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 March 31, 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 March 31, 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
Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998..... 1
Consolidated Statements of Income for the three months
ended March 31, 1999 and March 31, 1998.................................... 2
Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and March 31, 1998.......................................... 3
Notes to Consolidated Financial Statements................................. 4
Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 8
New Accounting Pronouncements..............................................24
PART II - OTHER INFORMATION
Other Information..........................................................25
Signatures.................................................................28
<PAGE>
Part I - Financial Information
<TABLE>
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DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
(Dollars in thousands, except for share data) 1999 1998
---------- -----------
<S> <C> <C>
Assets
Cash and interest-bearing deposits $ 56,674 49,152
Accounts receivable 25,857 22,549
Loans held for sale, net 88,290 87,170
Accrued interest and late charges receivable 49,279 46,897
Capitalized mortgage servicing rights 36,011 33,490
Interest-only and residual certificates 208,641 203,803
Equipment, net 18,662 16,962
Cash held for advance payments 10,755 10,031
Prepaid and other assets 5,540 5,839
Goodwill 5,718 6,014
---------- ----------
Total assets $ 505,427 481,907
========== ==========
Liabilities and Stockholders' Equity
Liabilities:
Bank payable $ 814 1,396
Warehouse financing and other borrowings 90,472 80,273
Senior Notes 149,408 149,387
Accounts payable and accrued expenses 19,391 20,966
Investor payable 72,396 63,790
Advance payment by borrowers for taxes and insurance 10,819 9,559
Deferred tax liability 18,695 18,848
---------- ----------
Total liabilities $ 361,995 344,219
---------- ----------
Stockholders' Equity:
Common stock, $.01 par value. Authorized
49,000,000 shares; 15,475,549 shares issued
and 15,358,749 shares outstanding at
March 31, 1999 and December 31, 1998 155 155
Additional paid-in capital 94,700 94,700
Retained earnings 49,895 44,151
Treasury stock, at cost (116,800 shares
at March 31, 1999 and December 31, 1998,
respectively) (1,318) (1,318)
---------- ----------
Total stockholders' equity 143,432 137,688
---------- ----------
Total liabilities and stockholders' equity $ 505,427 481,907
========== ==========
See accompanying notes to consolidated financial statements.
1
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<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
(Dollars in thousands, except per share data) 1999 1998
-------- --------
<S> <C> <C>
Revenues:
Net gain on sale of mortgage loans $ 25,103 26,580
Interest 6,433 6,665
Servicing fees 3,613 2,160
Origination fees 7,364 5,749
-------- --------
Total revenues 42,513 41,154
-------- --------
Expenses:
Payroll and related costs 15,842 13,354
Interest expense 6,172 7,066
General and administrative 11,057 7,633
-------- --------
Total expenses 33,071 28,053
-------- --------
Income before income taxes 9,442 13,101
Provision for income taxes 3,698 4,850
-------- --------
Net income $ 5,744 8,251
======== ========
Per share data:
Net income per common
share - basic and diluted $ 0.37 0.54
======== ========
Weighted-average number
of shares outstanding 15,358,749 15,372,688
========== ==========
See accompanying notes to consolidated financial statements.
2
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
(Dollars in thousands) 1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,744 8,251
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan and recourse losses 25 25
Depreciation and amortization 1,289 928
Deferred tax (benefit) expense (153) 4,803
Capitalized mortgage servicing rights, net of amortization (2,521) (3,054)
Deferred origination costs 170 850
Interest-only and residual certificates received in
Securitization transactions, net (4,838) (18,273)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (3,308) 6,520
(Increase) decrease in loans held for sale, net (1,298) 7,008
Increase in accrued interest and late charges receivable (2,382) (3,411)
Increase in cash held for advance payments (724) (1,010)
Decrease in prepaid and other assets 299 377
Decrease in accounts payable and accrued expenses (1,592) (4,670)
Increase in investor payable 8,606 11,703
Increase in advance payments by borrowers for taxes and insurance 1,260 1,203
---------- ----------
Net cash provided by operating activities 577 11,250
---------- ----------
Cash flows from investing activities:
Purchase of equipment (2,672) (3,155)
---------- ----------
Net cash used in investing activities (2,672) (3,155)
---------- ----------
Cash flows from financing activities:
Proceeds from (repayments of) warehouse financing and other
borrowings, net 10,199 (640)
Decrease in bank payable, net (582) (705)
---------- ----------
Net cash provided by (used in) financing activities 9,617 (1,345)
---------- ----------
Net increase in cash and interest-bearing deposits 7,522 6,750
Cash and interest-bearing deposits at beginning of period 49,152 32,858
---------- ----------
Cash and interest-bearing deposits at end of period $ 56,674 39,608
========== ==========
Supplemental Information:
Cash paid during the period for:
Interest $ 9,518 10,626
========== ==========
Income taxes $ 3,850 118
========== ==========
See accompanying notes to consolidated financial statements.
3
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<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 months
ended March 31, 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
4
have been made. Certain prior period amounts in the financial statements have
been reclassified to conform with the current year presentation.
(3) Fair Value Adjustments
As required by SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise," at each reporting period the Company estimates the fair
value of its interest-only and residual certificates and its capitalized
mortgage servicing rights. The carrying amount of the interest-only and residual
certificates is adjusted to their current fair value. 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 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.
5
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 Description Month 1 Speed Peak Speed
- --------------------------------------------------------------------------------
New Old New Old New Old
- --------------------------------------------------------------------------------
Fixed Rate Loans 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 March 31, 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.
(4) Earnings Per Share
The following is a reconciliation of the denominators used in the
computations of basic and diluted earnings per share (EPS). The numerator for
calculating both basic and diluted EPS is net income.
6
<PAGE>
For the three months ended March 31:
(Dollars in thousands, except EPS data) 1999 1998
- --------------------------------------------------------------------------------
Net income $ 5,744 $ 8,251
Weighted-average shares - basic 15,358,749 15,372,688
Basic EPS $ 0.37 $ 0.54
Weighted-average shares - basic 15,358,749 15,372,688
Incremental shares-options 10,973 1,081
- --------------------------------------------------------------------------------
Weighted-average shares - diluted 15,369,722 15,373,769
Diluted EPS $ 0.37 $ 0.54
(5) Stock Repurchase Plan
On May 7, 1998, the Company's Board of Directors authorized a program to
repurchase up to two hundred thousand (200,000) shares of its issued and
outstanding common stock. No time limit has been placed on the duration of the
stock repurchase program. Subject to applicable securities laws, such purchases
will be 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 quarter ended March 31, 1999, the Company did not repurchase any
shares of its common stock under its stock repurchase plan. At March 31, 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 the share repurchase program and
no subsequent decision has been made to recommence repurchases.
7
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements of the Company and accompanying Notes to Consolidated
Financial Statements set forth therein.
General
Delta Financial Corporation (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.
For the three months ended March 31, 1999 the Company originated and
purchased $404 million of loans, an increase of 4% over the $387 million of
loans originated and purchased in the comparable period in 1998. Of these
amounts, approximately $236 million were originated through its network of
brokers, $91 million were purchased from its network of correspondents and $77
million were originated through its retail network during the three months ended
March 31, 1999 compared to $168 million, $167 million and $52 million,
respectively, for the same period in 1998. These originations reflect the
Company's strategy to focus on broker and retail channels, which are more
profitable and 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 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
Three Months Ended
------------------------------
(Dollars in thousands) March 31, December 31,
1999 1998
--------------- -------------
Total Outstanding Principal Balance
(at period end).............................. $ 3,156,232 $ 2,950,435
Average Outstanding(1)......................... 3,085,118 2,864,224
DELINQUENCY (at period end) 30-59 Days:
Principal Balance............................ $ 136,549 $ 153,726
Percent of Delinquency(2).................... 4.33% 5.21%
60-89 Days:
Principal Balance............................ $ 54,511 $ 50,034
Percent of Delinquency(2).................... 1.73% 1.70%
90 Days or More:
Principal Balance............................ $ 52,757 $ 47,887
Percent of Delinquency(2).................... 1.67% 1.62%
Total Delinquencies:
Principal Balance............................ $ 243,817 $ 251,647
Percent of Delinquency(2).................... 7.72% 8.53%
FORECLOSURES
Principal Balance............................ $ 154,629 $ 145,679
Percent of Foreclosures by Dollar(2)......... 4.90% 4.94%
REO (at period end)............................ $ 21,868 $ 18,811
Percent of REO.............................. 0.69% 0.64%
Net Losses on Liquidated Loans................. $ (3,038) $ (2,645)
Percentage of Net Losses on Liquidated Loans
(based on Average Outstanding Balance)(3).... (0.39%) (0.37%)
- ---------------
(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.
Securitizations
As a fundamental part of its business and financing strategy, the Company
sells the majority of its loans through securitization and derives a substantial
portion of its income therefrom. In a securitization, the Company sells a pool
of loans it has originated or purchased to a special purpose real estate
mortgage investment conduit ("REMIC") trust for a cash price. The trust, in
turn, finances the pool of loans it has acquired by issuing "pass-through
certificates," which represent undivided ownership interests in the trust. The
holders of the pass-through certificates are entitled to receive monthly
distributions of all principal received on the underlying mortgage loans and a
specified amount of interest, determined at the time of the offering of the
certificates.
When the Company sells a pool of loans to the securitization trust, the
Company receives the following economic interests in the trust: (a) the
difference between the interest payments due on the loans sold to the trust and
the interest rate paid to the holders of pass-through certificates, less the
Company's contractual servicing fee and other costs and expenses of
administering the
9
trust, the economic value of which is represented by interest-only and residual
certificates, and (b) the right to service the loans on behalf of the trust and
earn a contractual servicing fee, as well as other ancillary servicing related
fees paid by the borrowers on the underlying loans.
Upon the securitization of a pool of loans, the Company (i) recognizes in
income, as origination fees, the unamortized origination fees included in the
investment in the loans sold, and (ii) recognizes a gain on sale of loans equal
to the difference between the amount of cash received by the Company from the
trust for the pool of loans and the investment in the loans remaining after the
allocation of portions of that investment to record the value of interest-only
and residual certificates and capitalized mortgage servicing rights received by
the Company in the securitization. The majority of the net gain on sale of
mortgage loans results from, and is initially realized in the form of, the
retention of interest-only and residual certificates.
In recording and accounting for interest-only and residual certificates and
capitalized mortgage servicing rights, the Company makes estimates of rates of
prepayments and defaults on the underlying pool of loans sold to the trust, and
the value of the collateral, which it believes reasonably reflect economic and
other conditions then in effect. The actual rate of prepayments, defaults and
the value of collateral will generally differ from the estimates used, due to
subsequent changes in economic and other conditions and the implicit imprecision
of estimates, and such differences often may be material. Prepayment and default
rates higher than those estimated would adversely affect the value of both the
capitalized mortgage servicing rights (actual mortgage servicing income will be
less, and significant changes could require an impairment of the capitalized
mortgage servicing rights) and the interest-only and residual certificates, for
which changes in fair value are recorded. Conversely, prepayment and default
rates lower than those estimated would increase the servicing income earned over
the life of the loans and positively impact the value of the interest-only and
residual certificates.
The Company has sold interest-only certificates created in securitizations
for cash proceeds in each of its eight most recent quarterly securitization
transactions and intends to continue to sell the interest-only certificate as
long as the sale effectively maximizes cash flow and profitability.
Fair Value Adjustments
As required by SFAS No. 134, at each reporting period the Company estimates
the fair value of its interest-only and residual certificates and its
capitalized mortgage servicing rights. The carrying amount of the interest-only
and residual certificates is adjusted to their current fair value. 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.
10
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 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 Description Month 1 Speed Peak Speed
- --------------------------------------------------------------------------------
New Old New Old New Old
- --------------------------------------------------------------------------------
Fixed Rate Loans 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
11
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 March 31,
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.
Results of Operations
Three Months Ended March 31, 1999 Compared to the Three Months Ended March 31,
1998
General
The Company's net income for the three months ended March 31, 1999 was $5.7
million, or $0.37 per share, compared to $8.3 million, or $0.54 per share, for
the three months ended March 31, 1998. Comments regarding the components of net
income are detailed in the following paragraphs.
Revenues
Total revenues for the three months ended March 31, 1999 increased by $1.3
million, or 3%, to $42.5 million from $41.2 million for the comparable period in
1998. The increase in revenue was primarily attributable to an increase in
origination fees and servicing fees, partially offset by a decrease in the net
gain recognized on the sale of mortgage loans.
The Company originated and purchased $404 million of mortgage loans for the
three months ended March 31, 1999, representing a 4% increase from $387 million
of mortgage loans originated and purchased for the three months ended March 31,
1998. The Company completed a $375 million securitization during the three
months ended March 31, 1999 compared to a $400 million securitization in the
corresponding period in 1998, representing a 6% decrease. Total loans serviced
at March 31, 1999 increased 50% to $3.16 billion from $2.10 billion at March 31,
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.
12
Net gain on sale of mortgage loans for the three months ended March 31,
1999 decreased by $1.5 million, or 6%, to $25.1 million from $26.6 million for
the comparable period in 1998. This decrease was primarily due to a 6% decrease
in the amount of loans securitized in the first quarter of 1999 compared to the
same period in 1998, coupled with the Company's change to a more conservative
prepayment assumption used in initially valuing the residual certificates and
capitalized mortgage servicing rights acquired subsequent to the first quarter
of 1998 (see "-Fair Value Adjustments"). This was partially offset by the
Company's de-emphasis of the correspondent loan production channel, thereby
decreasing the amount of premiums paid to correspondents. The weighted average
net gain on sale ratio was 6.7% for the three months ended March 31, 1999
compared to 6.6% for the comparable period in 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) interest earned
on loans held for sale, and (3) interest earned on cash collection balances.
Interest income for the three months ended March 31, 1999 decreased by $0.3
million, or 4%, to $6.4 million from $6.7 million in the comparable period in
1998. The decrease in interest income was primarily due to (1) the accounting of
loans sold through a commercial paper conduit prior to 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 March 31, 1999, (2) a higher fair value adjustment, including
a $3.8 million reduction in the Company's value of residual and interest-only
certificates,related to an increase in its loan reserve and (3) a lower mortgage
coupon rate of 10.2% from 10.4% reflecting the Company's shift to a higher
credit quality borrower and a lower economic interest rate environment. This was
partially offset by a $1.0 million increase in accrued bond interest during the
first quarter of 1999 as compared to the first quarter of 1998, which represents
the interest payments received by the Company from a pool of loans it sold into
a securitization, upon the closing of a securitization.
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 March 31, 1999 increased by $1.4
million, or 64%, to $3.6 million from $2.2 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 54% to $3.09 billion for the three months ended March 31,
1999 from $2.01 billion during the comparable period in 1998.
Origination Fees. Origination fees represent fees earned on brokered and
retail originated loans. Origination fees for the three months ended March 31,
1999 increased by $1.7 million, or 30%, to $7.4 million from $5.7 million in the
comparable period in 1998. The increase is
13
primarily the result of (1) a 40% increase in broker originated loans and (2) a
48% increase in retail originated loans.
Expenses
Total expenses for three months ended March 31, 1999 increased by $5.0
million, or 18%, to $33.1 million from $28.1 million for the comparable period
in 1998. The increase in expenses was primarily the result of an increase in
general and administrative, 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 March 31, 1999 increased by $2.4 million, or 18%, to $15.8
million from $13.4 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 March 31, 1999, the Company employed 1,237 full-
and part-time employees, 427 of which are employees of Fidelity Mortgage,
compared to 941 full- and part-time employees as of March 31, 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 March 31, 1999 decreased by $0.9
million, or 13%, to $6.2 million from $7.1 million for the comparable period in
1998. The decrease in interest expense was primarily due to (1) the accounting
of loans sold through a commercial paper conduit prior to 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 March 31, 1999 and (2) a lower 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 March 31, 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 March 31, 1999
increased $3.5 million, or 46%, to $11.1 million from $7.6 million for the
comparable period in 1998. This increase was primarily attributable to (1) an
increase in expenses associated with the Company's increase in retail and broker
loan originations, (2) an increase in depreciation expense and management and
consulting fees, reflecting the Company's ongoing investment in technology and
(3) an increase in legal-related costs and reserves. This increase was offset by
14
the de-emphasis of correspondent purchases, resulting in a reduction in premiums
paid, reflected in the gain on sale of mortgage loans.
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 $3.7 million and $4.9 million for the
periods ended March 31, 1999 and 1998, respectively.
Financial Condition
March 31, 1999 compared to December 31, 1998
Cash and interest-bearing deposits increased $7.5 million, or 15%, to $56.7
million at March 31, 1999, from $49.2 million at December 31, 1998. The increase
was primarily the result of additional monies held in securitization trust
accounts by the Company, acting as servicer for its ongoing securitization
program.
Accounts receivable increased $3.3 million, or 15%, to $25.9 million at March
31, 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 7% to $3.16 billion as of
March 31, 1999 from $2.95 billion as of December 31, 1998.
Loans held for sale, net increased $1.1 million, or 1%, to $88.3 million at
March 31, 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 three months ended March 31, 1999.
Accrued interest and late charges receivable increased $2.4 million, or 5%,
to $49.3 million at March 31, 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 $2.5 million, or 7%, to $36.0
million at March 31, 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 $4.4 million, resulting from the
Company's completion of a securitization during the first quarter of 1999,
partially offset by the amortization of capitalized mortgage servicing rights.
Interest-only and residual certificates increased $4.8 million, or 2%, to
$208.6 million at March 31, 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 $15.1 million from the securitization in the
first quarter of 1999, partially offset by normal amortization due to cash
distributions and the fair value adjustment.
Equipment, net, increased $1.7 million, or 10%, to $18.7 million at March 31,
1999, from $17.0 million at December 31, 1998. The increase was primarily due to
capital expenditures related to new technology and expansion.
15
Cash held for advance payments increased $0.8 million, or 8%, to $10.8
million at March 31, 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 $10.2 million, or 13%, to
$90.5 million at March 31, 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
March 31, 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 decreased $1.6 million, or 8%, to $19.4
million at March 31, 1999, from $21.0 million at December 31, 1998. This
decrease was primarily attributable to the payment of interest on Senior Notes,
partially offset by the timing of various operating accruals.
Investor payable increased $8.6 million, or 13%, to $72.4 million at March
31, 1999, from $63.8 million at December 31, 1998. This increase was primarily
due to the 7% increase in the Company's portfolio of serviced loans to $3.16
billion at March 31, 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 $1.2 million,
or 13%, to $10.8 million at March 31, 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 $5.7 million, or 4%, to $143.4 million at
March 31, 1999, from $137.7 million at December 31, 1998. This increase is due
to net income for the three month period ending March 31, 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 two consecutive quarters. The Company's focus is to
maintain a neutral 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. 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 five most recent securitizations, it has successfully
16
increased the amount of senior interest-only certificates offered to investors,
compared to prior securitizations, which has also enhanced cash flow.
For the three months ended March 31, 1999 and 1998, the Company had positive
operating cash flows of $0.6 million and $11.3 million, respectively. The
decline in positive cash flow was primarily due to a one-time tax refund during
the first quarter of 1998, coupled with a tax payment during the first quarter
of 1999.
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. 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 three warehouse facilities as of March 31, 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
is a syndicated $150 million committed revolving line with a variable rate of
interest and a maturity date of June 1999. The Company's third warehouse
facility is a $200 million committed commercial paper conduit with a variable
rate of interest and a maturity date of September 1999. Subsequent to March 31,
1999, the Company obtained two additional warehouse facilities, which include,
(1) 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 (2) a
warehouse facility with a $250 million committed credit facility that has a
variable rate of interest and a maturity date of April 2000. The outstanding
balances on the $200 million, $150 million, and $200 million facilities as of
March 31, 1999 were $78.9 million, $0 million, and $0 million, respectively.
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
17
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 March 31, 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
quarter of 1999, no additional shares were repurchased.
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 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").
Hedging
The Company originates and purchases mortgage loans and then sells them
primarily through securitizations. At the time of securitization and delivery of
the loans, the Company recognizes gain on sale based on a number of factors
including the difference, or "spread," between the interest rate on the loans
and the interest rate paid to asset-backed investors who purchase pass-through
certificates issued by securitization trusts, which historically was generally
related to the interest rate on treasury securities with maturities
corresponding to the
18
anticipated life of the loans. If interest rates rise between the time the
Company originates or purchases the loans and the time the loans are sold at
securitization, the excess spread narrows, resulting in a loss in value of the
loans. The Company has implemented a strategy to protect against such losses and
to reduce interest rate risk on loans originated and purchased that have not yet
been securitized through the use of treasury rate lock contracts with various
durations (which are similar to selling a combination of United States Treasury
securities), which equate to a similar duration of the underlying loans. The
nature and quantity of hedging transactions are determined by the Company based
upon various factors including, without limitation, market conditions and the
expected volume of mortgage originations and purchases. The Company will enter
into treasury rate lock contracts through one of its warehouse lenders and/or
one of the investment bankers, which underwrite the Company's securitizations.
These contracts are designated as hedges in the Company's records and are closed
out when the associated loans are sold through securitization.
If the value of the hedges decrease, offsetting an increase in the value of
the loans, the Company, upon settlement with its counterparty, will pay the
hedge loss in cash and realize the corresponding increase in the value of the
loans as part of its net gain on sale of mortgage loans and its corresponding
interest-only and residual certificates. Conversely, if the value of the hedges
increase, offsetting a decrease in the value of the loans, the Company, upon
settlement with its counterparty, will receive the hedge gain in cash and
realize the corresponding decrease in the value of the loans through a reduction
in the value of the corresponding interest-only and residual certificates.
Up to and including the second quarter of 1998, the Company believed that its
hedging strategy of using treasury rate lock contracts was the most effective
way to manage its interest rate risk on loans prior to securitization. However,
in the third quarter of 1998, asset-backed investors, responding to lower
treasury yields and global financial market volatility, demanded substantially
wider spreads over treasuries than historically experienced for newly issued
asset-backed securities. As a result, Delta's $8.8 million hedge loss in that
quarter, resulting from lower interest rates, was not offset by a higher gain on
sale as the Company has historically seen.
Given the Company's belief that the volatile market experienced in the third
quarter would likely continue well into the fourth quarter - and, as a result,
that the amount of the spreads demanded by asset-backed securitization investors
would be difficult to predict, as asset-backed securitization investors were
more interested in absolute yields, instead of spreads over treasuries - the
Company did not hedge any of its warehoused loans pending securitization in the
fourth quarter; believing that its historical hedging strategy would continue to
be largely ineffective in such an environment.
As the asset-backed securitization market improved in the first quarter of
1999, and spreads over treasuries became largely more predictable, the Company
resumed its hedging strategy of selling treasury rate-lock contracts to mitigate
its interest rate risk pending securitization.
The Company believes that its current hedging strategy of using treasury rate
lock contracts is the most effective way to manage its interest rate risk on
loans prior to securitization, however, it will continue to review its hedging
strategy on an ongoing basis in order to best mitigate risk pending
securitization. The Company had no hedge outstanding as of March 31,
19
1999, since the Company's securitization closed on March 30, 1999.
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 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:
* 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.
* 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
20
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.
* 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 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 June 1999 with all systems year 2000 compliant.
21
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 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.
Cost 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 $0.6 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
22
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.
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. This was the case in the third quarter of 1998, when asset-backed
investors, responding to lower treasury yields and global financial market
volatility, demanded substantially wider spreads over treasuries than
historically experienced for newly issued asset-backed securities. As a result,
Delta's $8.8 million hedge loss in that quarter, resulting from lower interest
rates, was not offset by a higher gain on sale as the Company has historically
seen.
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").
23
Recently Issued Accounting Pronouncements
SFAS No. 133
In June 1998, SFAS No. 133 was issued, "Accounting for Derivative Instruments
and Hedging Activities." SFAS No. 133 is effective for fiscal years that begin
after June 15, 1999, and in general requires that entities recognize all
derivative financial instruments as assets or liabilities, measured at fair
value, and include in earnings the changes in the fair value of such assets and
liabilities. SFAS No. 133 also provides that changes in the fair value of assets
or liabilities being hedged with recognized derivative instruments be recognized
and included in earnings. 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>
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.
1. Several class-action lawsuits have been filed against a number of consumer
finance companies alleging that the compensation of mortgage brokers through the
payment of yield spread premiums violates various federal and state consumer
protection laws. The Company has been named in two such lawsuits:
a. In or about February 1998, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the
Northern District of Mississippi - Greenville Division, alleging that
the Company's compensation or mortgage brokers by means of yield spread
premiums violates the Real Estate Settlement Procedures Act ("RESPA").
The complaint seeks (i) certification of a class of plaintiffs, and
(ii) unspecified compensatory damages (including attorney's fees). On
March 31, 1998, the Company filed an answer to the complaint. On
December 1, 1998, the District Court judge denied plaintiff's motion
for class certification. Plaintiff petitioned the Fifth Circuit to
accept its interlocutory appeal and, after the Company submitted
opposition papers, Plaintiff withdrew such petition. In May 1999, the
Company agreed to an individual settlement with plaintiff, and the
lawsuit has been dismissed with prejudice.
b. In or about October 1998, the Company was served with a lawsuit filed
in the United States District Court for the Northern District of
Georgia, Atlanta Division, alleging that the Company's compensation of
mortgage brokers by means of yield spread premiums violates RESPA. The
complaint seeks (i) certification of a class of plaintiffs, and (ii)
unspecified compensatory and treble damages (including attorney's
fees). In November 1998, the Company filed an answer to the complaint
and Plaintiff filed a motion seeking class certification. In March
1999, the Company submitted its opposition to the motion for class
certification. The District Court has not yet decided the action.
2. 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
25
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.
3. 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.
4. 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 (i) certification of a class of plaintiffs, (ii) an
accounting, and (iii) unspecified compensatory and punitive damages (including
attorneys' fees), based upon alleged (a) unjust enrichment, (b) fraud, and (c)
deceptive trade practices. In April 1999, the Company filed an answer to 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.
Item 2. Changes in Securities. None
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.
26
(a) Exhibits: 11.1 Statement re: Computation of Per Share Earnings
27.1 Financial Data Schedule - Three Months Ended
March 31, 1999
(b) Reports on Form 8-K: None.
27
<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: May 14, 1999 By:/s/ HUGH MILLER
-----------------------------------
Hugh Miller
President & Chief Executive Officer
By:/s/ RICHARD BLASS
-----------------------------------
Richard Blass
Senior Vice President and
Chief Financial Officer
28
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
11.1 Statement re: Computation of Per Share Earnings.
27.1 Financial Data Schedule - Three Months Ended March 31, 1999
<TABLE>
<CAPTION>
Exhibit 11.1. Statement Re: Computation of Per Share Earnings
Three Months Ended
March 31,
(Dollars in thousands) 1999 1998
---- ----
<S> <C> <C>
Basic Earnings Per Share
Net income $ 5,744 $ 8,251
=========== ===========
Weighted average number of common
and common equivalent shares: 15,358,749 15,372,688
-------------------------------------------
Basic earnings per share $ 0.37 $ 0.54
=========== ===========
Diluted Earnings Per Share
Net income $ 5,744 $ 8,251
=========== ===========
Weighted average number of common
and common equivalent shares:
-------------------------------------------
Average number of shares outstanding 15,358,749 15,372,688
Net effect of dilutive stock options
based on treasury stock method 10,973 1,081
Total average shares: 15,369,722 15,373,769
========== ==========
Diluted earnings per share $ 0.37 $ 0.54
============ ============
</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 THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1000
<S>
<C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 56,674
<SECURITIES> 208,641
<RECEIVABLES> 199,774
<ALLOWANCES> 337
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 27,205
<DEPRECIATION> 8,543
<TOTAL-ASSETS> 505,427
<CURRENT-LIABILITIES> 0
<BONDS> 149,408
0
0
<COMMON> 155
<OTHER-SE> 143,277
<TOTAL-LIABILITY-AND-EQUITY> 505,427
<SALES> 0
<TOTAL-REVENUES> 42,513
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 26,874
<LOSS-PROVISION> 25
<INTEREST-EXPENSE> 6,172
<INCOME-PRETAX> 9,442
<INCOME-TAX> 3,698
<INCOME-CONTINUING> 5,744
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,744
<EPS-PRIMARY> 0.37
<EPS-DILUTED> 0.37
</TABLE>
