SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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 September 30, 1999
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 (I.R.S. 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 September 30, 1999, 15,883,749 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
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998................................................. 2
Consolidated Statements of Operations for the three months and
nine months ended September 30, 1999 and September 30, 1998....... 3
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1999 and September 30, 1998......................... 4
Notes to Consolidated Financial Statements........................ 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk........24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings..............................................26
Item 2. Changes in Securities and Use of Proceeds......................28
Item 3. Defaults Upon Senior Securities................................28
Item 4. Submission of Matters to a Vote of Security Holders............28
Item 5. Other Information..............................................28
Item 6. Exhibits and Current Reports on Form 8-K.......................28
Signatures.................................................................30
1
<PAGE>
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
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<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA) 1999 1998
------------- ------------
<S> <C> <C>
ASSETS
Cash and interest-bearing deposits $ 55,027 49,152
Accounts receivable 29,757 22,549
Loans held for sale, net 101,937 87,170
Accrued interest and late charges receivable 58,197 46,897
Capitalized mortgage servicing rights 36,371 33,490
Interest-only and residual certificates 222,673 203,803
Equipment, net 20,226 16,962
Cash held for advance payments 13,982 10,031
Prepaid and other assets 5,481 5,839
Goodwill 5,126 6,014
-------------- ------------
Total assets $ 548,777 481,907
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Bank payable $ 1,479 1,396
Warehouse financing and other borrowings 120,625 80,273
Senior Notes 149,452 149,387
Accounts payable and accrued expenses 37,696 20,966
Investor payable 71,341 63,790
Advance payment by borrowers for taxes and insurance 13,646 9,559
Deferred tax liability 10,209 18,848
-------------- ------------
Total liabilities 404,448 344,219
-------------- ------------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value. Authorized 49,000,000 shares;
16,000,549 shares issued and 15,883,749 shares outstanding
at September 30, 1999 and 15,475,549 shares issued and
15,358,749 shares outstanding at December 31, 1998 160 155
Additional paid-in capital 99,472 94,700
Retained earnings 46,015 44,151
Treasury stock, at cost (116,800 shares at September 30,
1999 and December 31, 1998, respectively) (1,318) (1,318)
-------------- ------------
Total stockholders' equity 144,329 137,688
-------------- ------------
Total liabilities and stockholders' equity $ 548,777 481,907
============== ============
See accompanying notes to consolidated financial statements.
2
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
REVENUES
Net gain on sale of mortgage loans $ 9,911 17,459 57,915 68,531
Interest 8,619 10,569 24,732 6,841
Servicing fees 4,219 3,764 11,575 6,598
Origination fees 6,937 6,295 22,426 17,953
--------- --------- --------- --------
Total revenues 29,686 38,087 116,648 99,923
--------- --------- --------- --------
EXPENSES
Payroll and related costs 16,123 15,257 49,709 41,759
Interest expense 6,205 8,521 18,454 23,213
General and administrative (1) 17,516 9,216 45,510 24,793
--------- --------- --------- --------
Total expenses 39,844 32,994 113,673 89,765
--------- --------- --------- --------
(Loss) income before income
tax (benefit) expense (10,158) 5,093 2,975 10,158
Provision for income taxes (benefit) (4,063) 1,987 1,111 3,703
--------- --------- --------- --------
Net (loss) income $ (6,095) 3,106 1,864 6,455
========= ========= ========= ========
PER SHARE DATA
Net (loss) income per common
share - basic and diluted $ (0.39) 0.20 0.12 0.42
======== ========= ========= =========
Weighted-average number
of shares outstanding 15,438,640 15,414,210 15,385,672 15,387,923
============ ============ ============ ============
- -----------------
<FN>
(1) The nine-month period ended September 30, 1999 includes a $12.0 million
pre-tax charge for the global settlement with the New York State Banking
Department (the "NY Banking Department") and the New York Office of the
Attorney General (the "NYOAG"). The Company recorded a $6.0 million
pre-tax charge in the second quarter of 1999 when it reached a settlement
in principle with the NYOAG. Subsequently, an additional $6.0 million
pre-tax charge was recorded in the third quarter of 1999 when the Company
reached a global settlement with the NY Banking Department and the NYOAG.
See "Legal Proceedings" herein for a more detailed discussion of the
settlement.
</FN>
See accompanying notes to consolidated financial statements.
3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 1999 1998
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,864 6,455
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan and recourse losses 76 75
Depreciation and amortization 4,196 3,091
Settlement issuance of common stock to the Trust 4,777 --
Deferred tax benefit (8,640) (837)
Capitalized mortgage servicing rights, net of amortization (2,881) (7,821)
Deferred origination costs (48) 1,108
Interest-only and residual certificates received in
Securitization transactions, net (18,870) (30,030)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (7,208) 5,022
Increase in loans held for sale, net (14,742) (9,775)
Increase in accrued interest and late charges receivable (11,300) (11,920)
Increase in cash held for advance payments (3,951) (5,255)
Decrease (increase) in prepaid and other assets 358 (321)
Increase (decrease) in accounts payable and accrued expenses 16,677 (1,238)
Increase in investor payable 7,551 13,007
Increase in advance payments by borrowers for taxes and insurance 4,087 3,860
------------- ----------
Net cash used in operating activities (28,054) (34,579)
------------- ----------
Cash flows from investing activities:
Purchase of equipment (6,506) (7,554)
------------- ----------
Net cash used in investing activities (6,506) (7,554)
------------- ----------
Cash flows from financing activities:
Proceeds from warehouse financing and other borrowings, net 40,352 53,800
Increase (decrease) in bank payable, net 83 (429)
Purchase of treasury stock -- (1,199)
Proceeds from exercise of stock options -- 25
------------- ----------
Net cash provided by financing activities 40,435 52,197
------------- ----------
Net increase in cash and interest-bearing deposits 5,875 10,064
Cash and interest-bearing deposits at beginning of period 49,152 32,858
------------- -----------
Cash and interest-bearing deposits at end of period $ 55,027 $ 42,922
============= ===========
Supplemental Information:
Cash paid during the period for:
Interest $ 20,901 26,850
============= ===========
Income taxes $ 9,750 4,591
============= ===========
See accompanying notes to consolidated financial statements.
4
</TABLE>
<PAGE>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION
Delta Financial Corporation (the "Company" or "Delta") is a Delaware
corporation which was organized in August 1996. On October 31, 1996, 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 for the
twelve-month period ended June 30, 1998, the sellers were paid an additional
$1.2 million of purchase price in the form of, and at a fair value equivalent to
101,361 shares of the Company's stock in August 1998. The additional
consideration has been recorded as additional goodwill and will 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, 1998. The results of operations for the three- and
nine-month periods ended September 30, 1999 are not necessarily indicative of
the results that will be expected for the entire year.
All adjustments that 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
5
have been made. Certain prior period amounts in the financial statements
have been reclassified to conform with the current year presentation.
(3) 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 income.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
(DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------
Net (loss) income $(6,095) $3,106 $1,864 $6,455
Weighted-average shares - basic 15,438,640 15,414,210 15,385,672 15,387,923
Basic EPS $(0.39) $0.20 $0.12 $0.42
Weighted-average shares - basic 15,438,640 15,414,210 15,385,672 15,387,923
Incremental shares-options 27,817 -- 25,700 31,341
- -------------------------------------------------------------------------------------------
Weighted-average shares - diluted 15,466,457 15,414,210 15,411,372 15,419,264
Diluted EPS $(0.39) $0.20 $0.12 $0.42
</TABLE>
(4) 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 made at times and in amounts as the Company deems appropriate and may be
discontinued at any time. 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. 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.
Given the consumer finance sector-wide focus on liquidity and conserving
capital, the Board of Directors decided in November 1998 to suspend repurchases
under the program and no subsequent decision has been made to recommence
repurchases. As such, during the nine months ended September 30, 1999, the
Company did not repurchase any shares of its common stock under its stock
repurchase plan. At September 30, 1999, the total number of treasury shares held
by the Company equaled 116,800.
6
<PAGE>
ITEM 2. 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 (the "Company" or "Delta") engages in the
consumer finance business by originating, acquiring, selling and servicing
non-conforming home equity loans. Throughout its 17 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 for such purposes as
debt consolidation, home improvement, mortgage refinancing or education.
Through its wholly-owned subsidiary, Delta Funding Corporation ("Delta
Funding"), 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 currently
originates and purchases the majority of its loans in 24 states, through its
network of approximately 1,400 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 nine states. Through a
strategic alliance between DFC Funding of Canada Limited, a wholly-owned
subsidiary of Delta Funding, and MCAP Mortgage Corporation, a Canadian mortgage
loan originator, the Company originated loans in Canada. In February 1999 the
Company decided to close its Canadian business to focus exclusively on its U.S.
based business.
For the three months ended September 30, 1999, the Company originated and
purchased $361.0 million of loans, a decrease of 24% from $476.2 million of
loans originated and purchased in the comparable period in 1998. Of these
amounts, approximately $222.2 million were originated through its network of
brokers, $79.4 million were originated through its retail network and $59.4
million were purchased from its network of correspondents for the three months
ended September 30, 1999 compared to $228.2 million, $67.0 million and $177.7
million, respectively, for the same period in 1998. In addition, $3.3 million
was originated through its Canadian network during the three months ended
September 30, 1998. The decrease in year-over-year loan originations is
primarily the result of a decline in correspondent purchases as the Company has
strategically shifted its loan production mix to a greater percentage of broker
and retail originations. This production shift reflects the Company's strategy
to focus on its broker and retail channels, which are less cash intensive than
correspondent loan purchases.
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
7
generally retains interest-only or residual certificates issued by the
securitization trusts, as well as the servicing rights, the value of each
of which may be adversely affected by defaults.
THREE MONTHS ENDED
------------------------------
(DOLLARS IN THOUSANDS) SEPTEMBER 30, JUNE 30,
1999 1999
-------------- -------------
Total Outstanding Principal Balance
(at period end).............................. $ 3,518,142 $ 3,358,818
Average Outstanding(1)......................... 3,470,468 3,288,247
DELINQUENCY (at period end) 30-59 Days:
Principal Balance............................ $ 181,180 $ 155,321
Percent of Delinquency(2).................... 5.15% 4.62%
60-89 Days:
Principal Balance............................ $ 70,552 $ 58,528
Percent of Delinquency(2).................... 2.00% 1.74%
90 Days or More:
Principal Balance............................ $ 55,913 $ 51,654
Percent of Delinquency(2).................... 1.59% 1.54%
Total Delinquencies:
Principal Balance............................ $ 307,645 $ 265,503
Percent of Delinquency(2).................... 8.74% 7.90%
FORECLOSURES
Principal Balance............................ $ 170,061 $ 161,073
Percent of Foreclosures by Dollar(2)......... 4.83% 4.80%
REO (at period end)............................ $ 31,900 $ 27,907
Percent of REO.............................. 0.91% 0.83%
Net Losses on Liquidated Loans................. $ (4,147) $ (3,255)
Percentage of Net Losses on Liquidated Loans
(based on Average Outstanding Balance)(3).... (0.48%) (0.40%)
- ---------------
(1)Calculated by summing the actual outstanding principal balances at the end
of each month and dividing the total principal balance 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.
On June 23, 1999, the Company announced a settlement in principle with the
office of the Attorney General for the State of New York ("NYOAG"). The NYOAG
took issue with Delta's lending practices, specifically which loans should and
should not be made by Delta. The Banking Department of the State of New York
("NY Banking Department") and the U.S. Department of Justice (the "DOJ") had
raised similar concerns relating to Delta's lending practices. On August 16,
1999, the Company entered into an agreement in principle with the NY Banking
Department, NYOAG and the DOJ with respect to their concerns. In September 1999,
the Company finalized its settlements with the NY Banking Department and the
NYOAG (but only after the NYOAG filed suit against the Company in August 1999).
As part of the global settlement (in lieu of the previously announced $6
million settlement
8
with the NYOAG), the Company will, among other things, implement agreed
upon changes to its lending practices; provide reduced loan payments aggregating
$7.25 million to certain borrowers identified by the NY Banking Department,
NYOAG and the DOJ; and create a reversionary fund (the "fund"), administered by
a trustee named by the NY Banking Department, financed by the grant by Delta of
525,000 shares of Delta's common stock, valued at an assumed constant price of
$9.10 per share, which approximates book value of the shares. All proceeds
raised through the fund shall be used for restitution and/or to pay for a
variety of educational and counseling programs at the discretion of the NY
Banking Department.
The nine-month period ended September 30, 1999 includes a $12.0 million
pre-tax charge for the global settlement with the NY Banking Department and the
NYOAG. The Company recorded a $6.0 million pre-tax charge in the second quarter
of 1999 when it reached a settlement in principle with the NYOAG. Subsequently,
an additional $6.0 million pre-tax charge was recorded in the third quarter of
1999 when the Company reached a global settlement with the NY Banking Department
and the NYOAG. See "Legal Proceedings" herein for a more detailed discussion of
the settlement.
FAIR VALUE ADJUSTMENTS
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities", upon the sale or securitization of a loan, a
gain on sale and a corresponding asset is recognized for any interest-only and
residual certificates and capitalized mortgage servicing rights. The carrying
amount of the interest-only and residual certificates is classified as a trading
security and, as such, they are recorded at their fair value. The Company
implemented SFAS No. 134, "Accounting for Mortgage-Backed Securities after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise"
in the first quarter of 1999. The implementation of SFAS 134 did not have a
material impact on the Company's financial condition or results of operations.
For capitalized mortgage servicing rights, a valuation allowance is recorded if
the fair value of such rights is less than the carrying amount.
The fair values of both interest-only and residual certificates and
capitalized mortgage servicing rights are significantly affected by, among other
factors, prepayments of loans and 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.
The Company's review of its prepayment experience and assumptions at June 30,
1998 indicated that the prepayment rates during 1998, particularly for
adjustable-rate mortgages ("ARMs"), and in particular during the second quarter
of 1998, were higher than those historically experienced, or previously
projected, by the Company. The Company believes that these increases in
prepayment rates were attributable to the continuation, for a longer period than
historically experienced, of low interest rates, together with 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
9
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 to estimate the fair value of the interest-only and
residual certificates and capitalized mortgage servicing rights retained by the
Company in securitizations completed prior to the second quarter of 1998. These
revised prepayment assumptions were also used in initially valuing and recording
the interest-only and residual certificates and capitalized mortgage servicing
rights retained by the Company in its securitizations completed subsequent to
the first quarter of 1998.
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
capitalized mortgage servicing rights to reflect a provision for impairment (the
"fair value adjustments"). Both impairment provisions resulted from reductions
in the Company's estimates of the fair value of those assets. The reductions in
the estimated fair value resulted from the aforementioned change in the
prepayment assumptions used by the Company to estimate the future cash flows to
be derived from the interest-only and residual certificates and the mortgage
servicing rights.
The Company assumes prepayment rates and defaults based upon the seasoning of
its existing securitization loan portfolio. The following table compares the
prepayment assumptions used subsequent to the first quarter of 1998 (the "new"
assumptions) with those used at December 31, 1997 and through the first quarter
of 1998 ( the "old" assumptions):
- --------------------------------------------------------------------------------
LOAN TYPE CURVE MONTH 1 SPEED PEAK SPEED
DESCRIPTION
- --------------------------------------------------------------------------------
NEW OLD NEW OLD NEW OLD
- --------------------------------------------------------------------------------
Loans Fixed Rate Vector Ramp 4.8% 4.8% 31% 24%
Six-Month LIBOR ARMs Vector Ramp 10.0% 5.6% 50% 28%
Hybrid ARMs Vector Ramp 6.0% 5.6% 50% 28%
- --------------------------------------------------------------------------------
In addition, in the first quarter of 1999, the Company increased its loss
reserve initially established for both fixed- and adjustable-rate loans sold to
the securitizations trusts from 2.00% to approximately 2.20% of the issuance
amount securitized. The Company made this change to better reflect what
management believes its loss experience will be, as the Company experienced
significantly slower prepayment rates in the first quarter of 1999 which,
coupled with an anticipated flat to slightly moderate rise in home values as
compared to the past few years, may have an adverse effect on the Company's
non-performing loans. This change resulted in approximately a $3.8 million
reduction in the Company's value of the residual and interest-only certificates.
An annual discount rate of 12.0% was utilized in determining the present value
of cash flows from residual certificates, using the "cash-out" method, which are
the predominant form of retained interests at both September 30, 1999 and
December 31, 1998.
10
The Company uses the same prepayment assumptions in estimating the fair value
of its mortgage servicing rights.
To date, aggregate actual cash flows from the Company's securitization trusts
have either met or exceeded management's expectations.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1998
GENERAL
The Company's net loss for the three months ended September 30, 1999 was
$(6.1) million, or $(0.39) per share, compared to net income of $3.1 million, or
$0.20 per share, for the three months ended September 30, 1998. Excluding a
one-time charge relating to the Company's settlement with the NY Banking
Department and the NYOAG, the Company's net loss for the three months ended
September 30, 1999 would have been reduced to $(2.5) million, or $(0.16) per
share. Comments regarding the components of net (loss) income are detailed in
the following paragraphs.
REVENUES
Total revenues for the three months ended September 30, 1999 decreased by
$8.4 million, or 22%, to $29.7 million from $38.1 million for the comparable
period in 1998. The decrease in revenue was primarily attributable to a decrease
in the net gain on sale recognized on the sale of mortgage loans and to a lesser
extent, a decrease in interest income. This was partially offset by an increase
in servicing fees and origination fees.
The Company originated and purchased $361.0 million of mortgage loans for the
three months ended September 30, 1999, representing a 24% decrease from the
$476.2 million of mortgage loans originated and purchased for the three months
ended September 30, 1998. The Company completed a loan sale through a mortgage
loan conduit facility for $360.0 million during the three months ended September
30, 1999 compared with a securitization totaling $475.0 million in the
corresponding period in 1998, representing a 24% decrease. Total loans serviced
at September 30, 1999 increased 30% to $3.52 billion from $2.69 billion at
September 30, 1998.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
represents (1) the sum of (a) the fair value of the residual certificates
retained by the Company in a securitization and the market value of the
interest-only certificates sold in connection with each securitization, or the
excess servicing receivable (net interest margin) retained (the difference
between the weighted average interest rate on the mortgage loans less the
variable funding rate; present valued using the same underlying assumptions used
in determining the fair market value of the residual certificates) in the loans
sold to a conduit for each period (b) the fair value of capitalized mortgage
servicing rights associated with loans securitized in each period, and (c)
premiums earned on the sale of whole loans on a servicing-released basis, (2)
less the (x) premiums paid to originate or acquire mortgage loans, (y) costs
associated with securitizations and (z) any hedge loss (gain) associated with a
particular securitization or loans sold.
11
Net gain on sale of mortgage loans for the three months ended September 30,
1999 decreased by $7.5 million, or 43%, to $9.9 million from $17.4 million for
the comparable period in 1998. This decrease was primarily due to a 24% decrease
in the amount of loans securitized and to a lower gain on sale of the loans sold
to a conduit primarily reflecting the interest rate risk associated with funding
fixed rate mortgage loans using a variable interest rate over the expected lives
of the mortgage loans. This was partially offset by lower premiums paid to
acquire loans resulting from both a decrease in the amount of loans purchased
through the correspondent channel and a decrease in the average premium paid to
correspondents. The weighted average net gain on sale ratio was 2.8% for the
three months ended September 30, 1999 compared to 3.7% for the three months
ended September 30, 1998.
INTEREST INCOME. Interest income primarily represents the sum of (1) the
difference between the distributions the Company receives on its interest-only
and residual certificates and the adjustments recorded to reflect changes in the
fair value of the interest-only and residual certificates, (2) the gross
interest earned on loans held for sale, (other than loans sold into the
conduit), (3) with respect to loans sold into the conduit, the net interest
margin earned (excess servicing) between the weighted average rate on the
mortgage loans less the conduit's variable funding rate plus administrative
fees, and (4) interest earned on cash collection balances.
Interest income for the three months ended September 30, 1999 decreased by
$2.0 million to $8.6 million from $10.6 million in the comparable period in
1998. The decrease in interest income was primarily due to the accounting for
loans sold by the Company through a mortgage loan conduit facility prior to
their securitization. For such conduit-related sales, the Company earns and
records the net interest margin between the interest rate earned on the pool of
mortgage loans sold to the mortgage loan conduit and the conduit financing rate,
plus administrative expenses, during the three months ended September 30, 1999.
Typically, interest expense related to the Company's other warehouse financing
and borrowings are recorded directly to interest expense.
SERVICING FEES. Servicing fees represent all contractual and ancillary
servicing revenue received by the Company less (1) the offsetting amortization
of the capitalized mortgage servicing rights, and any adjustments recorded to
provide valuation allowances for the impairment in mortgage servicing rights and
(2) prepaid interest shortfalls.
Servicing fees for the three months ended September 30, 1999 increased by
$0.4 million, or 11%, to $4.2 million from $3.8 million in the comparable period
in 1998. This increase was primarily due to an increase in the aggregate size of
the Company's servicing portfolio. The average balance of the mortgage loans
serviced increased 34% to $3.47 billion for the three months ended September 30,
1999 from $2.59 billion during the comparable period in 1998.
ORIGINATION FEES. Origination fees represent fees earned on retail and
brokered originated loans. Origination fees for the three months ended September
30, 1999 increased by $0.6 million, or 10%, to $6.9 million from $6.3 million in
the comparable period in 1998. The increase is primarily the result of an
increase in the rate of origination fees earned, coupled with an increase in
retail originated loans, partially offset by a slight decline in broker
originated loans.
12
EXPENSES
Total expenses for three months ended September 30, 1999 increased by $6.8
million, or 21%, to $39.8 million from $33.0 million for the comparable period
in 1998. The increase in expenses was primarily the result of an increase in
general and administrative primarily related to the Company's settlement with
the NY Banking Department and the NYOAG, and personnel costs associated with the
Company's expanded retail, broker and servicing divisions, partially offset by a
decrease in interest expense.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees. Payroll and related costs for the
three months ended September 30, 1999 increased by $0.8 million, or 5%, to $16.1
million from $15.3 million for the comparable period in 1998. This increase is
primarily due to staff increases related to growth in the Company's servicing
portfolio and in the Company's loan originations associated with the Company's
broker and retail divisions. As of September 30, 1999, the Company employed
1,190 full- and part-time employees, 368 of which are employees of Fidelity
Mortgage, compared to 1,041 full- and part-time employees as of September 30,
1998.
INTEREST EXPENSE. Interest expense includes the borrowing costs to finance
loan originations and purchases under the $150 million aggregate principal
amount of 9.5% Senior Notes due 2004 issued in July 1997 (the "Senior Notes")
and the Company's credit facilities.
Interest expense for the three months ended September 30, 1999 decreased by
$2.3 million, or 27%, to $6.2 million from $8.5 million for the comparable
period in 1998. The decrease in interest expense was primarily due to the
accounting for loans sold through a mortgage loan conduit prior to their
securitization, in which the Company earns and records the net interest margin
between the interest rate earned on the pool of mortgage loans sold to mortgage
loans conduit and the variable funding rate, plus administrative expenses,
during the three months ended September 30, 1999. Typically, interest expense
related to the Company's other warehouse financing and borrowings are recorded
directly to interest expense. In addition, there was a decrease in the cost of
funds on the Company's credit facilities which were tied to one-month London
Inter-Bank Offering Rate ("LIBOR"). The one-month LIBOR index decreased to an
average interest rate of 5.3% in the three months ended September 30, 1999,
compared to an average interest rate of 5.6% for the comparable period in 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of office rent, insurance, telephone, depreciation, goodwill
amortization, license fees, legal and accounting fees, travel and entertainment
expenses, advertising and promotional expenses and the provision for loan losses
on the inventory of loans held for sale and recourse loans.
General and administrative expenses for the three months ended September 30,
1999 increased $8.3 million, or 90%, to $17.5 million from $9.2 million for the
comparable period in 1998. This increase was primarily attributable to (1) the
Company's settlement with the NY Banking Department and the NYOAG, and legal
costs associated with the settlement, and (2) an increase in depreciation
expense and management and consulting fees, reflecting the Company's ongoing
investment in technology.
13
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 $(4.1) million and a tax provision $2.0
million for the three month periods ended September 30, 1999 and 1998,
respectively.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1998
GENERAL
The Company's net income for the nine months ended September 30, 1999 was
$1.9 million, or $0.12 per share, compared to $6.5 million, or $0.42 per share,
for the nine months ended September 30, 1998. Excluding a one-time charge
relating to the Company's settlement with the NY Banking Department and the
NYOAG, the Company's net income for the nine months ended September 30, 1999
would have been $9.1 million, or $0.59 per share. Comments regarding the
components of net income are detailed in the following paragraphs.
REVENUES
Total revenues for the nine months ended September 30, 1999 increased by
$16.7 million, or 17%, to $116.6 million from $99.9 million for the comparable
period in 1998. The increase in revenue was primarily attributable to 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"), an increase in servicing fees and origination fees, and was
partially offset by a decrease in the net gain recognized on the sale of
mortgage loans.
The Company originated and purchased $1.18 million of mortgage loans for the
nine months ended September 30, 1999, which represented a decrease of 8% from
the $1.31 billion of mortgage loans originated and purchased for the nine months
ended September 30, 1998. The Company completed two securitizations and a loan
sale through a conduit facility totaling $1.20 billion during the nine months
ended September 30, 1999 compared to three securitizations totaling $1.32
billion in the corresponding period in 1998, representing an 8% decrease. Total
loans serviced at September 30, 1999 increased 31% to $3.52 billion from $2.69
billion at September 30, 1998.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans for
the nine months ended September 30, 1999 decreased by $10.6 million, or 15%, to
$57.9 million from $68.5 million for the comparable period in 1998. This
decrease was primarily due to an 8% decrease in the amount of loans securitized
and to a lower gain on sale associated with loans sold to a mortgage loan
conduit in the third quarter of 1999, reflecting the interest rate risk
associated with funding fixed rate mortgage loans using a variable interest rate
over the expected lives of the mortgage loans. The decrease was partially offset
by lower aggregate premiums paid to acquire loans, resulting from both a
decrease in the amount of loans purchased through the correspondent channel and
lower average premiums paid to correspondents. The weighted average net gain on
sale ratio for the nine months ended September 30, 1999 was 5.0%
14
compared to 5.2% for the nine months ended September 30, 1998.
INTEREST INCOME. Interest income for the nine months ended September 30, 1999
increased by $17.9 million to $24.7 million from $6.8 million in the comparable
period in 1998. The increase in interest income was primarily due to fair value
adjustments made in 1998 to the Company's interest-only and residual
certificates, including a $15.5 million reduction in the second quarter of 1998
related to the change in prepayment assumptions (see "-Fair Value Adjustments").
In addition, there was an increase in interest income related to higher levels
of interest-only and residual certificates. This was partially offset by the
accounting for loans sold by the Company through a mortgage loan conduit during
the nine months ended September 30, 1999. For such conduit-related sales, the
Company earns and records the net interest margin between the interest rate
earned on the pool of mortgage loans sold to the mortgage loan conduit and the
variable funding rate, plus administrative expenses. Typically, interest expense
related to the Company's other warehouse financing and borrowings are recorded
directly to interest expense.
SERVICING FEES. Servicing fees for the nine months ended September 30, 1999
increased by $5.0 million, or 76%, to $11.6 million from $6.6 million in the
comparable period in 1998. This increase was primarily due to (1) the recording
of a $1.9 million impairment provision for the Company's mortgage servicing
rights during the second quarter of 1998 (See "-Fair Value Adjustments") and (2)
an increase in the aggregate size of the Company's servicing portfolio. The
average balance of the mortgage loans serviced increased 43% to $3.28 billion
for the nine months ended September 30, 1999 from $2.29 billion during the
comparable period in 1998.
ORIGINATION FEES. Origination fees for the nine months ended September 30,
1999 increased by $4.4 million, or 24%, to $22.4 million from $18.0 million in
the comparable period in 1998. The increase is primarily the result of (1) a 46%
increase in retail originated loans and (2) a 21% increase in broker originated
loans.
EXPENSES
Total expenses for nine months ended September 30, 1999 increased by $23.9
million, or 27%, to $113.7 million from $89.8 million for the comparable period
in 1998. The increase in expenses was the result of an increase in general and
administrative expenses primarily related to the Company's settlement with the
NY Banking Department and the NYOAG, and legal fees associated with the
settlement, as well as personnel costs associated with the Company's expanded
retail, broker and servicing divisions, partially offset by a decrease in
interest expense.
PAYROLL AND RELATED COSTS. Payroll and related costs for the nine months
ended September 30, 1999 increased by $7.9 million, or 19%, to $49.7 million
from $41.8 million for the comparable period in 1998. This increase is primarily
due to staff increases related to growth in the Company's servicing portfolio
and in the Company's loan originations associated with the Company's broker and
retail divisions. As of September 30, 1999, the Company employed 1,190 full- and
part-time employees, 368 of which are employees of Fidelity Mortgage, compared
to 1,041 full- and part-time employees as of September 30, 1998.
INTEREST EXPENSE. Interest expense for the nine months ended September 30,
1999 decreased by $4.7 million, or 20%, to $18.5 million from $23.2 million for
the comparable period in 1998. The decrease in interest expense was primarily
due to the accounting for loans sold through a
15
mortgage loan conduit prior to their securitization in the third quarter of
1999, in which the Company earns and records the net interest margin between the
interest rate earned on the pool of mortgage loans sold to the mortgage loan
conduit and the conduit financing rate, plus administrative expenses.
Typically, interest expense related to the Company's other warehouse financing
and borrowings are recorded directly to interest expense. In addition, there
was a decrease in the cost of funds on the Company's credit facilities, which
were tied to one-month LIBOR. The one-month LIBOR index decreased to an average
interest rate of 5.1% in the nine months ended September 30, 1999, compared to
an average interest rate of 5.6% for the comparable period in 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for
the nine months ended September 30, 1999 increased $20.7 million, or 83%, to
$45.5 million from $24.8 million for the comparable period in 1998. This
increase was primarily attributable to (1) the Company's settlement with the NY
Banking Department and the NYOAG, and the associated legal costs, and (2) an
increase in depreciation expense and management and consulting fees, reflecting
the Company's ongoing investment in technology.
INCOME TAXES. The Company recorded a tax provision of $1.1 million and
$3.7 million for the periods ended September 30, 1999 and 1998, respectively.
FINANCIAL CONDITION
SEPTEMBER 30, 1999 COMPARED TO DECEMBER 31, 1998
Cash and interest-bearing deposits increased $5.8 million, or 12%, to $55.0
million at September 30, 1999, from $49.2 million at December 31, 1998. The
increase was the result of additional monies held in restricted trust accounts
by the Company, acting as servicer for its ongoing securitization program.
Accounts receivable increased $7.3 million, or 32%, to $29.8 million at
September 30, 1999, from $22.5 million at December 31, 1998. The increase was
attributable to 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 19% to $3.52
billion as of September 30, 1999 from $2.95 billion as of December 31, 1998.
Loans held for sale, net increased $14.7 million, or 17%, to $101.9 million
at September 30, 1999, from $87.2 million at December 31, 1998. This increase
was primarily due to the net difference between loan originations and loans
securitized or sold during the nine months ended September 30, 1999.
Accrued interest and late charges receivable increased $11.3 million, or 24%,
to $58.2 million at September 30, 1999, from $46.9 million at December 31, 1998.
This increase was primarily due to a larger 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 $2.9 million, or 9%, to $36.4
million at September 30, 1999, from $33.5 million at December 31, 1998. This
increase was directly attributable to the Company's capitalizing the fair market
value of the servicing assets, totaling $9.2 million, resulting from the
Company's completion of two securitizations during the nine
16
months ended September 30, 1999, partially offset by the amortization of
capitalized mortgage servicing rights.
Interest-only and residual certificates increased $18.9 million, or 9%, to
$222.7 million at September 30, 1999, from $203.8 million at December 31, 1998.
This increase is primarily attributable to the Company's receipt of residual
certificates valued and recorded at $40.7 million from its securitizations and
conduit loan sales during the nine months ended September 30, 1999, partially
offset by normal amortization due to cash distributions and fair value
adjustments.
Equipment, net, increased $3.2 million, or 19%, to $20.2 million at September
30, 1999, from $17.0 million at December 31, 1998. The increase was primarily
due to capital expenditures related to new technology and expansion.
Cash held for advance payments increased $4.0 million, or 40%, to $14.0
million at September 30, 1999, from $10.0 million at December 31, 1998. 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 $40.3 million, or 50%,
to $120.6 million at September 30, 1999, from $80.3 at December 31, 1998. This
increase was primarily attributable to the increase in loans held for sale, and
to an increase in financing using capital leases to fund the Company's
investment in technology.
The aggregate principal balance of the Senior Notes totaled $149.5 million at
September 30, 1999 compared to $149.4 million at December 31, 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.
Accounts payable and accrued expenses increased $16.7 million, or 80%, to
$37.7 million at September 30, 1999, from $21.0 million at December 31, 1998.
This increase was primarily attributable to the accrual of the Company's
settlement with the NY Banking Department and the NYOAG, in addition to the
timing of various other operating accruals and payables.
Investor payable increased $7.5 million, or 12%, to $71.3 million at
September 30, 1999, from $63.8 million at December 31, 1998. This increase was
primarily due to the 19% increase in the Company's portfolio of serviced loans
to $3.52 billion at September 30, 1999 from $2.95 billion at December 31, 1998.
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 $4.0 million,
or 42%, to $13.6 million at September 30, 1999, from $9.6 million at December
31, 1998. 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.
Deferred tax liability decreased $8.6 million, or 46%, to $10.2 million at
September 30, 1999, from $18.8 million at December 31, 1999. This decrease was
primarily due to income tax payments of $9.8 million.
17
Stockholders' equity increased $6.6 million, or 5%, to $144.3 million at
September 30, 1999, from $137.7 million at December 31, 1998. This increase was
primarily due to the issuance of 525,000 shares of the Company's common stock at
$9.10 per share related to Company's legal settlement and net income of $1.9
million for the nine months ending September 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company's strategy is to maintain a neutral to slightly negative cash
flow position for the foreseeable future, as a result of aggregate annual cash
inflows from the Company's retained interest-only and residual certificates,
advantageous securitization structures, which have allowed the Company to sell
senior interest-only certificates, and a greater concentration on less
cash-intensive broker and retail originations. However, market conditions could
impact the Company's cash flows potentially resulting in a more significant
negative cash flow. Since the second quarter of 1997, the Company has sold the
senior interest-only certificates in each of its securitizations and, in the
Company's six most recent securitizations, it has successfully increased the
amount of senior interest-only certificates offered to investors, compared to
prior securitizations, which has also enhanced cash flow.
For the nine months ended September 30, 1999, the Company had negative
operating cash flow of $28.1 million compared to a negative operating cash flow
of $34.6 million for the comparable period in 1998. The reduction in negative
operating cash flow was primarily due to the Company's de-emphasis of the
correspondent loan production channel, thereby decreasing the amount of premiums
paid to correspondents and an increase in the cash flows from the Company's
retained interest-only and residual certificates. The reduction was partially
offset by the Company's decision not to execute a securitization during the
third quarter of 1999 in which the Company typically generates cash through the
sale of its senior interest-only certificates, an increase in investor payable,
an increase in tax payments and a one-time tax refund during the first quarter
of 1998.
Currently, the Company's primary cash requirements include the funding of (1)
mortgage originations and purchases pending their pooling and sale, (2) the
points and expenses paid in connection with the acquisition of correspondent
loans, (3) interest expense on its Senior Notes and warehouse and other
financings, (4) fees, expenses, delinquency advances, servicing-related advances
and tax payments incurred in connection with its securitization program, and (5)
ongoing administrative and other operating expenses, including fees and expenses
associated with the Company's settlement of claims by the NY Banking Department
and the NYOAG. 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.
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 an 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
18
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 relied upon
a few lenders to provide the primary credit facilities for its loan originations
and purchases. The Company had six warehouse facilities as of September 30, 1999
for this purpose. One warehouse facility is a $200.0 million committed credit
line with a variable rate of interest and a maturity date of March 2000. This
facility's maturity date was extended from February 1999 to March 2000 during
the three months ended March 31, 1999. The Company's second warehouse facility,
a syndicated $100.0 million committed revolving line with a variable rate of
interest, was renewed in June 1999 and extended to mature in June 2000. The
Company's third warehouse facility is a renewal of a committed $200.0 million
mortgage loan conduit with a variable rate of interest and a maturity date of
September 2000. In addition, this facility has been temporarily increased to
$400.0 million until December 26, 1999. The Company's fourth warehouse facility
is a $200.0 million committed credit facility that has a variable rate of
interest and a maturity date of April 2000. The Company's fifth warehouse
facility is a $250.0 million committed credit facility that has a variable rate
of interest and a maturity date of April 2000. During the third quarter of 1999,
the Company obtained an additional warehouse facility with a $200.0 million
committed credit line that has a variable rate of interest and a maturity date
of September 2000. As of September 30, 1999, the first warehouse facility had an
outstanding balance of $99.9 million, the second warehouse facility had an
outstanding balance of $7.5 million and the third warehouse facility had an
outstanding balance of $360.0 million.
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 the Company is in compliance with all such covenants under these agreements
as of September 30, 1999.
The Company purchased a total of 116,800 shares of its common stock during
the year ended December 31, 1998, under the Company's stock repurchase program,
at a total cost of $1.3 million. All of the repurchased shares were purchased in
open market transactions at then prevailing market prices. During the first nine
months of 1999, no additional shares were repurchased.
INFLATION
Inflation affects the Company most significantly in the area of loan
originations and can have a substantial effect on interest rates. Interest rates
normally increase during periods of high inflation and decrease during periods
of low inflation. (See "--Interest Rate Risk.")
RISK FACTORS
Except for historical information contained herein, certain matters discussed
in this Form 10-
19
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:
* Costs associated with litigation and rapid or unforeseen escalation of
the cost of regulatory compliance, including but not limited to,
environmental compliance, licenses, adoption of new, or changes in
accounting polices and practices and the application of such polices and
practices. Failure to comply with various federal, state and local
regulations, accounting policies, and environmental compliance can lead to
loss of approved status, certain rights of rescission for mortgage loans,
class action lawsuits and administrative enforcement action.
* The Company's ability or inability to continue to access lines of credit
at favorable terms and conditions, including without limitation, warehouse
and other credit facilities used to finance newly originated mortgage
loans held for sale.
* The Company's ability or inability to continue its practice of
securitization of mortgage loans held for sale, as well as its ability to
utilize optimal securitization structures at favorable terms to the
Company.
* A general economic slowdown. Periods of economic slowdown or recession
may be accompanied by decreased demand for consumer credit and declining
real estate values. Because of the Company's focus on credit-impaired
borrowers, the actual rate of delinquencies, foreclosures and losses on
loans affected by the borrowers reduced ability to use home equity to
support borrowings could be higher than those generally experienced in the
mortgage lending industry. Any sustained period of increased
delinquencies, foreclosure, losses or increased costs could adversely
affect the Company's ability to securitize or sell loans in the secondary
market.
* The effects of interest rate fluctuations and the Company's ability or
inability to hedge effectively against such fluctuations in interest
rates; the effect 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.
* Increased competition within the Company's markets has taken on many
forms, such as convenience in obtaining a loan, customer service,
marketing and distribution channels, loan origination fees and interest
rates. The Company is currently competing with large finance companies and
conforming mortgage originators many of whom have greater
20
financial, technological and marketing resources.
* 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 development of new product
programs.
* Year 2000 Compliance and Technology Enhancements. The Company is
utilizing both internal and external resources to identify, correct,
reprogram or replace, and test its systems for year 2000 compliance.
Although to date, the Company has been completing its Year 2000 compliance
efforts on time, there can be no assurance that the Company will not
experience unexpected delay. There can also be no assurance that the
systems of other companies on which the Company's systems rely will be
timely reprogrammed for year 2000 compliance.
INFORMATION SERVICES YEAR 2000 PROJECT
The Year 2000 issue centers on the inability of certain computer hardware and
software systems and associated applications to correctly recognize and process
dates beyond December 31, 1999. Many computer programs used by the Company, its
suppliers and outside service providers were developed using only six digits to
define the date field (two fields each for the month, day and year) and may
recognize "00" as the year 1900, rather than the year 2000. Due to the nature of
financial information, if corrective action is not taken, calculations that rely
on the integrity of the date field for the processing of information could be
significantly misstated.
STATE OF READINESS
The Company has implemented a detailed Year 2000 Plan (the "Plan") to
evaluate the Year 2000 readiness of the computer systems that support the
operation of the Company including vendor computer systems. This Plan concluded
in August 1999 with all systems year 2000 compliant.
The Plan includes upgrading the origination system software, upgrading the
loan servicing software, upgrading the accounting system software, upgrading the
wide area network software, assessing the proper integration of all systems and
communicating with vendors and liquidity providers to ascertain their Year 2000
compliance.
To date, the Company believes its internal control systems are Year 2000
compliant and vendors and liquidity providers have been contacted regarding
their readiness. Results of system tests conducted by the Company and other
service providers will continue to be carefully monitored to ensure that all
issues have been identified and addressed.
The Company believes it has developed an effective Plan to address the Year
2000 issue and that based on the available information, the execution of the
Plan will not have any significant or material impact to the Company's ability
to operate before, during or after the transition to the
21
new millennium. However, the Company has no control over the process of
third parties in addressing their own Year 2000 issues and, if the necessary
changes are not effected or are not completed in a timely manner, or if
unanticipated problems arise, there may be a material impact on the Company's
financial condition and result of operations.
COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
The Company's costs to resolve the Year 2000 issue are not expected to have a
material financial impact on the Company and are expected to be less than $1.0
million, which the Company intends to fund from its current operations. To date,
the Company has paid and expensed approximately $0.7 million. However, as stated
above, there can be no assurance that all such costs have been identified, or
that there may not be some unforeseen cost which may have a material adverse
effect on the Company's financial condition and results of operations.
RISK OF YEAR 2000 ISSUES
To date, the Company has not identified any system which presents a material
risk of failing to be Year 2000 complaint in a timely manner, or for which a
suitable alternative cannot be implemented. However, as the Company progresses
with its Plan and continues its testing, systems or equipment may be identified
which present a material risk of business interruption. Such disruption may
include the inability to process customer accounting transactions; the inability
to process loan applications; the inability to reconcile and record daily
activity; the inability to track delinquencies; or the inability to generate
checks or to clear funds. In addition, if any of the Company's liquidity
providers should fail to achieve the Year 2000 compliance and they experience a
disruption of their own businesses which prevents them from fulfilling their
obligations, the Company may be materially impacted.
To the extent that the risks posed by the Year 2000 issue, which are beyond
the Company's control, are pervasive in data processing, utility and
telecommunication services worldwide, the Company cannot predict with certainty
that it will remain materially unaffected by issues related to the Year 2000
problem.
CONTINGENCY PLANS
As part of the Plan implemented by the Company, periodic assessments are made
to determine that all Year 2000 issues will be addressed prior to the new
millennium. If this assessment determines that any systems are not Year 2000
compliant, and will not become Year 2000 compliant in a timely manner, then a
contingency plan to implement a suitable alternative will be put in place. At
this time all systems are believed to be compliant and no contingency plan is in
place.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
SFAS NO. 133
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
No. 133 establishes
22
accounting and reporting standards for derivative instruments and for
hedging activities. It requires that any entity recognize all derivatives as
either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. The accounting for changes in the fair value of
a derivative (that is, gains and losses) depends on the intended use of the
derivative and the resulting designation. In July 1999, the FASB issued SFAS No.
137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement No. 133." SFAS No.137 delays the effective
date of SFAS No. 133, for one year, to all fiscal quarters of all fiscal years
beginning after June 15, 2000. The delay applies to quarterly and annual
financial statements. SFAS No. 137 is effective upon issuance and does not
require restatement of prior periods. Management of the Company currently
believes the implementation of SFAS No. 133 will not have a material impact on
the Company's financial condition or results of operations.
23
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary market risk to which the Company is exposed is interest rate
risk, which is highly sensitive to many factors, including governmental monetary
and tax policies, domestic and international economic and political
considerations and other factors beyond the control of the Company. Changes in
the general level of interest rates between the time the Company originates or
purchases mortgage loans and the time the Company sells such mortgage loans at
securitization can affect the value of the Company's mortgage loans held for
sale and, consequently, the Company's net gain on sale revenue by affecting the
"excess spread" between the interest rate on the mortgage loans and the interest
rate paid to asset-backed investors who purchase pass-through certificates
issued by the securitization trusts. 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 generally narrows, resulting in a loss in
value of the loans and a lower net gain on sale.
A hypothetical 10 basis point increase in interest rates, which historically
has resulted in approximately a 10 basis point decrease in the excess spread,
would be expected to reduce the Company's net gain on sale by approximately 25
basis points. Many factors, however, can affect the sensitivity analysis
described above including, without limitation, the structure and credit
enhancement used in a particular securitization, the Company's prepayment, loss
and discount rate assumptions, and the spread over treasuries demanded by
asset-backed investors who purchase the Companies asset-backed securities.
To reduce its financial exposure to changes in interest rates, the Company
generally hedges its mortgage loans held for sale by entering into treasury rate
lock contracts (see "-Hedging"). The Company's hedging strategy has largely been
an effective tool to manage the Company's interest rate risk on loans prior to
securitization, by providing the Company with a cash gain (or loss) to largely
offset the reduced (increased) excess spread (and resultant lower (or higher)
net gain on sale) from an increase (decrease) in interest rates. A hedge may
not, however, perform its intended purpose of offsetting changes in net gain on
sale primarily due to a less then perfect correlation between the hedging
instrument used to hedge the securities issued by the securitization trust.
Changes in interest rates could also adversely affect the Company's ability
to purchase and originate loans and/or could affect the level of loan
prepayments thereby impacting the size of the Company's loan servicing portfolio
and the value of the Company's interest only and residual certificates and
capitalized mortgage servicing rights. (See "-Interest Rate Risk").
INTEREST RATE RISK
Among 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, commercial paper rates and 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
24
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 have proven historically
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. (See
"--Hedging").
25
<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 various state and
federal lending laws, the Company is subject, in the normal course of business,
to numerous claims and legal proceedings. The Company's lending practices have
been the subject of several lawsuits styled as class actions and of
investigations by various regulatory agencies including the Office of the
Attorney General of the State of New York (the "NYOAG"), the New York State
Banking Department (the "NY Banking Department") and the United States
Department of Justice (the "DOJ"). The current status of these actions are
summarized below.
* In or about November 1998, 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. In December 1998, plaintiffs filed an
amended complaint alleging that the Company had violated the Home Equity
and Ownership Protection Act ("HOEPA"), the Truth in Lending Act ("TILA")
and New York State General Business Law ss. 349. The complaint seeks (a)
certification of a class of plaintiffs, (b) declaratory judgment
permitting rescission, (c) unspecified actual, statutory, treble and
punitive damages (including attorneys' fees), (d) certain injunctive
relief, and (e) declaratory judgment declaring the loan transactions as
void and unconscionable. On December 7, 1998, plaintiff filed a motion
seeking a temporary restraining order and preliminary injunction,
enjoining Delta from conducting foreclosure sales on 11 properties. The
District Court Judge ruled that in order to consider such a motion,
plaintiff must move to intervene on behalf of these 11 borrowers.
Thereafter, plaintiff moved to intervene on behalf of 3 of these 11
borrowers and sought the injunctive relief on their behalf. The Company
opposed the motions. On December 14, 1998, the District Court Judge
granted the motion to intervene and on December 23, 1998, the District
Court Judge issued a preliminary injunction enjoining the Company from
proceeding with the foreclosure sales of the three intervenors'
properties. The Company has filed a motion for reconsideration of the
December 23, 1998 order. In January 1999, the Company filed an answer to
plaintiffs' first amended complaint. In July 1999, plaintiffs were granted
leave, on consent, to file a second amended complaint. In August 1999,
plaintiffs filed a second amended complaint that, among other things,
added additional parties but contained the same causes of action alleged
in the first amended complaint. In September 1999, the Company filed a
motion to dismiss the complaint. Also in September 1999, plaintiffs filed
a motion for class certification; which Delta will respond to in or about
December 1999, after class discovery is completed. In or about October
1999, plaintiffs filed a motion seeking an order preventing the Company,
its attorneys and/or the New York State Banking Department (the "NY
Banking Department")from issuing notices to certain of Delta's borrowers,
in accordance with a settlement agreement entered into by and between
the Company and the NY Banking Department. In or about October 1999 and
November 1999, respectively, Delta and the NY Banking Department submitted
opposition to plaintiffs' motion. The Company believes that it has
meritorious defenses and intends to defend this suit, but cannot estimate
with any certainty its ultimate legal or financial
26
liability, if any, with respect to the alleged claims.
* In or about March 1999, the Company received notice that it had been
named in a lawsuit filed in the Supreme Court of the State of New York,
New York County, alleging that Delta had improperly charged certain
borrowers processing fees. The complaint seeks (a) certification of a
class of plaintiffs, (b) an accounting, and (c) unspecified compensatory
and punitive damages (including attorneys' fees), based upon alleged (i)
unjust enrichment, (ii) fraud, and (iii) deceptive trade practices. In
April 1999, the Company filed an answer to the complaint. In August 1999,
plaintiffs filed a motion for class certification. In September 1999, the
Company filed a motion to dismiss the complaint, which was opposed by
plaintiffs. The Company's response to the motion for class certification
is not due until after class discovery is completed and its motion to
dismiss is decided. The Company believes that it has meritorious defenses
and intends to defend this suit, but cannot estimate with any certainty
its ultimate legal or financial liability, if any, with respect to the
alleged claims.
* In or about July 1999, the Company received notice that it had been named
in a lawsuit filed in the United States District Court for the Western
District of New York, alleging that amounts collected and maintained by it
in certain borrowers' tax and insurance escrow accounts exceeded certain
statutory (RESPA) and/or contractual (the respective borrowers' mortgage
agreements) ceilings. The complaint seeks (a) certification of a class of
plaintiffs, (b) declaratory relief finding that the Company's practices
violate applicable statutes and/or the mortgage agreements, (c) injunctive
relief, and (d) unspecified compensatory and punitive damages (including
attorneys' fees). In October 1999, the Company filed a motion to dismiss
the complaint. The Company believes that it has meritorious defenses and
intends to defend this suit, but cannot estimate with any certainty its
ultimate legal or financial liability, if any, with respect to the alleged
claims.
* In or about August 1999, the Office of the Attorney General for the State
of New York (the "NYOAG") filed a lawsuit against the Company alleging
violations of (a) RESPA (by paying yield spread premiums), (b) HOEPA and
TILA, (c) ECOA, (d) New York Executive Law ss. 296-a, and (e) New York
Executive Law ss. 63(12). In September 1999, Delta and the NYOAG settled
the lawsuit, as part of a global settlement by and among Delta, the NYOAG
and the NY Banking Department, evidenced by that certain (a) Remediation
Agreement by and between Delta and the NY Banking Department, dated as
of September 17, 1999 and (b) Stipulated Order on Consent by and among
Delta, Delta Financial and the NYOAG, dated as of September 17, 1999. As
part of the Settlement, Delta will, among other things, implement
agreed upon changes to its lending practices; provide reduced loan
payments aggregating $7.25 million to certain borrowers identified by
the NY Banking Department; and create a fund of approximately $4.75
million to be financed by the grant of 525,000 shares of Delta Financial's
common stock valued at a constant assumed priced of $9.10 per share, which
approximates book value. The proceeds of the fund will be used, for among
other things, to pay for a variety of consumer educational and counseling
programs. As a result, the NYOAG lawsuit has
27
been dismissed as against the Company.
The Remediation Agreement and Stipulated Order on Consent supersede the
Company's previously announced settlements with the NYOAG and the NY
Banking Dept. The Company contemplates the United States Department of
Justice (the "DOJ") joining this global settlement and is negotiating the
terms of a settlement agreement with the DOJ in that regard.
In November 1999, 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, seeking certification as a class action and alleging violations of the
federal securities laws in connection with the Company's initial public offering
in 1996 and its reports subsequently filed with the Securities and Exchange
Commission. The complaint alleges that the scope of the violations alleged
recently in the consumer lawsuits and regulatory actions indicate a pervasive
pattern of action and risk that should have been more thoroughly disclosed to
investors in the Company's common stock. The Company has learned of two other
lawsuits that purportedly contain the same or similar allegations, WHICH
have apparently also been filed against the Company. The Company believes that
it has meritorious defenses and intends to defend these suits, but has not
answered yet and cannot estimate with any certainty its ultimate legal or
financial liability, if any, with respect to the alleged claims.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
In September 1999, in connection with a settlement entered into by and among
the Company, the NY Banking Department and the NYOAG, the Company issued 525,000
shares of Delta Financial's common stock valued at a constant assumed priced of
$9.10 per share, which approximates book value. The unregistered shares were
deposited into a trust maintained by the NY Banking Department, the proceeds
from which will be used for, among other things, restitution, education and
counseling, at the discretion of the NY Banking Department, in accordance with
the settlement agreement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None
ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS. None
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
27.1 Financial Data Schedule - Nine Months
Ended September 30, 1999
28
(b)Reports on Form 8-K: On September 22, 1999, the Company filed
a Current Report on Form 8-K in which it
reported the completion of settlement
agreements with the NY Banking Department and
the NYOAG, and filed as exhibits copies of that
certain (1) Remediation Agreement by and between
Delta Funding Corporation and the NY Banking
Department, dated as of September 17, 1999 and
(2) Stipulated Order on Consent by and among
Delta Funding Corporation, Delta Financial
Corporation and the NYOAG, dated as of September
17, 1999.
29
<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: November 15, 1999
By:/S/ HUGH MILLER
------------------------------------
Hugh Miller
PRESIDENT & CHIEF EXECUTIVE OFFICER
By:/S/ RICHARD BLASS
------------------------------------
Richard Blass
SENIOR VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
30
<PAGE>
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
11.1 Statement re: Computation of Per Share Earnings.
27.1 Financial Data Schedule - Nine Months Ended September 30, 1999
<TABLE>
<CAPTION>
EXHIBIT 11.1. STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 1999 1998 1999 1998
- -------------------------------------------------------------------- -----------------------
<S> <C> <C> <C> <C>
BASIC EARNINGS PER SHARE
Net (loss) income $ (6,095) $ 3,106 $ 1,864 $ 6,455
========== ========== ========== ==========
Weighted average number of common
and common equivalent shares: 15,438,640 15,414,210 15,385,672 15,387,923
Basic earnings per share $ (0.39) $ 0.20 $ 0.12 $ 0.42
=========== ========== ========== ==========
DILUTED EARNINGS PER SHARE
Net income $ (6,095) $ 3,106 $ 1,864 $ 6,455
=========== ========== ========== ==========
Weighted average number of common
and common equivalent shares:
---------------------------------
Average number of shares outstandinding 15,438,640 15,414,210 15,385,672 15,387,923
Net effect of dilutive stock optionions
based on the treasury method 27,817 -- 25,700 31,341
Total average shares: 15,466,457 15,414,210 15,411,372 15,419,264
=========== ========== ========== ==========
Diluted earnings per share $ (0.39) $ 0.20 $ 0.12 $ 0.42
=========== ========== ========== ==========
1
</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 NINE MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 55,027
<SECURITIES> 222,673
<RECEIVABLES> 226,810
<ALLOWANCES> 548
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 31,041
<DEPRECIATION> 10,815
<TOTAL-ASSETS> 548,777
<CURRENT-LIABILITIES> 0
<BONDS> 149,452
0
0
<COMMON> 160
<OTHER-SE> 144,169
<TOTAL-LIABILITY-AND-EQUITY> 548,777
<SALES> 0
<TOTAL-REVENUES> 116,648
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 95,194
<LOSS-PROVISION> 25
<INTEREST-EXPENSE> 18,454
<INCOME-PRETAX> 2,975
<INCOME-TAX> 1,111
<INCOME-CONTINUING> 1,864
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,864
<EPS-BASIC> 0.12
<EPS-DILUTED> 0.12
</TABLE>
