Summary of Significant Accounting Policies
Principals of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
Pervasiveness of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles 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 financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The Company records the present value of estimated future cash flows in
connection with its determination of the carrying value of its retained interest
in securitizations. Such estimation considers significant assumptions about the
future performance of finance contracts, including prepayments, default rates,
collections on repossessions of automobiles, delinquencies and timing of cash
receipts. Since such assumptions may not predict actual performance, it is at
least reasonably possible that the carrying value of the retained interest in
securitizations will be adjusted in the near term and the change could be
material to the results of operations.
Risks and Uncertainties
The Company requires access to significant sources and amounts of cash to
fund its operations and to acquire and sell or securitize finance contracts.
The Company's primary operating cash requirements include the funding of (i) the
acquisition of finance contracts, (ii) the initial cash deposits to reserve
accounts in connection with the warehousing and securitization of contracts in
order to obtain such sources of financing, (iii) fees and expenses incurred in
connection with the warehousing and securitization of contracts and (iv) ongoing
administrative and other operating expenses. The Company has traditionally
obtained these funds in three ways: (a) loans and warehouse financing
arrangements, pursuant to which acquisition of finance contracts are funded on a
temporary basis; (b) securitizations or sales of finance contracts, pursuant to
which finance contracts are funded on a permanent basis; and (c) general working
capital, which if not obtained from operations, may be obtained through the
issuance of debt or equity. Failure to procure funding from all or any one of
these sources could have a material adverse effect on the Company.
-- F-10 --
<PAGE>
Cash and Cash Equivalents
The Company considers highly liquid investments with maturities of three
months or less when purchased to be cash equivalents.
Restricted Cash
In accordance with certain of the Company's revolving credit facilities,
proceeds advanced by the lender for purchase of finance contracts were to be
held by a trustee until the Company delivers qualifying collateral to release
the funds, normally in a matter of days. The Company was also required to
maintain a cash reserve up to 10% of the proceeds received from the lender for
the origination of the finance contracts. Access to these funds was restricted
by the lender. The Company is not currently using its revolving credit
facilities, and therefore has no restricted cash at December 31, 1998.
Finance Contracts Held for Sale
Finance contracts held for sale are stated at the lower of amortized cost
or market value. Market value is determined based on the estimated value of the
finance contracts as if securitized and sold. The Company generally acquires
finance contracts at a discount, and (except for loans sold to Dynex) purchased
loss default and vender single interest physical damage insurance on the finance
contracts. The purchase discount and insurance were amortized as an adjustment
to the related finance contract's yield and operating expense, respectively,
utilizing the same basis as that used to record income on the finance contracts,
over the contractual life of the related finance contracts. At the time of sale,
any remaining unamortized amounts are netted against the finance contract's
principal amounts outstanding to determine the resultant gain or loss on sale.
Allowance for credit losses on the finance contracts is based on the
Company's historical default rate, the liquidation value of the underlying
collateral in the existing portfolio, estimates of repossession costs and
probable recoveries from insurance proceeds. The allowance is increased by
provisions for estimated future credit losses which are charged against income.
The allowance account is reduced for direct charge-offs using the specific
identification method, and for estimated losses upon repossession of automobiles
which is netted against the related finance contracts and transferred to
collateral acquired.
Collateral Acquired
Automobiles repossessed and held for sale are initially recorded at the
carrying value of in the finance contracts on the date of repossession less an
allowance. This value approximates the expected cash proceeds from the sale of
the assets and applicable insurance payments, net of all disposition costs. Due
to the relatively short time period between acquisition and disposal of the
assets, discounting of the expected net cash proceeds to determine fair value is
not utilized.
Subsequent impairment reviews are performed quarterly on a disaggregated
basis. A valuation allowance is established if the carrying amount is greater
than the underlying fair value of the assets. Subsequent increases and decreases
in fair value result in an adjustment of the valuation allowance which is
recorded in earnings during the period of adjustment. Adjustments for subsequent
increases in fair value are limited to the existing valuation allowance amount,
if any.
-- F-11 --
<PAGE>
Retained interest in securitizations
The Company adopted Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" ("SFAS No. 125"), as amended. SFAS No. 125 applies a
control-oriented, financial-components approach to financial-asset-transfer
transactions whereby the Company (1) recognizes the financial and servicing
assets it controls and the liabilities it has incurred, (2) derecognizes
financial assets when control has been surrendered, and (3) derecognizes
liabilities once they are extinguished. Under SFAS No. 125, control is
considered to have been surrendered only if: (i) the transferred assets have
been isolated from the transferor and its creditors, even in bankruptcy or other
receivership (ii) the transferee has the right to pledge or exchange the
transferred assets, or, is a qualifying special-purpose entity (as defined) and
the holders of beneficial interests in that entity have the right to pledge or
exchange those interests; and (iii) the transferor does not maintain effective
control over the transferred assets through an agreement which both entitles and
obligates it to repurchase or redeem those assets prior to maturity, or through
an agreement which both entitles and obligates it to repurchase or redeem those
assets if they were not readily obtainable elsewhere. If any of these conditions
are not met, the Company accounts for the transfer as a secured borrowing.
Pursuant to certain securitization transactions, the related trusts have
issued Class B certificates to the Company which are subordinate to the Class A
Certificates and senior to the retained interest in securitizations with respect
to cash distributions from the trust. The Company accounts for the Class B
certificates as trading securities with any unrealized gain or loss recorded in
the statements of operations in the period of the change in fair value.
All other retained interests in securitizations are accounted for as
investment securities classified as "available for sale". Accordingly, any
unrealized gain or loss in the fair value is included in accumulated other
income, a component of equity, net of the income tax effect. Any impairment
deemed permanent is recorded as a charge against earnings.
The fair value of retained interest in securitizations is calculated based
upon the present value of the estimated future cash flows after considering the
effects or estimated prepayments, defaults and delinquencies. The discount rate
utilized is based upon assumptions that market participants would use for
similar financial instruments subject to prepayments, defaults, collateral value
and interest rate risks.
Bank Overdraft
Bank overdrafts result from checks prepared but not sent to the related
creditor.
Debt Issuance Costs
The costs related to the issuance of debt are capitalized and amortized
into interest expense over the lives of the related debt. Debt issuance costs
related to warehouse credit facilities are amortized using the straight-line
method over the term of commitment.
Property, Plant and Equipment, Net
Property, plant and equipment are stated at cost less accumulated
depreciation. Expenditures for additions and improvements are capitalized while
minor replacements, maintenance and repairs which do not improve or extend the
life of such assets are charged to expense. Gains or losses on disposal of fixed
assets are reflected in operations. Depreciation is computed using the
straight-line method over the estimated useful lives of the depreciable assets,
ranging from 3 to 5 years. Leasehold improvements are depreciated over the term
of the lease.
In the event that facts and circumstances indicate that the cost of
long-lived assets may be impaired, an evaluation of recoverability would be
performed. If an evaluation of impairment is required, the estimated future
undiscounted cash flows associated with the asset would be compared to the
asset's carrying amount to determine if a write-down to market value or
discounted cash flow value is required. No such write-downs were recorded during
the years ended December 31, 1996, 1997 and 1998.
-- F-12 --
<PAGE>
Advertising
Advertising costs are expensed as incurred.
Income Taxes
The Company uses the liability method in accounting for income taxes. Under
this method, 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. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized. The provision for income taxes represents the tax
payable for the period and the change during the year in deferred tax assets and
liabilities. The Company files a consolidated federal income tax return.
Earnings per Share
Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per share 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.
Interest Income
The Company generally uses the simple interest method to determine interest
income on finance contracts acquired. The Company discontinued the accrual of
interest on finance contracts in 1998 as loans are sold shortly after
origination.
Concentration of Credit Risk
The Company generally acquires finance contracts from a network of
automobile dealers located in 40 states. Finance contracts acquired with
borrowers in Texas totaled 38% and 50% of the portfolio at December 31, 1997 and
1998, respectively. The Company had no dealer concentrations which accounted for
more than 10% of the portfolio at December 31, 1997 and 1998.
Reclassifications
Certain reclassifications have been made to prior years' financial
statements to conform with the current year's presentation.
3. Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133").
SFAS No. 133 requires than an entity recognize all derivatives as either assets
or liabilities in its balance sheet and that it measure those instruments at
fair value. The accounting for changes in the fair value of a derivative (that
is, gains and losses) is dependent upon the intended use of the derivative and
the resulting designation. SFAS No. 133 generally provides for matching the
timing of gain or loss recognition on the hedging instrument with the
recognition of (1) the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk or (2) the earnings effect of
the hedged forecast transaction. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999, although earlier
application is encouraged. The Company plans to comply with the provisions of
SFAS No. 133 upon its initial use of derivative instruments. As of December 31,
1998, no such instruments were being utilized by the Company.
-- F-13 --
<PAGE>
4. Finance Contracts Held for Sale
<TABLE>
<CAPTION>
The following amounts are included in finance contracts held for sale as
of:
December 31,
1996 1997 1998
-------------- ----------- ---------
<S> <C> <C> <C>
Unpaid principal balance . . . $ 266,450 $1,946,135 $944,830
Prepaid insurance. . . . . . . 18,733 - -
Contract acquisition discounts (31,554) (129,899) (64,067)
Allowance for credit losses. . (25,200) (450,122) (13,693)
-------------- ----------- ---------
$ 228,429 $1,366,114 $867,070
============== =========== =========
</TABLE>
<TABLE>
<CAPTION>
The activity in the allowance for credit losses for the years ended December 31
is summarized as follows:
December 31,
1996 1997 1998
--------- ---------- ----------
<S> <C> <C> <C>
Beginning Balance . . . . . 93,702 $ 25,200 $ 450,122
Provision for Credit Losses 412,387 612,715 100,000
Net Charge Offs . . . . . . (480,889) (187,793) (536,429)
--------- ---------- ----------
Ending Balance. . . . . . . 25,200 450,122 13,693
========= ========== ==========
</TABLE>
5. Retained interest in securitizations
The changes in retained interest in securitizations follow:
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1998
------------ -------------
<S> <C> <C>
Beginning balance. . . . . . . . . . . . . . . . . $16,942,571 $ 32,016,649
Unrealized gain (loss) . . . . . . . . . . . . . . 1,589,782 (1,589,782)
Changes from securitization and sale transactions. 14,250,024 8,621,373
Proceeds from retained interests (15,370,700)
Accretion of discount. . . . . . . . . . . . . . . 546,506 127,980
Impairment charge. . . . . . . . . . . . . . . . . (1,312,234) (9,932,169)
------------ -------------
Ending balance . . . . . . . . . . . . . . . . . . $32,016,649 $ 13,873,351
============ =============
Consisting of:
Trading . . . . . . . . . . . . . . . . . $ 7,878,306 $ 4,586,908
Available for sale. . . . . . . . . . . . 24,138,343 9,286,443
------------ -------------
$32,016,649 $ 13,873,351
============ =============
</TABLE>
-- F-14 --
<PAGE>
The Company periodically reviews the fair value of the retained interest in
securitizations. The difference in the fair value of securities available for
sale and the historical carrying value on a disaggregated basis, where any
reduction in value does not result in an impairment that is other than
temporary, is recognized as an adjustment to accumulated other comprehensive
income, a separate component of shareholder's equity. The Company recorded a
charge against earnings for permanent impairment of retained interest in
securitizations, determined on a disaggregated basis, of $1,312,234 and
$9,932,169 for the years ended December 31, 1997 and 1998 respectively.
The Company's retained interests in securitizations represent the present
value of expected future cash flows to the Company from sales of finance
contracts. The amount of these retained interests may be increased by
additional sales or securitizations. The amount of these retained interests of
finance contracts may decrease due to the Company's receipt of cash flows from
their investment. Retained interests in securitizations will also decrease in
the case of impairments caused by a revaluation of the future cash flows.
The Company utilizes a financial model to project the cash flows from a
pool of finance contracts. This model projects cash flows for contractual
parties including investors, trustees and servicers, as well as the Company's
retained interests. As is the case with most financial models, its
effectiveness is primarily driven by the performance over time of key financial
model assumptions, including: default rates; delinquency rates; prepayment
rates; discount rates; initial, ongoing and minimum cash reserve requirements;
the interest rate earned on cash reserves; recovery amounts for repossessions;
repossession recovery lags; insurance claims recovery amounts, insurance
recovery lags; and on-going servicing/trustee fees. Periodically, the Company's
financial models and related assumptions have been updated to reflect the actual
performance characteristics of the finance contracts. All valuations are
conducted on a disaggregated basis.
The Company's term securitizations have involved the placement of excess
spread backed-notes, sometimes referred to as "B Pieces" with institutional
investors. All assumptions used to size and sell these "B Pieces" were
identical to the initial gain-on-sale assumptions the Company applied with
respect to retained interests. The discount rates applied for retained interests
ranged from 15% to 17%. The non-vector equivalent of annualized default rates
typically ranged from 10% to 12%. The default rate assumptions are estimated
based on the historical static pool results. Repossession recovery ratios, with
deficiency insurance proceeds reflected, typically ranged from 80% to 90%.
There were two primary causes of the impairment charges to retained
interest in securitizations during the year ended December 31, 1998. The Company
has been engaged in litigation with Progressive Northern Insurance Company
("Progressive") regarding the interpretation of default insurance coverage the
Company acquired to enhance recoveries. During the earlier stages of the
dispute, Progressive continued to pay claims. However, in April 1998
Progressive stopped paying claims. The immediate impact of the loss of cash
flow from Progressive was the necessity to draw funds from the applicable trust
cash reserves to pay senior security holders. The Company is the ultimate
beneficiary of the cash reserves, and such reserves will need to be replenished
before cash flows may resume to the other certificate holders and ultimately to
the Company. The depletion and expected delay in receiving any ultimate cash
flows reduced the value of the retained interests. The Company has continued to
include the expected cash flows from Progressive Insurance in its cash flows
models. Even though the Company and its legal counsel are optimistic that the
Company will prevail in its litigation, at this time, Progressive has not
resumed payment of claims. Should the Company's interpretation be incorrect,
the Company would need to reassess the carrying value of its retained interest
in securitizations under new assumptions and the result of this revaluation
could be material.
The second additional factor was the transfer of servicing functions to the
Company from a third party service provider, Loan Servicing Enterprise ("LSE").
In March 1998, the Company commenced litigation against LSE, pertaining to
breaches of its servicing obligations. As the Company assumed all servicing it
accelerated the recording of charge-offs as compared with prior periods.
Accelerated charge-offs result in any available cash flow going to the senior
investors that otherwise would go to subordinate investors or to the benefit of
the Company. In attempting to resolve certain of these issues with Moody's
-- F-15 --
<PAGE>
Investors Service ("Moody's"), the agency rating the senior securities, the
Company committed to Moody's in May 1998 that it would not release monies to the
"B Piece" investors until all charge-offs have been reflected in the cash flows
attributable to the senior investors. The delay of payments to the subordinated
investors causes accretion of the principal amount of their high interest-rate B
Pieces and a corresponding impairment of the Company's retained interest. The
accelerated charge-offs and the Company's decision in May 1998 to commit to
Moody's to withhold monies from the B Pieces, resulted in a direct impact on the
valuation of the retained interests. A total of eight securitizations were
impacted by this action.
The Company has engaged counsel to perform the deal-by-deal analysis of the
structural and legal integrity of these transactions and resolve the concerns
raised by Moody's. In the meantime, the Company has been notified by the
trustees on certain of the securitizations that the action of Moody's and the
alleged causes constituted events of servicer termination under such
transactions. The trustees have threatened to remove the Company as servicer on
certain transactions, and have withheld administrator fees and expenses of
approximately $900,000 as of December 31, 1998, due to the Company. Since the
Company is of the view that no events of servicing termination have occurred and
that the transactions documents did not intend for servicing compensation to the
Company to be cut off where the cause of an event of default is due to the
actions of Progressive and LSE (the former servicer), the Company is seeking to
resolve those issues to the satisfaction of all parties.
Significant assumptions utilized in the estimation of future cash flows
include:
<TABLE>
<CAPTION>
<S> <C>
Variable . . . . . . . . . . . . . . . . . . . . Assumptions
- ------------------------------------------------ ----------------------------------------------------
Discount rate. . . . . . . . . . . . . . . . . . 15% - 17%
Default rates. . . . . . . . . . . . . . . . . . Variable curve based upon historical experience,
varies from 5% to 17% annually
Lag in sale of collateral and insurance receipts 5 months and 7 months, respectively
Collections on defaulted loans . . . . . . . . . Based upon historical percentages of collections or
wholesale prices of collateral plus insurance
collections reduced over time to give effect to
estimated changes in such wholesale used
automobile prices
Prepayment rates . . . . . . . . . . . . . . . . 1% in first month, reducing to 0.4% per month over
the loan term
- ------------------------------------------------ ----------------------------------------------------
</TABLE>
-- F-16 --
<PAGE>
At the close of a rated securitization, the Company is required to
establish a cash reserve within the trust for future credit losses.
Additionally, depending on each securitization structure, a portion of the
Company's future cash flow is required to be deposited as additional reserves
for credit losses. The initial cash reserve deposits for the Company's
securitizations totaled $1.6 million and $7.4 million for the years ended
December 31, 1996 and 1997, respectively. These amounts represented 2.0% and
3.9% of the senior investor certificates issued by the trusts during the
respective periods. Cash reserve deposits are not required for the 1998
transactions with Dynex. The trust reserves are increased monthly from excess
cash flows until such time as they attain a level of 6% of the outstanding
principal balance.
6. Revolving Credit Facilities
On June 10, 1998, the Company and Dynex Capital, Inc., ("Dynex") entered
into an arrangement whereby the Company obtained a commitment from Dynex to
purchase all currently warehoused and future automobile finance contract
acquisitions through at least May 31, 1999 (the "Funding Agreement"). The terms
of the Funding Agreement were modified on June 30, October 20, and October 28,
1998. Under the prior terms of the Funding Agreement, the Company transferred
finance contracts to AutoBond Master Funding Corporations V ("Master Funding
V"), a qualified unconsolidated special purpose subsidiary, and Dynex provided
credit facilities in an amount equal to 104% of the unpaid principal balance of
the finance contracts (the "Advance Rate"), the proceeds of such facilities are
received by the Company. Under the modified terms of the Funding Agreement, the
Advance Rate was reduced from 104% to 88% for an
-- F-17 --
<PAGE>
interim period (the "Interim Period") ending December 31, 1998. At the end of
the Interim Period, the Advance Rate reverted to 104% and Dynex was to advance
to Master Funding V an additional amount equal to 16% of the unpaid principal
balance of finance contracts financed by Dynex during the Interim Period. This
additional amount receivable from Dynex of $6.5 million at December 31, 1998 was
collected in January and February 1999. Advances under the Funding Agreement are
limited to $25 million per month after June 1998 until the commitment
termination date. Under the modified terms of the Funding Agreement, the
commitment terminates on July 31, 1999 (provided that 90 days' prior written
notice from Dynex is given), or if such notice is not given, July 31, 2000. At
the Company's option the commitment termination date can be extended an
additional four months to November 30, 1999 (provided that 90 days' prior
written notice to Dynex is given), or if such notice is not given, November 30,
2000. Advances under the Funding Agreement are evidenced by Class A and Class B
Notes (collectively, the "Notes") issued by Master Funding V to Dynex. The
Class A Notes are issued in a principal amount equal to 94.0% of the unpaid
principal balance of the finance contracts (88.0% for advances funded during the
Interim Period) and bear interest at a rate equal to 190 basis points over the
corporate bond equivalent yield n the three-year Treasury note on the closing
date for each such advance (equal to an average of 7.02% as of December 31,
1998); provided however, that during the Interim Period, the interest rate on
the Company's Class A Notes equaled One-Month LIBOR plus 1.50%. The Class B
Notes are issued in a principal amount equal to 10.0% of the unpaid principal
balance of the finance contracts (0.0% for advances funded during the Interim
Period) and bear interest at a rate equal to 16% per annum. The Company retains
a subordinated interest in the pooled finance contracts. Transfers of finance
contracts to the qualified special purpose entity have been recognized as sales
under SFAS No. 125. At December 31, 1998, advances by Dynex under the Funding
Agreement totaled $155 million. See Notes 1 and 14 for the status of the Dynex
Funding Agreement.
Effective August 1, 1994, the Company entered into a secured revolving
credit agreement with Sentry Financial Corporation ("Sentry") which was amended
and restated on July 31, 1995. The amended agreement (the "Sentry Facility")
provides for a $10.0 million warehouse line of credit which terminates December
31, 2000, unless terminated earlier by the Company or Sentry. The proceeds of
the Sentry Facility are to be used to originate and acquire finance contracts,
to pay for loss default insurance premiums, to make deposits to a reserve
account with Sentry, and to pay for fees associated with the origination of
finance contracts. The Sentry Facility is collateralized by the finance
contracts acquired with the outstanding borrowings. Interest is payable monthly
and accrues at a rate of prime plus 1.75%. The Sentry Facility contains certain
restrictive covenants that only apply when there is an outstanding balance,
including requirements to maintain a certain minimum net worth, and cash and
cash equivalent balances. Under the Sentry Facility, the Company paid interest
of $220,674, $420,674 and $189,985 for the years ended December 31, 1996, 1997
and 1998, respectively. Pursuant to the Sentry Facility, the Company was
required to pay a $700,000 warehouse facility fee payable upon the successful
securitization of finance contracts. The $700,000 was payable in varying amounts
after each of the first three securitizations. The Company accrued the $700,000
debt issuance cost upon the first securitization in December 1995, the date the
Company determined the liability to be probable. The $700,000 debt issuance cost
is being amortized as interest expense through December 31, 2000, the
termination date of the Sentry Facility. The Company pays a utilization fee of
up to 0.21% per month on the average outstanding balance of the Sentry Facility.
The Sentry Facility also requires the Company to pay up to 0.62% per quarter on
the average unused balance. The Sentry Facility was amended in May 1998 to add
additional representations, covenants, a general release of Sentry, the
guarantee of William O. Winsauer, and the right of Sentry to refuse future
advances at its sole discretion. At December 31, 1998, as there were no amounts
outstanding at that date.
The Company and its wholly owned subsidiary, AutoBond Funding Corporation
II, entered into a $50 million revolving warehouse facility (the "Daiwa
Facility") with Daiwa Finance Corporation ("Daiwa") effective as of February 1,
1997. Advances under the Daiwa Facility matured on the earlier of 120 days
following the date of the advance or March 31, 1998. The proceeds from the
borrowings under the Daiwa Facility were used to acquire finance contracts and
to make deposits to a reserve account. Interest was payable upon maturity of the
advances and accrued at the lesser of (x) 30 day LIBOR plus 1.15% or (y) 11% per
annum. The Company also paid a non-utilization fee of .25% per annum on the
unused amount of the line of credit. Pursuant to the Daiwa Facility, the Company
paid a $243,750 commitment fee which is recorded as debt issue costs. The debt
issuance cost was amortized as interest
-- F-18 --
<PAGE>
expense through March 1998. The Daiwa Facility contained certain covenants and
representations similar to those in the agreements governing the Company's
existing securitizations including, among other things, delinquency and
repossession triggers. At December 31, 1997, advances under the Daiwa Facility
totaled $7,639,201. The Company paid off the Daiwa facility in June 1998 after
closing the Dynex Funding Agreement. The Company incurred interest expense under
the Daiwa Facility of approximately $1,118,883 and $ 333,085 the years ended
December 31, 1997 and 1998, respectively.
7. Notes Payable and Non-Recourse Debt
Notes payable:
<TABLE>
<CAPTION>
The following amounts are included in notes payable as of:
December 31,
1997 1998
---------- ------------
<S> <C> <C>
Convertible Senior Note . . . . . . . $ - $ 3,000,000
Convertible notes payable . . . . . . 2,000,000 7,500,000
Other notes payable . . . . . . . . . 57,824 23,342
Discount on convertible notes payable - (356,373)
---------- ------------
$2,057,824 $10,166,969
========== ============
</TABLE>
On June 10, 1998, the Company sold to Dynex at par $3 million of the
Company's 12% Convertible Senior Notes due 2003 (the "Senior Notes"). Interest
on the Senior Notes is payable quarterly in arrears, with the principal amount
due on June 9, 2003. The Senior Notes may be converted at the option of Dynex on
or before May 31, 1999 into shares of the Company's common stock at a conversion
price of $6.00 per share. Demand and "piggyback" registration rights with
respect to the underlying shares of common stock were granted. The Company has
made all payments due on the Senior Notes and expects to continue to meet such
obligations. See Note 1 regarding Dynex' claim that note has been accelerated.
In January 1998, the Company privately placed with BancBoston Investments,
Inc. ("BankBoston") $7,500,000 in aggregate principal amount of its 15% senior
subordinated convertible notes (the "Subordinated Notes"). Interest on the
Subordinated Notes is payable quarterly until maturity on February 1, 2001. The
Subordinated Notes are convertible at the option of the holder for up to 368,462
shares of common stock of the Company, at a conversion price of $3.30 per share,
subject to adjustment under standard anti-dilution provisions. The Company also
granted BancBoston a warrant to purchase company stock exercisable to the extent
the debt is not converted (See Note 9). In the event of a change of control
transaction, the holder of the Subordinated Notes may require the Company to
repurchase the Subordinated Notes at 100% of the principal amount plus accrued
interest. The Subordinated Notes are redeemable at the option of the Company on
or after July 1, 1999 at redemption prices starting at 105% of the principal
amount, with such premium reducing to par on and after November 1, 2000, plus
accrued interest. The Subordinated Notes were issued pursuant to an Indenture,
dated as of January 30, 1998 (the "Indenture") between the Company and
BankBoston, N.A., as agent. The Indenture contains certain restrictive covenants
including (i) a consolidated leveraged ratio not to exceed 2 to 1 (excluding
non-recourse warehouse debt and securitization debt), (ii) limitations on
restricted payments such as dividends (but excluding, so long as no event of
default has occurred under the Indenture, dividends or distributions on the
preferred stock of the Company), (iii) limitations on sales of assets other than
in the ordinary course of business and (iv) certain financial covenants,
including a minimum consolidated net worth of $12 million (plus proceeds from
equity offerings), a minimum ratio of EBITDA to interest of 1.5 to 1, and a
maximum cumulative repossession ratio of 27%. Events of default under the
Indenture include failure to pay, breach of covenants, cross-defaults in excess
of $1 million or material breach of representations or covenants under the
purchase agreement with BancBoston. The Company capitalized debt issuance costs
of
-- F-19 --
<PAGE>
$594,688, and recorded a discount of $507,763 on the debt representing the value
of the warrants issued. The debt issuance cost and discount is being amortized
as interest expense on the interest method through February 2001. At December
31, 1998 the Company did not meet certain of its financial covenants which
constitutes an event of default on the Subordinated Notes. The Company has made
all payments due on its Subordinated Notes and expects to continue to meet such
obligations. The Subordinated Notes have not been formally accelerated by
BankBoston; however, if such acceleration were made, BankBoston could declare
such amounts immediately due.
Pursuant to the an agreement (the "Securities Purchase Agreement") entered
into on June 30, 1997, the Company issued by private placement $2,000,000 in
aggregate principal amount of senior secured convertible notes ("convertible
notes"). Interest is payable quarterly at a rate of 18% per annum until maturity
on June 30, 2000. The convertible notes, collateralized by the retained interest
in securitizations from the Company's first four securitizations, were
convertible into shares of common stock of the Company. Also pursuant to the
Securities Purchase Agreement, the Company issued warrants which upon exercise
allow the holders to purchase up to 200,000 shares of common stock at $4.225 per
share. The Company also issued a warrant to purchase up to 30,000 shares of
Common Stock at $4.225 per share to an individual assisting in the placement of
such debt. The warrants are exercisable to the extent the holders thereof
purchase up to $10,000,000 of the Company's subordinated asset-backed securities
before June 30, 1998. The holders purchased $5,800,000 of subordinated
asset-backed securities. The total value assigned to these warrants was
approximately $154,000, which was included in the cost of sale of the
asset-backed securities. The Company paid off this debt in February 1998 which
terminated the conversion rights.
Non-Recourse Debt:
Prior to the adoption of SFAS No. 125, the Company securitized loans
through special purpose entities, however, the structure resulted in the Company
retaining Class B certificates that were then financed directly by the Company
rather than through related trusts. The Company obtained non-recourse financing
from several finance companies with terms substantially identical to the Class B
certificates, which are pledged to the debt. The effect was to grant the
non-recourse note-holder, the economic benefit of the Class B certificates. The
Company recorded the Class B certificates and the non-recourse financing on its
balance sheet. The non-recourse loans bear interest at 15% per annum and have
stated terms of six years. Principal and interest payments are paid by the
related securitization trustee directly to the financing company consisting of
all funds available to be paid to the Class B certificate holders.
During 1998 the Class B certificates were deemed to be impaired and were
marked to market. As the non-recourse debt holders are only entitled to receive
amounts attributable to the Class B certificates, their value and ultimate
settlement is based on such Class B certificate and are also marked-to-market.
-- F-20 --
<PAGE>
<TABLE>
<CAPTION>
The following summarizes the non-recourse debt outstanding at December 31, 1997 and
1998
Stated
Origination Date Terms Rate Original Amount 1997 1998
- ------------------------------- ----- ----- ---------------- ---------- ------------
<S> <C> <C> <C> <C> <C>
April 8, 1996 . . . . . . . . . 6 years 15% $ 2,585,757 $1,142,517 $ 1,120,300
March 28, 1996. . . . . . . . . 6 years 15% 2,059,214 1,230,464 1,205,733
June 27, 1996 . . . . . . . . . 6 years 15% 2,066,410 1,491,786 1,480,957
September 30, 1996. . . . . . . 6 years 15% 2,403,027 1,672,318 1,660,140
December 27, 1996 . . . . . . . 6 years 15% 2,802,891 2,246,134 2,221,356
Valuation Adjustment -0- (4,503,436)
---------- ------------
Carrying Value at end of period $7,783,219 $ 3,185,050
========== ============
</TABLE>
8. Initial Public Offering
On November 14, 1996, the Company and selling shareholders sold 750,000 and
250,000, respectively, of shares of common stock in an initial public offering
at a price of $10 per share. The net proceeds from the issuance and sale of
common stock amounted to approximately $5,000,000 after deducting underwriter
discounts and issuer expenses. Portions of the net proceeds were used (i) to
prepay outstanding subordinated debt of approximately $300,000 plus accrued
interest, (ii) to repay advances under revolving credit facilities and (iii) for
general corporate and working capital purposes.
The underwriters of the Company's initial public offering purchased an
additional 75,000 shares of the Company's common stock at $10 per share by
exercising half of their over-allotment option. The net proceeds from the
issuance and sale of these shares amounted to approximately $700,000 after
deducting underwriter's discounts.
9. Income Taxes
The provision for income taxes for the years ended December 31, 1996, 1997
and 1998 consisted of a provision for deferred taxes and the Company had no
current tax liability. The reconciliation between the provision for income taxes
and the amounts that would result from applying the Federal statutory rate is as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1997 1998
---------- -------- ------------
<S> <C> <C> <C>
Federal tax (benefit)at statutory rate of 34% $1,907,889 $850,415 $(3,662,069)
Nondeductible expenses. . . . . . . . . . . . 18,664 37,755 35,700
Change in valuation allowance . . . . . . . . - - -
---------- -------- ------------
Provision for income taxes. . . . . . . . . . $1,926,553 $888,170 $(3,626,369)
========== ======== ============
</TABLE>
-- F-21 --
<PAGE>
Deferred income tax assets and liabilities reflect the tax effect of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and income tax purposes Significant components of
the Company's net deferred tax liability are as follows:
<TABLE>
<CAPTION>
December 31,
1997 1998
------------- -----------
<S> <C> <C>
Deferred tax assets:
Allowance for credit losses . . . . . . . . . . . . . . . . . . $ 244,489 $ 136,259
Cost related to securitizations . . . . . . . . . . . . . . . . 727,443 3,659,080
Income on prior securitizations . . . . . . . . . . . . . . . . - 4,474,621
Impairment of retained interest . . . . . . . . . . . . . . . . - 3,324,065
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61,769 87,040
Net operating loss carryforwards. . . . . . . . . . . . . . . . 8,098,975 7,676,996
------------- -----------
Gross deferred tax assets . . . . . . . . . . . . . . . . . . . 9,132,676 19,358,061
------------- -----------
Deferred tax liabilities:
Gain on securitizations . . . . . . . . . . . . . . . . . . . . 11,755,155 19,015,754
Unrealized appreciation on retained interest in securitizations 540,525 -
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341,245 444,107
Gross deferred tax liabilities. . . . . . . . . . . . . . . . . 12,636,925 19,459,861
------------- -----------
Net deferred tax liabilities. . . . . . . . . . . . . . . . . . $ 3,504,249 101,800
============= ===========
</TABLE>
At December 31, 1998, the Company had tax net operating loss carryforwards
of approximately $22.5 million expiring in fiscal years 2009 through 2012.
10. Shareholders' Equity
Stock Based Compensation Plan
The Company grants stock options under a stock-based incentive compensation
plan (the "Option Plan"). The Company applies Accounting Principles Board
Opinion No. 25 and related interpretations in accounting for the Option Plan. In
1995, SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123") was
issued, which, if fully adopted by the Company, would change the methods the
Company applies in recognizing the cost of the Option Plan. Adoption of the cost
recognition provisions of SFAS 123 is optional and the Company has elected not
to adopt these provisions of SFAS 123. However, pro forma disclosures as if the
Company adopted the expense recognition provisions of SFAS 123 are required by
SFAS 123 and are presented below.
Under the Option Plan, the Company is authorized to issue shares of Common
Stock pursuant to "Awards" granted in various forms, including incentive stock
options (intended to qualify under Section 422 of the Internal Revenue Code of
1986, as amended), non-qualified stock options, and other similar stock-based
Awards. The Company granted stock options in 1996 through 1998 under the Option
Plan in the form of non-qualified stock options.
Stock Options
The Company has granted stock options to employees and directors. The stock
options granted have contractual terms of 10 years. All options granted to the
employees and directors have an exercise price not less than the fair market
value of the stock at the grant date. The options granted vest, 33.33% per year,
beginning on the first anniversary of the date of grant. In accordance with APB
25, the Company has not recognized any compensation cost for the stock options
granted.
-- F-22 --
<PAGE>
A summary of the status of the Company's stock options for the years ended
December 31, 1996 through 1998 is presented below:
<TABLE>
<CAPTION>
Shares of Weighted Average
Underlying Options Exercise Price
------------------- -----------------
<S> <C> <C>
Outstanding at January 1, 1996 . . . - -
Granted. . . . . . . . . . . . . . 297,500 $ 10.11
------------------- -----------------
Outstanding at December 31, 1996 . . 297,500 10.11
Granted. . . . . . . . . . . . . . 93,000 5.67
Exercised. . . . . . . . . . . . . - -
Forfeited. . . . . . . . . . . . . (119,500) 9.50
------------------- -----------------
Outstanding at December 31, 1997 . . 271,000 $ 8.85
Granted. . . . . . . . . . . . . . 330,000 $ 5.85
Exercised. . . . . . . . . . . . . - -
Forfeited. . . . . . . . . . . . . 52,668 $ 7.44
------------------- -----------------
Outstanding at December 31, 1998 . . 548,332 $ 7.18
Options exercisable at end of period 139,660 $ 9.52
=================== =================
</TABLE>
<TABLE>
<CAPTION>
Shares of Weighted Average Weighted Average
Range of Exercise Prices Underlying Options Remaining Life Exercise Price
- ------------------------- ------------------ ---------------- ----------------
<S> <C> <C> <C>
2.00 to $2.99. . . . . . 10,000 8.4 $ 2.49
3.00 to $3.99. . . . . . 114,000 9.0 3.72
4.00 to $4.99. . . . . . 41,000 8.9 4.40
5.00 to $5.99. . . . . . 20,000 9.7 5.50
6.00 to $6.99. . . . . . 10,000 9.1 6.13
7.00 to $7.99. . . . . . 150,000 9.3 7.32
8.00 to $8.99. . . . . . 13,000 9.2 8.20
9.00 to $9.99. . . . . . 92,332 8.0 9.81
10.00 to $10.99. . . . . 100,000 7.9 10.48
------------------ ---------------- -----------------
Total . . . . . . . . . 548,332 8.5 $ 7.18
================== ================ =================
</TABLE>
The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions: dividend yield of 0%; risk-free interest rates of
5.5%, the expected lives of options of 5 years; and a volatility of 40.0% for
all grants in 1996 and 1997 and 45% for all grants in 1998.
-- F-23 --
<PAGE>
Pro Forma Net Income and Net Income Per Common Share
Had the compensation cost for the Company's Option Plan been determined
consistent with SFAS 123, the Company's net income and net income per common
share for 1996, 1997 and 1998 would approximate the pro forma amounts below:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1997 1998
---------- ---------- -----------
<S> <C> <C> <C>
Net income attributable to common shareholders (loss):
As reported. . . . . . . . . . . . . . . . . . . . . . 3,584,886 1,613,053 (8,584,423)
Pro Forma. . . . . . . . . . . . . . . . . . . . . . . 3,562,991 1,370,422 (8,811,364)
Net income (loss) per common share (basic):
As reported. . . . . . . . . . . . . . . . . . . . . . $ .062 $ 0.25 ($1.31)
Pro Forma. . . . . . . . . . . . . . . . . . . . . . . 0.62 0.21 (1.35)
Net income (loss)per common share (diluted):
As reported. . . . . . . . . . . . . . . . . . . . . . $ 0.62 $ 0.25 ($1.31)
Pro Forma. . . . . . . . . . . . . . . . . . . . . . . 0.61 0.20 (1.35)
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts.
Warrants
In connection with the issuance of preferred stock, the Company sold to
Tejas Securities Group, Inc. ("Tejas"), for $100, a warrant (the "Tejas
Warrant") to purchase up to 100,000 shares of the Company's common stock at an
exercise price equal to $7.75 per share. The Tejas Warrant is exercisable for a
period of four years commencing February 17, 1999. The Tejas Warrant includes a
net exercise provision permitting the holder, upon consent of the Company, to
pay the exercise price by cancellation of a number of shares with a fair market
value equal to the exercise price of such Tejas Warrant. The value of the
warrant of $394,000 was considered additional issuance cost of the preferred
stock.
In June 1997, the Company issued $2,000,000 in aggregate principal amount
of its 18% senior secured convertible notes (which have been redeemed in full)
and Common Stock Purchase Warrants, dated June 30, 1997, to Infinity Investors
Limited. The warrants entitle the holders of such warrants, upon exercise
thereof, to purchase from the Company 200,000 shares of its common stock at
$4.225 per share. The Company also issued a warrant to purchase 30,000 shares of
its common stock at $4.225 per share to an individual assisting in the placement
of such debt.
In connection with the issuance of the Company's Subordinated Notes in
January 1998, the Company issued to BancBoston a warrant (the "Subordinated Note
Warrant"). The Subordinated Note Warrant entities the holder, upon exercise of
the Warrant, to purchase from the Company that number of shares of the Company's
common stock, up to 368,462, which were available for conversion at the maturity
of the Subordinated Notes on February 1, 2001. The holder may either convert the
debt or exercise the warrant but not both. The Subordinated Note Warrant
contains customary anti-dilution provisions, as well as certain demand and
"piggyback" registration rights. In addition, if certain major corporate events
(such as a change in control or major stock offering) do not occur prior to
February 1, 2001, then the holder will have the right to put the Warrant to the
Company at the difference between the current market price and the warrant
exercise price. Based on the market price at December 31, 1998, no amount would
be payable at such date. The Company has the option to redeem the Subordinated
Note Warrant under certain circumstances. The Subordinated Note Warrant expires
on January 31, 2005. The warrant was valued at $375,831 which was recorded as a
discount on the debt.
-- F-24 --
<PAGE>
In connection with the placement of the Subordinated Notes and the
Subordinated Note Warrant, the Company, William O. Winsauer and John S.
Winsauer, as principals (the "Principals") entered into a Shareholders Agreement
with BancBoston pursuant to which the Principals granted to BancBoston certain
"tag-along rights" in connection with sales of common stock by the Principals.
Also, the Company paid a placement fee of 5% of the principal amount of the
Subordinated Notes to Dresner Investment Services, Inc. and issued to the
placement agent a warrant to purchase 65,313 shares of common stock of the
Company, at an exercise price of $6.30 per share.
The Company's remaining outstanding warrants are a warrant (expiring
January 12, 2000) held by an individual exercisable for 7,500 shares of common
stock of the Company at a price of $4.00 per share, and a warrant (expiring
March 31, 2002) held by Infinity Investors Limited exercisable for 100,000
shares of common stock of the Company at a price of $8.73 per share .
Preferred Stock
Pursuant to the Company's amended articles of incorporation, the Company is
authorized to issue from time to time up to 5,000,000 shares of preferred stock,
in one or more series. The Board of Directors is authorized to fix the dividend
rights, dividend rates, any conversion rights or right of exchange, any voting
right, any rights and terms of redemption (including sinking fund provisions),
the redemption rights or prices, the liquidation preferences and any other
rights, preferences, privileges and restrictions of any series of preferred
stock and the number of shares constituting such series and the designation
thereof. There were no shares of preferred stock issued or outstanding at
December 31, 1997.
In February 1998, the Company completed the underwritten public offering of
1,125,000 shares of its 15% Series A Cumulative Preferred Stock (the "Preferred
Stock"), with a liquidation preference of $10 per share. The price to the public
was $10 per share, with net proceeds to the Company of approximately $9,631,000.
Such net proceeds have been utilized for working capital purposes, including the
funding of finance contracts. Dividends on the Preferred Stock are cumulative
and payable quarterly on the last day of March, June, September and December of
each year, commencing on June 30, 1998, at the rate of 15% per annum. After
three years from the date of issuance, the Company may, at its option, redeem
one-sixth of the Preferred Stock each year, in cash at the liquidation price per
share (plus accrued and unpaid dividends), or, if in common stock, that number
of shares equal to $10 per share of Preferred Stock to be redeemed, divided by
85% of the average closing sale price per share for the common stock for the 5
trading days prior to the redemption date. The Preferred Stock is not
redeemable at the option of the holder and has no stated maturity. Preferred
Stock dividends of $596,250 , $421,875, and $421,875 were paid on June 30, 1998,
September 30, 1998, and December 31, 1998 respectively.
Because the Company is not in compliance with certain of the financial
covenants of its subordinated notes, the Company will not pay the quarterly
dividend on its Preferred Stock, otherwise payable on March 31, 1999. If
dividends on the Preferred Stock are in arrears for two quarterly dividend
periods, holders of the Preferred Stock will have the right to elect three
additional directors to serve on the Company's Board until such dividend
arrearage is eliminated. In addition, certain changes that could materially
affect the holders of Preferred Stock, such as a merger of the Company, cannot
be made without the affirmative vote of the holders of two-thirds of the shares
of Preferred Stock, voting as a separate class. The Preferred Stock ranks senior
to the common stock with respect to the payment of dividends and amounts upon
liquidation, dissolution or winding up.
Common Stock Investment Agreement
On May 20, 1998, the Company and Promethean Investment Group, L.L.C.
("Promethean") entered into a common stock investment agreement (the "Investment
Agreement") and related registration rights agreement whereby Promethean agreed
to purchase from the Company, on the terms and conditions outlined below, up to
$20 million (subject to increase up to $25 million at Promethean's option) of
the Company's common stock. The Company must deliver a preliminary notice of its
intention to require Promethean to purchase its common shares at least ten but
not more than thirty days prior to the Company's delivery of its final notice.
The Company may only deliver such final notice if (i) the dollar volume-
-- F-25 --
<PAGE>
weighted price of its common stock reported on the business day of such final
notice is at least $3.25 per share, (ii) at all times during the period
beginning on the date of delivery of the preliminary notice and ending on and
including the closing date (a) a registration statement covering the resale of
no less than 150% of the shares to be sold to Promethean under the Investment
Agreement has been declared and remains effective and (b) shares of the
Company's common stock are at such time listed on a major national securities
exchange, and (iii) the Company has not delivered another final notice to
Promethean during the preceding twenty-five business days preceding delivery of
such final notice. Following receipt of a final notice, Promethean's purchase
obligation will equal the lowest of: (i) the amount indicated in such final
notice, (ii) $5,000,000 and (iii) 20% of the aggregate of the daily trading
dollar volume on the twenty consecutive business days following delivery of the
put notice. Promethean may, in its sole discretion, increase the amount
purchasable in the preceding sentence by 125%. Promethean must conclude all
required purchases of common shares within twenty-five business days of receipt
of the final notice. The purchase price for the Company's shares will be equal
to 95% of the lowest daily dollar volume-weighted average price during the six
consecutive trading days ending on and including the date of determination.
Promethean's obligation to purchase shares under the Investment Agreement shall
end either upon the mutual consent of the parties or automatically upon the
earliest of the date (a) on which total purchases by Promethean under the
Investment Agreement total $20,000,000, (b) which is two years after the
effective date of the registration statement relating to the common stock
covered by the Investment Agreement, or (c) which is twenty-seven months from
the date of the Investment Agreement. In consideration of Promethean's
obligations under the Investment Agreement, the Company paid $527,915 in cash on
August 19, 1998, which was treated as an investment in a common stock agreement.
Earnings Per Share
Basic earnings per share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the period.
Diluted earnings per share differs from basic earnings per share due to the
assumed conversions of dilutive options, warrants and convertible debt that were
outstanding during the period.
<TABLE>
<CAPTION>
Earnings per share is calculated as follows:
1996 1997 1998
---------- ---------- ------------
<S> <C> <C> <C>
Net income (loss) (basic) . . . . . . . . . . $3,584,886 $1,613,053 $(7,144,423)
Effect of convertible debt, net of taxes. . . - 119,460 -
---------- ---------- ------------
Net income (loss) (diluted) . . . . . . . . . $3,584,886 $1,732,513 $(7,144,423)
========== ========== ============
Weighted average shares outstanding (basic) . 5,791,189 6,516,056 6,531,311
Assuming conversion of convertible debt . . . - 428,237 -
Warrants. . . . . . . . . . . . . . . . . . . 16,470 16,590 -
Dilutive stock options. . . . . . . . . . . . 1,498 4,994 -
---------- ---------- ------------
Weighted average shares outstanding (diluted) 5,809,157 6,965,877 6,531,311
========== ========== ============
</TABLE>
As the Company posted a net loss for the year ended December 31, 1998, the
effects of stock options and contingently issuable shares for the year ended
December 31, 1998 are anti-dilutive and not included in the computation of
diluted loss per share.
Effective May 30, 1996, the Board of Directors of the Company voted to
effect a 767.8125-for-1 stock split. All share information and earnings per
share calculations for the periods presented in the financial statements herein,
and the notes hereto, have been retroactively restated for such stock split.
-- F-26 --
<PAGE>
11. Related Party Transactions
The Company and AutoBond, Inc. ("ABI"), which was founded and is 100% owned
by the Chief Executive Officer ("CEO") of the Company entered into a management
agreement dated as of January 1, 1996 (the "ABI Management Agreement") which
requires ABI to pay an annual fee of $50,000 to the Company for services
rendered by it or the Company's employees on behalf of ABI as follows: (i)
monitoring the performance of certain partnership interests owned by ABI and its
sole shareholder, (ii) certain cash management services, including the advancing
of funds to pay ABI's ordinary business expenses and (iii) providing advice as
to regulatory compliance. The ABI Management Agreement also provides that the
Company will perform certain accounting functions on behalf of ABI including (i)
maintenance of financial books and records, (ii) monitoring of cash management
functions, (iii) preparation of financial statements and tax returns and (iv)
providing advice in connection with retention of independent accountants. The
ABI Management Agreement further provides for the reimbursement of advances made
by the Company for out-of-pocket costs and expenses incurred on behalf of ABI.
Amounts due to the Company under the ABI Management Agreement amounted to
$176,963 and $204,325 at December 31, 1997 and 1998, respectively. As of July 1,
1998, the Company no longer provides management services, administrative
services or accounting services for ABI.
Since July 1994, ABI provided certain administrative services to
Intercontinental Brokerage Inc. ("Intercontinental"), an independent insurance
broker in connection with Intercontinental's obligations as administrator of
pools of finance contracts subject to an insurance policy. ABI received fees
from Intercontinental totaling approximately $752,000 for the period from July
1994 to March 1997, with respect to finance contracts as to which the Company
has paid administrative fees to Intercontinental. Since March 1997, the Company
has elected not to insure finance contracts under such insurance policy and ABI
will not receive any future fees from Intercontinental with respect to such
finance contracts.
Certain executive officers received (repaid) advances from the Company
totaling $225,259 and ($368,026) during the years ended December 31, 1996, and
1997. The outstanding advances, provided on a non-interest-bearing basis without
repayment terms, are shown as a reduction of shareholders' equity.
12. Employment Agreements
The Company and its Chief Operating Officer ("COO") entered into an
employment agreement dated November 15, 1995 and subsequently amended on March
31, 1998. Under the terms of this Agreement, the COO has agreed to serve as Vice
Chairman, Chief Financial Officer, and Chief Operating Officer of the Company
through the period ending November 15, 2000 and, during such time, to devote his
full business time and attention to the business of the Company. The Agreement
grants the COO a base salary of $200,000 ( effective April 1, 1998) per annum,
which amount may be increased from time to time at the sole discretion of the
Board. The Agreement terminates upon the death of the COO. In the event of any
disability of the COO which continues for a period of six months, the agreement
may be terminated by the Company at the expiration of such six-month period. The
Agreement automatically terminates upon the discharge of the COO for cause. The
Agreement contains standard non-competition covenants, among other terms.
Pursuant to the terms of the Agreement, the COO received 568,750 shares of
the Company's Common Stock on January 1, 1996, equal to 10% of the Company's
outstanding shares of Common Stock following the issuance of such shares to the
COO. Pursuant to the amendment to the agreement, the COO received 145,000 share
options (at a strike price of $7 5/16 per share) under the Company's Option Plan
and will receive an additional 35,000 share options under the Company's Option
Plan.
The Company and its chief executive officer ("CEO") also entered into an
employment agreement dated May 31, 1996, and effective from such date for five
years. The agreement provides for compensation at a base salary of $240,000 per
annum, which may be increased and may be decreased to an amount of not less than
$240,000, at the discretion of the Board of Directors. The agreement entitles
the CEO to receive the benefits of any cash incentive compensation as may be
granted by the Board to employees, and to participate in any executive bonus or
incentive plan established by the Board of Directors. The agreement
-- F-27 --
<PAGE>
also provides the CEO with certain additional benefits. The agreement
automatically terminates upon (i) the death of the CEO, (ii) disability of the
CEO for six continuous months together with the likelihood that the CEO will be
unable to perform his duties for the following continuous six months, as
determined by the Board of Directors, (iii) termination of the CEO "for cause"
(which termination requires the vote of a majority of the Board) or (iv) the
occurrence of the five-year expiration date provided, however, the agreement may
be extended for successive one-year intervals unless either party elects to
terminate the agreement in a prior written notice.
The CEO may terminate his employment for "good reason" as defined in the
agreement. In the event of the CEO's termination for cause, the agreement
provides that the Company shall pay the CEO his base salary through the date of
termination and the vested portion of any incentive compensation plan to which
the CEO may be entitled. Other than following a change in control, if the
Company terminates the CEO in breach of the agreement, or if the CEO terminates
his employment for good reason, the Company must pay the CEO: (i) his base
salary through the date of termination; (ii) a severance payment equal to the
base salary multiplied by the number of years remaining under the agreement; and
(iii) in the case of breach by the Company of the agreement, all other damages
to which the CEO may be entitled as a result of such breach, including lost
benefits under retirement and incentive plans. In the event of the CEO's
termination following a change in control, the Company is required to pay the
CEO an amount equal to three times the sum of (i) his base salary, (ii) his
annual management incentive compensation and (iii) his planned level of annual
perquisites. The agreement also provides for indemnification of the CEO for any
costs or liabilities incurred by the CEO in connection with his employment.
The Company entered into an employment agreement, dated as of January 1,
1998, with a former outside director to serve as a consultant to the Company
until February 1, 1998, whereupon he agreed to become President of the Company
for a period of three years. The agreement provides for compensation at a base
salary of $200,000 per annum, with a one time signing bonus of $100,000 and
additional performance bonuses of up to $25,000 per quarter, as approved by the
CEO and the Compensation Committee. In addition, the President received options
under the Option Plan to purchase 100,000 shares of the Company's common stock,
along with an agreement to grant additional options to purchase 50,000 of the
Company's common stock on December 1, 1998. The agreement automatically
terminates upon (i) the death of the President, (ii) the disability of the
President, which continues for a period of six months, (iii) "for cause," (iv)
at the President's option, or (v) at the Company's option. Upon such
termination, the Company is obligated to pay the President his accrued base pay
through the date of such termination, unless terminated by the Company without
cause, whereupon he would be entitled to his base pay for the remainder of the
year in which such termination occurred. Pursuant to a separate Severance
Agreement, dated as of February 1, 1998, upon the occurrence of a "change in
control" the Company must pay the President a lump sum payment equal to the sum
of the base pay plus any incentive pay for that year, plus the Company will
arrange to provide, for a period of twelve months following the termination
date, such employee benefits as are substantially similar to those that he was
receiving or entitled to receive immediately prior to such termination date.
-- F-28 --
<PAGE>
13. Leases
<TABLE>
<CAPTION>
The Company leases property under capital leases as follows:
1997 1998
--------- ----------
<S> <C> <C>
Furniture . . . . . . . . $ 49,606 $ 49,606
Equipment . . . . . . . . 515,891 515,891
Accumulated depreciation: (92,941) (233,951)
--------- ----------
Net . . . . . . . . . . . $472,556 $ 331,546
========= ==========
</TABLE>
<TABLE>
<CAPTION>
Future minimum lease payments under capital leases together with the
present value of the future minimum lease payments as of December 31, 1998
follow:
Year ending December 31,
- ---------------------------
<S> <C>
1999 . . . . . . . . . . . . . . . . . . . . . 217,329
2000 . . . . . . . . . . . . . . . . . . . . . 152,088
---------
Total minimum lease payments . . . . . . . . . 369,417
Less: amounts representing interest. . . . . . (31,493)
---------
Present value of future minimum lease payments $337,924
=========
</TABLE>
Future minimum lease payments under operating leases (which reflect leases
having noncancelable lease terms in excess of one year) as of December 31, 1998
follow:
<TABLE>
<CAPTION>
Year ending December 31,
- ---------------------------
<S> <C>
1999. . . . 861,404
2000. . . . 813,509
2001. . . . 680,818
2002. . . . 562,356
2003. . . . 562,356
Later years 749,807
----------
Total . . . $4,230,250
==========
</TABLE>
14. Commitments and Contingencies
On February 8, 1999, the Company, AutoBond Master Funding Corporation V, a
wholly-owned subsidiary of the Company ("Master Funding"), William O. Winsauer,
the Chairman and Chief Executive Officer of the Company, John S. Winsauer, a
Director and the Secretary of the Company, and Adrian Katz, the Vice-Chairman,
Chief Financial Officer and Chief Operating Officer of the Company
(collectively, the "Plaintiffs") commenced an action in the District Court of
Travis County, Texas (250th Judicial District) against Dynex and James Dolph
(collectively, the "Defendants"). This action is hereinafter referred to as the
"Texas Action". The Company and the other Plaintiffs assert in the Texas Action
that Dynex breached the terms of the Credit Agreement (the "Credit Agreement"),
dated June 9, 1998, by and among the Company, Master Funding and Dynex. Such
breaches include chronic delays and shortfalls in funding the advances required
under the Credit Agreement and ultimately the refusal by Dynex to fund any
further advances under the Credit Agreement. Plaintiffs also allege that Dynex
and Mr. Dolph conspired to misrepresent and mischaracterize the Company's credit
underwriting criteria and its compliance with such criteria with the intention
of interfering with and causing actual damage to the Company's business,
-- F-29 --
<PAGE>
prospective business and contracts. The Plaintiffs assert that Dynex' funding
delays and ultimate breach of the Credit Agreement were intended to force the
Plaintiffs to renegotiate the terms of their various agreements with Dynex and
related entities. Specifically, the Plaintiffs assert that Dynex intended to
force the Company to accept something less than Dynex' full performance of its
obligations under the Credit Agreement. Further, Dynex intended to force the
controlling shareholders of the Company to agree to sell their stock in the
Company to Dynex or an affiliate at a share price substantially lower than the
$6.00 per share price specified in the Stock Option Agreement, dated as of June
9, 1998, by and among Messrs. William O. Winsauer, John S. Winsauer and Adrian
Katz (collectively, the "Shareholders") and Dynex Holding, Inc. Plaintiffs in
the Texas Action request declaratory judgement that (a) Dynex has breached and
is in breach of its various agreements and contracts with the Plaintiffs, (b)
Plaintiffs have not and are not in breach of their various agreements and
contracts with Defendants, (c) neither the Company nor Master Funding has
substantially or materially violated or breached any representation or warranty
made to Dynex, including but not limited to the representation and warranty that
all or substantially all finance contracts funded or to be funded by Dynex
comply in full with, and have been acquired by the Company in accordance with,
the Company's customary underwriting guidelines and procedures; and (d) Dynex is
obligated to fund the Company in a prompt and timely manner as required by the
parties' various agreements. In addition to actual, punitive and exemplary
damages, the Plaintiffs also seek injunctive relief compelling Dynex to fund
immediately all advances due to the Company under the Credit Agreement.
On February 9, 1999, Dynex commenced an action against the Company in the
United States District Court for the Eastern District of Virginia (Richmond
District) (the "Virginia Action") seeking declaratory relief that Dynex is (a)
not obligated to advance funds to Master Funding under the Credit Agreement
because the conditions to funding set forth in the Credit Agreement have not
been met, and (b) entitled to access to all books, records and other documents
of Master Funding, including all finance contract files. Specifically, Dynex
alleges that as a result of a partial inspection of certain finance contract
files by Mr. Dolph and Virgil Baker & Associates in January 1999, Dynex
concluded that a significant number of such contracts contained material
deviations from the applicable credit criteria and procedures, an apparent
breach of the Credit Agreement. Dynex also alleges that on February 8, 1999, the
Company refused to permit Mr. Dolph and representatives from Dynex access to the
books, records and finance contract files of the Company. Dynex concludes that
as a result of such alleged breaches, it is not obligated to provide advances
under the Credit Agreement. The Company, Messrs. William O. Winsauer, John S.
Winsauer and Adrian Katz filed a responsive pleading on March 25, 1999. The
Company intends to seek dismissal of the Virginia Action on the basis that these
matters are being litigated in the previously filed Texas Action.
On February 22, 1999, the same day that Dynex notified the Company of a
purported servicing termination, Dynex filed another action against the Company
in the United States District Court for the Southern District of New York (the
"New York Action"), seeking damages and injunctive relief for the Company's
alleged breaches under the servicing agreement among the Company, Dynex and
Master Funding. The Company was not notified of the New York Action until March
1, 1999, when Dynex sought a temporary restraining order against the Company.
After hearing argument from counsel for both sides, the temporary restraining
order was denied. On March 23, 1999, the court issued an order transferring the
action to the federal district court in the Eastern District of Virginia. The
Company remains the servicer, is performing in its capacity as servicer, and has
not hit any triggering event thresholds, which include a repossession ratio and
a delinquency ratio, as defined in the servicing agreement.
On March 1, 1999, the Company and the other Plaintiffs filed an application
in the Texas Action for a temporary injunction enjoining Dynex (a) from
continuing to suspend or withhold funding pursuant to the Credit Agreement, (b)
from removing or attempting to remove the Company as servicer, and (c) from
making any further false or defamatory public statements regarding the
Plaintiffs. A hearing is scheduled for mid-April 1999, to consider this
application. Dynex has yet to file any responsive pleadings in the Texas Action.
By letter dated March 24, 1999, Dynex has purportedly accelerated all
amounts due under the Senior Note Agreement dated June 9, 1998, by and between
Dynex and the Company (See Note 7). Dynex alleges that any default under the
Stock Option Agreement dated June 9, 1998, by and between Dynex
-- F-30 --
<PAGE>
Holding, Inc., the Company, William O. Winsauer, John S. Winsauer, and Adrian
Katz is an "Event of Default" under the Senior Note Agreement. Dynex
specifically alleges that the Company has breached the negative covenant set
forth in Section 3.2(j) of the Stock Option Agreement, wherein the Company
covenants that it will not "change its underwriting or servicing practices and
guidelines in any material respect without the prior written consent of [Dynex
Holding, Inc.]" Management adamantly denies that the Company has at any time
since June 9, 1998, changed its underwriting or servicing practices and
guidelines in any material respect. Therefore, Dynex' assertion that there has
been an "Event of Default" under the Senior Note Agreement is in management's
judgment wholly without merit. It is anticipated that this dispute will become
part of the litigation with Dynex that is described above.
The Company is required to represent and warrant certain matters with
respect to the finance contracts sold to the Trusts, which generally duplicate
the substance of the representations and warranties made by the dealers in
connection with the Company's purchase of the finance contracts. In the event of
a breach by the Company of any representation or warranty, the Company is
obligated to repurchase the finance contracts from the Trust at a price equal to
the remaining principal plus accrued interest. The Company repurchased finance
contracts totaling $619,520 from a Trust during 1997. Of the total amount of
these finance contracts, $190,320 was purchased from one dealer. Although the
Company has requested that this dealer repurchase such contracts, the dealer has
refused. After such dealer's refusal to repurchase, the Company commenced an
action in the 157th Judicial District Court for Harris County, Texas against
Charlie Thomas Ford, Inc. to compel such repurchase. On favorable terms, the
Company has reached a settlement agreement with Charlie Thomas Ford, Inc. The
Company has received funds related to such settlement sufficient to reimburse it
for the repurchased finance contracts.
In connection with the 1997-B and 1997-C securitization, $5.8 million in
Class B Notes are exchangeable (at a rate of 117.5% of the principal amount of
Class B Notes exchanged) for the Company's 17% Convertible Notes, solely upon
the occurrence of a delinquency ratio trigger relating to the securitized pools.
In March 1998, after Progressive Northern Insurance ("Progressive")
purported to cancel the VSI and deficiency balance insurance policies issued in
favor of the Company, the Company sued Progressive, its affiliate United
Financial Casualty Co. and their agent in Texas, Technical Risks, Inc. in the
district court of Harris County, Texas. The action seeks declaratory relief
confirming the Company's interpretation of the policies as well as claims for
damages based upon breach of contract, bad faith and fraud. The Company has
received the defendants' answers, denying the Company's claims, and discovery is
proceeding. Progressive stopped paying claims during the second quarter of 1998.
As a result of the attempt by Progressive to cancel its obligations and its
refusal to honor claims after March 1998, the Company has suffered a variety of
damages, including impairment of its retained interest in securitizations. The
Company is vigorously contesting the legitimacy of Progressive's actions through
litigation. Although a favorable outcome cannot be assured, success in the
litigation could restore at least some of the value of the Company's interests
in such securitizations. Conversely, if the court were to uphold Progressive's
position, further impairment of the Company's interests could occur, resulting
in an adverse effect on the Company's results of operations.
Also in March 1998, the Company commenced an action in Travis County,
Texas, against Loan Servicing Enterprise ("LSE"), alleging LSE's contractual
breach of its servicing obligations on a continuing basis. LSE has commenced an
action against The Company in Texas State court seeking recovery from the
Company of putative termination fees in connection with termination of LSE as
servicer. The Company expects the two actions to be consolidated. If the Company
prevails against LSE, some of the value of the Company's interest in
securitizations could be restored.
The Company's carrier for the credit deficiency insurance obtained through
1996, Interstate Fire & Casualty Co. ("Interstate") determined in late 1996 to
no longer offer such coverage to the auto finance industry, including the
Company. In connection with Interstate's attempt to no longer offer credit
deficiency coverage for contracts originated after December 1996, the Company
commenced an action in the United States District Court for the Western District
of Texas, Austin Division, seeking a declaratory judgment that (a) the Company
was entitled to 180 days' prior notice of cancellation and (b) Interstate was
not
-- F-31 --
<PAGE>
entitled to raise premiums on finance contracts for which coverage was obtained
prior to the effectiveness of such cancellation, as well as seeking damages for
Interstate's alleged deficiencies in paying claims. Prior to receiving the
Company's complaint in the Texas action, Interstate commenced a similar action
for declaratory relief in the United States Court for the Northern District of
Illinois. Both suits have been voluntarily dismissed, and Interstate and the
Company have to date acted on the basis of a cancellation date of May 12, 1997
(i.e., no finance contracts presented after that date will be eligible for
credit deficiency coverage by Interstate, although all existing contracts for
which coverage was obtained will continue to have the benefits of such
coverage), no additional premiums have been demanded or paid, and the
claims-paying process has been streamlined. In particular, in order to speed the
claims-paying process, Interstate has paid lump sums to the Company as an
estimate of claims payable prior to completion of processing. Pending the
Company's determination of the appropriate beneficiary for such claims payments,
the Company has deposited and will continue to deposit such funds into a
segregated account.
The Company is the plaintiff or the defendant in several legal proceedings
that its management considers to be the normal kinds of actions to which an
enterprise of its size and nature might be subject, and not to be material to
the Company's overall business or financial condition, results of operations or
cash flows.
The Company is taking actions to provide that their computer systems are
capable of processing for the periods in the year 2000 and beyond. The costs
associated with this are not expected to significantly affect operating cash
flow; however, the nature of their business requires that they rely on external
vendors and services who may not be year 2000 compliant. Therefore, there is no
assurance that the Company's actions in this regard will be successful.
On April 6, 1999, the Company and the controlling shareholders of the
Company, as defendants (the "Defendants"), were served with notice of a suit
filed on March 31, 1999 in the United States District Court for the Western
District of Texas (Austin Division) by Bruce Willis (the "Plaintiff"), a holder
of the Company's 15% Series A Cumulative Preferred Stock. The suit alleges,
among other things, that the Defendants violated Section 10(b) of the Securities
and Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder) in failing to
disclose adequately and in causing misstatements concerning the nature and
condition of the Company's financing sources. The suit also alleges that such
actions constituted statutory fraud under the Texas Business Corporation Act,
common law fraud and negligent misrepresentation. The Plaintiff seeks class
action certification. The Plaintiff also seeks, among other things, actual,
special, consequential, and exemplary damages in an unspecified sum, as well as
costs and expenses incurred in connection with pursuing the action against the
Company. While the Company has yet to file a responsive pleading, the Company
nevertheless believes that it has consistently and accurately informed the
public of its business and operations, including the viability of its funding
sources, and, as a consequence believes the suit to be without merit and intends
to vigorously defend against this action.
15. Fair Value of Financial Instruments
The estimated fair value amounts have been determined by the Company, using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required in interpreting market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts that the Company would realize in
a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts. The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value.
Cash and Cash Equivalents and Restricted Cash
The carrying amount approximates fair value because of the short maturity
of those investments.
-- F-32 --
<PAGE>
Finance Contracts Held for Sale
The fair value of finance contracts held for sale is based on the estimated
proceeds expected on sale or securitization of the finance contracts held for
sale.
Retained interest in securitizations
The fair value on retained interest in securitizations is determined based
on discounted future net cash flows utilizing a discount rate that market
participants would use for financial instruments with similar risks.
Revolving Credit Borrowings, Notes Payable and Non-recourse debt
The fair value of the Company's debt is based upon the quoted market prices
for the same or similar issues or on the current rates offered to the Company
for debt of the same remaining maturities and characteristics. The revolving
credit lines are variable rate loans, resulting in a fair value that
approximates carrying value.
<TABLE>
<CAPTION>
The estimated fair values of the Company's financial instruments at December 31, 1997 and 1998 are as
follows:
December 31, 1997 December 31, 1998
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Cash and cash equivalents . . . . . . . . . . . . . . . $ 159,293 $ 159,293 $ 5,170,969 $ 5,170,969
Restricted Funds. . . . . . . . . . . . . . . . . . . . 6,904,264 6,904,264 - -
Finance contracts held for sale . . . . . . . . . . . . 1,366,114 1,366,114 867,070 867,070
Retained interest in securitizations-trading. . . . . . 7,878,306 7,878,306 4,586,908 4,586,908
Retained interest in securitizations-available for sale 32,016,649 32,016,649 9,286,443 9,286,443
Revolving credit facilities . . . . . . . . . . . . . . 7,639,201 7,639,201 - -
Notes payable & non-recourse debt . . . . . . . . . . . 9,841,043 9,841,043 13,352,019 13,352,019
</TABLE>
16. Supplemental Cash Flow Disclosures
<TABLE>
<CAPTION>
Supplemental cash flow information with respect to payments of interest and
warrants issued for services is as follows:
Year Ended December 31,
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Interest paid. . . . . . . . $1,885,322 $3,771,566 $2,212,748
Warrants issued for services - 25,000 335,432
</TABLE>
No income taxes were paid during fiscal 1996, 1997 or 1998.
-- F-33 --
<PAGE>
17. Quarterly Information (unaudited)
<TABLE>
<CAPTION>
The following financial data summarizes quarterly results for the Company for the years ended December 31,
1997 and December 31, 1998:
Three Months Ended
Fiscal 1997 March 31 June 30 September 30 December 31
-------------------- ------------ -------------- -------------
<S> <C> <C> <C> <C>
Total revenues. . . . . . . . . . . . . . . . . $ 4,288,664 $ 6,110,826 $ 6,370,219 $ 5,661,419
Net income. . . . . . . . . . . . . . . . . . . 179,028 966,869 511,814 (44,658)
Earnings per common share basic and diluted . . 0.03 0.15 0.08 (0.01)
Three Months Ended
March 31 June 30 September 30 December 31
-------------------- ------------ -------------- -------------
Fiscal 1998
Total revenues. . . . . . . . . . . . . . . . . . $ 5,351,158 $ 3,901,647 $ 4,723,397 $ 9,078,276
Net income (loss) . . . . . . . . . . . . . . . . (121,138) (5,233,788) (2,051,476) 261,979
Net income (loss) available to common shareholders (295,513) (5,655,663) (2,473,351) (159,896)
Earnings per common share basic and diluted . . . (0.05) (0.86) (0.38) (0.02)
</TABLE>
-- F-34 --
<PAGE>
EXHIBIT 21.3
Additional Subsidiaries of the Company
------------------------------------------
AutoBond Master Funding Corporation III
AutoBond Master Funding Corporation IV
AutoBond Master Funding Corporation V
-- F-35 --
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
EXHIBIT 27.1
<CAPTION>
<S> <C>
<FISCAL YEAR-END>. . . . . . DEC-31-1998
<PERIOD-START> . . . . . . . JAN-01-1998
<PERIOD-END> . . . . . . . . DEC-31-1998
<PERIOD-TYPE>. . . . . . . . 12-MOS
<CASH> . . . . . . . . . . . 5,170,969
<SECURITIES> . . . . . . . . 13,873,351
<RECEIVABLES>. . . . . . . . 6,969,122
<ALLOWANCES> . . . . . . . . 13,694
<INVENTORY>. . . . . . . . . 70,957
<CURRENT ASSETS> . . . . . . 0
<PP&E> . . . . . . . . . . . 1,839,992
<DEPRECIATION> . . . . . . . 652,571
<TOTAL ASSETS> . . . . . . . 30,331,142
<CURRENT LIABILITIES>. . . . 0
<BONDS>. . . . . . . . . . . 13,352,019
. . . . 0
. . . . . . . . . 10,856,000
<COMMON> . . . . . . . . . . 1,000
<OTHER-SE> . . . . . . . . . 4,695,372
<TOTAL-LIABILITY-AND-EQUITY> 30,331,142
<SALES>. . . . . . . . . . . 0
<TOTAL REVENUES> . . . . . . 23,054,478
<CGS>. . . . . . . . . . . . 0
<TOTAL COSTS>. . . . . . . . 0
<OTHER EXPENSES> . . . . . . 3,422,260
<LOSS PROVISION> . . . . . . 100,000
<INTEREST EXPENSE> . . . . . 3,117,211
<INCOME-PRETAX>. . . . . . . (10,770,792)
<INCOME-TAX> . . . . . . . . (3,626,369)
<INCOME-CONTINUING>. . . . . 0
<DISCONTINUED> . . . . . . . 0
<EXTRAORDINARY>. . . . . . . 0
<CHANGES>. . . . . . . . . . 0
<NET INCOME> . . . . . . . . (7,144,423)
<EPS-PRIMARY>. . . . . . . . (1.31)
<EPS-DILUTED>. . . . . . . . (1.31)
</TABLE>
