SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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: 1-12109
DELTA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 11-3336165
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1000 Woodbury Road, Suite 200, Woodbury, New York 11797
(Address of registrant's principal executive offices including ZIP Code)
(516) 364 - 8500
(Registrant's telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since last
report)
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 and 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 [ ]
As of June 30, 1998, 15,359,588 shares of the Registrant's common stock,
par value $.01 per share, were outstanding.
<PAGE>
INDEX TO FORM 10-Q
Page No.
PART I - FINANCIAL INFORMATION
Consolidated Balance Sheets as of June 30, 1998 and December 31, 1997...... 1
Consolidated Statements of Operations for the three months and six months
ended June 30, 1998 and June 30, 1997...................................... 2
Consolidated Statements of Cash Flows for the six months ended
June 30, 1998 and June 30, 1997............................................ 3
Notes to Consolidated Financial Statements................................. 4
Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 8
New Accounting Pronouncements..............................................22
PART II - OTHER INFORMATION
Other Information..........................................................24
Signatures.................................................................26
<PAGE>
Part I - Financial Information
<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
(Dollars in thousands, except for share data) 1998 1997
----------- ------------
<S> <C> <C>
Assets
Cash and interest bearing deposits $ 37,850 $ 32,858
Accounts receivable 25,667 31,209
Loans held for sale 81,880 79,247
Accrued interest and late charges receivable 37,846 29,598
Capitalized mortgage servicing rights 26,887 22,862
Interest-only and residual certificates 183,938 167,809
Equipment, net 14,365 11,211
Cash held for advance payments 8,535 6,325
Prepaid and other assets 6,472 6,224
Goodwill 6,605 5,889
--------- ---------
Total assets $ 430,045 $ 393,232
========= =========
Liabilities and Stockholders' Equity
Liabilities:
Bank payable $ 864 $ 2,222
Warehouse financing and other borrowings 50,263 28,233
Senior Notes 149,346 149,307
Accounts payable and accrued expenses 16,800 15,503
Investor payable 51,428 40,852
Advance payment by borrowers for taxes and insurance 7,934 5,750
Income taxes payable 23,852 24,912
--------- ---------
Total liabilities $ 300,487 $ 266,779
--------- ---------
Stockholders' Equity:
Capital stock, $.01 par value. Authorized
49,000,000 shares; issued and outstanding
15,359,588 shares and 15,372,688 shares at
June 30, 1998 and December 31, 1997, respectively $ 154 $ 154
Additional paid-in capital 93,501 93,476
Retained earnings 36,172 32,823
Treasury stock, at cost (14,600 shares and 0 shares
at June 30, 1998 and December 31, 1997,
respectively) (269) ---
--------- ---------
Total stockholders' equity 129,558 126,453
Total liabilities and stockholders' equity --------- ---------
$ 430,045 $ 393,232
========= =========
See accompanying notes to consolidated financial statements.
1
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands, except per share data) 1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Net gain on sale of mortgage loans $24,755 $18,454 $51,581 $35,768
Interest (10,393) 6,339 (3,728) 11,898
Servicing fees 411 1,899 2,325 3,291
Origination fees 5,909 3,774 11,658 6,814
-------- -------- -------- --------
Total revenues 20,682 30,466 61,836 57,771
-------- -------- -------- --------
Expenses:
Payroll and related costs 13,141 9,013 26,400 16,945
Interest expense 7,626 3,921 14,692 7,091
General and administrative 7,951 4,914 15,679 8,877
-------- -------- -------- --------
Total expenses 28,718 17,848 56,771 32,913
-------- -------- -------- --------
(Loss) income before income
taxes (benefit) (8,036) 12,618 5,065 24,858
Provision for income taxes (benefit) (3,134) 5,394 1,716 10,644
-------- -------- -------- --------
Net (loss) income $(4,902) $ 7,224 $ 3,349 $14,214
======== ======== ======== ========
Per share data:
Net (loss) income per common
share - basic and diluted $(0.32) $ 0.47 $ 0.22 $ 0.92
========= ========= ========= =========
Weighted-average number
of shares outstanding 15,376,416 15,372,288 15,374,535 15,345,926
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
2
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
(Dollars in thousands) 1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,349 $ 14,214
Adjustments to reconcile net income to net cash used in
Operating activities:
Provision for loan and recourse losses 50 50
Depreciation and amortization 1,953 1,047
Net increase in capitalized mortgage servicing rights (4,025) (4,615)
Deferred origination fees 896 114
Net increase in interest-only and residual certificates (16,129) (38,543)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 5,542 (11,501)
Increase in loans held for sale, net (3,544) (71)
Increase in accrued interest and late charges receivable (8,248) (3,854)
Increase in cash held for advance payments (2,210) (39)
(Increase) decrease in prepaid and other assets (248) 32
Increase in accounts payable and accrued expenses 62 236
Increase in investor payable 10,576 2,087
Increase in advance payments by borrowers for
taxes and insurance 2,184 26
(Decrease) increase in income taxes payable (1,060) 7,168
--------- ---------
Net cash used in operating activities (10,852) (33,649)
--------- ---------
Cash flows from investing activities:
Acquisition of Fidelity Mortgage --- (3,675)
Purchase of equipment (4,584) (2,968)
--------- ---------
Net cash used in investing activities (4,584) (6,643)
--------- ---------
Cash flows from financing activities:
Proceeds from warehouse financing and other borrowings, net 22,030 38,058
(Decrease) increase in bank payable, net (1,358) 5,366
Purchase of treasury stock (269) ---
Proceeds from exercise of stock options 25 ---
--------- ---------
Net cash provided by financing activities 20,428 43,424
--------- ---------
Net increase in cash and interest bearing deposits 4,992 3,132
Cash and interest bearing deposits at beginning of period 32,858 18,741
--------- ---------
Cash and interest bearing deposits at end of period $ 37,850 $ 21,873
========= =========
Supplemental Information:
Cash paid during the period for:
Interest $ 14,513 $ 7,697
Income taxes 2,799 $ 12,991
See accompanying notes to consolidated financial statements.
3
</TABLE>
<PAGE>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Organization
Delta Financial Corporation (the "Company") is a Delaware corporation which was
organized in August 1996. On October 31, 1996, in connection with its initial
public offering, the Company acquired all of the outstanding common stock of
Delta Funding Corporation ("Delta Funding"), a New York corporation which had
been organized on January 8, 1982 for the purpose of originating, selling,
servicing and investing in residential first and second mortgages. On November
1, 1996, the Company completed an initial public offering of 4,600,000 shares of
common stock, par value $.01 per share.
On February 11, 1997, the Company acquired Fidelity Mortgage Inc. and Fidelity
Mortgage (Florida), Inc. (together referred to herein as "Fidelity Mortgage"),
retail residential mortgage origination companies, for a combination of cash and
stock with a value of $6.3 million. These transactions were accounted for under
the purchase method of accounting. Accordingly, the results of operations of
Fidelity Mortgage from February 11, 1997 have been included in the Company's
consolidated financial statements. In connection with these acquisitions the
Company recorded goodwill of approximately $6.3 million, which is being
amortized on a straight-line basis over seven years. On October 1, 1997, the
acquired operations were merged and have continued to operate as Fidelity
Mortgage. As a result of meeting certain production targets during the year
ended June 30, 1998, the sellers will be paid in August 1998 an additional $1.2
million of purchase price in the form of 101,361 shares of Delta stock. The
additional consideration of $1.2 million has been recorded as additional
goodwill at June 30, 1998 to be amortized over the remaining life of the
goodwill.
(2) Basis of Presentation
The accompanying unaudited consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
inter-company accounts and transactions have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and the instructions to Form 10-Q. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. The accompanying unaudited consolidated financial statements and the
information included under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations" should be read in conjunction
with the consolidated financial statements and related notes of the Company for
the year ended December 31, 1997.
All adjustments which are, in the opinion of management, considered necessary
for a fair presentation of the financial position and results of operations for
the interim periods presented
4
have been made. Certain prior period amounts in the financial statements have
been reclassified to conform with the current year presentation.
(3) Fair Value Adjustments
During the second quarter of 1998 the Company recorded a $15.5 million reduction
in the carrying amount of its interest-only and residual certificates, and also
recorded a $1.9 million reduction in the carrying amount of its mortgage
servicing rights to reflect a provision for impairment (the "fair values
adjustments"). Both provisions result from reductions in the Company's estimates
of the fair values of those assets, which reductions resulted from a change in
the prepayment assumptions used to estimate the future cash flows to be derived
from the interest-only and residual certificates and the servicing rights.
As required by generally accepted accounting principles, the Company at each
reporting period estimates the fair value of its interest-only and residual
certificates and its mortgage servicing rights. The carrying amount of the
interest-only and residual certificates is adjusted to the fair value. For
mortgage servicing rights, a valuation allowance is recorded if the fair value
is less than the carrying amount.
The fair values of both interest-only and residual certificates and mortgage
servicing rights are significantly affected by, among other factors, prepayments
of loans and the estimates of future prepayment rates. The Company continually
reviews its prepayment assumptions in light of company and industry experience,
and makes adjustments to those assumptions when such experience indicates.
During 1997 the Company made certain changes in its prepayment assumptions,
principally increasing the estimated maximum prepayment rates for
adjustable-rate loan pools. The effect of that change in prepayment assumptions
did not materially affect the fair value of the interest-only and residual
certificates in 1997.
The Company again reviewed its prepayment experience and assumptions at June 30,
1998. Such review indicated that the prepayment rates during 1998, particularly
for adjustable-rate mortgages, and in particular during the second quarter of
1998, have been higher than those historically experienced, or previously
projected, by the Company. The Company believes that these increases in
prepayments are attributable to the continuation, for a longer period than
historically experienced, of low interest rates, together with recent changes,
to a flatter or inverted curve, of the relationship between long-term and
short-term interest rates (the "yield curve").
As a result, at June 30, 1998 the Company adjusted its prepayment assumptions,
increasing the maximum prepayment rates for all loans, and changing the rate at
which prepayments are assumed to increase from the initial rate to the maximum
rate from a straight-line build-up to a "vector" curve. These revised prepayment
assumptions were used in estimating the fair value of the interest-only and
mortgage servicing rights retained by the Company in securitizations completed
prior to the second quarter of 1998, requiring the fair value adjustments. These
revised prepayment assumptions were also used in initially valuing and recording
the interest-only and residual certificates and mortgage servicing rights
retained by the Company in its second quarter
5
1998 securitization.
The following table compares the prepayment assumptions used at June 30, 1998
(the "new" assumptions) with those used at December 31, 1997 and through the
first quarter of 1998 (the "old" assumptions):
- --------------------------------------------------------------------------------
Loan Type Curve Description Month 1 Speed Peak Speed
- --------------------------------------------------------------------------------
Old New Old New Old New
- --------------------------------------------------------------------------------
Fixed Rate Loans Ramp Vector 4.8% 4.8% 24% 31%
Six-Month LIBOR ARMs Ramp Vector 5.6% 10.0% 28% 50%
Hybrid ARMs Ramp Vector 5.6% 6.0% 28% 50%
- --------------------------------------------------------------------------------
(4) Earnings Per Share
The following is a reconciliation of the denominators used in the computations
of basic and diluted Earnings Per Share (EPS). The numerator for calculating
both basic and diluted EPS is net (loss) income.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ------------------------
(Dollars in thousands, except EPS data) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net (loss) income $(4,902) $7,224 $3,349 $14,214
Weighted-average shares 15,376,416 15,372,288 15,374,535 15,345,926
Basic EPS $(0.32) $0.47 $0.22 $0.92
Weighted-average shares 15,376,416 15,372,288 15,374,535 15,345,926
Incremental shares-options and
Fidelity additional shares 143,616 65,156 51,656 64,304
- ----------------------------------------------------------------------------------------------
15,520,032 15,437,444 15,426,191 15,410,230
Diluted EPS $(0.32) $0.47 $0.22 $0.92
</TABLE>
(5) Stock Repurchase Plan
On May 7, 1998, the Company's Board of Directors authorized a program to
repurchase up to two hundred thousand (200,000) shares of its issued and
outstanding common stock. No time limit has been placed on the duration of the
stock repurchase program. Subject to applicable securities laws, such purchases
will be at times and in amounts as the Company deems appropriate and may be
discontinued at any time. Repurchased shares will be held as treasury shares
available for general corporate purposes including, but not limited to,
satisfying the Company's contingent share obligations to the former shareholders
of Fidelity Mortgage, and in connection with Delta Financial's employee stock
plans.
During the quarter ended June 30, 1998, the Company repurchased 14,600 shares
of its common
6
stock under its stock repurchase plan. At June 30, 1998, the total number of
treasury shares amounted to 14,600. The repurchases may be effected from time to
time in accordance with applicable securities laws, through solicited or
unsolicited transactions in the open market, on the New York Stock Exchange or
in privately negotiated transactions, subject to availability of shares at
prices deemed appropriate by the Company.
7
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements of the Company and accompanying Notes to Consolidated
Financial Statements set forth therein.
General
Delta Financial Corporation engages in the consumer finance business by
originating, acquiring, selling and servicing non-conforming home equity loans.
Throughout its 16 years of operating history, the Company has focused on lending
to individuals who generally have impaired or limited credit profiles or higher
debt-to-income ratios and typically have substantial equity in their homes.
Through its wholly-owned subsidiary, Delta Funding Corporation, the Company
originates home equity loans indirectly through licensed mortgage brokers and
other real estate professionals who submit loan applications on behalf of the
borrower ("Brokered Loans") and also purchases loans from mortgage bankers and
smaller financial institutions that satisfy Delta's underwriting guidelines
("Correspondent Loans"). Delta Funding Corporation currently originates and
purchases the majority of its loans in 22 states, through its network of
approximately 1,150 brokers and correspondents.
Through its wholly-owned subsidiary, Fidelity Mortgage Inc., the Company
develops retail loan leads ("Retail Loans") primarily through its telemarketing
system and its network of 15 retail offices located in 9 states.
For the three months ended June 30, 1998, the Company originated and
purchased $450 million of loans, an increase of 70% over the $265 million of
loans originated and purchased in the comparable period in 1997. Of these
amounts, approximately $199 million were originated through its network of
brokers, $199 million were purchased from its network of correspondents and $52
million were originated through its retail network in the three months ended
June 30, 1998, compared to $103 million, $138 million and $24 million,
respectively, for the same period in 1997.
In May 1998, the Company announced that it had entered into a strategic
alliance to originate, underwrite and service nonconforming loans in Canada with
MCAP Mortgage Corporation and MCAP Service Corporation. The strategic alliance
provides that MCAP Mortgage Corp. will originate non-conforming mortgage loans
through its network of brokers with all loans being underwritten by Delta to
meet its underwriting guidelines. Once approved, the loans are funded by Delta
and serviced by MCAP Service Corp. The operations in Canada will be conducted
through a subsidiary of Delta Funding Corporation, DFC Funding of Canada
Limited. Delta's activities in the Canadian market in the second quarter were
not material.
The following table sets forth information relating to the delinquency and
loss experience of the mortgage loans serviced by the Company (primarily for the
securitization trusts, as described below) for the periods indicated. The
Company is not the holder of the securitization loans, but generally holds
interest-only or residual certificates of the trusts, as well as the servicing
rights, each of which may be adversely affected by defaults.
8
Three Months Ended
----------------------------------
(Dollars in Thousands) June 30, 1998 March 31, 1998
------------- --------------
Total Outstanding Principal Balance
(at period end)....................... $ 2,391,719 $ 2,100,124
Average Outstanding(1).................... $ 2,285,348 $ 2,007,612
DELINQUENCY (at period end)
30-59 Days:
Principal Balance..................... $ 113,197 $ 88,795
Percent of Delinquency(2)............. 4.73% 4.23%
60-89 Days:
Principal Balance..................... $ 38,605 $ 33,401
Percent of Delinquency(2)............. 1.61% 1.59%
90 Days or More:
Principal Balance..................... $ 25,688 $ 22,607
Percent of Delinquency(2)............. 1.07% 1.08%
Total Delinquencies:
Principal Balance..................... $ 177,490 $ 144,803
Percent of Delinquency(2)............. 7.42% 6.90%
FORECLOSURES
Principal Balance..................... $ 110,462 $ 102,743
Percent of Foreclosures by Dollar(2).. 4.62% 4.89%
REO (at end of period).................... $ 13,648 $ 13,192
Net Losses on Liquidated Loans............ $ (2,044) $ (1,542)
Percentage of Net Losses on Liquidated Loans
(based on Average Outstanding Balance)(3) (0.36%) (0.31%)
- ---------------
(1)Calculated by summing the actual outstanding principal balances at the end
of each month and dividing the total by the number of months in the
applicable period.
(2)Percentages are expressed based upon the total outstanding principal balance
at the end of the indicated period.
(3)Annualized
Securitizations
As a fundamental part of its business and financing strategy, the Company
sells the majority of its loans through securitization and derives a substantial
portion of its income therefrom. In a securitization, the Company sells a pool
of loans it has originated or purchased to a REMIC trust for a cash price. The
trust, in turn, finances the pool of loans it has acquired by issuing
"pass-through certificates," or bonds, which represent undivided ownership
interests in the trust. The holders of the pass-through certificates are
entitled to receive monthly distributions of all principal received on the
underlying mortgages and a specified amount of interest, as determined at the
time of the trust offering.
When the Company sells a pool of loans to the securitization trust, it
receives the following economic interests in the trust: (a) the difference
between the interest payments due on the loans sold to the trust and the
interest rate paid to the holders of pass-through certificates, less the
Company's contractual servicing fee and other costs and expenses of
administering the trust, represented by interest-only and residual certificates,
and (b) the right to service the loans on
9
behalf of the trust and earn a contractual servicing fee, as well as other
ancillary servicing related fees directly from the borrowers on the underlying
loans.
Upon the securitization of a pool of loans, the Company (i) recognizes in
income, as origination fees, the unamortized origination fees included in the
investment in the loans sold, and (ii) recognizes a gain on sale of loans for
the difference between cash received from the trust and the investment in the
loans remaining after the allocation of portions of that investment to record
interest-only and residual certificates and capitalized mortgage servicing
rights received in the securitization. The majority of the net gain on sale of
mortgage loans results from, and is initially realized in the form of, the
retention of interest-only and residual certificates.
In recording and accounting for capitalized mortgage servicing rights and
interest-only and residual certificates, the Company makes estimates of rates of
prepayments and defaults, and the value of collateral, which it believes
reasonably reflect economic and other relevant conditions then in effect. The
actual rate of prepayments, defaults and the value of collateral will generally
differ from the estimates used, due to subsequent changes in economic and other
relevant conditions and the implicit imprecision of estimates, and such
differences can be material. Prepayment and default rates which are higher than
those estimated would adversely affect the value of both the capitalized
mortgage servicing rights (actual mortgage servicing income will be less, and
significant changes could require an impairment of the capitalized mortgage
servicing rights) and the interest-only and residual certificates, for which
changes in fair value are recorded in operations. Conversely, prepayment and
default rates which are lower than those estimated would increase the servicing
income earned over the life of the loans and positively impact the value of the
interest-only and residual certificates.
The Company has sold interest-only certificates created in securitizations
for cash proceeds in each of its five most recent quarterly securitization
transactions and intends to continue this practice as long it effectively
maximizes cash flow and profitability.
Fair Value Adjustments
During the second quarter of 1998 the Company recorded a $15.5 million
reduction in the carrying amount of its interest-only and residual certificates,
and also recorded a $1.9 million reduction in the carrying amount of its
mortgage servicing rights to reflect a provision for impairment (the "fair
values adjustments"). Both provisions result from reductions in the Company's
estimates of the fair values of those assets, which reductions resulted from a
change in the prepayment assumptions used to estimate the future cash flows to
be derived from the interest-only and residual certificates and the servicing
rights.
As required by generally accepted accounting principles, the Company at each
reporting period estimates the fair value of its interest-only and residual
certificates and its mortgage servicing rights. The carrying amount of the
interest-only and residual certificates is adjusted to the fair value. For
mortgage servicing rights, a valuation allowance is recorded if the fair value
is less than the carrying amount.
The fair values of both interest-only and residual certificates and mortgage
servicing rights are significantly affected by, among other factors, prepayments
of loans and the estimates of future prepayment rates. The Company continually
reviews its prepayment assumptions in light of
10
company and industry experience, and makes adjustments to those assumptions when
such experience indicates.
During 1997 the Company made certain changes in its prepayment assumptions,
principally increasing the estimated maximum prepayment rates for
adjustable-rate loan pools. The effect of that change in prepayment assumptions
did not materially affect the fair value of the interest-only and residual
certificates in 1997.
The Company again reviewed its prepayment experience and assumptions at June
30, 1998. Such review indicated that the prepayment rates during 1998,
particularly for adjustable-rate mortgages, and in particular during the second
quarter of 1998, have been higher than those historically experienced, or
previously projected, by the Company. The Company believes that these increases
in prepayments are attributable to the continuation, for a longer period than
historically experienced, of low interest rates, together with recent changes,
to a flatter or inverted curve, of the relationship between long-term and
short-term interest rates (the "yield curve").
As a result, at June 30, 1998 the Company adjusted its prepayment
assumptions, increasing the maximum prepayment rates for all loans, and changing
the rate at which prepayments are assumed to increase from the initial rate to
the maximum rate from a straight-line build-up to a "vector" curve. These
revised prepayment assumptions were used in estimating the fair value of the
interest-only and mortgage servicing rights retained by the Company in
securitizations completed prior to the second quarter of 1998, requiring the
fair value adjustments. These revised prepayment assumptions were also used in
initially valuing and recording the interest-only and residual certificates and
mortgage servicing rights retained by the Company in its second quarter 1998
securitization.
The following table compares the prepayment assumptions used at June 30, 1998
(the "new" assumptions) with those used at December 31, 1997 and through the
first quarter of 1998 (the "old" assumptions):
- --------------------------------------------------------------------------------
Loan Type Curve Description Month 1 Speed Peak Speed
- --------------------------------------------------------------------------------
Old New Old New Old New
- --------------------------------------------------------------------------------
Fixed Rate Loans Ramp Vector 4.8% 4.8% 24% 31%
Six-Month LIBOR ARMs Ramp Vector 5.6% 10.0% 28% 50%
Hybrid ARMs Ramp Vector 5.6% 6.0% 28% 50%
- --------------------------------------------------------------------------------
11
Results of Operations
Three Months Ended June 30, 1998 Compared to the Three Months Ended June 30,
1997
Revenues
Total revenues for the three months ended June 30, 1998 decreased $9.8
million, or 32%, to $20.7 million from $30.5 million for the comparable period
in 1997. This decrease was primarily attributable to the fair value adjustments
the Company made to its interest-only and residual certificates and capitalized
mortgage servicing rights in the second quarter of 1998. (See "-Fair Value
Adjustments"). This was partially offset by an increase in the net gain
recognized on the sale of mortgage loans, reflecting the growth in the Company's
level of loan originations, purchases and securitizations and an increase in
origination fees as a result of increased loan originations.
For the three months ended June 30, 1998, the Company originated and
purchased $450 million of mortgage loans, representing a 70% increase from $265
million of mortgage loans originated and purchased for the three months ended
June 30, 1997. The Company completed a $445 million securitization during the
three months ended June 30, 1998 compared to a $260 million securitization in
the corresponding period in the prior year, representing a 71% increase. Total
loans serviced at June 30, 1998 increased 82% to $2.39 billion from $1.31
billion at June 30, 1997.
Net Gain on Sale of Mortgage Loans. Net gain on sale of mortgage loans
represents (i) the sum of (a) the fair value of the residual certificates
associated with loans securitized in each period and the market value of the
sold interest-only strips, and (b) the fair value of capitalized mortgage
servicing rights associated with loans securitized in each period, (ii) less the
(x) premiums paid to originate or acquire mortgage loans, (y) costs associated
with securitizations and (z) any hedge loss (gain).
For the three months ended June 30, 1998, net gain on sale of mortgage loans
increased $6.3 million, or 34%, to $24.8 million from $18.5 million for the
three months ended June 30, 1997. This increase was primarily due to the
increase in the amount of loans securitized in the first quarter of 1998
compared to the same period in 1997, but was partially offset by a lower
weighted average net gain on sale ratio. The weighted average net gain on sale
ratio, which is calculated by dividing the net gain on sale by the total amount
of loans securitized, was 5.6% compared to 7.1% for the six months ended June
30, 1997.
Net gains from the sale of loans increased less than the overall increase in
loan securitizations primarily because of (a) the current period change to a
more conservative prepayment assumption used in initially valuing the
interest-only and residual certificates acquired in the second quarter 1998
securitization (see "-Fair Value Adjustments") and (b) a lower weighted average
coupon of 10.2% from 11.3% reflecting the Company's shift to a higher credit
quality borrower which reduced the value of the interest-only and residual
certificates the Company received in connection with the second quarter 1998
securitization.
Interest Income. Interest income primarily represents the sum of (i) interest
earned on loans held for sale, (ii) interest earned on cash collection balances,
and (iii) the difference between the distributions the Company receives on its
interest-only and residual certificates and the adjustments recorded to reflect
the change in the fair value of the interest-only and residual
12
certificates.
Interest income for the three months ended June 30, 1998 decreased $16.7
million, or 265%, to ($10.4) million from $6.3 million in the comparable period
in 1997. The decrease in interest income was primarily due to the $15.5 million
fair value adjustment to the interest-only and residual certificates previously
discussed (see "-Fair Value Adjustments"). The effect of that adjustment was
partially offset by increases in interest income produced by higher levels of
both loans held for sale and interest-only and residual certificates. However,
interest income from loans held for sale was reduced by a decline, from 11.3% to
10.2%, in the weighted average coupon rate on the mortgage loans, reflecting
both lower interest rates and the Company's shift to higher credit quality
loans.
Servicing Fees. Servicing fees represent all contractual and ancillary
servicing revenue received by the Company less (a) the offsetting amortization
of the capitalized mortgage servicing rights, and any adjustments recorded to
provide valuation allowances for the impairment in capitalized mortgage
servicing rights and (b) prepaid interest shortfalls.
Servicing fees for the three months ended June 30, 1998 decreased $1.5
million, or 79%, to $0.4 million from $1.9 million in the comparable period in
1997. This decrease was primarily due to recording of the $1.9 million
impairment provision for the Company's mortgage servicing rights. (See "-Fair
Value Adjustments"). Partially offsetting the effect of this charge was an
increase in servicing fees reflecting the increase in the aggregate size of the
Company's servicing portfolio. During the three months ended June 30, 1998, the
average balance of mortgage loans serviced by the Company increased 83% to $2.29
billion from $1.25 billion during the comparable period in 1997.
Origination Fees. Origination fees represent fees earned on brokered and
retail originated loans. Origination fees for the three months ended June 30,
1998 increased $2.1 million, or 55%, to $5.9 million from $3.8 million in the
comparable period in 1997. The increase is primarily the result of increased
Brokered and Retail loan originations.
Expenses
Total expenses increased $10.9 million, or 61%, to $28.7 million for three
months ended June 30, 1998, from $17.8 million for the comparable period in
1997. The increase in expenses was primarily the result of (i) increased
interest expense due to (a) higher interest cost associated with increased
borrowings under the Company's warehouse facilities to finance the growth in
loan origination and purchase activities, and (b) the issuance in July 1997 of
$150 million aggregate principal amount of 9.5% Senior Notes due 2004 (the
"Senior Notes"), (ii) an increase in the Company's personnel to support its
higher level of loan originations, and (iii) costs associated with the expansion
of the Company's retail, broker and correspondent divisions.
Payroll and Related Costs. Payroll and related costs include salaries,
benefits and payroll taxes for all employees. Payroll and related costs
increased $4.1 million, or 46%, to $13.1 million for the three months ended June
30, 1998 from $9.0 million for the comparable period in 1997. This increase is
primarily due to staff increases related to growth in the Company's loan
originations and the costs associated with the Company's broker, correspondent
and Fidelity
13
Mortgage retail division. As of June 30, 1998, the Company employed 980 full-
and part-time employees, compared to 722 full- and part-time employees as of
June 30, 1997.
Interest Expense. Interest expense includes the borrowing costs to finance
loan originations and purchases under (i) the Company's credit facilities, (ii)
the Senior Notes and (iii) its investment in interest-only and residual
certificates.
For the three months ended June 30, 1998, interest expense increased $3.7
million, or 95%, to $7.6 million from $3.9 million for the comparable period in
1997. The increase in interest expense was attributable to (i) growth in loan
production, which increased the level of debt needed throughout the second
quarter of 1998 to finance the inventory of loans held for sale prior to their
securitization and (ii) the Company's issuance in July 1997 of the Senior Notes.
General and Administrative Expenses. General and administrative expenses
consist primarily of office rent, insurance, telephone, depreciation, goodwill
amortization, travel and entertainment expenses, license fees, legal and
accounting fees, postage expenses, office supplies, credit reporting, repairs
and maintenance, advertising and promotional expenses and the provision for loan
losses on the inventory of loans held for sale and recourse loans.
For the three months ended June 30, 1998, general and administrative expenses
increased $3.0 million, or 61%, to $7.9 million from $4.9 million for the
comparable period in 1997. This increase was primarily attributable to (i) the
expansion costs associated with the Company's increasing the number of Fidelity
Mortgage retail branch offices from eight to fifteen and (ii) an increase in
expenses associated with the Company's increased loan originations and
purchases.
Income Taxes. Income taxes are accounted for under SFAS No. 109, "Accounting
for Income Taxes." Deferred tax assets and liabilities are recognized on the
income reported in the financial statements regardless of when such taxes are
paid. These deferred taxes are measured by applying current enacted tax rates.
The Company recorded a tax benefit of $3.1 million and a provision of $5.4
million for the three month periods ended June 30, 1998 and 1997, respectively.
Income taxes provided a 39.0% effective tax rate for the three months ended
June 30, 1998, compared to a 42.7% effective tax rate for the three months ended
June 30, 1997. The reduction in the effective tax rate is primarily attributable
to the Company's expansion into lower tax rate states and local jurisdictions
and to the benefits for permanent book/tax differences.
Six Months Ended June 30, 1998 Compared to the Six Months Ended June 30, 1997
Revenues
Total revenues for the six months ended June 30, 1998 increased $4.0 million,
or 7%, to $61.8 million from $57.8 million for the comparable period in 1997.
The increase in revenue was primarily attributable to the increase in the net
gain recognized on the sale of mortgage loans, reflecting the growth in the
Company's level of loan originations, purchases and securitizations. Revenue
also increased in origination fees as a direct result of increased broker and
retail loan origination volume. These increases were partially offset by the
fair value adjustments the Company made to its interest-only and residual
certificates, and capitalized mortgage servicing rights in the second quarter of
1998. (See "-Fair Value Adjustments").
14
For the six months ended June 30, 1998, the Company originated and purchased
$836 million of mortgage loans, representing a 67% increase from $502 million of
mortgage loans originated and purchased for the six months ended June 30, 1997.
The Company completed two securitizations totaling $845 million during the six
months ended June 30, 1998 compared to two securitizations totaling $495 million
in the corresponding period in the prior year, representing a 71% increase.
Total loans serviced at June 30, 1998 increased 82% to $2.39 billion from $1.31
billion at June 30, 1997.
Net Gain on Sale of Mortgage Loans. For the six months ended June 30, 1998,
net gain on sale of mortgage loans increased $15.8 million, or 44%, to $51.6
million from $35.8 million for the six months ended June 30, 1997. This increase
was primarily due to the increase in the amount of loans securitized in the
first quarter of 1998 compared to the same period in 1997, but was partially
offset by a lower weighted average net gain on sale ratio. The weighted average
net gain on sale ratio was 6.1% compared to 7.2% for the six months ended June
30, 1997.
Net gains from the sale of loans increased less than the overall increase in
loan securitizations primarily due to a lower mortgage coupon of 10.3% from
11.3% reflecting the Company's shift to a higher credit quality borrower which
reduced the value of the interest-only and residual certificates the Company
received in connection with securitizations during that period. In addition, the
value of the residual certificate and capitalized mortgage servicing rights
retained in the Company's second quarter 1998 securitization were lower,
relative to those retained in securitizations in prior periods, due to the
change in the Company's prepayment assumptions (see "-Fair Value Adjustments").
Interest Income. Interest income for the six months ended June 30, 1998
decreased $15.6 million to ($3.7) million from $11.9 million in the comparable
period in 1997. The decrease in interest income was primarily due to the $15.5
million fair value adjustment to the interest-only and residual certificates
previously discussed (see "-Fair Value Adjustments"). The effect of that
adjustment was partially offset by increases in interest income produced by
higher levels of both loans held for sale and interest-only and residual
certificates. However, interest income from loans held for sale was reduced by a
decline, from 11.3% to 10.3%, in the weighted average coupon rate on the
mortgage loans, reflecting both lower interest rates and the Company's shift to
higher credit quality loans.
Servicing Fees. Servicing fees for the six months ended June 30, 1998
decreased $1.0 million, or 30%, to $2.3 million from $3.3 million in the
comparable period in 1997. This decrease was primarily due to recording of the
$1.9 million provision for the Company's mortgage servicing rights. (See "-Fair
Value Adjustments"). Partially offsetting the effect of this charge was an
increase in servicing fees reflecting the increase in the aggregate size of the
Company's servicing portfolio. During the six months ended June 30, 1998, the
average balance of mortgage loans serviced by the Company increased 87% to $2.15
billion from $1.15 billion during the comparable period in 1997.
Origination Fees. Origination fees for the six months ended June 30, 1998
increased $4.8 million, or 71%, to $11.6 million from $6.8 million in the
comparable period in 1997. The increase is primarily the result of increased
Broker and Retail loan originations.
15
Expenses
Total expenses increased $23.9 million, or 73%, to $56.8 million for six
months ended June 30, 1998, from $32.9 million for the comparable period in
1997. This increase was primarily the result of (i) increased interest expense,
(ii) an increase in the Company's personnel to support its higher level of loan
originations, and (iii) costs associated with the expansion of the Company's
retail, broker and correspondent divisions.
Payroll and Related Costs. For the six months ended June 30, 1998, payroll
and related costs expense increased $9.5 million, or 56%, to $26.4 million from
$16.9 million for the comparable period in 1997. This increase is primarily due
to staff increases related to growth in the Company's loan originations and the
costs associated with the Company's broker, correspondent and Fidelity Mortgage
retail division, which only reflects expenses from February 11, 1997. As of June
30, 1998, the Company employed 980 full- and part-time employees compared to 722
full- and part-time employees as of June 30, 1997.
Interest Expense. For the six months ended June 30, 1998, interest expense
increased $7.6 million, or 107%, to $14.7 million from $7.1 million for the
comparable period in 1997. The increase in interest expense was attributable to
(i) growth in loan production, which increased the level of debt needed
throughout the first six months of 1998 to finance the inventory of loans held
for sale prior to their securitizations, (ii) a higher cost of funds on the
Company's credit facilities which were tied to one-month London Inter-Bank
Offered Rate ("LIBOR"), which increased to an average interest rate of 5.7% in
the six months ended June 30, 1998, compared to an average interest rate of 5.6%
for the comparable period in 1997, and (iii) the Company's issuance in July 1997
of the Senior Notes. This increase was partially offset by the reduction in
interest expense attributable to the Company's repayment of financing on its
interest-only and residual certificates in July 1997.
General and Administrative Expenses. For the six months ended June 30, 1998,
general and administrative expenses increased $6.8 million, or 76%, to $15.7
million from $8.9 million for the comparable period in 1997. This increase was
primarily attributable to (i) the expansion costs associated with the Company's
increasing the number of Fidelity Mortgage retail branch offices from five to
fifteen and (ii) an increase in expenses associated with the Company's increased
loan originations and purchases.
Income Taxes. The Company recorded a tax provision of $1.7 million and
$10.6 million for the six months ended June 30, 1998 and 1997, respectively.
Income taxes provided a 33.9% effective tax rate for the six months ended
June 30, 1998, compared to a 42.8% assumed effective tax rate for the six months
ended June 30, 1997. The reduction in the effective tax rate is primarily
attributable to the Company's expansion into lower tax rate states and local
jurisdictions and to the benefits for permanent book/tax differences.
Financial Condition
June 30, 1998 compared to December 31, 1997
Cash and interest bearing deposits increased $5.0 million, or 15%, to $37.9
million at June 30, 1998 from $32.9 million at December 31, 1997. The increase
was primarily the result of
16
additional monies held in securitization trust accounts by the Company, acting
as servicer for its ongoing securitization program.
Accounts receivable decreased $5.5 million, or 18%, to $25.7 million at June
30, 1998 from $31.2 million at December 31, 1997. The decrease was primarily
attributable to the receipt of a federal tax refund partially offset by an
increase in reimbursable servicing advances made by the Company, acting as
servicer on its securitizations, related to a higher average servicing
portfolio. The Company's servicing portfolio increased 30% to $2.39 billion as
of June 30, 1998 from $1.84 billion as of December 31, 1997.
Loans held for sale increased $2.7 million, or 3%, to $81.9 million at June
30, 1998 from $79.2 million at December 31, 1997. This increase was the result
of a lower percentage of loans securitized compared to loans originated and
purchased, in the second quarter of 1998, as compared to the fourth quarter of
1997.
Accrued interest and late charges receivable increased $8.2 million, or 28%,
to $37.8 million at June 30, 1998 from $29.6 million at December 31, 1997. This
increase was primarily due to a higher average loan servicing portfolio which
resulted in increased reimbursable interest advances made by the Company, acting
as servicer on its securitizations.
Capitalized mortgage servicing rights increased $4.0 million, or 17%, to
$26.9 million at June 30, 1998, from $22.9 million at December 31, 1997. This
increase was directly attributable to the Company's capitalizing the fair market
value of the servicing assets, totaling $9.8 million, resulting from the
Company's completion of two securitizations during the first six months of 1998,
partially offset by the amortization of capitalized mortgage servicing rights
and the fair value adjustment (see "-Fair Value Adjustments").
Interest-only and residual certificates increased $16.1 million, or 10%, to
$183.9 million at June 30, 1998 from $167.8 million at December 31, 1997. This
increase is primarily attributable to the Company's receipt of residual
certificates valued and recorded at $23.9 million and $24.1 million from its
securitizations during the six months ended June 30, 1998. The increase was
partially offset by the effect of the fair value adjustment to the residual
certificates.
Equipment, net, increased $3.2 million, or 29%, to $14.4 million at June 30,
1998 from $11.2 million at December 31, 1997. The increase was primarily due to
capital expenditures related to new technology and continued expansion.
Cash held for advance payments increased $2.2 million, or 35%, to $8.5
million at June 30, 1998 from $6.3 million at December 31, 1997. The increase
was primarily due to a higher average loan servicing portfolio resulting in
additional monies held in escrow trust accounts by the Company acting as a
servicer.
Warehouse financing and other borrowings increased $22.0 million, or 78%, to
$50.2 million at June 30, 1998 from $28.2 million at December 31, 1997. This
increase was primarily related to the operating cash deficit and, to a lesser
extent, to fund purchases of equipment and an increase in the amount of loans
for sale.
The aggregate principal balance of the Senior Notes totaled $149.3 million at
June 30, 1998, net of unamortized bond discount. The Senior Notes accrue
interest at a rate of 9.5% per annum, payable semi-annually on February 1 and
August 1. The Company did not have any Senior Notes
17
outstanding prior to July 1997.
Accounts payable and accrued expenses increased $1.3 million or 8%, to $16.8
million at June 30, 1998 from $15.5 million at December 31, 1997. This increase
was primarily attributable to Fidelity Mortgage additional earn out payable in
the Company's stock during August 1998.
Investor payable increased $10.5 million, or 26%, to $51.4 million at June
30, 1998 from $40.9 million at December 31, 1997. This increase was primarily
due to the 30% increase in the Company's portfolio of serviced loans. Investor
payable is comprised of all principal collected on mortgage loans and accrued
interest. Variability in this account is primarily due to the principal payments
collected within a given collection period.
Advance payments by borrowers for taxes and insurance increased $2.1 million,
or 36%, to $7.9 million at June 30, 1998 from $5.8 million at December 31, 1997.
This increase is primarily due to a higher average loan servicing portfolio and
the timing of payments collected and disbursed resulting in additional monies
held in escrow trust accounts by the Company acting as a servicer.
Stockholders' equity increased $3.1 million, or 2%, to $129.6 million at June
30, 1998 from $126.5 million at December 31, 1997. This increase is due to net
income of $3.4 million for the six month period ending June 30, 1998 and was
partially offset by the Company's repurchase of 14,600 shares of its common
stock for $0.3 million.
Liquidity and Capital Resources
While the Company has historically operated on a negative cash flow basis due
primarily to increases in the volume of loan purchases and originations and the
growth of its securitization program, the Company has reduced its negative cash
flow in recent quarters, and expects to continue to do so for the foreseeable
future, as a result of (a) increased cash inflows reflecting the increase in the
aggregate amount of the Company's retained interest-only and residual
certificates, (b) changes in the securitization structures that the Company has
utilized, and (c) the Company's concentration on the less cash-intensive broker
and retail originations (as compared to correspondent purchases). Currently, the
Company's primary cash requirements include the funding of (i) mortgage
originations and purchases pending their pooling and sale, (ii) the points and
expenses paid in connection with the acquisition of correspondent loans, (iii)
interest expense on its Senior Notes and warehouse and other financings, (iv)
fees, expenses and tax payments incurred in connection with its securitization
program, and (v) ongoing administrative and other operating expenses. The
Company has relied upon a few lenders to provide the primary credit facilities
for its loan originations and purchases.
The Company must be able to sell loans and obtain adequate credit facilities
and other sources of funding in order to continue to originate and purchase
loans. For the six months ended June 30, 1998 and 1997, the Company had
operating cash deficits of $10.9 million and $33.6, respectively. The
improvement of the operating cash deficit from 1997 compared to 1998 was
primarily due to increased cash inflows from the Company's interest-only and
residual certificates, changes in the securitization structures related to
interest-only certificates, a one-time tax refund, an increase in the Company's
restricted cash held for securitization trust accounts and a lower percentage of
Correspondent loan purchases.
18
Since the second quarter of 1997, Delta has (a) utilized a
senior/subordinate securitization structure, which generally carries lower
overcollateralization levels because the subordinate certificates provide
additional credit support to the senior certificates, thereby allowing the
Company to receive cash inflows sooner, and (b) sold the senior (i.e.,, AAA/Aaa
by Standard & Poor's Ratings Group, Fitch IBCA, Inc. and Moody's Investor
Services, Inc.) interest-only certificates. In addition, due to market
conditions, the Company was able to sell larger senior interest-only
certificates in connection with its last two securitizations, as compared to
sales of senior interest-only certificates related to prior securitizations. The
increase in cash inflows from these changes in the Company's securitization
structure, together with increased cash inflows from the Company's interest-only
and residual certificates, receipt of a tax refund, an increase in restricted
cash held for securitization trusts, partially offset by the semi-annual Senior
Note interest payment, resulted in additional cash flow for the six months ended
June 30, 1998 compared to 1997.
Historically, the Company has utilized various financing facilities and an
equity financing to offset negative operating cash flows and support the
continued growth of its loan originations and purchases, securitizations and
general operating expenses. On July 23, 1997, the Company completed its offering
of the Senior Notes. A portion of the Senior Notes proceeds were used to pay
down various financing facilities with the remainder used to fund the Company's
growth in loan originations and purchases and its ongoing securitization
program. The Company's primary sources of liquidity continue to be warehouse and
other financing facilities, securitizations and, subject to market conditions,
sales of whole loans and additional debt and equity securities.
To accumulate loans for securitization, the Company borrows money on a
short-term basis through warehouse lines of credit. The Company has three
warehouse facilities for this purpose. One warehouse facility is a $400 million
committed credit line with a variable rate of interest and a maturity date of
February 1999. This facility was converted from an uncommitted to a committed
line during the three months ended March 31, 1997 and the maturity date was
extended from February 1998 to February 1999 during the three months ended March
31, 1998. The Company's second warehouse facility is a $250 million committed
revolving line with a variable rate of interest and a maturity date of June
1999. The Company's third warehouse facility is a syndicated $150 million
committed revolving line with a variable rate of interest and a maturity date of
June 1999. This facility was increased from $140 million to $150 million during
the three months ended June 30, 1998. The outstanding balance on the $400
million facility as of June 30, 1998 was $44.6 million. The Company had no
outstanding balances for the $250 million facility and the $150 million facility
as of June 30, 1998.
The Company has in the past obtained financing facilities for interest-only
and residual certificates acquired as part of its securitizations. As of June
30, 1998, the Company did not have any indebtedness secured by interest-only and
residual certificates. In addition, the Company is limited by the terms of the
Indenture governing the Senior Notes as to the amount of future indebtedness
permitted to be secured by interest-only and residual certificates.
The Company is required to comply with various operating and financial
covenants as provided in the agreements described above which are customary for
agreements of their type. The Company does not believe that its existing
financial covenants will restrict its operations or growth. The continued
availability of funds provided to the Company under these agreements is subject
to the Company's continued compliance with these covenants. Management believes
that
19
the Company is in compliance with all such covenants under these agreements as
of June 30, 1998.
The Company purchased a total of 14,600 shares of its common stock during the
quarter ended June 30, 1998, under the Company's ongoing stock repurchase
program, at a total cost of $0.3 million. All of the repurchased shares were
purchased in open market transactions at their prevailing market prices.
Interest Rate Risk
The Company's primary market risk exposure is interest rate risk.
Profitability may be directly affected by the level of, and fluctuation in,
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of its borrowings, which are tied
to various United States Treasury maturities and the London Inter-Bank Offered
Rate ("LIBOR"). The profitability of the Company is likely to be adversely
affected during any period of unexpected or rapid changes in interest rates. A
substantial and sustained increase in interest rates could adversely affect the
Company's ability to purchase and originate loans. A significant decline in
interest rates could increase the level of loan prepayments thereby decreasing
the size of the Company's loan servicing portfolio. To the extent servicing
rights and interest-only and residual classes of certificates have been
capitalized on the books of the Company, higher than anticipated rates of loan
prepayments or losses could require the Company to write down the value of such
servicing rights and interest-only and residual certificates, adversely
impacting earnings. As previously discussed, the fair value adjustments that the
Company recorded in the second quarter of 1998 were primarily attributable to
the Company's change in prepayment assumptions to reflect higher than originally
anticipated rates of prepayments. (See "-Fair Value Adjustments"). In an effort
to mitigate the effect of interest rate risk, the Company has reviewed its
various mortgage products and has identified and modified those that
historically proved more susceptible to prepayments. However, there can be no
assurance that such modifications to its product line will effectively mitigate
interest rate risk in the future.
Fluctuating interest rates also may affect the net interest income earned by
the Company resulting from the difference between the yield to the Company on
loans held pending sales and the interest paid by the Company for funds borrowed
under the Company's warehouse facilities, although the Company undertakes to
hedge its exposure to this risk by using treasury rate lock contracts.
Hedging
The Company originates and purchases mortgage loans and then sells them
primarily through securitizations. At the time of securitization and delivery of
the loans, the Company recognizes gain on sale based on a number of factors
including the difference, or "spread" between the interest rate on the loans and
the interest rate on treasury securities with maturities corresponding to the
anticipated life of the loans. If interest rates rise between the time the
Company originates or purchases the loans and the time the loans are sold at
securitization, the excess spread narrows, resulting in a loss in value of the
loans. The Company has implemented a strategy to protect against such losses and
to reduce interest rate risk on loans originated and purchased that have not yet
been securitized through the use of treasury rate lock contracts with various
durations (which are similar to selling a combination of United States Treasury
securities), which equate to
20
a similar duration of the underlying loans. The nature and quantity of
hedging transactions are determined by the Company based upon various factors
including, without limitation, market conditions and the expected volume of
mortgage originations and purchases. The Company will enter into treasury rate
lock contracts through one of its warehouse lenders and/or one of the investment
bankers which underwrite the Company's securitizations. These contracts are
designated as hedges in the Company's records and are closed out when the
associated loans are sold through securitization.
If the value of the hedges decrease, offsetting an increase in the value of
the loans, the Company, upon settlement with its counterparty, will pay the
hedge loss in cash and realize the corresponding increase in the value of the
loans as part of its net gain on sale of mortgage loans and its corresponding
interest-only and residual certificates. Conversely, if the value of the hedges
increase, offsetting a decrease in the value of the loans, the Company, upon
settlement with its counterparty, will receive the hedge gain in cash and
realize the corresponding decrease in the value of the loans through a reduction
in the value of the corresponding interest-only and residual certificates.
The Company believes that its current hedging strategy of using treasury rate
lock contracts is the most effective way to manage its interest rate risk on
loans prior to securitization. Because the Company's securitization closed on
June 30, 1998, the Company had no hedge outstanding as of that date.
Information Services Year 2000 Project
The Year 2000 Problem centers on the inability of some computer systems to
recognize the year 2000. Many existing computer programs and systems were
originally programmed with six digit dates that provided only two digits to
identify the calendar year in the data field, without considering the upcoming
change in the century. With the impending millenium, these programs and
computers may recognize "00" as the year 1900 rather than the year 2000. Like
most financial service providers, the Company and its operations may be
significantly affected by the Year 2000 Problem due to the nature of financial
information. Software, hardware, and equipment both within and outside the
Company's direct control and with which the Company electronically or
operationally interfaces (e.g. third party vendors providing data processing,
information system management, maintenance of computer systems, and credit
bureau information) are likely to be affected. Furthermore, if computer systems
are not adequately changed to identify the year 2000, many computer applications
could fail or create erroneous results. As a result, many calculations which
rely on the date field information, such as interest, payment or due dates and
other operating functions, will generate results which could be significantly
misstated, and the Company could experience a temporary inability to process
transactions, send invoices or engage in similar normal business activities. In
addition, under certain circumstances, failure to adequately address the Year
2000 Problem could adversely affect the viability of the Company's suppliers and
creditors and the creditworthiness of its borrowers. Thus, if not adequately
addressed, the Year 2000 Problem could result in a material adverse impact on
the Company's products, services and competitive condition and therefore, its
results of operations.
The Company has developed and is implementing a Year 2000 Project Plan (the
"Plan") to address the Year 2000 Problem and its effects on the Company. The
Plan includes five components which address issues involving awareness,
assessment, renovation, validation and
21
implementation. As part of the Plan, the Company has initiated formal
communications with all of its significant suppliers to determine the extent to
which the Company is vulnerable to those third parties' failure to remediate
their own Year 2000 Problem. The Company presently believes that with
modifications to existing software and conversions to new software and hardware
where necessary, the Year 2000 Problem will be mitigated without causing a
material adverse impact on the operations of the Company. However, if such
modifications and conversions are not made or are not completed timely, the Year
2000 Problem could have an adverse impact on the operations of the Company.
Monitoring and managing the Year 2000 Project Plan will result in additional
direct and indirect costs to the Company. Direct costs include potential charges
by third party software vendors for product enhancements, costs involved in
testing software products for the Year 2000 compliance, and costs for developing
and implementing contingency plans for critical software products which are not
enhanced. Indirect costs will principally consist of the time devoted by
existing employees in monitoring software vendor progress, testing enhanced
software products and developing and implementing any necessary contingency
plans. Both direct and indirect costs of addressing the Year 2000 Problem will
be charged to earnings as incurred. Such costs have not been material to date.
The Company does not believe that such costs will have a material effect on
results of operations, although there can be no assurance that such costs would
not become material in the future.
New Accounting Pronouncements
SFAS No. 130
SFAS No. 130, "Reporting on Comprehensive Income" was issued in June 1997 and
is effective for fiscal years beginning after December 15, 1997. SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. The Statement requires all items that are
required to be recognized under accounting standards as components of
comprehensive income to be reported in a financial statement that is displayed
with the same prominence as other financial statements. The Company has
determined that the implementation of the requirements of SFAS No. 130 will not
affect the Company's net income, cash flows or financial position.
SFAS No. 131
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information" was issued in June 1997 and is effective for fiscal years beginning
after December 15, 1997. SFAS No. 131 establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. The Statement requires a public business enterprise to report a
measure of segment profit or loss, certain specific revenue and expense items
and segment assets. The Company has determined that the implementation of the
requirements of SFAS No.131 will not affect the Company's net income, cash flows
or financial position.
SFAS No. 133
In June 1998, SFAS No. 133 was issued, "Accounting for Derivative Instruments
and
22
Hedging Activities." SFAS No. 133 is effective for fiscal years that begin
after June 15, 1999, and in general requires that entities recognize all
derivative financial instruments as assets or liabilities, measured at fair
value, and include in earnings the changes in the fair value of such assets and
liabilities. SFAS No. 133 also provides that changes in the fair value of assets
or liabilities being hedged with recognized derivative instruments be recognized
and included in earnings. The Company has not yet completed its evaluation of
SFAS No. 133, and therefore at this time cannot predict what, if any, effect its
adoption will have on the Company's results of operations or financial position.
Risk Factors
Except for historical information contained herein, certain matters discussed
in this Form 10-Q are "forward-looking statements" as defined in the Private
Securities Litigation Reform Act (PSLRA) of 1995, which involve risk and
uncertainties that exist in the Company's operations and business environment,
and are subject to change on various important factors. The Company wishes to
take advantage of the "safe harbor" provisions of the PSLRA by cautioning
readers that numerous important factors discussed below, among others, in some
cases have caused, and in the future could cause the Company's actual results to
differ materially from those expressed in any forward-looking statements made
by, or on behalf of, the Company. The following include some, but not all, of
the factors or uncertainties that could cause actual results to differ from
projections:
* A general economic slowdown.
* Increases in prepayments or loan losses that could require the Company
to write down further the value of its interest-only and residual
certificates and its capitalized mortgage servicing rights, adversely
affecting earnings.
* The effects of interest rate fluctuations and the Company's ability or
inability to hedge effectively against such fluctuations in interest
rates; the effects of changes in monetary and fiscal policies, laws and
regulations, other activities of governments, agencies, and similar
organizations, social and economic conditions, unforeseen inflationary
pressures and monetary fluctuation.
* The Company's ability or inability to continue its practice of
securitization of mortgage loans held for sale.
* Increased competition within the Company's markets.
* The unanticipated expenses of assimilating newly-acquired businesses
into the Company's structure; as well as the impact of unusual expenses
from ongoing evaluations of business strategies, asset valuations,
acquisitions, divestitures and organizational structures.
* Unpredictable delays or difficulties in the development of new product
programs.
* Rapid or unforeseen escalation of the cost of regulatory compliance
and/or litigation, including but not limited to, environmental
compliance, licenses, adoption of new, or changes in accounting
policies and practices and the application of such policies and
practices.
23
<PAGE>
Part II - Other Information
Item 1. Legal Proceedings
Because the nature of the Company's business involves the collection of
numerous accounts, the validity of liens and compliance with state and federal
lending laws, the Company is subject to numerous claims and legal actions in the
ordinary course of its business. While it is impossible to estimate with
certainty the ultimate legal and financial liability with respect to such claims
and actions, the Company believes that the aggregate amount of such liabilities
will not result in monetary damages which in the aggregate would have a material
adverse effect on the financial condition or results of the Company.
Several class-action lawsuits have been filed against a number of consumer
finance companies alleging that the compensation of mortgage brokers through the
payment of yield spread premiums violates various federal and state consumer
protection laws. The Company has been named in two such lawsuits:
a. On March 18, 1997, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the
Eastern District of New York, alleging that the Company's compensation of
mortgage brokers by means of yield spread premiums violates, among other
things, the Real Estate Settlement Procedures Act ("RESPA"). The complaint
seeks (i) certification of a class of plaintiffs, (ii) an injunction
against payment of yield spread premiums by the Company and (iii)
unspecified compensatory and punitive damages (including attorney's fees).
On July 7, 1997, the Company filed an answer to the plaintiff's amended
complaint.
b. On or about February 10, 1998, the Company received notice that it
had been named in a lawsuit filed in the United States District Court for
the Northern District of Mississippi - Greenville Division, alleging that
the Company's compensation of mortgage brokers by means of yield spread
premiums violates RESPA. The complaint seeks (i) certification of a class
of plaintiffs, and (ii) unspecified compensatory damages (including
attorney's fees). On March 31, 1998, the Company filed an answer to the
complaint.
Management believes the Company has meritorious defenses and intends to
defend these suits, but the Company cannot estimate with any certainty its
ultimate legal or financial liability, if any, with respect to the alleged
claims.
Item 2. Changes in Securities. None
Item 3. Defaults Upon Senior Securities. None
24
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders was held on May 19, 1998. At the
meeting, Sidney A. Miller and Martin D. Payson were elected as Class II
Directors for a term of three years. Hugh Miller, Richard Blass and Arnold B.
Pollard continue to serve as members of the Board of Directors.
Votes cast in favor of Mr. Miller's election totaled 14,884,446,
while 27,325 votes were withheld.
Votes cast in favor of Mr. Payson's election totaled 14,884,146,
while 27,625 votes were withheld.
The stockholders also voted to ratify the appointment of KPMG Peat Marwick
LLP as the Company's independent public accountants for the fiscal year ending
December 31, 1998. Votes cast in favor of this ratification were 14,903,146,
while votes cast against were 2,600 and abstentions totaled 6,025.
Item 5. Other Information. None
Item 6. Exhibits and Current Reports on Form 8-K:
(a) Exhibits: 11.1 Statement re: Computation of Per Share Earnings.
27 Financial Data Schedule.
(b) Reports on Form 8-K: None.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the Registrant has duly caused this Report on Form 10-Q to be signed on
its behalf by the undersigned, thereunto duly authorized.
DELTA FINANCIAL CORPORATION
(Registrant)
Date: August 14, 1998
By:/s/ HUGH MILLER
-----------------------------------
Hugh Miller
President & Chief Executive Officer
By:/s/ RICHARD BLASS
-----------------------------------
Richard Blass
Senior Vice President and
Chief Financial Officer
26
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
(Dollars in thousands, except EPS data) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Basic Earnings Per Share
Net (loss) income $ ( 4,902) $ 7,224 $ 3,349 $ 14,214
========== =========== =========== ===========
Weighted average number of common
and common equivalent shares: 15,376,416 15,372,288 15,374,535 15,345,926
---------------------------------------
Basic earnings per share $ ( 0.32) $ 0.47 $ 0.22 $ 0.92
=========== =========== =========== ===========
Diluted Earnings Per Share
Net income $ ( 4,902) $ 7,224 $ 3,349 $ 14,214
=========== =========== =========== ===========
Weighted average number of common
and common equivalent shares:
----------------------------------
Average no. of shares outstanding 15,376,416 15,372,288 15,374,535 15,345,926
Net effect of dilutive stock options
based on treasury stock method &
Fidelity additional shares 143,616 65,156 51,656 65,304
Total average shares: 15,520,032 15,437,444 15,426,191 15,410,230
=========== =========== =========== ===========
Diluted earnings per share $ (0.32) $ 0.47 $ 0.22 $ 0.92
=========== =========== =========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
BALANCE SHEETS AND STATEMENTS OF INCOME FOUND IN THE COMPANY'S FORM 10-Q
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 37,850
<SECURITIES> 183,938
<RECEIVABLES> 172,595
<ALLOWANCES> 315
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 20,135
<DEPRECIATION> 5,770
<TOTAL-ASSETS> 430,035
<CURRENT-LIABILITIES> 0
<BONDS> 149,346
0
0
<COMMON> 154
<OTHER-SE> 129,404
<TOTAL-LIABILITY-AND-EQUITY> 430,035
<SALES> 0
<TOTAL-REVENUES> 61,836
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 42,029
<LOSS-PROVISION> 50
<INTEREST-EXPENSE> 14,692
<INCOME-PRETAX> 5,065
<INCOME-TAX> 1,716
<INCOME-CONTINUING> 3,349
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,349
<EPS-PRIMARY> 0.22
<EPS-DILUTED> 0.22
</TABLE>
