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 June 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 June 30, 1999, 15,358,749 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 June 30, 1999 and
December 31, 1998................................................ 2
Consolidated Statements of Operations for the three months and
six months ended June 30, 1999 and June 30, 1998.................. 3
Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and June 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........ 25
PART II- OTHER INFORMATION
Item 1. Legal Proceedings................................................. 27
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............... 29
Item 5. Other Information................................................. 29
Item 6. Exhibits and Current Reports on Form 8-K.......................... 29
Signatures................................................................. 30
1
<PAGE>
Item 1. Financial Statements (unaudited)
<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, DECEMBER 31,
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA) 1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Cash and interest-bearing deposits $ 61,713 49,152
Accounts receivable 27,276 22,549
Loans held for sale, net 85,404 87,170
Accrued interest and late charges receivable 54,323 46,897
Capitalized mortgage servicing rights 38,552 33,490
Interest-only and residual certificates 216,253 203,803
Equipment, net 19,759 16,962
Cash held for advance payments 12,173 10,031
Prepaid and other assets 5,180 5,839
Goodwill 5,422 6,014
------------ ------------
Total assets $ 526,055 481,907
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Bank payable $ 1,373 1,396
Warehouse financing and other borrowings 92,292 80,273
Senior Notes 149,429 149,387
Accounts payable and accrued expenses 30,576 20,966
Investor payable 76,828 63,790
Advance payment by borrowers for taxes and insurance 11,808 9,559
Deferred tax liability 18,102 18,848
------------ ------------
Total liabilities 380,408 344,219
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value. Authorized
49,000,000 shares; 15,475,549 shares issued
and 15,358,749 shares outstanding at
June 30, 1999 and December 31, 1998 155 155
Additional paid-in capital 94,700 94,700
Retained earnings 52,110 44,151
Treasury stock, at cost (116,800 shares at
June 30, 1999 and December 31, 1998, respectively) (1,318) (1,318)
------------- ------------
Total stockholders' equity 145,647 137,688
------------- ------------
Total liabilities and stockholders' equity $ 526,055 481,907
============= ============
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 SIX MONTHS ENDED
JUNE 30, JUNE 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 $ 22,901 $ 24,493 $ 48,004 $ 51,072
Interest 9,680 (10,393) 16,113 (3,728)
Servicing fees 3,743 673 7,356 2,834
Origination fees 8,125 5,909 15,489 11,658
---------- ---------- ---------- ----------
Total revenues 44,449 20,682 $ 86,962 61,836
---------- ---------- ---------- ----------
EXPENSES
Payroll and related costs 17,744 13,148 33,586 26,502
Interest expense 6,077 7,626 12,249 14,692
General and administrative (1) 16,937 7,944 27,994 15,577
---------- ---------- ---------- ----------
Total expenses 40,758 28,718 73,829 56,771
---------- ---------- ---------- ----------
Income (loss) before income
tax expense (benefit) 3,691 (8,036) 13,133 5,065
Provision for income taxes 1,476 (3,134) 5,174 1,716
---------- ---------- ---------- ----------
Net income (loss) $ 2,215 $ (4,902) $ 7,959 $ 3,349
========== ========== ========== ==========
PER SHARE DATA
Net income (loss) per common
share - basic and diluted $ 0.14 $ (0.32) $ 0.52 $ 0.22
========== ========== ========== ==========
Weighted-average number
of shares outstanding 15,358,749 15,376,416 15,358,749 15,374,535
============ ============ ============ ============
- - -----------------
<FN>
(1) The three- and six-month periods ended June 30, 1999 include a $6.0 million
pre-tax charge for a settlement in principle with the Office of the Attorney
General for the State of New York. On August 16, 1999, the Company entered into
an agreement in principle with the New York State Banking Department, New York
Office of the Attorney General and the Department of Justice, which $12 million
global settlement shall be entered into in lieu of the prior agreement. See
"Legal Proceedings" herein for a more detailed discussion of the proposed
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)
SIX MONTHS ENDED
JUNE 30,
(DOLLARS IN THOUSANDS) 1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 7,959 3,349
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan and recourse losses 50 50
Depreciation and amortization 2,742 1,953
Deferred tax benefit (746) (1,060)
Capitalized mortgage servicing rights, net of amortization (5,062) (4,025)
Deferred origination costs 232 896
Interest-only and residual certificates received in
Securitization transactions, net (12,450) (16,129)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (4,727) 5,542
Decrease (increase) in loans held for sale, net 1,519 (3,544)
Increase in accrued interest and late charges receivable (7,426) (8,248)
Increase in cash held for advance payments (2,142) (2,210)
Decrease (increase) in prepaid and other assets 659 (248)
Increase in accounts payable and accrued expenses 9,575 62
Increase in investor payable 13,038 10,576
Increase in advance payments by borrowers for taxes and insurance 2,249 2,184
--------- ---------
Net cash provided by (used in) operating activities 5,470 (10,852)
--------- ---------
Cash flows from investing activities:
Purchase of equipment (4,905) (4,584)
--------- ---------
Net cash used in investing activities (4,905) (4,584)
--------- ---------
Cash flows from financing activities:
Proceeds from warehouse financing and other borrowings, net 12,019 22,030
Decrease in bank payable, net (23) (1,358)
Purchase of treasury stock --- (269)
Proceeds from exercise of stock options --- 25
--------- ---------
Net cash provided by financing activities 11,996 20,428
--------- ---------
Net increase in cash and interest-bearing deposits 12,561 4,992
Cash and interest-bearing deposits at beginning of period 49,152 32,858
--------- ---------
Cash and interest-bearing deposits at end of period $ 61,713 37,850
========= =========
Supplemental Information:
Cash paid during the period for:
Interest $ 11,717 14,513
========= =========
Income taxes $ 5,921 2,799
========= =========
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
six month periods ended June 30, 1999 are not necessarily indicative of the
results that will be expected for the entire year.
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
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
(DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
- - ------------------------------------------------------------------------------------------
Net income $2,215 $(4,902) $7,959 $3,349
Weighted-average shares - basic 15,358,749 15,376,416 15,358,749 15,374,535
Basic EPS $0.14 $(0.32) $0.52 $0.22
Weighted-average shares - basic 15,358,749 15,376,416 15,358,749 15,374,535
Incremental shares-options 36,942 143,616 24,619 51,656
- - ------------------------------------------------------------------------------------------
Weighted-average shares - diluted 15,395,691 15,520,032 15,383,368 15,426,191
Diluted EPS $0.14 $(0.32) $0.52 $0.22
</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.
During the six months ended June 30, 1999, the Company did not repurchase any
shares of its common stock under its stock repurchase plan. At June 30, 1999,
the total number of treasury shares held by the Company equaled 116,800. Given
the 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.
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 and typically have
substantial equity in their homes.
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.
7
For the three months ended June 30, 1999, the Company originated and
purchased $414 million of loans, a decrease of 8% from $450 million of loans
originated and purchased in the comparable period in 1998. Of these amounts,
approximately $257 million were originated through its network of brokers, $65
million were purchased from its network of correspondents and $92 million were
originated through its retail network for the three months ended June 30, 1999
compared to $199 million, $199 million and $52 million, respectively, for the
same period in 1998. The decrease in year-over-year loan originations is 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. As a result of this change in strategy, coupled with the timing
of the cash flows received from the Company's retained interest-only and
residual certificates and the sale of its interest-only strips, the Company has
been able to achieve positive operating cash flows for the past three quarters.
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 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.
8
<PAGE>
THREE MONTHS ENDED
--------------------------------
(DOLLARS IN THOUSANDS) JUNE 30, MARCH 31,
1999 1999
-------------- --------------
Total Outstanding Principal Balance
(at period end).............................. $ 3,358,818 $ 3,156,232
Average Outstanding(1)......................... 3,288,247 3,085,118
DELINQUENCY (at period end) 30-59 Days:
Principal Balance............................ $ 155,321 $ 136,549
Percent of Delinquency(2).................... 4.62% 4.33%
60-89 Days:
Principal Balance............................ $ 58,528 $ 54,511
Percent of Delinquency(2).................... 1.74% 1.73%
90 Days or More:
Principal Balance............................ $ 51,654$ 52,757
Percent of Delinquency(2).................... 1.54% 1.67%
Total Delinquencies:
Principal Balance............................ $ 265,503 $ 243,817
Percent of Delinquency(2).................... 7.90% 7.72%
FORECLOSURES
Principal Balance............................ $ 161,073 $ 154,629
Percent of Foreclosures by Dollar(2)......... 4.80% 4.90%
REO (at period end)............................ $ 27,907 $ 21,868
Percent of REO.............................. 0.83% 0.69%
Net Losses on Liquidated Loans................. $ (3,255) $ (3,038)
Percentage of Net Losses on Liquidated Loans
(based on Average Outstanding Balance)(3).... (0.40%) (0.39%)
- - ---------------
(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. 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.
As part of the global settlement (in lieu of the previously announced six
million settlement 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 the creation of a reversionary fund
(the "fund"), administered by a trustee named by the NYOAG, NY Banking
Department and/or the DOJ, financed by the grant by Delta of 525,000 shares of
Delta's common stock, valued at $9.10 per share. All proceeds raised through the
funds shall be used to pay for a variety of educational and counseling programs,
approved by the NY Banking Department, NYOAG and the DOJ.
The Company previously recorded a charge of $6 million for its original
settlement in principle with the NYOAG. This expense was included in General &
Administrative expenses in the Company's Statement of Operations for the three
and six months ended June 30, 1999.
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 Liabilites", 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 classifed 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 Mortage 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 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
10
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 June 30, 1999 and December
31, 1998.
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.
11
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1998
GENERAL
The Company's net income for the three months ended June 30, 1999 was $2.2
million, or $0.14 per share, compared to a net loss of $4.9 million, or ($0.32)
per share, for the three months ended June 30, 1998. Excluding a one-time charge
relating to the Company's original settlement in principle with the NYOAG (which
settlement has been replaced by the Company's global settlement with the NYOAG,
NY Banking Department, and the DOJ), the Company's net income for the three
months ended June 30, 1999 would have been $5.8 million, or $0.38 per share.
Comments regarding the components of net income are detailed in the following
paragraphs.
REVENUES
Total revenues for the three months ended June 30, 1999 increased by $23.7
million, or 114%, to $44.4 million from $20.7 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 $414 million of mortgage loans for the
three months ended June 30, 1999, representing 8% decrease from the $450 million
of mortgage loans originated and purchased for the three months ended June 30,
1998. The Company completed a $420 million securitization during the three
months ended June 30, 1999 compared to a $445 million securitization in the
corresponding period in 1998, representing a 6% decrease. Total loans serviced
at June 30, 1999 increased 41% to $3.36 billion from $2.39 billion at June 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 for each period and the market value
of the interest-only certificates sold in connection with each securitization,
(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.
Net gain on sale of mortgage loans for the three months ended June 30, 1999
decreased by $1.6 million, or 7%, to $22.9 million from $24.5 million for the
comparable period in 1998. This decrease was primarily due to a 6% decrease in
the amount of loans securitized and wider spreads to U.S. treasuries demanded by
asset-backed investors who purchased the pass-through certificates issued by the
securitization trust in the second quarter of 1999 compared to the second
quarter of 1998. This was partially offset by both a decrease in the amount of
loans purchased through the correspondent channel and a decrease in the average
premium paid to correspondents (i.e., costs in acquiring these loans), resulting
in aggregate reduction in the amount of premiums paid to correspondents. The
weighted average net gain on sale ratio was 5.5% for the three months ended June
30, 1999 and 1998.
12
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) interest earned
on loans held for sale, and (3) interest earned on cash collection balances.
Interest income for the three months ended June 30, 1999 increased by $20.1
million to $9.7 million from ($10.4) 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"). This was partially
offset by the accounting for loans sold by the Company through a commercial
paper conduit 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 commercial paper conduit and
the commercial paper financing rate, plus administrative expenses, during the
three months ended June 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 June 30, 1999 increased by $3.0
million, or 429%, to $3.7 million from $0.7 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 44% to $3.29 billion for the three months
ended June 30, 1999 from $2.29 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 June 30,
1999 increased by $2.2 million, or 37%, to $8.1 million from $5.9 million in the
comparable period in 1998. The increase is primarily the result of (1) a 77%
increase in retail originated loans and (2) a 29% increase in broker originated
loans.
EXPENSES
Total expenses for three months ended June 30, 1999 increased by $12.1
million, or 42%, to $40.8 million from $28.7 million for the comparable period
in 1998. The increase in expenses was the result of an increase in general and
administrative primarily related to the Company's origainal settlement in
principle with the NYOAG (which settlement has been replaced by the Company's
global settlement with the NYOAG, the NY Banking Department and the DOJ), and
personnel costs associated with the Company's expanded retail and broker
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 June 30, 1999
13
increased by $4.6 million, or 35%, to $17.7 million from $13.1 million for the
comparable period in 1998. 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 and retail divisions. As of June 30, 1999, the Company
employed 1,278 full- and part-time employees, 444 of which are employees of
Fidelity Mortgage, compared to 980 full- and part-time employees as of June 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 June 30, 1999 decreased by $1.5
million, or 20%, to $6.1 million from $7.6 million for the comparable period in
1998. The decrease in interest expense was primarily due to the accounting for
loans sold through a commercial paper 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 the commercial paper conduit
and the commercial paper financing rate, plus administrative expenses, during
the three months ended June 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 5.0% in the three months ended June 30, 1999, compared to an
average interest rate of 5.7% 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 June 30,
1999 increased $9.0 million, or 114%, to $16.9 million from $7.9 million for the
comparable period in 1998. This increase was primarily attributable to (1) the
Company's original settlement with the NYOAG (which settlement has been replaced
by the Company's global settlement with the NYOAG, the NY Banking Department and
the DOJ), (2) an increase in expenses associated with the Company's increase in
retail and broker loan originations (which was offset by the de-emphasis of
correspondent purchases, resulting in a reduction in premiums paid, reflected in
the gain on sale of mortgage loans) and (3) an increase in depreciation expense
and management and consulting fees, reflecting the Company's ongoing investment
in technology.
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 provision of $1.5 million and a tax benefit of
$3.1 million for the three month periods ended June 30, 1999 and 1998,
respectively.
14
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1998
GENERAL
The Company's net income for the six months ended June 30, 1999 was $8.0
million, or $0.52 per share, compared to $3.3 million, or $0.22 per share, for
the six months ended June 30, 1998. Excluding a one-time charge relating to the
Company's original settlement in principle with the NYOAG (which settlement has
been replaced by the Company's global settlement with regulators), the Company's
net income for the six months ended June 30, 1999 would have been $11.6 million,
or $0.76 per share. Comments regarding the components of net income are detailed
in the following paragraphs.
REVENUES
Total revenues for the six months ended June 30, 1999 increased by $25.2
million, or 41%, to $87.0 million from $61.8 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 $819 million of mortgage loans for the
six months ended June 30, 1999, which represented a decrease of 2% from the $836
million of mortgage loans originated and purchased for the six months ended June
30, 1998. The Company completed two securitizations totaling $795 million during
the six months ended June 30, 1999 compared to two securitizations totaling $845
million in the corresponding period in 1998, representing a 6% decrease. Total
loans serviced at June 30, 1999 increased 41% to $3.36 billion from $2.39
billion at June 30, 1998.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans for
the six months ended June 30, 1999 decreased by $3.1 million, or 6%, to $48.0
million from $51.1 million for the comparable period in 1998. This decrease was
primarily due to a 6% decrease in the amount of loans securitized and wider
spreads demanded by asset-backed investors who purchase the pass-through
certificates issued by securitization trusts during the six months ended June
30, 1999 compared to the same period in 1998. This was partially offset by both
a decrease in the amount of loans purchased through the correspondent channel
and the reduced costs in acquiring these loans, resulting in aggregate reduction
in the amount of premiums paid to correspondents. The weighted average net gain
on sale ratio was 6.0% for the six months ended June 30, 1999 and 1998.
INTEREST INCOME. Interest income for the six months ended June 30, 1999
increased by $19.8 million to $16.1 million from ($3.7) 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").
This was partially offset by the accounting for loans sold by the Company
through a commercial paper conduit 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
commercial paper conduit and the commercial paper financing rate, plus
administrative expenses, during the six months ended June 30, 1999. Typically,
interest expense
15
related to the Company's other warehouse financing and borrowings are recorded
directly to interest expense.
SERVICING FEES. Servicing fees for the six months ended June 30, 1999
increased by $4.6 million, or 164%, to $7.4 million from $2.8 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 48% to $3.19 billion
for the six months ended June 30, 1999 from $2.15 billion during the comparable
period in 1998.
ORIGINATION FEES. Origination fees for the six months ended June 30, 1999
increased by $3.8 million, or 32%, to $15.5 million from $11.7 million in the
comparable period in 1998. The increase is primarily the result of (1) a 63%
increase in retail originated loans and (2) a 35% increase in broker originated
loans.
EXPENSES
Total expenses for six months ended June 30, 1999 increased by $17.0
million, or 30%, to $73.8 million from $56.8 million for the comparable period
in 1998. The increase in expenses was the result of an increase in general and
administrative primarily related to the Company's original settlement in
principle with the NYOAG (which settlement has been replaced by the Company's
global settlement with the NYOAG, the NY Banking Department and the DOJ), and
personnel costs associated with the Company's expanded retail and broker
divisions, partially offset by a decrease in interest expense.
PAYROLL AND RELATED COSTS. Payroll and related costs for the six months ended
June 30, 1999 increased by $7.1 million, or 27%, to $33.6 million from $26.5
million for the comparable period in 1998. 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 and Fidelity Mortgage retail
division. As of June 30, 1999, the Company employed 1,278 full- and part-time
employees, 444 of which are employees of Fidelity Mortgage, compared to 980
full- and part-time employees as of June 30, 1998.
INTEREST EXPENSE. Interest expense for the six months ended June 30, 1999
decreased by $2.5 million, or 17%, to $12.2 million from $14.7 million for the
comparable period in 1998. The decrease in interest expense was primarily due to
the accounting for loans sold through a commercial paper 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 the
commercial paper conduit and the commercial paper financing rate, plus
administrative expenses, during the six months ended June 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 LIBOR. The one-month LIBOR index decreased to an average interest
rate of 5.0% in the six months ended June 30, 1999, compared to an average
interest rate of 5.7% for the comparable period in 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
for the six months ended June 30, 1999 increased $12.4 million, or 79%, to $28.0
million from $15.6 million for the comparable period in 1998. This increase was
primarily attributable to (1) the Company's original settlement with the NYOAG
(which settlement has been replaced by the Company's global settlement with the
NYOAG, the NY Banking Department and the DOJ), (2) an increase in expenses
associated with the Company's increase in retail and broker loan originations
(which was offset by the de-emphasis of correspondent purchases, resulting in a
reduction in premiums paid, reflected in the gain on sale of mortgage loans) and
(3) 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 $5.2 million and
$1.7 million for the periods ended June 30, 1999 and 1998, respectively.
FINANCIAL CONDITION
JUNE 30, 1999 COMPARED TO DECEMBER 31, 1998
Cash and interest-bearing deposits increased $12.5 million, or 25%, to $61.7
million at June 30, 1999, from $49.2 million at December 31, 1998. The increase
was the result of additional monies held in securitization trust accounts by the
Company, acting as servicer for its ongoing securitization program and the cash
received by the Company from generating positive cash flow from operations.
Accounts receivable increased $4.7 million, or 21%, to $27.3 million at June
30, 1999, from $22.6 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 14% to $3.36 billion as
of June 30, 1999 from $2.95 billion as of December 31, 1998.
Loans held for sale, net decreased $1.8 million, or 2%, to $85.4 million at
June 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 during the six months ended June 30, 1999.
Accrued interest and late charges receivable increased $7.4 million, or 16%,
to $54.3 million at June 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 $5.1 million, or 15%, to
$38.6 million at June 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 six months ended June 30,
1999, partially offset by the amortization of capitalized mortgage servicing
rights.
Interest-only and residual certificates increased $12.5 million, or 6%, to
$216.3 million at June 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 $28.1 million from its securitizations
during the six months ended June 30, 1999, partially offset by normal
amortization due to cash distributions and fair value adjustments.
Equipment, net, increased $2.8 million, or 16%, to $19.8 million at June 30,
1999, from $17.0 million at December 31, 1998. The increase was primarily due to
capital expenditures related to new technology and expansion.
17
Cash held for advance payments increased $2.2 million, or 22%, to $12.2
million at June 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 $12.0 million, or 15%, to
$92.3 million at June 30, 1999, from $80.3 at December 31, 1998. This increase
was primarily attributable to the operating cash deficit and to a lesser extent,
the funding of the company's investment in technology.
The aggregate principal balance of the Senior Notes totaled $149.4 million at
June 30, 1999 and 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 $9.6 million, or 46%, to
$30.6 million at June 30, 1999, from $21.0 million at December 31, 1998. This
decrease was primarily attributable to the accrual of the Company's original
settlement with the NYOAG (which settlement has been replaced by the Company's
global settlement with the NYOAG, the NY Banking Department and the DOJ), in
addition to the timing of various other operating accruals.
Investor payable increased $13.0 million, or 20%, to $76.8 million at June
30, 1999, from $63.8 million at December 31, 1998. This increase was primarily
due to the 14% increase in the Company's portfolio of serviced loans to $3.36
billion at June 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 $2.2 million,
or 23%, to $11.8 million at June 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.
Stockholders' equity increased $8.0 million, or 6%, to $145.7 million at June
30, 1999, from $137.7 million at December 31, 1998. This increase is due to net
income for the six month period ending June 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
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. In recent quarters, however, the Company
has reduced its negative cash flow and achieved a positive cash flow from
operations during the last three consecutive quarters. 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 changes
in the securitization structures the Company has used 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
18
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 six months ended June 30, 1999, the Company had positive operating
cash flow of $5.5 million compared to a negative operating cash flow of $10.9
million for the comparable period in 1998. The increase in 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 increase was partially offset by 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,
NYOAG and the DOJ. 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 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 five warehouse facilities as of June 30, 1999 for
this purpose. One warehouse facility is a $200 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 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 $200 million committed commercial paper
conduit with a variable rate of interest and a maturity date of September 1999.
During the second quarter of 1999, the Company obtained two additional warehouse
facilities, which include, a warehouse facility with a $200 million committed
credit facility that has a variable rate of interest and a maturity date of
April 2000, and a warehouse facility with a $250 million committed credit
facility that has a variable rate of interest and a maturity date of April 2000.
Only the first $200 million warehouse facility had an outstanding balance as of
June 30, 1999 of $78.4 million.
19
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 June 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 six
months of 1999, no additional shares were repurchased.
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. 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.
As part of the global settlement (in lieu of the previously announced six
million settlement 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 the creation of a reversionary fund
(the "fund"), administered by a trustee named by the NYOAG, the NY Banking
Department and/or the DOJ, financed by the grant by Delta of 525,000 shares of
Delta's common stock, valued at $9.10 per share. All proceeds raised through the
funds shall be used to pay for a variety of educational and counseling programs,
approved by the NYOAG, the NY Banking Department and/or the DOJ.
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-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
20
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:
* 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 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 financial,
technological and marketing resources.
* The unanticipated expenses of assimilating newly-acquired businesses into
the
21
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 is
expected to conclude 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 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
22
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, 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 expected to be compliant and no contingency plan is in
place.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
SFAS NO. 133
In June 1998, SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities" was issued. SFAS No. 133 is effective for fiscal years that begin
after June 15, 2000, 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
23
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. Management of the Company believes the implementation
of SFAS No. 133 will not have a material impact on the Company's financial
condition or results of operations.
24
<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
25
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").
26
<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, including several class action
lawsuits set forth below. 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 operations of the Company.
* 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, the Truth in Lending Act 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 the 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 the amended complaint. In July 1999, Plaintiffs
were granted leave, on consent, to file a second amended complaint.
* In or about January 1999, the Company received notice that it had been
named in a lawsuit filed in the Court of Common Pleas in Cuyahoga County,
Ohio, alleging that Delta had violated Ohio state law and breached its
contract with Plaintiff by assessing a prepayment penalty and certain
other miscellaneous fees when Plaintiff paid off his loan. The complaint
seeks certification of two classes of plaintiffs. In March 1999, the
Company filed an answer to the complaint. In July 1999, the Company agreed
to an individual settlement with Plaintiff and the lawsuit has been
dismissed with prejudice.
* 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)
27
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 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). Delta has not yet answered the complaint.
The Company believes that it has meritorious defenses and intends to defend
each of these lawsuits, but cannot estimate with any certainty its ultimate
legal or financial liability, if any, with respect to the alleged claims.
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. 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.
As part of the global settlement (in lieu of the previously announced six
million settlement 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 the creation of a reversionary fund
(the "fund"), administered by a trustee named by the NYOAG, the NY Banking
Department and/or the DOJ, financed by the grant by Delta of 525,000 shares of
Delta's common stock, valued at $9.10 per share. All proceeds raised through the
funds shall be used to pay for a variety of educational and counseling programs,
approved by the NY Banking Department, NYOAG and the DOJ.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None
28
ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS.
The annual meeting of stockholders was held on May 12, 1999. At the
meeting, Hugh Miller was elected as a Class III Director for a term of three
years. Sidney A. Miller, Martin D. Payson, 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 14,125,210,
while 26,985 votes were withheld.
The stockholders also voted to ratify the appointment of KPMG LLP as the
Company's independent public accountants for the fiscal year ending December 31,
1999. Votes cast in favor of this ratification were 14,140,984, while votes
cast against were 9,861 and abstentions totaled 1,350.
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 - Six Months
Ended June 30, 1999
(b) Reports on Form 8-K: None.
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: August 13, 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 - Six Months Ended June 30, 1999
<TABLE>
<CAPTION>
EXHIBIT 11.1. STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(DOLLARS IN THOUSANDS) 1999 1998 1999 1998
- - --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BASIC EARNINGS PER SHARE
Net (loss) income $ 2,215 $ (4,902) $ 7,959 $ 3,349
=========== =========== =========== ===========
Weighted average number of common
and common equivalent shares: 15,358,749 15,376,416 15,358,749 15,374,535
Basic earnings per share $ 0.14 $ ( 0.32) $ 0.52 $ 0.22
=========== =========== =========== ===========
DILUTED EARNINGS PER SHARE
Net income $ 2,215 $ (4,902) $ 7,959 $ 3,349
=========== =========== =========== ===========
Weighted average number of common
and common equivalent shares:
---------------------------------
Average number of shares outstanding 15,358,749 15,376,416 15,358,749 15,374,535
Net effect of dilutive stock options
based on the treasury method 36,942 143,616 24,619 51,656
Total average shares: 15,395,691 15,520,032 15,383,368 15,426,191
=========== =========== =========== ===========
Diluted earnings per share $ 0.14 $ ( 0.32) $ 0.52 $ 0.22
=========== =========== =========== ===========
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 SIX MONTHS ENDED JUNE 30, 1999 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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 61,713
<SECURITIES> 216,253
<RECEIVABLES> 206,095
<ALLOWANCES> 540
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 29,439
<DEPRECIATION> 9,680
<TOTAL-ASSETS> 526,055
<CURRENT-LIABILITIES> 0
<BONDS> 149,429
0
0
<COMMON> 155
<OTHER-SE> 145,492
<TOTAL-LIABILITY-AND-EQUITY> 526,055
<SALES> 0
<TOTAL-REVENUES> 86,962
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 61,555
<LOSS-PROVISION> 25
<INTEREST-EXPENSE> 12,249
<INCOME-PRETAX> 13,133
<INCOME-TAX> 5,174
<INCOME-CONTINUING> 7,959
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,959
<EPS-BASIC> 0.52
<EPS-DILUTED> 0.52
</TABLE>
