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, 2000
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, 2000, 15,883,749 shares of the Registrant's common stock,
par value $.01 per share, were outstanding.
<PAGE>
INDEX TO FORM 10-Q
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets as of June 30, 2000 and
December 31, 1999................................................... 1
Consolidated Statements of Operations for the three months and
six months ended June 30, 2000 and June 30, 1999.................... 2
Consolidated Statements of Cash Flows for the six months ended
June 30, 2000 and June 30, 1999..................................... 3
Notes to Consolidated Financial Statements.......................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings...................................................23
Item 2. Changes in Securities and Use of Proceeds...........................26
Item 3. Defaults Upon Senior Securities.....................................26
Item 4. Submission of Matters to a Vote of Security Holders.................26
Item 5. Other Information...................................................26
Item 6. Exhibits and Current Reports on Form 8-K........................... 26
Signatures...................................................................27
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS (UNAUDITED)
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DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, DECEMBER 31,
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA) 2000 1999
---------- ----------
<S> <C> <C>
ASSETS
Cash and interest-bearing deposits $ 58,228 69,557
Accounts receivable 39,814 32,367
Loans held for sale, net 65,500 89,036
Accrued interest receivable 13,223 63,309
Capitalized mortgage servicing rights 42,872 45,927
Interest-only and residual certificates 238,089 224,659
Equipment, net 19,765 21,721
Prepaid and other assets 19,542 5,428
Goodwill 4,239 4,831
---------- ----------
Total assets $ 501,272 556,835
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Bank payable $ 617 1,195
Warehouse financing and other borrowings 82,582 109,019
Senior Notes 149,521 149,474
Accounts payable and accrued expenses 30,262 43,607
Investor payable 70,896 82,204
Advance payment by borrowers for taxes and insurance 14,841 13,784
Deferred tax liability 7,113 10,411
---------- ----------
Total liabilities 355,832 409,694
---------- ----------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value. Authorized 49,000,000 shares;
16,000,549 shares issued and 15,883,749 shares
outstanding at June 30, 2000 and December 31, 1999 160 160
Additional paid-in capital 99,472 99,472
Retained earnings 47,126 48,827
Treasury stock, at cost (116,800 shares) (1,318) (1,318)
---------- ----------
Total stockholders' equity 145,440 147,141
---------- ----------
Total liabilities and stockholders' equity $ 501,272 556,835
========== ==========
See accompanying notes to consolidated financial statements.
1
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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) 2000 1999 2000 1999
------- ------- ------- ------
<S> <C> <C> <C> <C>
Revenues
Net gain on sale of mortgage loans $ 11,274 $ 22,901 $ 25,928 $ 48,004
Interest 7,567 9,680 18,104 16,113
Servicing fees 3,738 3,743 7,804 7,356
Origination fees 6,365 8,125 13,053 15,489
------- ------- ------- -------
Total revenues 28,944 44,449 64,889 86,962
------- ------- ------- -------
Expenses
Payroll and related costs 15,699 17,744 31,260 33,586
Interest expense 8,528 6,077 16,331 12,249
General and administrative (1) 10,750 16,937 20,206 27,994
------- ------- ------- -------
Total expenses 34,977 40,758 67,797 73,829
------- ------- ------- -------
(Loss) income before income
tax (benefit) expense (6,033) 3,691 (2,908) 13,133
Income taxes (benefit) expense (2,506) 1,476 (1,207) 5,174
------- ------- -------- -------
Net (loss) income $ (3,527) $ 2,215 $ (1,701) $ 7,959
======= ======= ======== =======
Per share data
Net (loss) income per common
share - basic and diluted $ (0.22) $ 0.14 $ (0.11) $ 0.52
======== ======= ======== =======
Weighted-average number
of shares outstanding 15,920,869 15,358,749 15,920,869 15,358,749
-----------------
(1) The Company recorded a $6.0 million pre-tax charge in the second quarter of
1999 when it reached a settlement in principle with the NYOAG. (An additional
$6.0 million pre-tax charge was recorded in the third quarter of 1999 in
connection with the Company's final global settlement with the NYSBD and the
NYOAG, which was later joined by the U.S. Department of Justice, the Federal
Trade Commission and the U.S. Department of Housing and Urban Development. See
"Legal Proceedings" for a more detailed discussion of the settlement.
See accompanying notes to consolidated financial statements.
2
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DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
(Dollars in thousands) 2000 1999
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income $ (1,701) $ 7,959
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan and recourse losses 542 50
Depreciation and amortization 3,664 2,742
Deferred tax benefit (3,298) (746)
Capitalized mortgage servicing rights, net of amortization 3,055 (5,062)
Deferred origination costs 499 232
Interest-only and residual certificates received in
securitization transactions, net (13,430) (12,450)
Changes in operating assets and liabilities:
Increase in accounts receivable (7,447) (4,727)
Decrease in loans held for sale, net 23,033 1,519
Decrease (increase) in accrued interest receivable 50,086 (7,426)
(Increase) decrease in prepaid and other assets (14,640) 659
(Decrease) increase in accounts payable and accrued expenses (13,357) 9,575
(Decrease) increase in investor payable (11,308) 13,038
Increase in advance payments by borrowers for taxes and insurance 1,057 2,249
------- -------
Net cash provided by operating activities 16,755 7,612
------- -------
Cash flows from investing activities:
Purchase of equipment (1,069) (4,905)
------- -------
Net cash used in investing activities (1,069) (4,905)
------- -------
Cash flows from financing activities:
(Repayments) proceeds from warehouse financing and other borrowings (26,437) 12,019
Decrease in bank payable, net (578) (23)
------- -------
Net cash (used in) provided by financing activities (27,015) 11,996
------- -------
Net (decrease) increase in cash and interest-bearing deposits (11,329) 14,703
Cash and interest-bearing deposits at beginning of period 69,557 59,183
------- -------
Cash and interest-bearing deposits at end of period $ 58,228 $ 73,886
======= =======
Supplemental Information:
Cash paid during the period for:
Interest $ 15,540 $ 11,717
======= =======
Income taxes $ 2,101 $ 5,921
======= =======
See accompanying notes to consolidated financial statements.
3
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DELTA FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Delta Financial Corporation (the "Company" or "Delta") is a Delaware
corporation, which was organized in August 1996.
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 audited consolidated financial statements and related notes of the
Company for the year ended December 31, 1999. The results of operations for the
three- and six-month periods ended June 30, 2000 are not necessarily indicative
of the results that will be expected for the entire year.
All adjustments that are, in the opinion of management, considered
necessary for a fair presentation of the financial position and results of
operations for the interim periods presented have been made. Certain prior
period amounts in the financial statements have been reclassified to conform
with the current year presentation.
(2) SUMMARY OF REGULATORY SETTLEMENTS
In September 1999, the Company settled allegations by the New York State
Banking Department (the "NYSBD") and a lawsuit by the New York State Office of
the Attorney General ("NYSOAG") alleging that Delta had violated various state
and federal lending laws. The global settlement was evidenced by that certain
(a) Remediation Agreement by and between Delta Funding and the NYSBD, dated as
of September 17, 1999 and (b) Stipulated Order on Consent by and among Delta
Funding, Delta Financial and the NYOAG, dated as of September 17, 1999. As part
of the Settlement, Delta, among other things, implemented agreed upon changes to
its lending practices; will provide reduced loan payments aggregating $7.25
million to certain borrowers identified by the NYSBD; and created a fund of
approximately $4.75 million financed by the grant of 525,000 shares of Delta
Financial's common stock valued at a constant assumed priced of $9.10 per share,
which approximates book value. The proceeds of the fund will be used, for among
other things, payments to borrowers, to pay for a variety of consumer
educational and counseling programs.
In March 2000, the Company finalized an agreement with the U.S. Department of
Justice (the "DOJ"), the Federal Trade Commission (the "FTC") and the Department
of Housing and Urban
4
Development ("HUD"), to complete the global settlement it
had reached with the NYSBD and NYOAG. The Federal agreement mandates some
additional compliance efforts for Delta, but it does not require any additional
financial commitment by Delta.
(3) IMPACT OF NEW ACCOUNTING STANDARDS
In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities - an amendment of FASB
Statement No. 133." This statement amends and supersedes certain paragraphs
of SFAS No. 133. The effective date for SFAS No. 138 is for fiscal years
beginning after June 15, 2000. SFAS No. 138 and 133 apply to quarterly and
annual financial statements. The Company does not believe that there will be
a material impact on its financial condition or results of operations upon
the adoption of SFAS No. 138 and 133.
(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.
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THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -----------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT EPS DATA) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------
Net (loss) income $(3,527) $2,215 $(1,701) $7,959
Weighted-average shares - basic 15,920,869 15,358,749 15,920,869 15,358,749
Basic EPS $(0.22) $0.14 $(0.11) $0.52
Weighted-average shares - basic 15,920,869 15,358,749 15,920,869 15,358,749
Incremental shares-options --- 36,942 693 24,619
-------------------------------------------------------------------------------------------
Weighted-average shares - diluted 15,920,869 15,395,691 15,921,562 15,383,368
Diluted EPS $(0.22) $0.14 $(0.11) $0.52
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(5) SUBSEQUENT EVENTS
In July 2000, the Company decided to discontinue its correspondent operations
to focus exclusively on its less cash intensive broker and retail channels.
In July 2000, the Company also sold a domain name for $2.125 million.
In August 2000, the Company announced an agreement to restructure (the
"Debt Restructuring") its outstanding $150 million aggregate principal amount of
9 1/2% senior notes due 2004 (the "Senior Notes"). With the consent of more than
fifty percent of its Senior Note holders, a negative covenant in the Senior
Notes Indenture that prevented the Company from encumbering, or otherwise
obtaining financing against, any of its residual assets has been modified. In
consideration for the Senior Note holders' consent to modify this restriction,
the Company has agreed to offer current Senior Note holders the option of
exchanging in an exchange offering (the "Exchange Offer") their existing
securities for new senior notes (the
5
"New Notes"), to be secured by at least $165 million of the Company's
residual assets. The New Notes will have the same coupon, face amount, and
maturity date as the Senior Notes. Note holders of the New Notes will receive
ten-year warrants to buy approximately 1.6 million shares, at an initial
exercise price of $9.10 per share, subject to upward or downward adjustment in
certain circumstances. The Company expects that this Exchange Offer will be
completed by October 15, 2000. All of the other terms of the New Notes will be
substantially similar to the terms of the Senior Notes.
In August 2000, the Company also announced that it was streamlining its
operations to improve efficiencies and increase profitability by reducing its
workforce, consolidating some of its offices and reducing the compensation of
its senior management and some of its general staff.
In August 2000, the Company entered into a financing agreement with a
lender to finance approximately $17 million of its interest-only and residual
certificates in accordance with its Debt Restructuring.
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"), through its
wholly-owned subsidiaries, engages in the consumer finance business by
originating, acquiring, selling and servicing non-conforming home equity loans.
Throughout its 18 years of operating history, the Company has focused on lending
to individuals who generally have impaired or limited credit profiles or higher
debt-to-income ratios for such purposes as debt consolidation, home improvement,
mortgage refinancing or education.
Through its wholly-owned subsidiary, Delta Funding Corporation ("Delta
Funding"), the Company originates home equity loans indirectly through licensed
mortgage brokers and other real estate professionals who submit loan
applications on behalf of the borrower ("Brokered Loans") and also purchases
loans from mortgage bankers and smaller financial institutions that satisfy
Delta's underwriting guidelines ("Correspondent Loans"). However, in July 2000,
the Company decided to discontinue its correspondent operations to focus
exclusively on its less cash intensive broker and retail channels. Delta Funding
currently originates the majority of its loans in 24 states, through its network
of approximately 1,500 brokers.
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 14 retail offices located in eight states. In March
2000, the Company closed a loan production center in Georgia. In July 2000, the
Company opened a new retail origination call center to expand the Company's
existing retail operations at its office in Woodbury, New York.
6
In June 1999, the Company announced a settlement in principle with the NYOAG,
which was to provide for retrospective relief to certain borrowers in the form
of reduced monthly obligations aggregating $6 million and prospective changes to
some of the Company's lending practices. The NYOAG took issue with Delta's
lending practices, specifically which loans should and should not be made by
Delta. The settlement in principle was later expanded to include the NYSBD and
the DOJ, which had raised similar concerns relating to Delta's lending
practices. In September 1999, the Company finalized its settlements with the
NYSBD and the NYOAG, but only after the NYOAG filed suit against the Company in
August 1999, as evidenced by (1) a Remediation Agreement by and between the
Company and the NYSBD, and (2) a Stipulated Order on Consent by and among the
Company and the NYOAG.
As part of the final global settlement (in lieu of the previously announced
$6 million settlement with the NYOAG), the Company agreed to, 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
NYSBD; and create a reversionary fund ("the Fund"), administered by a trustee
named by the NYSBD, financed by the grant by Delta of 525,000 shares of Delta's
common stock, valued at an assumed constant price of $9.10 per share, which
approximates the book value of the shares. All proceeds raised through the Fund
shall be used for restitution and/or to pay for a variety of educational and
counseling programs at the discretion of the NYSBD.
The Company recorded a $6.0 million pre-tax charge in the second quarter of
1999 when it reached a settlement in principle with the NYOAG. Subsequently, an
additional $6.0 million pre-tax charge was recorded in the third quarter of 1999
when the Company reached a global settlement with the NYSBD and the NYOAG. The
Company finalized its agreement with the DOJ in March 2000. The DOJ settlement,
which parallels the NYSBD and NYOAG settlement agreements, was also signed by
the FTC and HUD. See "Legal Proceedings" for a discussion of the settlement.
For the three months ended June 30, 2000 the Company originated and purchased
$264 million of loans, a decrease of 36% over the $414 million of loans
originated and purchased in the comparable period in 1999. Of these amounts,
approximately $167 million were originated through its network of brokers, $71
million were originated through its retail network and $26 million were
purchased from its network of correspondents during the three months ended June
30, 2000 compared to $257 million, $92 million and $65 million, respectively,
for the same period in 1999. In July 2000, the Company decided to discontinue
its correspondent operations to focus exclusively on its less cash intensive
broker and retail channels.
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.
7
THREE MONTHS ENDED
--------------------------------
(Dollars in thousands) JUNE 30, MARCH 31,
2000 2000
----------- -----------
Total Outstanding Principal Balance
(at period end)...................... $ 3,816,818 $ 3,732,118
Average Outstanding(1)................. 3,792,340 3,698,545
DELINQUENCY (at period end) 30-59 Days:
Principal Balance.................... $ 208,674 $ 195,375
Percent of Delinquency(2)............ 5.47% 5.24%
60-89 Days:
Principal Balance.................... $ 103,347 $ 81,290
Percent of Delinquency(2)............ 2.71% 2.18%
90 Days or More:
Principal Balance................... $ 54,718 $ 48,619
Percent of Delinquency(2)............ 1.43% 1.30%
Total Delinquencies:
Principal Balance.................... $ 366,739 $ 325,284
Percent of Delinquency(2)............ 9.61% 8.72%
FORECLOSURES
Principal Balance.................... $ 190,059 $ 192,067
Percent of Foreclosures by Dollar(2). 4.98% 5.15%
REO (at period end)................... $ 47,098 $ 44,588
Percent of REO...................... 1.23% 1.19%
Net Losses on Liquidated Loans......... $ (6,517) $ (4,544)
Percentage of Net Losses on Liquidated Loans
(based on Average Outstanding Balance)(3) (0.69%) (0.49%)
---------------
(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.
Management believes that its loan servicing portfolio may incur higher
delinquency and loss experience for the foreseeable future as its portfolio
becomes more seasoned (aged) and is not offset as much by newer originated loans
(loan originations have been lower as compared to prior periods) which usually
carry a lower delinquency and loss experience and due to the overall decline in
its servicing portfolio due to the sale of its servicing on loans sold through a
securitization in June 2000.
FAIR VALUE ADJUSTMENTS
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.
8
The Company makes assumptions concerning prepayment rates and defaults based
upon the seasoning of its existing securitization loan portfolio. The following
table compares the prepayment assumptions used during the first six months of
2000 (the "new" assumptions), with those used during the first six months of
1999 (the "old" assumptions):
LOAN TYPE MONTH 1 SPEED PEAK SPEED
--------- ------------- ----------
NEW OLD NEW OLD
--- --- --- ---
Fixed Rate Loans 4.0% 4.8% 31% 31%
Six-Mo. LIBOR ARMs 10.0% 10.0% 50% 50%
Hybrid ARMs 4.0% 6.0% 50% 50%
In the fourth quarter of 1999, the Company lowered its prepayment speed
assumption along parts of the prepayment rate vector curve while leaving the
peak speeds intact. In addition, the Company increased its loss reserve
initially established for both fixed- and adjustable-rate loans sold to the
securitizations trusts from 2.20% to approximately 3.10% of the issuance amount
securitized.
The prepayment rate assumption was revised primarily to reflect the Company's
actual loan performance experience over the past several quarters. Management
believes that industry consolidation and a higher interest rate environment has
and will continue to deter borrowers from refinancing their mortgage loans. The
loan loss reserve assumption was revised to reflect management's belief that
slower prepayment speeds, coupled with an anticipated flat to slightly moderate
rise in home values as compared to the past few years and borrowers who had
avoided default through refinancing may be readily unable to do so because of
industry consolidation and a higher interest rate environment, may have an
adverse effect on the Company's non-performing loans.
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, 2000 and
December 31, 1999.
In the second quarter of 2000, the Company was required to take a $3.7
million valuation adjustment to its interest only and residual certificates in
accordance with SFAS 115, due to the increase in one-month LIBOR. Some of the
Company's interest only and residual certificates are backed by floating rate
securities, which are susceptible to interest rate risk associated with movement
in short-term interest rates.
The Company uses the same prepayment assumptions in estimating the fair value
of its mortgage servicing rights.
9
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1999
GENERAL
The Company's net loss for the three months ended June 30, 2000 was $3.5
million, or ($0.22) per share, compared to net income of $2.2 million, or $0.14
per share, for the three months ended June 30, 1999. 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 NYSBD,
NYOAG 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 decreased $15.5 million, or 35%, to $28.9 million for the
three months ended June 30, 2000, from $44.4 million for the comparable period
in 1999. The decrease in revenue was primarily attributable to a decrease in the
net gain recognized on the sale of mortgage loans and to a lesser extent,
decreases in interest income and origination fees.
The Company originated and purchased $264 million of mortgage loans for the
three months ended June 30, 2000, representing a 36% decrease from $414 million
of mortgage loans originated and purchased for the comparable period in 1999.
The Company securitized and sold $275 million in loans (and sold the related
servicing rights) during the three months ended June 30, 2000 compared to $420
million securitized or sold in the corresponding period in 1999, representing a
35% decrease. Total loans serviced increased 14% to $3.82 billion at June 30,
2000 from $3.36 billion at June 30, 1999.
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 interest-only and 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 the market value of
capitalized mortgage servicing rights sold in connection with each
securitization, 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 decreased $11.6 million, or 51%, to $11.3
million for the three months ended June 30, 2000, from $22.9 million for the
comparable period in 1999. This decrease was primarily due to a 35% decrease in
the amount of loans securitized or sold to $275 million in 2000, compared to
$420 million of loans securitized or sold in 1999; and a lower amount of gross
excess spread expected to be earned over the life of the loans as calculated by
the weighted average coupon on the pool of mortgage loans securitized less the
total cost of funds on the securitization. The decrease in the gross excess
spread was attributable primarily to wider spreads demanded by asset-backed
investors who purchased the pass-through certificates issued by the
securitization trust during the three months ended June 30, 2000 compared to the
corresponding period in 1999. The decrease was partially offset by lower
10
aggregate premiums paid to acquire loans, resulting from both a decrease in
amount of loans purchased through the correspondent channel and lower average
premiums paid to correspondents. The weighted average net gain on sale ratio was
4.1% for the three months ended June 30, 2000 compared to 5.5% for the
comparable period in 1999.
INTEREST INCOME. Interest income primarily represents the sum of (1) the
difference between the distributions the Company receives on its interest-only
and residual certificates and the adjustments recorded to reflect changes in the
fair value of the interest-only and residual certificates, (2) the gross
interest earned on loans held for sale (other than for loans sold into the
mortgage loan conduit, in which case it is the net interest spread), (3) with
respect to loans sold into the mortgage loan conduit, the net interest margin
earned (excess servicing) between the weighted average rate on the mortgage
loans less the conduit's variable funding rate plus administrative fees, and (4)
interest earned on cash collection balances.
Interest income decreased $2.1 million, or 22%, to $7.6 million for the
three months ended June 30, 2000, from $9.7 million for the comparable period in
1999. The decrease in interest income was primarily due to (1) a higher fair
value adjustment during the second quarter of 2000 due to an increase in one
month LIBOR (see "Fair Value Adjustment")and (2)a decreased amount of loans held
prior to securitization, reflecting lower overall loan production in the three
months ended June 30, 2000. This was partially offset by (a) a higher mortgage
coupon rate of 11.2% from 10.0% reflecting a higher economic interest rate
environment and (b) the accounting for loans sold through a mortgage loan
conduit (special purpose vehicle) prior to securitization in the second quarter
of 1999, in which the Company earns and records the net interest margin between
the interest rate earned on the pool of mortgage loans sold to the mortgage loan
conduit and the conduit financing rate, less administrative expenses.
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
reflect valuation allowances for the impairment in mortgage servicing rights and
(2) prepaid interest shortfalls.
Servicing fees remained flat at $3.7 million for both the three months ended
June 30, 2000, and June 30, 1999. Contractual servicing income increased due to
the increase in the aggregate size of the Company's servicing portfolio, but was
offset by a decrease in ancillary service fees collected. The average balance of
the mortgage loans serviced by the Company increased 15% to $3.79 billion for
the three months ended June 30, 2000 from $3.29 billion during the comparable
period in 1999.
ORIGINATION FEES. Origination fees represent fees earned on brokered and
retail originated loans. Origination fees decreased $1.7 million, or 21%, to
$6.4 million for the three months ended June 30, 2000, from $8.1 million for the
comparable period in 1999. The decrease was primarily the result of (a) a 35%
decrease in broker originated loans and (b) a 23% decrease in retail originated
loans.
11
EXPENSES
Total expenses decreased by $5.8 million, or 14%, to $35.0 million for the
three months ended June 30, 2000, from $40.8 million for the comparable period
in 1999. The decrease was primarily the result of a decrease in general and
administrative costs related to the Company's original settlement in principle
with the NYOAG in June 1999 (which settlement has been replaced by the Company's
global settlement with the NYSBD, NYOAG and the DOJ) and a decrease in personnel
costs, partially offset by an increase in interest expense.
PAYROLL AND RELATED COSTS. Payroll and related costs include salaries,
benefits and payroll taxes for all employees. Payroll and related costs
decreased by $2.0 million, or 11%, to $15.7 million for the three months ended
June 30, 2000, from $17.7 million for the comparable period in 1999. The
decrease was primarily due to a decline in staffing in the Company's broker and
retail divisions and in commissions paid to these employees, related to a
decrease in loans originated. In addition, there was a decrease in bonuses
related to executive employees. This was partially offset by an increase in
staffing related to growth in the Company's servicing portfolio, coupled with an
increase in employee fringe benefits. As of June 30, 2000, the Company employed
1,063 full- and part-time employees, compared to 1,278 full- and part-time
employees as of June 30, 1999.
INTEREST EXPENSE. Interest expense includes the borrowing costs to finance
loan originations and purchases, equipment financing and the Company's
overall operations under the Senior Notes and the Company's credit facilities.
Interest expense increased by $2.4 million, or 39%, to $8.5 million for the
three months ended June 30, 2000 from $6.1 million for the comparable period in
1999. The increase was primarily attributable to the accounting for loans sold
through a mortgage loan conduit prior to their securitization during the second
quarter of 1999, in which the Company earns and records the net interest margin
between the interest rate earned on the pool of mortgage loans sold to the
mortgage loan conduit and the conduit financing rate, less administrative
expenses. Typically, interest expense related to the Company's other warehouse
financing and borrowings are recorded directly to interest expense. The Company
did not utilize its mortgage loan conduit during the second quarter of 2000. In
addition, there was an increase in the cost of funds on the Company's credit
facilities, which were tied to one-month LIBOR. The one-month LIBOR index
increased to an average interest rate of 6.5% in the three months ended June 30,
2000, compared to an average interest rate of 5.0% for the comparable period in
1999.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of office rent, insurance, telephone, depreciation, goodwill
amortization, legal reserves and fees, license fees, 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 decreased $6.2 million, or 37%, to
$10.7 million for the three months ended June 30, 2000, from $16.9 million for
the comparable period in 1999. This decrease was primarily
attributable to the Company's original settlement in principle with the
12
NYOAG (which settlement has been replaced by the Company's global
settlement with the NYSBD, NYOAG and the DOJ).
INCOME TAXES. Income taxes are accounted for under SFAS No. 109, "Accounting
for Income Taxes." Deferred tax assets and liabilities are recognized on the
income reported in the financial statements regardless of when such taxes are
paid. These deferred taxes are measured by applying current enacted tax rates.
The Company recorded a tax benefit of $2.5 million and a tax provision of
$1.5 million for the three months ended June 30, 2000 and 1999, respectively.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1999
GENERAL
The Company's net loss for the six months ended June 30, 2000 was $1.7
million, or ($0.11) per share, compared to net income of $8.0 million, or $0.52
per share, for the six months ended June 30, 1999. 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 NYSBD,
NYOAG and the DOJ), 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 decreased $22.1 million, or 25%, to $64.9 million for the six
months ended June 30, 2000, from $87.0 million for the comparable period in
1999. The decrease in revenue was primarily attributable to a decrease in the
net gain recognized on the sale of mortgage loans and origination fees,
partially offset by an increase in interest income and servicing fees.
The Company originated and purchased $551 million of mortgage loans for the
six months ended June 30, 2000, representing a 33% decrease from $819 million of
mortgage loans originated and purchased for the comparable period in 1999. The
Company securitized and sold $565 million in loans (and sold the related
servicing rights on its second quarter $275 million securitization) during the
six months ended June 30, 2000 compared to $795 million securitized or sold in
the corresponding period in 1999, representing a 29% decrease. Total loans
serviced increased 14% to $3.82 billion at June 30, 2000 from $3.36 billion at
June 30, 1999.
NET GAIN ON SALE OF MORTGAGE LOANS. Net gain on sale of mortgage loans
decreased $22.1 million, or 46%, to $25.9 million for the six months ended June
30, 2000, from $48.0 million for the comparable period in 1999. This decrease
was primarily due to a 29% decrease in the amount of loans securitized or sold;
a revision to the Company's loan loss reserve assumption in 1999 (see "-Fair
Value Adjustments"); a change in the securitization structure which reduced the
Company's profitability (but provided better cash flow dynamics, such as selling
of the senior interest-only certificate), coupled with wider spreads demanded by
asset-backed investors who purchase the pass-through certificates issued by
securitization trusts during the six months ended June 30, 2000 compared to the
corresponding period in 1999. The decrease was partially offset by lower
aggregate premiums paid to acquire loans, resulting from both a decrease in
amount of
13
loans purchased through the correspondent channel and lower average
premiums paid to correspondents. The weighted average net gain on sale ratio was
4.6% for the six months ended June 30, 2000 compared to 6.0% for the comparable
period in 1999.
INTEREST INCOME. Interest income increased $2.0 million, or 12%, to $18.1
million for the six months ended June 30, 2000, from $16.1 million for the
comparable period in 1999. The increase in interest income was primarily due to
(1) the accounting of loans sold through a mortgage loan conduit prior to
securitization in the first six months of 1999, in which the Company earns and
records the net interest margin between the interest rate earned on the pool of
mortgage loans sold to the mortgage loan conduit and the conduit financing rate,
less administrative expenses and (2) a higher mortgage coupon rate of 11.1% from
10.1% reflecting a higher economic interest rate environment.
SERVICING FEES. Servicing fees increased $0.4 million, or 5%, to $7.8 million
for the six months ended June 30, 2000, from $7.4 million for the comparable
period in 1999. This increase was primarily due to an increase in the aggregate
size of the Company's servicing portfolio, but was offset by a decrease in
ancillary service fees collected. The average balance of the mortgage loans
serviced by the Company increased 18% to $3.75 billion for the six months ended
June 30, 2000 from $3.19 billion during the comparable period in 1999.
ORIGINATION FEES. Origination fees decreased $2.4 million, or 15%, to $13.1
million for the six months ended June 30, 2000, from $15.5 million for the
comparable period in 1999. The decrease was primarily the result of (a) a 31%
decrease in broker originated loans and (b) a 16% decrease in retail originated
loans.
EXPENSES
Total expenses decreased by $6.0 million, or 8%, to $67.8 million for the six
months ended June 30, 2000, from $73.8 million for the comparable period in
1999. The decrease was primarily the result of a decrease in general and
administrative costs related to the Company's original settlement in principle
with the NYOAG in June 1999 (which settlement has been replaced by the Company's
global settlement with the NYSBD, NYOAG and the DOJ) and a decrease in personnel
costs, partially offset by an increase in interest expense.
PAYROLL AND RELATED COSTS. Payroll and related costs decreased by $2.3
million, or 7%, to $31.3 million for the six months ended June 30, 2000, from
$33.6 million for the comparable period in 1999. The decrease was due primarily
to a decline in staffing in the Company's broker and retail divisions and in
commissions paid to these employees, related to a decrease in loans originated.
In addition, there was a decrease in bonuses related to executive employees.
This was partially offset by an increase in staffing related to growth in the
Company's servicing portfolio, coupled with an increase in employee fringe
benefits. As of June 30, 2000, the Company employed 1,063 full- and part-time
employees, compared to 1,278 full- and part-time employees as of June 30, 1999.
INTEREST EXPENSE. Interest expense increased by $4.1 million, or 34%, to
$16.3 million for the six months ended June 30, 2000 from $12.2 million for the
comparable period in 1999. The increase was primarily attributable to the
accounting for loans sold through a mortgage loan
14
conduit prior to their securitization during the six months ended June 30,
1999, in which the Company earns and records the net interest margin between the
interest rate earned on the pool of mortgage loans sold to the mortgage loan
conduit and the conduit financing rate, less administrative expenses. Typically,
interest expense related to the Company's other warehouse financing and
borrowings are recorded directly to interest expense. The Company did not
utilize its mortgage loan conduit during the six months ended June 30, 2000. In
addition, there was a increase in the cost of funds on the Company's credit
facilities, which were tied to one-month LIBOR. The one-month LIBOR index
increased to an average interest rate of 6.2% in the six months ended June 30,
2000, compared to an average interest rate of 5.0% for the comparable period in
1999.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased $7.8 million, or 28%, to $20.2 million for the six months ended June
30, 2000, from $28.0 million for the comparable period in 1999. This decrease
was primarily attributable to the Company's original settlement with the NYOAG
(which settlement has been replaced by the Company's global settlement with the
NYSBD, NYOAG and the DOJ) and higher legal-related costs and reserves during the
six months ended June 30, 1999.
INCOME TAXES. The Company recorded a tax benefit of $1.2 million and a tax
provision of $5.2 million for the six months ended June 30, 2000 and 1999,
respectively.
FINANCIAL CONDITION
JUNE 30, 2000 COMPARED TO DECEMBER 31, 1999
Cash and interest-bearing deposits decreased $11.4 million, or 16%, to $58.2
million at June 30, 2000, from $69.6 million at December 31, 1999. The decrease
was primarily the result of lower prepayments which caused a decrease in monies
held in securitization trust accounts by the Company, acting as servicer for its
ongoing securitization program.
Accounts receivable increased $7.4 million, or 23%, to $39.8 million at June
30, 2000, from $32.4 million at December 31, 1999. The increase was primarily
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, coupled with a $2.7 million receivable related to the sale
of servicing rights in conjunction with the Company's second quarter loan
securitization.
Loans held for sale, net decreased $23.5 million, or 26%, to $65.5 million at
June 30, 2000, from $89.0 million at December 31, 1999. This decrease was
primarily due to the net difference between loan originations and loans sold or
securitized during the six months ended June 30, 2000.
Accrued interest receivable decreased $50.1 million, or 79%, to $13.2 million
at June 30, 2000, from $63.3 million at December 31, 1999. This decrease was
primarily due to the sale of interest receivable assets, partially offset by an
increase in reimbursable interest advances made by the Company, acting as
servicer on its securitizations.
Capitalized mortgage servicing rights decreased $3.0 million, or 7%, to
$42.9 million at June 30, 2000, from $45.9 million at December 31, 1999. This
decrease was primarily due to the
15
amortization of the capitalized mortgage servicing rights which was not
offset in the second quarter 2000, with a new recorded capitalized mortgage
servicing rights usually associated with a securitization. The Company sold its
contractual right to service the loans on its second quarter 2000 securitization
for a cash premium.
Interest-only and residual certificates increased $13.4 million, or 6%, to
$238.1 million at June 30, 2000, from $224.7 million at December 31, 1999. This
increase is primarily attributable to the Company's receipt of residual
certificates valued and recorded at $17.8 million from loans securitized during
the six months ended June 30, 2000, partially offset by normal amortization due
to cash distributions and fair value adjustments.
Prepaid and other assets increased $14.1 million, or 261%, to $19.5 million
at June 30, 2000, from $5.4 million at December 31, 1999. This increase was
primarily attributable to the Company's investment in new affiliate companies
(qualified special purpose entities used for securitizations).
Warehouse financing and other borrowings decreased $26.4 million, or 24%, to
$82.6 million at June 30, 2000, from $109.0 at December 31, 1999. This decrease
was primarily attributable to the repayment in full of the Company's bank
syndicate working capital line in June 2000.
The aggregate principal balance of the Senior Notes totaled $149.5 million at
June 30, 2000 and December 31, 1999, 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 (See Subsequent Events, Note 5).
Accounts payable and accrued expenses decreased $13.3 million, or 31%, to
$30.3 million at June 30, 2000, from $43.6 million at December 31, 1999. The
decrease was primarily the result of timing of various operating accruals and
payables.
Investor payable decreased $11.3 million, or 14%, to $70.9 million at June
30, 2000, from $82.2 million at December 31, 1999. The decrease was primarily
the result of lower prepayments, which caused a decrease in the amount payable
to investors. 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.
Deferred tax liability decreased $3.3 million, or 32%, to $7.1 million as
June 30, 2000, from $10.4 million as December 31, 1999. This decrease is
primarily due to a tax benefit of $1.2 million and tax payments of $2.1 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company has primarily operated on a negative cash flow basis in the past
and anticipates that it will continue to have a negative operating cash flow for
the foreseeable future due primarily to lower projected aggregate cash
inflows from the Company's retained interest-only and residual certificates. The
lower projected inflows are due to expected timing differences between older
deals cash flowing less per month per deal as the mortgage pool pays down and
newer deals not yet cash flowing until initial reserve requirements are
satisfied. As initial reserve requirements on some newer deals are reached, the
Company
16
will begin to receive additional cash inflows from its retained
interest-only and residual certificates which, coupled with (a) the Company's
continued concentration on its less cash-intensive broker and retail
originations, and (b) its recent history of utilizing favorable securitization
structures that have allowed the Company to sell senior interest-only
certificates and/or mortgage servicing rights for an up front cash purchase
price, may help offset the operating cash deficit in future quarters. However,
market conditions and various other possibilities identified below under "Risk
Factors" could impact the Company's cash flows potentially resulting in a more
significant negative cash flow.
For the six months ended June 30, 2000, the Company had an operating cash
flow of $16.8 million compared to an operating cash flow of $7.6 million for the
comparable period in 1999. The increase in operating cash flow was primarily due
to the Company's sale of interest receivable assets during the six months ended
June 30, 2000, which, due to the "off-balance sheet" nature of the transactions
are classified as "operating activities." However, the majority of the proceeds
- approximately $25 million - from these interest receivable asset sales was
used to repay the Company's bank syndicate working capital line, which is
classified as a "financing activity." Excluding those proceeds that were used to
repay the working capital line from operating cash flows results in a pro forma
net operating deficit of $[8.2] million.
To a lesser extent, the increase in operating cash flow also was due to a
reduction in tax payments and the Company's de-emphasis of the correspondent
loan production channel (thereby decreasing the amount of premiums paid to
correspondents) during the six months ended June 30, 2000. This was partially
offset by a decrease in cash flows from the Company's retained interest-only and
residual certificates, a reduction in cash received on the sale of interest only
assets at the time of securitization and the Company's use of operating cash to
fund interest (delinquency) and servicing advance obligations required as
servicer for its securitization program. These interest and servicing advances
are reimbursable to the Company as the borrowers repay their obligations over
time. As such, the exact timing of these reimbursements cannot be predicted with
certainty.
Currently, the Company's primary cash requirements include the funding of (1)
loan originations pending their pooling and sale, (2) interest expense on its
Senior Notes and warehouse and other financings, (3) fees, expenses, interest
(delinquency) advances, servicing-related advances and tax payments incurred in
connection with its securitization program, and (4) 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 service
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, securitizations and general operating
expenses. In July 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 its ongoing securitization program. The Company's primary
sources of liquidity continue to be warehouse and other financing facilities,
securitizations (of mortgage loans, interest (delinquency) advances and
servicing advances) and, subject to market conditions, sales of whole loans, and
debt and equity securities. The Company also anticipates, subject to market
conditions, utilizing net interest
17
margin securitizations ("NIMS") and/or other financing against its residual
assets, following its Debt Restructuring, which was announced subsequent to June
30, 2000 and which permits the Company to now sell and/or obtain financing
against a portion of its residual and interest-only certificates.
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 June 30, 2000
for this purpose. One of the Company's facilities is a $200 million credit line
with a variable rate of interest. This credit line was renewed in June 2000.
However, the Company and the lender have not finalized all terms and as such are
still operating under the existing agreement. The Company's second warehouse
facility is a renewal of a $200 million mortgage loan conduit with a variable
rate of interest and a final maturity date of September 2000. The Company's
third warehouse facility is a $200 million credit facility that has a variable
rate of interest and a final maturity date of September 2000. There can be no
assurance that the Company will be able to renew any of these warehouse
facilities at their respective maturities.
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 continued availability of funds provided to the
Company under these agreements is subject to, among other conditions, 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, 2000.
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 2000, no additional shares were repurchased.
INTEREST RATE RISK
The Company's primary market risk exposure is interest rate risk.
Profitability may be directly affected by the level of, and fluctuation in,
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of its borrowings, which are tied
to various United States Treasury maturities, commercial paper rates and the
London Inter-Bank Offered Rate ("LIBOR"). The profitability of the Company is
likely to be adversely affected during any period of unexpected or rapid changes
in interest rates.
A substantial and sustained increase in interest rates could adversely
affect the Company's ability to purchase and originate loans. A significant
decline in interest rates could increase the level of loan prepayments thereby
decreasing the size of the Company's loan servicing portfolio. To the extent
servicing rights and interest-only and residual classes of certificates have
been capitalized on the books of the Company, higher than anticipated rates of
loan prepayments or losses could require the Company to write down the value of
such servicing rights and interest-only and residual certificates, adversely
impacting earnings. In an effort to mitigate the effect of
18
interest rate risk, the Company periodically reviews its various mortgage
products and identifies and modifies 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.
Periods of unexpected or rapid changes in interest rates, and/or other
volatility or uncertainty regarding interest rates, can also adversely affect
the Company by increasing the likelihood that asset-backed investors will demand
higher spreads than normal to offset the volatility and/or uncertainty, which
decreases the value of the residual assets received by the Company through
securitization.
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"). Fluctuating interest rates may also affect net interest income as
certain of the Company's asset-backed securities are priced off of one-month
LIBOR, but the collateral underlying such securities are comprised of mortgage
loans with either fixed interest rates or "hybrid" interest rates - fixed for
the initial 2 or 3 years, and then adjusts thereafter every six months - which
creates basis risk (See "--Fair Value Adjustments").
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. Historically, the rate paid on the
pass-through certificates generally was related to the interest rate on treasury
securities with maturities corresponding to the anticipated life of the loans.
If interest rates rise between the time the Company originates or purchases the
loans and the time the loans are sold at securitization, the excess spread
narrows, resulting in a loss in value of the loans. The Company has implemented
a strategy to protect against such losses and to reduce interest rate risk on
loans originated and purchased that have not yet been securitized through the
use of treasury rate lock contracts with various durations (which are similar to
selling a combination of United States Treasury securities), which equate to a
duration similar to the 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 hedge counterparty, will pay
the hedge loss in cash and then realize the corresponding increase in the value
of the loans as part of its net gain on sale of
19
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 hedge
counterparty, will receive the hedge gain in cash and realize the corresponding
decrease in the value of the loans through a reduction in the value of the
corresponding interest-only and residual certificates.
The Company has continued to review its hedging strategy in order to best
mitigate risk pending securitization. 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. For the six months ended June 30, 2000 and 1999, the Company
recorded a hedge loss of $0.1 million and a hedge gain of $4.1 million
respectively, which largely offset a change in the value of mortgage loans being
hedged, as part of its gain on sale of loans.
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.")
IMPACT OF NEW ACCOUNTING STANDARDS
For discussion regarding the impact of new accounting standards, refer to
Note 3 of Notes to the Consolidated Financial Statements.
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:
o Costs associated with litigation, compliance with the NYSBD Remediation
Agreement and NYOAG Stipulated Order on Consent, and rapid or unforeseen
escalation of the cost of regulatory compliance, generally including but
not limited to, adoption of new, or changes in state or federal lending
laws and regulations and the application of such laws and regulations,
licenses, environmental compliance, adoption of new, or changes in
accounting policies and practices and the application of such polices and
practices. Failure to comply with various federal, state and local
regulations, accounting policies, environmental compliance, and compliance
with the Remediation Agreement and Stipulated Order on Consent can lead to
20
loss of approved status, certain rights of rescission for mortgage loans,
class action lawsuits and administrative enforcement action against the
Company.
o 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 and interest and delinquency advances.
o 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.
o 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.
o 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.
o 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.
21
<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 when the Company originates
or purchases mortgage loans and the time when 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 reported by the Company.
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 been for the
most part 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 (increase) 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.
Changes in interest rates also could 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").
22
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Because the nature of the Company's business involves the collection of
numerous accounts, the validity of liens and compliance with various state and
federal lending laws, the Company is subject, in the normal course of business,
to numerous claims and legal proceedings. The Company's lending practices have
been the subject of several lawsuits styled as class actions and of
investigations by various regulatory agencies including the New York State
Banking Department (the "NYSBD"), the Office of the Attorney General of the
State of New York (the "NYOAG") and the United States Department of Justice (the
"DOJ"). The current status of these actions are summarized below.
o In or about November 1998, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the
Eastern District of New York. In December 1998, plaintiffs filed an
amended complaint alleging that the Company had violated the Home
Equity and Ownership Protection Act ("HOEPA"), the Truth in Lending Act
("TILA") and New York State General Business Lawss.349. The complaint
seeks (a) certification of a class of plaintiffs, (b) declaratory
judgment permitting rescission, (c) unspecified actual, statutory,
treble and punitive damages (including attorneys' fees), (d) certain
injunctive relief, and (e) declaratory judgment declaring the loan
transactions as void and unconscionable. On December 7, 1998,
plaintiff filed a motion seeking a temporary restraining order and
preliminary injunction, enjoining Delta from conducting foreclosure
sales on 11 properties. The District Court Judge ruled that in order
to consider such a motion, plaintiff must move to intervene on behalf
of these 11 borrowers. Thereafter, plaintiff moved to intervene on
behalf of 3 of these 11 borrowers and sought the injunctive relief on
their behalf. The Company opposed the motions. On December 14, 1998,
the District Court Judge granted the motion to intervene and on
December 23, 1998, the District Court Judge issued a preliminary
injunction enjoining the Company from proceeding with the foreclosure
sales of the three intervenors' properties. The Company has filed a
motion for reconsideration of the December 23, 1998 order. In January
1999, the Company filed an answer to plaintiffs' first amended
complaint. In July 1999, plaintiffs were granted leave, on consent, to
file a second amended complaint. In August 1999, plaintiffs filed a
second amended complaint that, among other things, added additional
parties but contained the same causes of action alleged in the first
amended complaint. In September 1999, the Company filed a motion to
dismiss the complaint, which was opposed by plaintiffs and, in June
2000, was denied in part and granted in part by the Court. Also in
September 1999, plaintiffs filed a motion for class certification,
which was opposed by Delta in February 2000, and is now fully briefed
and filed pending hearing. In or about October 1999, plaintiffs filed
a motion seeking an order preventing the Company, its attorneys and/or
the NYSBD from issuing notices to certain of Delta's borrowers, in
accordance with a settlement agreement entered into by and between the
Company and the NYSBD. In or about October 1999 and November 1999,
respectively, Delta and the NYSBD submitted opposition to plaintiffs'
motion. In March 2000, the Court issued an order that permits Delta to
issue an approved
23
form of the notice. The Company believes that it has meritorious
defenses and intends to defend this suit, but cannot
estimate with a ny certainty its ultimate legal or financial liability,
if any, with respect to the alleged claims.
o In or about March 1999, the Company received notice that it had been
named in a lawsuit filed in the Supreme Court of the State of New York,
New York County, alleging that Delta had improperly charged certain
borrowers processing fees. The complaint seeks (a) certification of a
class of plaintiffs, (b) an accounting, and (c) unspecified
compensatory and punitive damages (including attorneys' fees), based
upon alleged (i) unjust enrichment, (ii) fraud, and (iii) deceptive
trade practices. In April 1999, the Company filed an answer to the
complaint. In August 1999, plaintiffs filed a motion for class
certification, which the Company opposed in July 2000 and the motion is
now submitted. In September 1999, the Company filed a motion to
dismiss the complaint, which was opposed by plaintiffs, and in February
2000, the Court denied the motion to dismiss. In April 1999, the
Company filed a motion to change venue and Plaintiff's opposed the
motion. In July 1999, the Court denied the motion to change venue.
The Company appealed and in March 2000, the Appellate Court granted
Delta's appeal to change venue from New York County to Nassau County.
The Company believes that it has meritorious defenses and intends to
defend this suit, but cannot estimate with any certainty its ultimate
legal or financial liability, if any, with respect to the alleged
claims.
o In or about July 1999, the Company received notice that it had been
named in a lawsuit filed in the United States District Court for the
Western District of New York, alleging that amounts collected and
maintained by it in certain borrowers' tax and insurance escrow
accounts exceeded certain statutory (RESPA) and/or contractual (the
respective borrowers' mortgage agreements) ceilings. The complaint
seeks (a) certification of a class of plaintiffs, (b) declaratory
relief finding that the Company's practices violate applicable statutes
and/or the mortgage agreements, (c) injunctive relief, and (d)
unspecified compensatory and punitive damages (including attorneys'
fees). In October 1999, the Company filed a motion to dismiss the
complaint. In or about November 1999, the case was transferred to the
United States District Court for the Northern District of Illinois. In
February 2000, the plaintiff opposed the Company's motion to dismiss.
In March 2000, the Court granted the Company's motion to dismiss in
part, and denied it in part. The Company believes that it has
meritorious defenses and intends to defend this suit, but cannot
estimate with any certainty its ultimate legal or financial liability,
if any, with respect to the alleged claims.
o In or about August 1999, the NYOAG filed a lawsuit against the Company
alleging violations of (a) RESPA (by paying yield spread premiums), (b)
HOEPA and TILA, (c) ECOA, (d) New York Executive Lawss.296-a, and (e)
New York Executive Lawss. 63(12). In September 1999, Delta and the
NYOAG settled the lawsuit, as part of a global settlement by and among
Delta, the NYOAG and the NYSBD, evidenced by that certain (a)
Remediation Agreement by and between Delta and the NYSBD, dated as of
September 17, 1999 and (b) Stipulated Order on Consent by and among
Delta, Delta
24
Financial and the NYOAG, dated as of September 17, 1999.
As part of the Settlement, Delta will, among other things, implement
agreed upon changes to its lending practices; provide reduced loan
payments aggregating $7.25 million to certain borrowers identified by
the NYSBD; and create a fund of approximately $4.75 million to be
financed by the grant of 525,000 shares of Delta Financial's common
stock valued at a constant assumed priced of $9.10 per share, which
approximates book value. The proceeds of the fund will be used, for
among other things, to pay borrowers and for a variety of consumer
educational and counseling programs. As a result, the NYOAG lawsuit
has been dismissed as against the Company.
The Remediation Agreement and Stipulated Order on Consent supersede the
Company's previously announced settlements with the NYSBD and NYOAG. In
March 2000, the Company finalized a settlement agreement with the United
States Department of Justice, the Federal Trade Commission and the
Department of Housing and Urban Renewal, to complete the global
settlementit had reached with the NYSBD and NYOAG. The Federal agreement
mandates some additional compliance efforts for Delta, but it does not
require any additional financial commitment.
o In November 1999, the Company received notice that it had been named in
a lawsuit filed in the United States District Court for the Eastern
District of New York, seeking certification as a class action and
alleging violations of the federal securities laws in connection with
the Company's initial public offering in 1996 and its reports
subsequently filed with the Securities and Exchange Commission. The
complaint alleges that the scope of the violations alleged recently in
the consumer lawsuits and regulatory actions indicate a pervasive
pattern of action and risk that should have been more thoroughly
disclosed to investors in the Company's common stock. In May 2000, the
Court consolidated this case and several other lawsuits that
purportedly contain the same or similar allegations. The Company
believes that it has meritorious defenses and intends to defend these
suits, but has not answered yet and cannot estimate with any certainty
its ultimate legal or financial liability, if any, with respect to the
alleged claims.
o In or about April 2000, the Company received notice that it had been
named in a lawsuit filed in the Supreme Court of the State of New York,
Nassau County, alleging that the Company has improperly charged and
collected from borrowers certain fees when they paid off their mortgage
loans with Delta. The complaint seeks (a) certification of a class of
plaintiffs, (b) declaratory relief finding that the payoff statements
used include unauthorized charges and are deceptive and unfair, (c)
injunctive relief, and (d) unspecified compensatory, statutory and
punitive damages (including legal fees), based upon alleged violations
of Real Property Law 274-a, unfair and deceptive practices, money had
and received and unjust enrichment, and conversion. The Company
answered the complaint in June 2000. The Company believes that it has
meritorious defenses and intends to defend this suit, but cannot
estimate with any certainty its ultimate legal or financial liability,
if any, with respect to the alleged claims.
25
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None
ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS.
The annual meeting of stockholders was held on May 16, 2000. At the meeting,
Richard Blass and Arnold B. Pollard were elected as a Class I Directors for a
term of three years. Sidney A. Miller, Hugh Miller, Martin D. Payson and
Margaret Williams continue to serve as members of the Board of Directors.
Votes cast in favor of Mr. Blass' selection totaled 14,598,596,
while 30,340 votes were withheld.
Votes cast in favor of Mr. Pollard's selection totaled 14,598,596,
while 30,340 votes were withheld.
The stockholders also voted to ratify the appointment of KPMG LLP as the
Company's independent auditors for the fiscal year ending December 31, 2000.
Votes cast in favor of this ratification were 14,620,621, while votes cast
against were 7,365 and abstentions totaled 950.
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, 2000
(b) Reports on Form 8-K: None.
26
<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 11, 2000
By: /S/ HUGH MILLER
---------------
Hugh Miller
PRESIDENT & CHIEF
EXECUTIVE OFFICER
By: /S/ RICHARD BLASS
-----------------
Richard Blass
SENIOR VICE PRESIDENT
AND
CHIEF FINANCIAL OFFICER
27
<PAGE>
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
27.1 Financial Data Schedule - Six Months Ended June 30, 2000
