<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission File Number: 0-22474
AMERICAN BUSINESS FINANCIAL SERVICES, INC.
------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 87-0418807
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
111 Presidential Boulevard, Bala Cynwyd, PA 19004
---------------------------------------------------
(Address of principal executive offices) (Zip Code)
(610) 668-2440
---------------------------------------------------
(Registrant's telephone number including area code)
Indicate by check mark whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act 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 November 10, 2000, there were 3,323,674 shares of the registrant's Common
Stock issued and outstanding.
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I FINANCIAL INFORMATION
Item 1- Financial Information.....................................................................................1
Consolidated Balance Sheets as of September 30, 2000 and June 30, 2000.........................................1
Consolidated Statements of Income for the three months ended September 30, 2000 and 1999.......................2
Consolidated Statement of Stockholders' Equity for the three months ended September 30, 2000 .................3
Consolidated Statements of Cash Flow for the three months ended September 30, 2000 and 1999....................4
Notes to Consolidated Financial Statements.....................................................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................16
Item 3. Quantitative and Qualitative Disclosure about Market Risk..............................................53
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................................54
Item 2. Changes in Securities...................................................................................54
Item 3. Defaults Upon Senior Securities.........................................................................54
Item 4. Submission of Matters to a Vote of Security Holders.....................................................54
Item 5. Other Information.......................................................................................54
Item 6. Exhibits and Reports on Form 8-K........................................................................54
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1- Financial Information
American Business Financial Services, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollars in thousands)
<TABLE>
<CAPTION>
September 30, June 30,
2000 2000
------------- ---------
(Unaudited) (Note)
<S> <C> <C>
Assets
Cash and cash equivalents....................................... $ 68,927 $ 69,751
Loan and lease receivables, net
Available for sale........................................... 76,291 44,132
Other........................................................ 14,481 13,002
Interest-only strips............................................ 304,012 277,872
Servicing rights................................................ 82,539 74,919
Receivable for sold loans and leases............................ 15,258 51,283
Prepaid expenses................................................ 3,122 2,209
Property and equipment, net..................................... 19,020 17,756
Other assets.................................................... 44,090 41,744
-------- --------
Total assets.................................................... $627,740 $592,668
======== ========
Liabilities and Stockholders' Equity
Liabilities
Subordinated debt............................................... $417,244 $390,676
Warehouse lines and other notes payable......................... 55,010 50,842
Accounts payable and accrued expenses........................... 35,384 31,496
Deferred income taxes........................................... 23,930 22,773
Other liabilities............................................... 33,048 34,766
-------- --------
Total liabilities............................................... 564,616 530,553
-------- --------
Stockholders' Equity
Preferred stock, par value $.001, Authorized, 1,000,000
shares issued and outstanding, none.......................... -- --
Common stock, par value $.001, Authorized, 9,000,000 shares
Issued: 3,642,592 shares (including treasury
shares of 318,918).......................................... 4 4
Additional paid-in capital...................................... 24,291 24,291
Accumulated other comprehensive income.......................... 5,379 5,458
Retained earnings............................................... 37,938 36,850
Treasury stock at cost, 318,918 shares.......................... (3,888) (3,888)
-------- --------
63,724 62,715
Note receivable................................................. (600) (600)
-------- --------
Total stockholders' equity...................................... 63,124 62,115
-------- --------
Total liabilities and stockholders' equity...................... $627,740 $592,668
======== ========
</TABLE>
Note: The balance sheet at June 30, 2000 has been derived from the audited
financial statements at that date.
See accompanying notes to consolidated financial statements.
1
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Income
(amounts in thousands except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------------------------------
2000 1999
------------- --------------
<S> <C> <C>
Revenues
Gain on sale of loans and leases.............. $ 26,090 $ 19,121
Interest and fees............................. 5,238 4,759
Interest accretion on interest-only strips.... 5,598 2,750
Servicing income.............................. 1,495 1,189
Other income.................................. 2 1
--------- ---------
Total revenues................................ 38,423 27,820
--------- ---------
Expenses......................................
Interest...................................... 12,807 7,646
Provision for credit losses................... 868 141
Employee related costs........................ 6,907 1,995
Sales and marketing........................... 5,718 7,187
General and administrative.................... 9,867 4,534
--------- ---------
Total expenses................................ 36,167 21,503
--------- ---------
Income before provision for income taxes...... 2,256 6,317
Provision for income taxes.................... 902 2,527
--------- ---------
Net income.................................... $ 1,354 $ 3,790
========= =========
Earnings per common share:
Basic...................................... $ 0.41 $ 1.06
========= =========
Diluted.................................... $ 0.40 $ 1.03
========= =========
Average common shares:
Basic...................................... 3,324 3,580
========= =========
Diluted.................................... 3,379 3,685
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Equity
(amounts in thousands)
(unaudited)
<TABLE>
<CAPTION>
Common Stock
-------------------------- Accumulated
Number of Additional Other
Shares Paid-In Comprehensive Retained Treasury
Outstanding Amount Capital Income Earnings Stock
----------- --------- ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance June 30, 2000.................... 3,324 $ 4 $ 24,291 $ 5,458 $ 36,850 $ (3,888)
Comprehensive income:
Net income............................. -- -- -- -- 1,354 --
Unrealized loss on interest-only strips -- -- -- (79) -- --
----- -------- ----------- ----------- ----------- ------------
Total comprehensive income............... -- -- -- (79) 1,354 --
----- -------- ----------- ----------- ----------- ------------
Cash dividends ($0.08 per share)......... -- -- -- -- (266) --
----- -------- ----------- ----------- ----------- ------------
Balance, September 30, 2000.............. 3,324 $ 4 $ 24,291 $ 5,379 $ 37,938 $ (3,888)
===== ======== =========== =========== =========== ============
</TABLE>
[RESTUB TABLE]
<TABLE>
<CAPTION>
Total
Note Stockholders'
Receivable Equity
---------- -------------
<S> <C> <C>
Balance June 30, 2000.................... $ (600) $ 62,115
Comprehensive income:
Net income............................. -- 1,354
Unrealized loss on interest-only strips -- (79)
--------- -----------
Total comprehensive income............... -- 1,275
--------- -----------
Cash dividends ($0.08 per share)......... -- (266)
--------- -----------
Balance, September 30, 2000.............. $ (600) $ 63,124
========= ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
----------------------------------
2000 1999
--------------- ---------------
<S> <C> <C>
Cash Flow from Operating Activities:
Net income......................................................... $ 1,354 $ 3,790
Adjustments to reconcile net income to net cash
used in operating activities:
Gain on sale of loans and leases............................. (26,090) (19,121)
Depreciation and amortization................................ 6,130 4,428
Interest accretion on interest-only strips................... (5,598) (2,750)
Provision for credit losses.................................. 868 141
Accounts written off, net ................................... (561) (10)
Loans and leases originated for sale............................... (320,904) (262,737)
Proceeds from sale of loans and leases............................. 272,959 234,079
Principal payments on loans and leases............................. 1,934 1,290
Increase in accrued interest and fees on
loan and lease receivables..................................... (1,479) (1,183)
Purchase of initial overcollateralization on
securitized loans and leases................................... (2,331) (2,210)
Required purchase of additional overcollateralization on
securitized loans and leases................................... (9,649) (3,882)
Cash flow from interest-only strips................................ 17,251 8,160
Decrease in receivable for loans and leases sold................... 44,945 13,277
Increase in prepaid expenses....................................... (913) (800)
Increase in accounts payable and accrued expenses.................. 3,888 3,610
Increase in deferred income taxes.................................. 1,232 3,389
Decrease in loans in process....................................... (6,566) (3,319)
Other, net......................................................... (4,433) 4,650
------------ ------------
Net cash used in operating activities.............................. (27,963) (19,198)
------------ ------------
Cash Flows from Investing Activities:
Purchase of property and equipment, net........................ (2,714) (2,800)
Principal receipts on investments.............................. 11 6
------------ ------------
Net cash used in investing activities.............................. (2,703) (2,794)
------------ ------------
</TABLE>
4
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow (continued)
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
----------------------------------
2000 1999
--------------- -------------
<S> <C> <C>
Cash Flow from Financing Activities:
Proceeds from issuance of subordinated debt..................... $ 48,004 $ 45,249
Redemptions of subordinated debt................................ (21,436) (16,693)
Net borrowings on revolving lines of credit..................... 5,850 (1,722)
Principal payments on lease financing facility.................. (1,197) --
Principal payments on note payable, other....................... (192) (945)
Repayments of repurchase agreement.............................. (293) --
Financing costs incurred........................................ (628) (1,073)
Cash dividend paid.............................................. (266) (250)
Repurchase of treasury stock.................................... -- (591)
----------- ----------
Net cash provided by financing activities........................... 29,842 23,975
----------- ----------
Net increase in cash and cash equivalents....................... (824) 1,983
Cash and cash equivalents, beginning of period.................. 69,751 22,395
----------- ----------
Cash and cash equivalents, end of period........................ $ 68,927 $ 24,378
=========== ==========
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest...................................................... $ 8,471 $ 7,646
</TABLE>
See accompanying note to consolidated financial statements.
5
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2000
1. Basis of Financial Statement Presentation
American Business Financial Services, Inc., together with its
subsidiaries (the "Company"), is a diversified financial service
organization operating throughout the United States. The Company
originates loans through a combination of channels including a national
processing center located in the Company's centralized operating office
in Bala Cynwyd, Pennsylvania, and a retail branch network of offices.
The Company, through its principal direct and indirect subsidiaries,
originates, sells and services loans to businesses secured by real
estate and other business assets and conventional first mortgage and
home equity loans, typically to credit impaired borrowers secured by
first and second mortgages. In addition, the Company offers
subordinated debt securities to the public, the proceeds of which are
used to fund loan originations and the Company's operations.
Prior to December 31, 1999 the Company also originated equipment
leases. Effective December 31, 1999 the Company de-emphasized the
leasing origination business as a result of its strategy of focusing on
its most profitable lines of business. The Company is continuing to
service the remaining leases in its managed portfolio which totaled
$105.5 million at September 30, 2000.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission. Accordingly,
they do not include all the information and footnotes required by
generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals and the elimination of intercompany
balances) considered necessary for a fair presentation have been
included. Operating results for the three month period ended September
30, 2000 are not necessarily indicative of financial results that may
be expected for the full year ended June 30, 2001. These unaudited
consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal
year ended June 30, 2000.
Certain prior period financial statement balances have been
reclassified to conform to the current period presentation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively
referred to as derivatives), and for hedging activities. It requires
that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative
may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment (fair value hedge), (b) a hedge of the
exposure to variable cash flows of a forecasted transaction (cash flow
hedge), or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation. If a derivative is a hedge,
depending on the nature of the hedge designation, changes in the fair
value of a derivative are either offset against the change in the fair
value of assets, liabilities, or firm commitments through earnings or
recognized in other
6
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
1. Basis of Financial Statement Presentation - (Continued)
comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a derivative's change in fair value will be
recognized in earnings immediately.
SFAS No. 133 is effective on a prospective basis for all fiscal
quarters of fiscal years beginning after June 15, 2000. The adoption of
SFAS No. 133 on July 1, 2000 resulted in the cumulative effect of a
change in accounting principal of $15 thousand pre-tax being recognized
as expense in the Consolidated Statement of Income for the three months
ended September 30, 2000. Due to the immateriality of the cumulative
effect of adopting SFAS No. 133, the $15 thousand pre-tax expense is
included in general and administrative expense in the Consolidated
Statement of Income. The tax effects and earnings per share amounts
related to the cumulative effect of adopting SFAS No. 133 are not
material.
In September 2000, the Financial Accounting Standards Board ("FASB")
issued the Statement of Financial Accounting Standards No. 140
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS No. 140"). SFAS No. 140 replaces
FASB Statement No. 125, also titled "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." SFAS
No. 140 revises the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, but it carries over most of FASB Statement No. 125's
provisions without reconsideration.
SFAS No. 140 provides accounting and reporting standards for transfers
and servicing of financial assets and extinguishments of liabilities.
Those standards are based on consistent application of a
financial-components approach that focuses on control. Under that
approach, after a transfer of financial assets, an entity recognizes
the financial and servicing assets it controls and the liabilities it
has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. This
statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured
borrowings.
SFAS No. 140 is effective on a prospective basis for transfers and
servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. This statement is effective for
recognition and reclassification of collateral and for disclosures
relating to securitization transactions and collateral for fiscal years
ending after December 15, 2000. Disclosures about securitization and
collateral accepted need not be reported for periods ending on or
before December 15, 2000, for which financial statements are presented
for comparative purposes. This Statement is to be applied prospectively
with certain exceptions. Other than those exceptions, earlier or
retroactive application of its accounting provisions is not permitted.
The adoption of this standard is not expected to have a material effect
on the Company's financial condition or results of operations.
7
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
2. Loan and Lease Receivables - Available for Sale
Loan and lease receivables available for sale which are held by the
Company were as follows (in thousands):
<TABLE>
<CAPTION>
September 30, June 30,
2000 1999
------------- -----------
<S> <C> <C>
Real estate secured loans................................. $ 60,408 $ 26,589
Leases, net of unearned income of $2,173 and $2,503....... 17,479 18,832
--------- -----------
77,887 45,421
Less: Allowance for credit losses on loans and leases
available for sale..................................... 1,596 1,289
--------- -----------
$ 76,291 $ 44,132
========= ===========
</TABLE>
At September 30, 2000 and June 30, 2000, the accrual of interest was
suspended on real estate secured loans of $4.1 million and $4.3
million, respectively.
3. Interest-Only Strips
Activity for interest-only strips for the three-month periods ended
September 30, 2000 and 1999 were as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
------------------------------------
2000 1999
----------------- -----------------
<S> <C> <C>
Balance at beginning of period............................. $ 277,872 $ 178,218
Initial recognition of interest-only strips, including
initial overcollateralization of $2,331 and $2,210...... 27,545 24,508
Required purchases of additional overcollateralization..... 9,649 3,882
Interest accretion......................................... 5,598 2,750
Cash flow from interest-only strips........................ (17,251) (8,160)
Net adjustments to fair value (1).......................... 599 1,120
----------- -----------
Balance at end of period................................... $ 304,012 $ 202,318
=========== ===========
</TABLE>
(1) Net adjustments to fair value are comprised of unrealized losses of
$155 thousand, which are reported as a component of comprehensive
income, and gains related to items hedged of $754 thousand, which are
reported in the Statement of Income as an offset to the losses on the
related fair value hedge derivative financial instruments.
.
Interest-only strips include overcollateralization balances that
represent excess principal balances of loans and leases in
securitization trusts over investor interests maintained to provide
credit enhancement to investors in securitization trusts. In order to
meet the required overcollateralization levels, the trust initially
retains cash flows until overcollateralization requirements, which are
specific to each securitization, are met. At September 30, 2000, the
Company's investment in overcollateralization was $93.1 million.
8
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
4. Servicing Rights
Activity for servicing rights for the three-month periods ended
September 30, 2000 and 1999 were as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
-----------------------------
2000 1999
----------- ----------
<S> <C> <C>
Balance at beginning of period................... $ 74,919 $ 43,210
Initial recognition of servicing rights.......... 11,373 9,344
Amortization..................................... (3,753) (2,455)
--------- ---------
Balance at end of period......................... $ 82,539 $ 50,099
========= =========
</TABLE>
Servicing rights are periodically valued by the Company based on the
current estimated fair value of the mortgage servicing asset. A review
for impairment is performed by stratifying the serviced loans and
leases based on the predominant risk characteristic, which consists of
loan type. Key assumptions used in the periodic valuation of the
servicing rights are described in "Management's Discussion and Analysis
- Securitization Accounting Considerations." Impairments, if they
occurred, would be recognized in a valuation allowance for each
impaired stratum in the period of adjustment. As of September 30, 2000,
no valuation allowance for impairment was required.
5. Other Assets
Other assets were comprised of the following (in thousands):
<TABLE>
<CAPTION>
September 30, June 30,
2000 1999
------------ ----------
<S> <C> <C>
Goodwill, net of accumulated amortization of $3,469
and $3,132............................................. $ 16,129 $ 16,465
Financing costs, debt offering costs, net of accumulated
amortization of $5,956 and $5,467...................... 6,421 6,244
Due from securitization trusts for servicing related
activities............................................ 11,555 10,075
Other .................................................... 5,903 5,605
Real estate owned......................................... 2,375 1,659
Investments held to maturity.............................. 972 983
Investments available for sale (U.S. Treasury Securities). 735 713
---------- ---------
$ 44,090 $ 41,744
========== =========
</TABLE>
9
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
6. Subordinated Debt and Warehouse Lines and Other Notes Payable
Subordinated debt was comprised of the following (in thousands):
<TABLE>
<CAPTION>
September 30, June 30,
2000 2000
---------------- --------------
<S> <C> <C>
Subordinated debentures (a)............................... $ 406,028 $ 379,836
Subordinated debentures - money market notes(b)........... 11,216 10,840
----------- -----------
Total subordinated debentures............................. $ 417,244 $ 390,676
=========== ===========
</TABLE>
Warehouse lines and other notes payable were comprised of the following
(in thousands):
<TABLE>
<CAPTION>
September 30, June 30,
2000 2000
------------- -----------
<S> <C> <C>
Warehouse revolving line of credit (c).................... $ 29,071 $ 28,229
Warehouse revolving line of credit (d).................... 9,118 3,861
Warehouse revolving line of credit (e).................... -- 250
Revolving line of credit (f).............................. 5,000 5,000
Repurchase agreement (g).................................. 3,314 3,606
Lease funding facility (h)................................ 8,142 9,339
Other debt................................................ 365 557
---------- -----------
Total warehouse lines and other notes payable............. $ 55,010 $ 50,842
========== ===========
</TABLE>
(a) Subordinated debentures due October 2000 through September 2010,
interest rates ranging from 7.75% to 12.90%; subordinated to all
of the Company's senior indebtedness.
(b) Subordinated debentures-money market notes due upon demand,
interest rate at 6.15%; subordinated to all of the Company's
senior indebtedness.
(c) $150 million warehouse revolving line of credit expiring October
2000, interest rates ranging from LIBOR plus 1.375% to LIBOR
plus 2.0%, collateralized by certain loan receivables.
(d) $25 million warehouse revolving line of credit expiring December
2000, interest rates at LIBOR plus 1.75%, collateralized by
certain loan receivables.
(e) $250 million warehouse line of credit expiring September 2001,
interest rate of LIBOR plus 1.0%, collateralized by certain loan
receivables. The combination of on-balance sheet borrowings
against the warehouse facility to fund loan originations and the
amount of loans sold into the off-balance sheet conduit facility
at any point in time is limited to $250 million at September 30,
2000. The sale into the off-balance sheet conduit facility
involves a two-step transfer that qualifies for sale accounting
under SFAS No. 125. First, we sell the loans to a special
purpose entity which has been established for the limited
purpose of buying and reselling the loans. Next, the special
purpose entity sells the loans to a qualified special purpose
entity (the "facility") for cash proceeds generated by its sale
of notes to a third party purchaser. We have no obligation to
repurchase the loans and neither the third party note purchaser
nor the facility has a right to require such repurchase. The
facility has the option to re-securitize the loans, ordinarily
using longer-term certificates. If the loans are not
re-securitized by the facility, the third party note purchaser
has the right to securitize or sell the loans. Under this
arrangement, the loans have been isolated from us and our
subsidiaries, and, as a result, the transfer to the conduit
facility is treated as a sale for financial reporting purposes.
As of September 30, 2000, the Company had sold approximately
$33.3 million in principal amount of loans to the conduit
facility and recognized gains on those sales totaling
approximately $1.5 million.
10
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
6. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
(f) $5 million revolving line of credit expiring December 2000,
interest rate of LIBOR plus 2.0%, collateralized by certain
interest-only strips in securitization trusts.
(g) Repurchase agreement due October 2000, interest rate of LIBOR
plus 0.5%, collateralized by certain lease backed securities.
(h) Lease funding facility due October 2000 through December 2004,
interest rate of LIBOR plus 1.775%, collateralized by certain
lease receivables.
Under a shelf registration statement declared effective by the
Securities and Exchange Commission on October 30, 2000, we registered
$350 million of subordinated debt which is available for future
issuance. The Company's subordinated debt securities are subordinated
in right of payment to, or subordinate to, the prior payment in full of
all senior debt as defined in the indentures related to such debt,
whether outstanding on the date of the applicable indenture or incurred
following the date of the indenture. There is no limit on the amount of
senior debt the Company may incur. The Company's assets, including the
stock it holds in its subsidiaries, are available to repay the
subordinated debt in the event of default following payment to holders
of the senior debt. In the event of the Company's default and
liquidation of its subsidiaries to repay the debt holders, creditors of
the subsidiaries must be paid or provision made for their payment from
the assets of the subsidiaries before the remaining assets of the
subsidiaries can be used to repay the holders of the subordinated debt
securities.
In July 2000, the Company established a $200.0 million facility, which
provides for the sale of mortgage loans into an off-balance sheet
funding facility with UBS Warburg. The sale into the off-balance sheet
conduit facility involves a two-step transfer that qualifies for sale
accounting under SFAS No. 125. First, the Company sells the loans to a
special purpose entity which has been established for the limited
purpose of buying and reselling the loans. Next, the special purpose
entity sells the loans to a qualified special purpose entity ("the
facility") for cash proceeds generated by its sale of notes to a third
party purchaser. The Company has no obligation to repurchase the loans
except under certain conditions where loans do not conform to
representations and warranties made at the time of sale, and neither
the third party note purchaser not the sponsor has a right to require
such repurchase. The facility has the option to re-securitize the loans
within a specified period, the third party note purchaser has the right
to securitize or sell the loans. Under this arrangement, the loans have
been isolated from the Company; and, as a result, transfers to the
conduit facility will be treated as sales for financial reporting
purposes. As of September 30, 2000, the Company had sold approximately
$73.5 million in principal amount of loans to the conduit facility and
recognized gains on those sales totaling approximately $8.7 million.
7. Derivative Financial Instruments
In June 1998, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain
11
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
7. Derivative Financial Instruments (continued)
liabilities in derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging activities.
It requires that an entity recognize all derivatives as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative
may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment (fair value hedge), (b) a hedge of the
exposure to variable cash flows of a forecasted transaction (cash flow
hedge), or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation. If a derivative is a hedge,
depending on the nature of the hedge designation, changes in the fair
value of a derivative are either offset against the change in the fair
value of assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's
change in fair value will be recognized in earnings immediately.
SFAS No. 133 is effective on a prospective basis for all fiscal
quarters of fiscal years beginning after June 15, 2000. The adoption of
SFAS No. 133 on July 1, 2000 resulted in the cumulative effect of a
change in accounting principal of $15 thousand pre-tax being recognized
as expense in the Consolidated Statement of Income for the three months
ended September 30, 2000. Due to the immateriality of the cumulative
effect of adopting SFAS No. 133, the $15 thousand pre-tax expense is
included in general and administrative expense in the Consolidated
Statement of Income. The tax effects and earnings per share amounts
related to the cumulative effect of adopting SFAS No. 133 are not
material.
For the three months ended September 30, 2000, the Company recorded a
loss on the fair value of derivative financial instruments of $784
thousand which was offset by a gain of $882 thousand in the fair value
of mortgage loans, loan commitments and residual interests in mortgage
loans, resulting in a net gain of $98 thousand for the period.
The primary market risk exposure that the Company faces is interest
rate risk. Interest rate risk occurs due to potential changes in
interest rates between the date fixed rate loans are originated and the
date of securitization. The company utilizes hedging strategies to
mitigate the effect of changes in interest between the date rate
commitments on loans are made and the date the fixed rate pass-through
certificates to be issued by a securitization trust are priced, a
period typically less than 90 days.
These strategies include the utilization of derivative financial
instruments such as futures and forward pricing on securitizations. The
nature and quality of hedging transactions are determined by the
Company's management based on various factors, including market
conditions and the expected volume of mortgage loan originations and
purchases. At the time the contract is executed, derivative contracts
are specifically designated as hedges of mortgage loans, loan
commitments or of residual interests in mortgage loans in the Company's
conduit facility to be included in the next subsequent securitization.
The mortgage loans, loan commitments and mortgage loans underlying the
residual interests in the conduit facility consist of essentially
similar pools of fixed rate loans and loan commitments, collateralized
by real estate (primarily residential real estate) with similar
maturities and credit characteristics. Fixed rate pass-through
certificates issued by securitization trusts are generally priced to
yield a spread above a
12
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
7. Derivative Financial Instruments (continued)
benchmark rate based on U.S. Treasury securities or Eurodollar futures
with a three-year maturity. The Company hedges potential rate changes
in the Treasury and Eurodollar securities with futures contracts or
forward sales contracts on a similar underlying security. This has
provided strong correlation between our hedge contracts and the
ultimate pricing we have received on the subsequent securitizations.
The unrealized gain or loss derived from these derivative financial
instruments, which are designated as fair value hedges, is reported in
earnings as it occurs with an offsetting adjustment to the fair value
of the item hedged. The effectiveness of our hedges are continuously
monitored. If correlation did not exist, the related gain or loss on
the hedged item no longer would be recognized as an adjustment to
income. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Interest Rate Risk Management"
for further discussion of the Company's use of derivative financial
instruments.
Outstanding derivative contracts by category of items hedged and losses
as of September 30, 2000 are as follows (in thousands):
<TABLE>
<CAPTION>
Eurodollar Forward Treasury
Futures Contracts Sales Total
----------------- ---------------- -----------
<S> <C> <C> <C>
Loans available for sale:
Notional Amount $ 35,000 $ -- $ 35,000
Unrealized Losses (293) -- (293)
Mortgage conduit facilities:
Notional Amount 60,000 25,000 85,000
Unrealized Losses (534) (192) (726)
-------- ------- -----------
Total:
Notional Amount $ 95,000 $25,000 $ 120,000
Unrealized Losses (827) (192) (1,019)
======== ======= ===========
</TABLE>
There were no hedges of loan commitments at September 30, 2000.
13
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
8. Earnings Per Share
Following is a reconciliation of the Company's basic and diluted
earnings per share calculations (in thousands except per share data):
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-----------------------------------
2000 1999
----------------- ----------------
<S> <C> <C>
Earnings
(a) Net Income................................................... $ 1,354 $ 3,790
========== ==========
Average Common Shares
(b) Average common shares outstanding.............................. 3,324 3,580
Average potentially dilutive shares............................ 55 105
---------- ----------
(c) Average common and potentially dilutive
shares......................................................... $ 3,379 $ 3,685
========== ==========
Earnings Per Common Share
Basic (a/b)......................................................... $ 0.41 $ 1.06
========== ==========
Diluted (a/c)....................................................... $ 0.40 $ 1.03
========== ==========
</TABLE>
9. Segment Information
The Company has three operating segments: Loan Origination, Servicing,
and Treasury and Funding.
The Loan Origination segment originates business purpose loans secured
by real estate and other business assets and home equity loans
including loans to credit-impaired borrowers and conventional first
mortgage loans secured by one to four family residential real estate.
The Servicing segment services the loans and leases the Company
originates both while held by the Company and subsequent to
securitization. Servicing activities include billing and collecting
payments from borrowers, transmitting payments to investors, accounting
for principal and interest, collections and foreclosure activities and
disposing of real estate owned.
The Treasury and Funding segment administers the Company's subordinated
debt securities sales and obtains other sources of funding for the
Company's general operating and lending activities.
The All Other segment mainly represents segments that do not meet the
Statement of Financial Accounting Standards No. 131 "Disclosures about
Segments of an Enterprise and Related Information" quantitative or
defined thresholds for determining reportable segments, financial
assets not related to operating segments, unallocated overhead and
other expenses of the Company unrelated to the
14
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
September 30, 2000
9. Segment Information (continued)
reportable segments identified. Transactions between reportable
segments have been reported at cost. The accounting policies of the
reportable segments are the same as those described in the summary of
significant accounting policies.
Reconciling items represent elimination of inter-segment income and
expense items.
<TABLE>
<CAPTION>
Treasury
Three months ended September 30, 2000 Loan and Reconciling
(in thousands) Origination Funding Servicing All Other Items Consolidated
----------- -------- --------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
External revenues:
Gain on sale of loan and leases. $ 26,090 $ - $ - $ - $ - $ 26,090
Interest income................. 1,562 197 442 5,598 - 7,799
Non-interest income............. 3,028 - 5,176 - (3,670) 4,534
Inter-segment revenues............. - 12,759 - 9,919 (22,678) -
Operating expense:
Interest expense................ 5,003 11,420 166 8,977 (12,759) 12,807
Non-interest expense............ 9,463 2,823 3,419 5,834 - 21,539
Depreciation and amortization... 888 34 193 706 - 1,821
Inter-segment expense........... 13,589 - - - (13,589) -
Income tax expense................. 694 (528) 736 - - 902
-------- -------- ------- -------- -------- --------
Net income......................... $ 1,043 $ (793) $ 1,104 $ - $ - $ 1,354
======== ======== ======= ======== ======== ========
Segment assets..................... $103,169 $127,496 $87,035 $310,040 $ - $627,740
======== ======== ======= ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
Treasury
Three months ended September 30, 1999 Loan and Reconciling
(in thousands) Origination Funding Servicing All Other Items Consolidated
----------- -------- --------- -------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
External revenues:
Gain on sale of loan and leases. $ 19,121 $ - $ - $ - $ - $ 19,121
Interest income................. 1,409 241 - 3,035 - 4,685
Non-interest income............. 2,995 3,118 - (2,099) 4,014
Inter-segment revenues............. 7,450 - 2,113 (9,563) -
Operating expense:
Interest expense................ 4,729 5,556 20 4,791 (7,450) 7,646
Non-interest expense............ 9,484 1,735 1,290 97 - 12,606
Depreciation and amortization... 976 9 66 200 - 1,251
Inter-segment expense........... 4,212 - - - (4,212) -
Income tax expense................. 1,650 156 697 24 - 2,527
-------- -------- ------- -------- -------- --------
Net income......................... $ 2,474 $ 235 $ 1,045 $ 36 $ - $ 3,790
======== ======== ======= ======== ======== ========
Segment assets..................... $ 86,508 $68,948 $49,349 $225,134 $ - $429,939
======== ======== ======= ======== ======== ========
</TABLE>
15
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
PART 1. FINANCIAL INFORMATION (continued)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Our consolidated financial information set forth below should be read
in conjunction with the consolidated financial statements and the accompanying
notes to consolidated financial statements included in Item 1 of this Quarterly
Report, and the consolidated financial statements, notes to consolidated
financial statements and Management's Discussion and Analysis of Financial
Condition and Results of Operations and the risk factors contained in our Annual
Report on Form 10-K for the year ended June 30, 2000 incorporated by reference
in this Form 10-Q in their entirety.
Forward Looking Statements
Some information in this Quarterly Report on Form 10-Q may contain
forward looking statements. You can identify these statements by words or
phrases such as "will likely result," "may," "are expected to," "will continue
to," "is anticipated," "estimate," "projected," "intends to" or other similar
words. These forward-looking statements regarding our business and prospects are
based upon numerous assumptions about future conditions, which may ultimately
prove to be inaccurate. Actual events and results may materially differ from
anticipated results described in those statements. Forward-looking statements
involve risks and uncertainties which could cause our actual results to differ
materially from historical earnings and those presently anticipated. When
considering forward-looking statements, you should keep these risk factors in
mind as well as the other cautionary statements in this Form 10-Q. You should
not place undue reliance on any forward-looking statement.
General
American Business Financial Services, Inc. is a diversified financial
services company operating throughout the United States. We originate, sell and
service business purpose loans, home equity loans and conventional first
mortgage loans through our principal direct and indirect subsidiaries. We also
underwrite, process and purchase home equity loans through the Bank Alliance
Program whereby we purchase home equity loans from financial institutions that
meet our underwriting criteria but do not meet the underwriting guidelines of
the selling institutions for loans to be held in the portfolio of the selling
institutions. Following our purchase of the loans through this program, we hold
these loans as available for sale until they are sold in connection with a
future securitization. The loans are originated by the selling institution and
immediately sold to us. Loans originated primarily consist of fixed rate loans
secured by first or second mortgages on single family residences. Our customers
include credit impaired borrowers and other borrowers who would qualify for
loans from traditional sources but who are attracted to our loan products due to
our personalized service and timely response to loan applications. We originate
loans through a combination of channels including a centralized processing
center located in Bala Cynwyd, Pennsylvania and a retail branch network of 17
offices. In addition, we offer subordinated debt securities to the public, the
proceeds of which are used to repay existing debt, to fund loan originations and
our operations and for general corporate purposes.
During the first quarter of fiscal 2001, declines in market interest
rates resulted in interest rate spreads related to our securitized loans
improving approximately 0.40% from the fourth quarter of fiscal 2000. Spreads
refer to the difference between the average coupon rate on our fixed rate loans
and the weighted average pass-through rate paid to investors for interests
issued in connection with a securitization. There can be no assurances that
interest rates will continue to decline or remain at current levels. However, in
a rising interest rate environment we would expect our ability to originate
loans at interest rates that will maintain our current level of profitability
would become more difficult than during a stable or falling interest rate
environment. We address this challenge by carefully monitoring our product
pricing, the actions of our competition, market trends and the use of hedging
strategies in order to continue to originate loans in as profitable a manner as
possible. See "Interest Rate Risk Management - Loans and Leases Available for
Sale" for a discussion of our hedging stragegies.
16
<PAGE>
A rising rate environment could also unfavorably impact our liquidity
and capital resources. Rising interest rates could impact our short-term
liquidity by widening investor spread requirements in pricing future
securitizations, increasing the levels of overcollateralization in future
securitizations, limiting our access to borrowings in the capital markets and
limiting our ability to sell our subordinated debt securities at favorable
interest rates. In a rising interest rate environment, short-term and long-term
liquidity could also be impacted by increased interest costs on all sources of
borrowed funds, including the subordinated debt, and by reducing interest rate
spreads on our securitized loans which would reduce our cash flows. See
"Liquidity and Capital Resources" for a discussion of both long and short-term
liquidity.
Prior to December 31, 1999 we also originated equipment leases.
Effective December 31, 1999, we de-emphasized the leasing origination business
in keeping with our strategy of focusing on our most profitable lines of
business. We are continuing to service the remaining leases in our managed
portfolio, which totaled $105.5 million in gross receivables at September 30,
2000 and we may from time to time consider originating or purchasing new leases.
A recent focus by state and federal banking regulatory agencies, state
attorneys general offices, the Federal Trade Commission, the U.S. Department of
Justice and the U.S. Department of Housing and Urban Development relates to
predatory lending practices by companies in our industry. Sanctions have been
imposed on selected industry competitors for practices including but not limited
to charging borrowers excess fees, imposing higher interest rates than the
borrower's credit risk warrants and failing to disclose the material terms of
loans to the borrowers. We have reviewed our lending policies in light of these
actions against other lenders and we believe we are in compliance with all
lending related guidelines. To date, no sanctions or recommendations from
governmental regulatory agencies regarding our practices related to predatory
lending have been imposed. We are unable to predict whether state or federal
regulatory authorities will require changes in our lending practices in the
future or the impact of those changes on our profitability.
Securitizations
The ongoing securitization of loans is a central part of our current
business strategy. We sell loans, and have in the past sold leases, through
securitizations with servicing retained. This strategy generates the cash
proceeds to repay warehouse and line of credit facilities, to fund additional
loan originations and to provide additional sources of revenue through retained
mortgage and lease servicing rights.
17
<PAGE>
The following table summarizes the volume of loan and lease
securitizations and whole loan sales for the three months ended September 30,
2000 and 1999 (in millions):
<TABLE>
<CAPTION>
Three Months Ended
September 30,
---------------------------
Securitizations: 2000 1999
----------- -----------
<S> <C> <C>
Business loans.................................................................... $ 23.2 $ 24.2
Home equity loans................................................................. 233.6 176.7
Equipment leases.................................................................. - 9.3
------- -------
Total.......................................................................... $ 256.8 $ 210.2
======= =======
Gain on sale of loans and leases through securitization.......................... $ 26.1 $ 19.1
Securitization gains as a percentage of total revenue............................. 67.9% 68.7%
Whole loan sales.................................................................. $ 16.2 $ 23.7
Gains on whole loan sales......................................................... $ 0.4 $ 0.4
</TABLE>
Our quarterly revenues and net income may fluctuate in the future
principally as a result of the timing, size and profitability of our
securitizations. The strategy of selling loans through securitizations requires
building an inventory of loans over time, during which time we incur costs and
expenses. Since a gain on sale is not recognized until a securitization is
closed, which may not occur until a subsequent quarter, operating results for a
given quarter can fluctuate significantly. If securitizations do not close when
expected, we could experience a materially adverse effect on our results of
operations for a quarter. In addition, due to the timing difference between the
period when costs are incurred in connection with the origination of loans and
their subsequent sale through the securitization process, we have operated on a
negative cash flow basis in the past and anticipate that we will continue to do
so in the foreseeable future, which could adversely impact our results of
operations and financial condition. See "Liquidity and Capital Resources" for a
discussion of our liquidity and cash flows.
Several factors affect our ability to complete securitizations on a
profitable basis, including conditions in the securities markets generally, such
as fluctuations in interest rates described below and conditions in the
asset-backed securities markets relating to the types of financial assets we
originate and credit quality of the managed portfolio of loans. Any substantial
reduction in the size or availability of the securitization market for loans
could have a material adverse effect on our results of operations and financial
condition.
During the first quarter of fiscal 2001, declines in market interest
rates resulted in interest rate spreads related to our securitized loans
improving approximately 0.40%. Spread refers to the difference between the
average coupon rate on our fixed rate loans, and the weighted average
pass-through rate paid to investors for interests issued in connection with a
securitization. There can be no assurances that interest rates will continue to
decline or remain at current levels. However, a rising interest rate environment
would negatively impact the profitability of our future securitizations. The
profitability of our securitizations may be unfavorably impacted to the extent
we hold fixed rate mortgage loans pending securitization and market interest
rates increase prior to the securitization of those fixed rate loans. Although
the loan coupon rate is fixed at the time the loan is originated, the interest
rate paid to investors in the securitization, called the pass-through rate, is
not fixed until the pricing of the securitization which occurs just prior to the
sale of the loans. Our gain on sale of loans in a securitization will be reduced
if the spread between the average coupon rate on our fixed rate loans and the
weighted average pass-through rate paid to investors for interests issued in
connection with a securitization declines. Since our September 1998 mortgage
loan securitization, the pass-through rates on the asset-backed securities
issued in our securitizations have increased by approximately 1.2%. During this
period, the average coupon on our loans securitized has increased 0.7%. Because
the coupon on our loans securitized has been relatively high, we have been able
to absorb this net reduction in spread and have continued to access the
asset-backed securities markets. We estimate that each 0.1% reduction in the
spread reduces the gain on sale of loans as a percentage of loans securitized by
approximately 0.25%. See "Interest Rate Risk Management" for further detail. We
are continuously monitoring market rate fluctuations, our loan pricing and our
hedging strategy in order to attempt to manage these changes and maintain our
current level of profitability in connection with the securitization of loans.
18
<PAGE>
In addition, when the spread is reduced, we could be required to
increase the level of overcollateralization which is required to provide
additional protection to trust investors. An increase in the amount of
overcollateralization would negatively impact the timing of the cash flows from
the interest-only strips. See "Securitization Accounting Considerations" for a
discussion of overcollateralization amounts.
Our strategy of securitizing loans could also impact our future
profitability to the extent that the carrying value of our interest-only strips
may require negative adjustments. We generally retain interest-only strips and
servicing rights in the securitization transactions we complete. We estimate the
fair value of the interest-only strips and servicing rights based upon estimated
discount rates and prepayment and default assumptions. Together, these two
assets represent 61.6% of our total assets at September 30, 2000. The value of
our interest-only strips totaled $304.0 million and the value of our servicing
rights totaled $82.5 million at September 30, 2000. Although we believe that
these amounts represent the fair value of these assets, the amounts were
estimated based on discounting the expected cash flows to be received in
connection with our securitizations using estimated discount rates, prepayment
rates and default rate assumptions. Changes in market interest rates may impact
our discount rate assumptions and our actual prepayment and default experience
may vary materially from these estimates. Even a small unfavorable change in
these assumptions utilized could have a significant adverse impact on the value
of these assets. In the event of an unfavorable change in these assumptions, the
fair value of these assets would be overstated, requiring an adjustment which
would adversely affect our income in the period of adjustment. See "Interest
Rate Risk Management - Interest-Only Strips and Servicing Rights" for further
discussion of the impact of changes in the assumptions described above.
Our business strategy is dependent upon our ability to identify and
emphasize lending related activities that will provide us with the most economic
value. The implementation of this strategy will depend in large part on a
variety of factors outside of our control, including, but not limited to, our
ability to obtain adequate financing on favorable terms and to profitably
securitize our loans on a regular basis. Our failure with respect to any of
these factors could impair our ability to successfully implement our strategy,
which would adversely affect our results of operations and financial condition.
Whole Loan Sales
We also sell loans with servicing released referred to as whole loan
sales. Gains on whole loan sales equal the difference between the net proceeds
from such sales and the loans' net carrying value. The net carrying value of
loans is equal to their principal balance plus unamortized origination costs and
fees. Gains from these sales are recorded as fee income.
Subordinated Debt and Other Borrowings
We also rely upon funds generated by the sale of subordinated debt and
other borrowings to fund our operations and to repay subordinated debt. At
September 30, 2000, $417.2 million of subordinated debt was outstanding and
warehouse and other credit facilities totaling $633.3 million were available, of
which $153.3 million was drawn upon on that date. We expect to continue to rely
on the borrowings to fund loans prior to securitization. See "Liquidity and
Capital Resources" for a discussion of short-term and long-term liquidity.
19
<PAGE>
Securitization Accounting Considerations
When we securitize our loans and leases by selling them to trusts we
receive cash and an interest-only strip, which represents our retained interest
in the securitized loans and leases. The trust issues multi-class securities,
which derive their cash flows from the pool of securitized loans and leases.
These securities, which are senior to our interest-only strips in the trusts,
are sold to public investors. In addition, when we securitize our loans and
leases we retain the right, for a fee paid to us, to service the loans and
leases which creates an asset that we refer to as our servicing rights.
Servicing includes billing and collecting payments from borrowers, transmitting
payments to investors, accounting for principal and interest, collections and
foreclosure activities and disposing of real estate owned.
As the holder of the interest-only strips received in a securitization,
we are entitled to receive excess (or residual) cash flows. These cash flows are
the difference between the payments made by the borrowers on securitized loans
and leases and the sum of the scheduled and prepaid principal and pass-through
interest paid to the investors in the trust, servicing fees, trustee fees and,
if applicable, surety fees. Surety fees are paid to an unrelated insurance
entity to provide protection for the trust investors. Overcollateralization is
the excess of the aggregate principal balances of loans and leases in a
securitized pool over investor interests. Overcollateralization requirements are
established to provide additional protection for the trust investors.
The overcollateralization requirements for a mortgage loan
securitization, which are different for each securitization, include:
(1) The initial requirement, which is a percentage of the original
balance of loans securitized and is paid in cash at the time
of sale;
(2) The final target, which is a percentage of the original
balance of loans securitized and is funded from the monthly
excess cash flow; and
(3) The stepdown overcollateralization requirement, which is a
percentage of the remaining balance of loans securitized.
During the stepdown period, the overcollateralization amount
is gradually reduced through cash payments to us. The stepdown
period begins at the later of 30 months or when the remaining
balance of loans securitized is less than 50% of the original
balance of securitized loans.
At September 30, 2000, investments in interest-only strips in
securitizations totaled $304.0 million including investments in
overcollateralization of $93.1 million.
In March 2000, we amended our arrangements with a warehouse lender to
include an off-balance sheet mortgage loan conduit facility. The sale into the
off-balance sheet conduit facility involves a two-step transfer that qualifies
for sale accounting under SFAS No. 125. First, we sell the loans to a special
purpose entity which has been established for the limited purpose of buying and
reselling the loans. Next, the special purpose entity sells the loans to a
qualified special purpose entity (the "facility") for cash proceeds generated by
its sale of notes to a third party purchaser. We have no obligation to
repurchase the loans and neither the third party note purchaser nor the facility
has a right to require such repurchase. The facility has the option to
re-securitize the loans, ordinarily using longer-term certificates. If the loans
are not re-securitized by the facility, the third party note purchaser has the
right to securitize or sell the loans. Under this arrangement, the loans have
been isolated from us and our subsidiaries, and, as a result, the transfer to
the conduit facility is treated as a sale for financial reporting purposes. As
of September 30, 2000, there were $33.3 million in principal amount of loans in
the off-balance sheet conduit facility. The on-balance sheet facility was not
utilized.
20
<PAGE>
In July 2000, we established a $200.0 million facility, which provides
for the sale of mortgage loans into an off-balance sheet funding facility with
UBS Warburg. The sale into the off-balance sheet conduit facility involves a
two-step transfer that qualifies for sale accounting under SFAS No. 125. First,
we sell the loans to a special purpose entity which has been established for the
limited purpose of buying and reselling the loans. Next, the special purpose
entity sells the loans to a qualified special purpose entity ("the facility")
for cash proceeds generated by its sale of notes to a third party purchaser. We
have no obligation to repurchase the loans except under certain conditions where
loans do not conform to representations and warranties made by us at the time of
sale, and neither the third party note purchaser nor the sponsor has a right to
require such repurchase. The facility has the option to re-securitize the loans,
ordinarily using longer-term certificates. If the facility fails to
re-securitize the loans within a specified period, the third party note
purchaser has the right to securitize or sell the loans. Under this arrangement,
the loans have been isolated from us and our subsidiaries; and, as a result,
transfers to the conduit facility will be treated as sales for financial
reporting purposes. As of September 30, 2000, we had sold approximately $73.5
million in principal amount of loans to the conduit facility and recognized
gains on those sales totaling approximately $8.7 million.
The following table provides information regarding the nature and
principal balances of mortgage loans securitized in each trust, the securities
issued by each trust, and the overcollateralization requirements of each trust.
21
<PAGE>
Summary of Selected Mortgage Loan Securitization Trust Information
Current Balances as of September 30, 2000
($ in millions)
<TABLE>
<CAPTION>
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998-4 1998-3
------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Original balance of loans securitized:
Business loans...................................... $ 16 $ 28 $ 25 $ 25 $ 28 $ 30 $ 16 $ 9 $ 17
Home equity loans................................... 134 275 212 197 194 190 169 71 183
------ ------ ------ ------ ------ ------ ------ ------ ------
Total............................................... $150 $303 $237 $222 $222 $220 $ 185 $80 $ 200
====== ====== ====== ====== ====== ====== ====== ====== ======
Current balance of loans securitized:
Business loans...................................... $ 16 $ 27 $ 25 $ 25 $ 25 $ 26 $ 13 $ 6 $ 12
Home equity loans................................... 134 272 201 181 172 161 136 54 132
------ ------ ------ ------ ------ ------ ------ ------ ------
Total............................................... $150 $299 $226 $206 $197 $187 $ 149 $60 $144
====== ====== ====== ====== ====== ====== ====== ====== ======
Weighted average coupon on loans securitized:
Business loans...................................... 16.06% 16.01% 16.10% 16.05% 15.78% 15.77% 15.99% 16.04% 15.96%
Home equity loans................................... 11.52% 11.43% 11.37% 11.10% 10.93% 10.48% 10.66% 10.83% 10.74%
Total............................................... 12.01% 11.85% 11.88% 11.70% 11.54% 11.22% 11.14% 11.39% 11.16%
Percentage of first mortgage loans..................... 85% 78% 77% 80% 82% 87% 90% 90% 90%
Weighted average loan-to-value......................... 77% 77% 78% 76% 77% 76% 77% 77% 78%
Weighted average remaining term (months) on
loans securitized.................................... 245 252 241 236 240 241 240 240 237
Original balance of Trust Certificates................. $ 150 $ 300 $ 235 $ 220 $ 219 $ 219 $ 184 $ 79 $ 198
Current balance of Trust Certificates.................. $ 150 $ 293 $ 220 $ 198 $ 188 $ 176 $ 140 $ 56 $ 134
Weighted average pass-through interest rate to Trust
Certificate holders.................................. 7.61% 7.88% 7.78% 7.40% 7.43% 7.12% 6.56% 6.69% 6.32%
Highest Trust Certificate pass-through rate............ 7.61% 8.04% 7.93% 7.68% 7.49% 7.13% 6.58% 7.08% 6.43%
Overcollateralization requirements:
Required percentages:
Initial............................................. 0.00% 0.90% 0.75% 1.00% 1.00% 0.50% 0.50% 1.00% 1.00%
Final target........................................ 4.75% 5.95% 5.95% 5.50% 5.00% 5.00% 5.00% 5.00% 5.00%
Stepdown overcollateralization...................... 9.50% 11.90% 11.90% 11.00% 10.00% 10.00% 10.00% 10.00% 10.00%
Required Amounts:
Initial........................................... $ -- $ 3 $ 2 $ 2 $ 2 $ 1 $ 1 $ 1 $ 2
Final target...................................... 7 18 14 12 11 11 9 4 10
Current Status:
Overcollateralization amount....................... $ -- $ 5 $ 6 $ 8 $ 9 $ 10 $ 9 $ 4 $ 10
Final target reached or anticipated date to reach.. 1/2002 3/2002 2/2002 7/2001 3/2001 1/2001 Yes Yes Yes
Stepdown reached or anticipated date to reach...... 7/2004 5/2004 1/2001 10/2003 7/2003 11/2002 7/2002 3/2002 3/2002
Annual surety wrap fee................................. 0.21% 0.21% 0.19% 0.21% 0.21% 0.19% 0.19% 0.20% 0.20%
Servicing rights:
Original balance.................................... $ 7 $ 10 $ 10 $ 10 $ 10 $ 10 $ 8 $ 3 $ 7
Current balance..................................... 7 10 10 9 8 8 6 2 4
</TABLE>
22
<PAGE>
Summary of Selected Mortgage Loan Securitization Trust Information (Continued)
Current Balances as of September 30, 2000
($ in millions)
<TABLE>
<CAPTION>
1998-2 1998-1 1997-2 1997-1 1996-2 1996-1
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Original balance of loans securitized:
Business loans........................................ $ 15 $ 16 $ 23 $ 22 $ 16 $ 13
Home equity loans..................................... 105 89 77 53 24 9
------ ------ ------ ------ ------ ------
Total................................................. $120 $105 $100 $ 75 $ 40 $ 22
====== ====== ====== ====== ====== ======
Current balance of loans securitized:
Business loans........................................ $ 10 $ 9 $ 13 $ 10 $ 6 $ 4
Home equity loans..................................... 60 46 30 19 6 3
------ ------ ------ ------ ------ ------
Total................................................. $ 70 $ 55 $ 43 $ 29 $ 12 $ 7
====== ====== ====== ====== ====== ======
Weighted average coupon on loans securitized:
Business loans........................................ 15.93% 15.98% 15.89% 15.90% 15.98% 15.87%
Home equity loans..................................... 10.70% 11.08% 11.54% 11.45% 11.33% 10.61%
Total................................................. 11.42% 11.92% 12.85% 13.00% 13.43% 13.38%
Percentage of first mortgage loans....................... 87% 79% 77% 73% 73% 71%
Weighted average loan-to-value........................... 77% 74% 74% 70% 66% 67%
Weighted average remaining term (months) on loans
securitized............................................ 212 199 191 169 140 136
Original balance of Trust Certificates................... $ 118 $ 103 $ 98 $ 73 $ 39 $ 22
Current balance of Trust Certificates.................... $ 64 $ 49 $ 37 $ 24 $ 9 $ 5
Weighted average pass-through interest rate to Trust
Certificate holders.................................... 6.50% 6.71% 6.79% 7.42% 7.53% 7.95%
Highest Trust Certificate pass-through rate.............. 6.85% 7.15% 7.13% 7.53% 7.53% 7.95%
Overcollateralization requirements:
Required percentages:
Initial............................................... 1.50% 1.50% 2.00% 3.00% 3.00% --
Final target.......................................... 5.00% 5.50% 7.00% 8.00% 10.00% 7.00%
Stepdown overcollateralization........................ 10.00% 11.00% 14.00% 16.00% 20.00% Na
Required Amounts:
Initial............................................. $ 2 $ 2 $ 2 $ 2 $ 1 $ --
Final target........................................ 6 6 7 6 4 2
Current Status:
Overcollateralization amount......................... $ 6 $ 6 $ 6 $ 5 $ 3 $ 2
Final target reached or anticipated date to reach.... Yes Yes Yes Yes Yes Yes
Stepdown reached or anticipated date to reach........ 6/2001 Yes Yes Yes Yes na
Annual surety wrap fee................................... 0.22% 0.23% 0.26% 0.26% 0.28% na
Servicing rights:
Original balance...................................... $ 4 $ 4 $ 4 $ 3 $ 2 $ 2
Current balance....................................... 3 2 2 2 1 1
</TABLE>
Na = not applicable
23
<PAGE>
Gains on sale of loans and leases through securitizations represent the
difference between our net proceeds and the allocated cost of loans and leases
securitized. The allocated cost of the loans and leases securitized is
determined by allocating their net carrying value between the loans and leases
securitized, the interest-only strips and the servicing rights retained, based
upon their relative fair values.
The calculation of the fair value of interest-only strips is based upon
a discounted cash flow analysis which estimates the present value of the future
expected excess cash flows utilizing assumptions made by management at the time
loans are sold. These original assumptions include the rate used to calculate
the present value of expected future cash flows, referred to as the discount
rate, the rates of prepayment and credit loss rates on the pool of loans. The
prepayment rate of loans may be affected by a variety of economic and other
factors, including prevailing interest rates and the availability of alternative
financing to borrowers. The effect of those factors on loan prepayment rates may
vary depending on the type of loan. Estimates of prepayment rates and credit
loss rates are made based on management's expectation of future experience,
which are based, in part, on the historical experience and in the case of
prepayment rate assumptions, consideration of the impact of changes in market
interest rates. Our interest-only strips and servicing rights are periodically
evaluated based upon the present value of the expected future cash flows from
our interest-only strips and servicing rights related to the loans remaining in
the trusts. The current assumptions for prepayment and credit loss rates are
monitored against actual experience and would be adjusted if necessary.
We use a discount rate which we believe is commensurate with the risks
involved in our securitization assets. While quoted market prices on comparable
interest-only strips are not available, we have performed comparisons of our
valuation assumptions and performance experience to others in the
non-conventional mortgage industry. We quantify the risks in our securitization
assets by comparing the asset quality and performance experience of the
underlying securitized mortgage pools to comparable industry performance. We
believe that the practice of many companies in the non-conventional mortgage
industry has been to add a spread for risk to the all-in cost of securitizations
to determine their discount rate. From these experience comparisons, we have
determined a spread, which is added to the all-in cost of our mortgage loan
securitization trusts' investor certificates. The 13% discount rate used to
discount our interest-only strips considers our higher asset quality and
performance of our securitized assets compared to industry asset quality and
performance and the other characteristics of our securitized loans described
below.
o Underlying loan collateral with fixed yields which are higher
than others in the non-conventional mortgage industry. Average
coupons of securitized loans exceed the industry average by
100 basis points or more. All of our loans have fixed interest
rates which are more predictable than adjustable rate loans.
o Most of our loans include prepayment fees. Approximately 90%
to 95% of our business purpose loans have prepayment fees.
Approximately 85% to 90% of our home equity loans have
prepayment fees. Our experience indicates that prepayment fees
increase the prepayment ramp periods and slow annual
prepayment speeds which have the effect of increasing the
life of the loans securitized.
o A portfolio mix of first and second mortgage loans of 80-85%
and 15-20%, respectively. The high proportion of first
mortgages results in lower delinquencies and losses.
o A portfolio credit grade mix comprised of 62% A credits, 22% B
credits, 13% C credits, and 3% D credits. In addition, our
loss experience is below what is experienced by others in the
non-conventional mortgage industry.
24
<PAGE>
The all-in cost of the trusts' investor certificates includes the
highest trust certificate pass through interest rate in each mortgage
securitization, trustee fees, and surety fees. Trustee fees and surety fees are
deal specific and generally range from 19 to 22 basis points combined.
The assumptions for prepayment rates and credit loss rates are compared
to actual experience and adjusted if warranted. The length of time before a pool
of mortgage loans reaches its expected constant prepayment rate is referred to
as the "prepayment ramp period." It is our policy to maintain the initial
assumptions used for the expected constant prepayment rate while a pool of
mortgage loans is in the ramp period even though actual experience may be lower.
During the ramp period, actual experience both quantitatively and qualitatively
is not sufficient to conclude that final actual experience would be materially
different than the initial assumptions used. However, if actual prepayment
experience is higher than our initial assumptions, and is expected to continue,
we adjust our assumptions to actual to avoid the potential of overstating the
value of our interest-only strips.
Due to increases in the volume of loans originated with prepayment
fees, we have reduced the initial annual prepayment rate assumption on business
loans and lengthened the prepayment ramp period for home equity loans for
mortgage loan securitizations beginning with the 1999-1 securitization. Reducing
the annual prepayment assumption and lengthening the prepayment ramp period is
supported by our experience with loans having prepayment fees, that fewer
borrowers will prepay, and those prepaying will do so more slowly. The
percentage of home equity loans containing prepayment fees increased from less
than 50% of loans originated to over 85% over the nine-month period ending
October 31, 1998. As a result of this increase in the percentage of loans
originated having prepayment fees, we had lengthened the initial assumptions
used for the prepayment ramp period on home equity loans from 12 to 18 months
beginning with the 1999-1 mortgage loan securitization through the 2000-1
mortgage loan securitization and to 24 months beginning with the 2000-2 mortgage
loan securitization. This increase in the length of the prepayment ramp period
for home equity loans was supported by actual cumulative prepayment experience
through June 30, 2000, which demonstrated that only 25% of home equity loans
having prepayment fees were actually prepaid by the borrowers, while 47% of home
equity loans without prepayment fees were prepaid. This cumulative historical
performance demonstrates that it is nearly twice as likely that a loan without a
prepayment fee will be prepaid.
25
<PAGE>
The initial credit loss assumptions beginning with the 1999-4 mortgage
loan securitization were increased as a result of an increase in the percentage
of second mortgage loans and our concerns regarding the current high levels of
real estate values. As shown on the table above, "Summary of Selected Mortgage
Loan Securitization Trust Information," the average percentage of first mortgage
loans securitized declined approximately 10% from fiscal 1999 to fiscal 2000
securitizations. The current high real estate values affected our loss
assumptions on recent securitizations because in the event of an economic
downturn, the loan-to-value ratios of the recently originated loans could be
understated. Both of these factors increase the potential that the underlying
real estate collateral would not be sufficient to satisfy the loan if a
foreclosure was required. We believe these factors may limit our ability in
recent securitizations to maintain the credit loss experience realized in prior
securitizations. Actual credit loss experience for securitizations prior to the
1999-4 mortgage loan securitization generally continue to support the initial
credit loss assumptions for those securitizations. The credit loss assumptions
in two mortgage loan securitizations have been increased to reflect the higher
level of losses experienced.
The following table provides information regarding the initial and
current assumptions applied in determining the fair values of mortgage loan
related interest-only strips and servicing rights.
26
<PAGE>
Summary of Material Mortgage Loan Securitization
Valuation Assumptions and Actual Experience at September 30, 2000
<TABLE>
<CAPTION>
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998-4
------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-only strip discount rate:
Initial valuation....................................... 13% 13% 11% 11% 11% 11% 11% 11%
Current valuation....................................... 13% 13% 13% 13% 13% 13% 13% 13%
Servicing rights discount rate:
Initial valuation....................................... 11% 11% 11% 11% 11% 11% 11% 11%
Current valuation....................................... 11% 11% 11% 11% 11% 11% 11% 11%
Prepayment rates:
Initial assumption:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 10% 10% 10% 10% 10% 10% 10% 13%
Home equity loans..................................... 24% 24% 24% 24% 24% 24% 24% 24%
Ramp period (months) (a):
Business loans........................................ 24 24 24 24 24 24 24 24
Home equity loans..................................... 24 24 18 18 18 18 18 12
Current assumptions:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 10% 10% 10% 10% 10% 13.75% 12% 15.25%
Home equity loans..................................... 24% 24% 24% 24% 24% 24% 24% 24%
Ramp period (months):
Business loans........................................ 24 24 24 24 24 12 12 12
Home equity loans..................................... 24 24 24 24 24 24 24 24
CPR adjusted to reflect ramp:
Business loans........................................ 3.00% 3.30% 4.22% 5.13% 6.04% 13.75% 12.00% 15.25%
Home equity loans..................................... 2.00% 2.96% 5.83% 8.70% 11.57% 14.43% 17.30% 20.17%
Blended rate.......................................... 2.10% 2.99% 5.66% 8.27% 10.88% 14.34% 16.83% 19.65%
Actual CPR experience:
Business loans........................................ -- 0.69% 2.91% 1.54% 4.28% 13.74% 12.00% 15.25%
Home equity loans..................................... -- 4.47% 8.41% 12.30% 10.69% 11.91% 11.92% 12.42%
Blended rate.......................................... -- 4.14% 7.51% 11.8% 9.98% 12.11% 11.93% 12.60%
Credit loss rates:
Annual credit loss rate:
Initial assumption.................................... 0.40% 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25%
Current assumption.................................... 0.40% 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25%
Actual experience..................................... -- -- 0.20% 0.01% 0.06% 0.02% 0.09% 0.23%
Cumulative credit loss rate:
Initial assumption.................................... 1.85% 1.85% 1.85% 1.35% 1.20% 1.20% 1.20% 1.20%
Current assumption.................................... 1.85% 1.85% 1.85% 1.35% 1.20% 1.20% 1.20% 1.20%
Cumulative experience to date......................... -- -- 0.12% 0.01% 0.06% 0.02% 0.14% 0.41%
Servicing fees:
Contractual fees........................................ 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Ancillary fees.......................................... 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
</TABLE>
(a)The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected Constant Prepayment Rate. The business loan prepayment ramp
begins at 3% in month one. The home equity loan prepayment ramp begins at 2% in
month one.
27
<PAGE>
Summary of Material Mortgage Loan Securitization (Continued)
Valuation Assumptions and Actual Experience at September 30, 2000
<TABLE>
<CAPTION>
1998-3 1998-2 1998-1 1997-2 1997-1 1996-2 1996-1
------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-only strip discount rate:
Initial valuation....................................... 11% 11% 11% 11% 11% 11% 11%
Current valuation....................................... 13% 13% 13% 13% 13% 13% 13%
Servicing rights discount rate:
Initial valuation....................................... 11% 11% 11% 11% 11% 11% 11%
Current valuation....................................... 11% 11% 11% 11% 11% 11% 11%
Prepayment rates:
Initial assumption:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 13% 13% 13% 13% 13% 13% 13%
Home equity loans..................................... 24% 24% 24% 24% 24% 24% 24%
Ramp period (months) (a):
Business loans........................................ 24 24 24 24 24 24 24
Home equity loans..................................... 12 12 12 12 12 12 12
Current assumptions:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 13.5% 13.5% 17% 16% 20% 22% 22%
Home equity loans..................................... 24% 21% 22.25% 25% 25% 26% 20%
Ramp period (months):
Business loans........................................ 24 24 24 24 24 24 24
Home equity loans..................................... 24 12 12 12 12 12 12
CPR adjusted to reflect ramp:
Business loans........................................ 13.50% 13.50% 17.00% 16.00% 20.00% 22.00% 22.00%
Home equity loans..................................... 23.04% 21.00% 22.25% 25.00% 25.00% 26.00% 20.00%
Blended rate.......................................... 22.26% 19.92% 21.36% 22.35% 23.28% 24.18% 21.08%
Actual CPR experience:
Business loans........................................ 13.33% 13.37% 16.07% 16.25% 19.59% 22.13% 21.76%
Home equity loans..................................... 13.47% 20.48% 22.09% 24.82% 24.96% 26.13% 19.12%
Blended rate.......................................... 13.46% 19.58% 21.17% 22.67% 23.29% 24.44% 20.60%
Credit loss rates:
Annual credit loss rate:
Initial assumption.................................... 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Current assumption.................................... 0.25% 0.40% 0.40% 0.25% 0.25% 0.25% 0.25%
Actual experience..................................... 0.21% 0.39% 0.35% 0.19% 0.25% 0.19% 0.22%
Cumulative credit loss rate:
Initial assumption.................................... 1.20% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20%
Current assumption.................................... 1.20% 1.85% 1.85% 1.20% 1.20% 1.20% 1.20%
Cumulative experience to date......................... 0.45% 0.91% 0.92% 0.59% 0.91% 0.77% 1.01%
Servicing fees:
Contractual fees........................................ 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Ancillary fees.......................................... 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75%
</TABLE>
-------------------------------
(a)The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected Constant Prepayment Rate. The business loan prepayment ramp
begins at 3% in month one. The home equity loan prepayment ramp begins at 2% in
month one.
28
<PAGE>
Although we believe we have made reasonable estimates of prepayment
rates and credit loss assumptions, the actual prepayment and credit loss
experience may materially vary from our estimates. To the extent that
prepayments or credit losses differ materially from the estimates made,
adjustments of our interest-only strips and servicing rights may be required in
accordance with Statement of Financial Accounting Standards No. 115. Levels of
future prepayments and credit loss assumptions higher than those initially
estimated could result in a reduction in the value of interest-only strips and
servicing rights which would adversely affect income in the period of
adjustment. Additionally, some of our securitization trusts have issued floating
rate certificates supported by fixed rate mortgages. The fair value of the
excess cash flow we will receive may be affected by any changes in the rates
paid on the floating rate certificates.
Lease Securitizations. Information related to our two lease
securitizations is presented in the table below. As of December 31, 1999, we
de-emphasized the lease origination business but continue to service the
remaining leases in our managed portfolio.
Summary of Selected Lease Securitization Information
Current Balances as of September 30, 2000
($ in millions)
<TABLE>
<CAPTION>
1999-a 1998-a
----------- ------------
<S> <C> <C>
Original balance of leases securitized.................................. $ 82 $ 80
Current balance of leases securitized................................... $ 51 $ 26
Weighted average yield on leases securitized............................ 11.17% 12.09%
Weighted average remaining term (months) on leases securitized.......... 30 17
Original balance of Trust Certificates.................................. $ 78 $ 76
Current balance of Trust Certificates................................... $ 48 $ 24
Weighted average pass-through interest rate to Trust Certificate Holders 6.55% 6.15%
Overcollateralization requirements...................................... 3% 3%
Annual surety wrap fee.................................................. 0.29% 0.29%
Valuation Assumptions
Residual interests discount rate:
Initial valuation.................................................... 11% 11%
Current valuation.................................................... 13% 13%
Servicing rights discount rate:
Initial valuation.................................................... 11% 11%
Current valuation.................................................... 11% 11%
Prepayment rates..................................................... (a) (a)
Credit loss rates:
Annual credit loss rate:
Initial assumption................................................. 0.50% 0.50%
Current assumption................................................. 0.70% 0.50%
Actual experience.................................................. 0.63% 0.56%
Servicing Fees:
Contractual fees..................................................... 0.50% 0.50%
Ancillary fees....................................................... 0.30% 0.30%
</TABLE>
(a) The equipment leasing portfolio has experienced insignificant
prepayments, less than 1.5% annualized. Should a lease terminate early,
any impact on the valuation of lease securitization assets would be
recorded upon termination of the lease.
29
<PAGE>
Servicing Rights. When loans or leases are sold through a
securitization, the servicing on the loans or leases is retained and we
capitalize the benefit associated with the rights to service securitized loans
and leases based on those servicing rights relative fair value to other
consideration received in the securitization. We receive annual contractual
servicing fees of 50 basis points which is paid out of accumulated mortgage loan
payments before payments of principal and interest are made to trust certificate
holders, prepayment fees, late charges, nonsufficient fund fees and other fees
which are retained directly by us as servicer as payments are collected from the
borrowers.
Fair value of servicing rights is determined by computing the present
value of projected net cash flows from contractual servicing fees and ancillary
servicing fees, as described above, net of costs to service expected to be
received over the life of the loans or leases securitized. These projections
incorporate assumptions, including prepayment rates, credit loss rates and
discount rates. These assumptions are similar to those used to value the
interest-only strips retained in a securitization. Periodically, capitalized
servicing rights are evaluated for impairment, which is measured as the excess
of unamortized cost over fair value. Interest rates are not considered as a
predominant risk characteristic for purposes of evaluating impairment. We have
generally found that the non-conforming mortgage market is less sensitive to
changes in interest rates than the conventional mortgage market where borrowers
have more favorable credit history for the following reasons. First, there are
relatively few lenders willing to supply credit to non-conforming borrowers
which limits those borrowers' opportunity to refinance. Second, interest rates
available to non-conforming borrowers tend to adjust much slower than
conventional mortgage rates which reduces the non-conforming borrowers'
opportunity to capture economic value from refinancing. Also, a majority of
loans to our borrowers require prepayment fees. As a result, the prepayment
experience on our managed portfolio is more stable than the mortgage market in
general. This stability favorably impacts our ability to value the future cash
flows from our servicing rights and interest-only strips because it increases
the predictability of future cash flows. At September 30, 2000, servicing rights
totaled $82.5 million, compared to $74.9 million at June 30, 2000.
Results of Operations
Overview
For the three months ended September 30, 2000, net income decreased
$2.4 million, or 64.3%, to $1.4 million from $3.8 million for the same period in
fiscal 2000. Basic earnings per share decreased $0.65 to $0.41 for the three
months ended September 30, 2000, on average common shares of 3,324,000, compared
to $1.06 on average common shares of 3,580,000 for the same period in fiscal
2000. Diluted earnings per share decreased $0.63 to $0.40 for the three months
ended September 30, 2000, on average common shares of 3,379,000 compared to
$1.03 on average common shares of 3,685,000 for the same period in fiscal 2000.
Dividends of $0.08 per share were paid for the three months ended September 30,
2000 compared to dividends of $0.07 per share for the three months ended
September 30, 1999. The common dividend payout ratio based on diluted earnings
per share was 20.0% for the first quarter of fiscal 2001 compared to 6.8% for
the first quarter of fiscal 2000.
The decrease in net income and earnings per share primarily resulted
from a decrease in the percentage of loans originated during the first quarter
of fiscal 2001 that were also securitized during the quarter. We retained on our
balance sheet approximately $45 million of loans originated during the first
quarter of fiscal 2001 to provide flexibility in structuring future
securitizations and to contribute to interest income. In addition employee costs
and general administrative expenses increased due to increases in costs to
service our managed portfolio which increased 59.0% from September 30, 1999,
increases in loan originations of 25.8% and increased costs associated with the
level of subordinated debt issued.
30
<PAGE>
Our business strategy is dependent upon our ability to increase loan
origination volume through both geographic expansion and growth in current
markets to realize efficiencies in the infrastructure and loan production
channels we have been building. The implementation of this strategy will depend
in large part on a variety of factors outside of our control, including, but not
limited to, the ability to obtain adequate financing on favorable terms and
profitably securitize loans and leases on a regular basis and continue to expand
in the face of increasing competition. Our failure with respect to any of these
factors could impair our ability to successfully implement our growth strategy,
which could adversely affect our results of operations and financial condition.
In fiscal 1999, the Company's Board of Directors initiated a stock repurchase
program in view of the price level of the Company's common stock, which was at
the time, and has continued to, trade at below book value. In addition, our
consistent earnings growth over the past several years did not result in a
corresponding increase in the market value of our common stock. The Board of
Directors recently extended this program to continue through fiscal 2001 and
authorized the purchase of 20% of the Company's outstanding shares of common
stock.
Summary Financial Results
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
------------------------ Percentage
2000 1999 Increase
------- ------- ----------
<S> <C> <C> <C>
Total revenues.................................................... $38,423 $27,820 38.01%
Total expenses.................................................... 36,167 21,503 68.02%
Net income........................................................ 1,354 3,790 (64.3%)
Return on average equity.......................................... 8.58% 25.03%
Return on average assets.......................................... 0.88% 3.64%
Earnings per share:
Basic.......................................................... $0.41 $1.06 (61.3%)
Diluted........................................................ $0.40 $1.03 (61.2%)
Dividends declared per share...................................... $0.08 $0.07 14.3%
</TABLE>
Total Revenues. For the first three months of fiscal 2001, total
revenues increased $10.6 million, or 38.1%, to $38.4 million from $27.8 million
for the first three months of fiscal 2000. Growth in total revenues was the
result of increases in gains on securitizations of mortgage loans, increases in
interest accretion earned on our interest-only strips, increases in interest and
fees on loans originated, and increases in servicing income due to the growth of
the total managed portfolio.
Gain on Sale of Loans and Leases. For the three months ended September
30, 2000, gains of $26.1 million were recorded on the securitization of $256.8
million of loans. This was an increase of $7.0 million, or 36.4%, over gains of
$19.1 million recorded on securitizations of $210.2 million of loans and leases
for the three months ended September 30, 1999.
The increase in securitization gains for the three months ended
September 30, 2000 was primarily due to the higher volume of loans securitized.
The securitization gain as a percentage of loans securitized increased to 10.2%
for the three months ended September 30, 2000 from 9.1% on loans and leases
securitized for the three months ended September 30, 1999. The increase in the
gain percentage on loans securitized for the three months ended September 30,
2000 was primarily due to an increase in the spread between the average coupon
on loans securitized and the pass-through rate paid to investors and a lower
write off for capitalized SFAS No. 91 loan origination costs. These increases
more than offset the negative effect of an increase to 13%, in the discount rate
used to value the interest-only strips in our first quarter fiscal 2001
securitizations, from 11% used in the first quarter of fiscal 2000.
31
<PAGE>
The increase in spread for the three months ended September 30, 2000
compared to the three months ended September 30, 1999 resulted from an increase
in the average coupon on loan securitized. For loans securitized during the
three months ended September 30, 2000, the average coupon was 12.01%, an
increase from 11.56% on loans securitized during the three months ended
September 30, 1999. The interest rate on trust certificates issued in mortgage
loan securitizations during the three months ended September 30, 2000 was 7.61%,
an increase from 7.49% during the three months ended September 30, 1999. The
resulting net improvement in spread was approximately 0.33%.
SFAS No. 91, "Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases,"
requires that certain direct loan origination costs related to the time spent
successfully originating loans be deferred and recorded as an addition to the
cost basis of loans originated. These costs are then recognized as a reduction
of the gain on sale recorded at the time loans are securitized. Because of
efficiencies and productivity gains achieved in our loan origination businesses,
we have reviewed and revised our estimates of costs related to time spent
successfully originating loans and have lowered the amount of employee related
costs previously deferred and capitalized. See "Employee Related Costs."
Changes in prepayment ramp and credit loss assumptions from those used
in calculating securitization gains in the three months ended September 30, 1999
had an insignificant net impact on the change in securitization gain percentage
from the first quarter of fiscal 2000.
The following schedule details our loan and lease originations (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended
September 30,
--------------------------------------------
2000 1999
------------------ -----------------
<S> <C> <C>
Business purpose loans............................................. $ 29,854 $ 23,411
Home equity loans.................................................. 281,060 208,262
Equipment leases................................................... - 15,509
--------- --------
$ 310,914 $247,182
========= ========
</TABLE>
Loan originations for our subsidiary, American Business Credit, Inc.,
which offers business purpose loans secured by real estate, increased $6.4
million, or 27.5%. This increase was attributable to geographic expansion of
American Business Credit's lending program as well as refocused marketing
efforts. In the third quarter of fiscal 2000, American Business Credit launched
a web site, www.abceasyloan.com, in order to increase its distribution channels
for business purpose loans.
Home equity loans originated by our Consumer Mortgage Group, which
includes Upland Mortgage, New Jersey Mortgage and Investment Corp. and
Processing Service Center, Inc., increased $72.8 million, or 35.0%. The Consumer
Mortgage Group has redirected its marketing mix to focus on targeted direct
mail, which delivers more leads at a lower cost than broadcast marketing
channels. The Consumer Mortgage Group has continued to phase in advanced
Internet technology through its web site, www.UplandMortgage.com. In addition to
the ability to take online loan applications and utilize an automated rapid
credit approval process, both of which reduce time and manual effort required
for loan approval, the site features our proprietary patent-pending Easy Loan
Advisor, which provides personalized services and solutions to retail customers
through interactive web dialog.
Interest and Fees. For the three months ended September 30, 2000,
interest and fee income increased $0.5 million, or 10.1%, to $5.2 million from
$4.8 million for the three months ended September 30, 1999. Interest and fee
income consists primarily of interest income earned on available for sale loans
and leases, premiums earned on whole loan sales and other ancillary fees
collected in connection with loan originations.
During the three months ended September 30, 2000, interest income
increased $0.3 million, or 13.7%, to $2.2 million from $1.9 million for the
three months ended September 30, 1999. The increase was attributable to an
increase in our balance of loans and leases available for sale.
For the three months ended September 30, 2000, fee income increased
$0.2 million, or 7.6%, to $3.0 million from $2.9 million for the three months
ended September 30, 1999. The increase for the three-month period was the
result of increases in application fees and other fees collected in connection
with the loan approval and closing process.
32
<PAGE>
Included in fee income are premiums earned on whole loan sales.
Premiums on whole loan sales were $0.4 million for both of the three-month
periods ended September 30, 2000 and 1999. The volume of whole loan sales
decreased 31.6%, to $16.2 million for the three months ended September 30, 2000
from $23.7 million for the three months ended September 30, 1999 which was
offset by an increase in the average premium earned on whole loan sales in the
period.
Interest Accretion on Interest-Only Strips. Interest accretion
represents the yield component of cash flows received on interest-only strips.
Interest accretion increased $2.8 million, or 103.6%, to $5.6 million in the
three-month period ended September 30, 2000 from $2.8 million in the three month
period ended September 30, 1999. The increase reflects the growth in the balance
of our interest-only strips of $101.8 million, or 50.3%, to $304.0 million at
September 30, 2000 from $202.3 million at September 30, 1999. In addition, cash
flows from interest-only strips increased $9.1 million, or 111.4%, from the
first quarter of fiscal 2000 due to the larger size of our more recent
securitizations and additional securitizations reaching final target
overcollateralization levels.
We use a prospective approach to estimate interest accretion.
Periodically, we update estimates of residual cash flow from our
securitizations. When it is probable that there is a favorable change in
estimated residual cash flow from the cash flow previously projected, we
recognize a greater percentage of estimated interest accretion earned by the
securitization. Any change in value of the underlying interest-only strip could
impact our current estimate of residual cash flow earned from the
securitizations. For example, a significant change in market interest rates
could increase or decrease the level of prepayments, thereby changing the size
of the total managed loan portfolio and related projected cash flows. See
"Securitization Accounting Considerations" for additional discussion.
Servicing Income. Servicing income is comprised of contractual and
ancillary fees collected on securitized loans and leases less amortization of
the servicing rights assets that are recorded at the time loans and leases are
securitized. Ancillary fees include prepayment fees, late fees and other
servicing fee compensation. For the three months ended September 30, 2000,
servicing income increased $0.3 million, or 25.7%, to $1.5 million from $1.2
million for the three months ended September 30, 1999.
The following table summarizes the components of servicing income for
the three months ended September 30, 2000 and 1999 (in thousands):
<TABLE>
<CAPTION>
September 30,
-----------------------------------
2000 1999
-------- ---------
<S> <C> <C>
Contractual and ancillary fees............................. $ 5,248 $ 3,644
Amortization of servicing rights........................... (3,753) (2,455)
-------- ---------
Net servicing income....................................... $ 1,495 $ 1,189
======== =========
</TABLE>
33
<PAGE>
As an annualized percentage of the average managed portfolio, servicing
income for the quarter decreased to 0.30%, from 0.39% in the first quarter of
the prior year. The decrease was the result of favorable prepayment experience
(lower prepayment fees) in the first quarter of fiscal 2001. In the three-month
period ended September 30, 2000, prepayment fees collected as a percentage of
the average managed portfolio were 0.05% compared to 0.07% for the three-month
period ended September 30, 1999. In the three-month period ended September 30,
2000, amortization as a percentage of the average managed portfolio was 0.19%
compared to 0.20% for the three-month period ended September 30, 1999.
The origination of loans with prepayment fees impacts our servicing
income in two ways. Prepayment fees reduce the likelihood of a borrower
prepaying their loan. This results in prolonging the length of time a loan is
outstanding which increases the contractual servicing fees to be collected over
the life of the loan. Additionally, the terms of our servicing agreements with
the securitization trusts allow us to retain prepayment fees collected from
borrowers as part of our compensation for servicing loans.
Amortization of the servicing rights asset for securitized loans and
leases is calculated individually for each securitized pool and is recognized in
proportion to, and over the period of estimated future servicing income on that
particular pool of loans and leases. We perform a valuation analysis of
servicing rights on a quarterly basis to determine the fair value of our
servicing rights. If our valuation analysis indicates the carrying value of
servicing rights are not recoverable through future cash flows from contractual
servicing and other ancillary fees, a valuation allowance would be recovered. To
date, our valuation analysis has not indicated any impairment, other than a $0.7
million writedown recorded in the fourth quarter of fiscal 2000, and no
valuation allowance has been required. Impairment is measured as the excess of
carrying value over fair value.
Total Expenses. Total expenses increased $14.7 million, or 68.2%, to
$36.2 million for the three months ended September 30, 2000 compared to $21.5
million for the three months ended September 30, 1999. As described in more
detail below, this increase was a result of increased interest expense
attributable to the sale of subordinated debt and borrowings used to fund loan
and lease originations and increases in employee related costs, and general and
administrative expenses related to growth in loan originations, the growth of
the total managed portfolio and the continued building of support area
infrastructure.
Interest Expense. For the first quarter of fiscal 2001, interest
expense increased $5.2 million, or 67.5%, to $12.8 million from $7.6 million for
the first quarter of fiscal 2000. The increase was attributable to an increase
in the amount of subordinated debt outstanding during the first quarter of
fiscal 2001, the proceeds of which were used to fund loan originations,
operating activities, repayments of maturing subordinated debt and investments
in systems technology and Internet capabilities required to position us for
future growth. Average subordinated debt outstanding during the three months
ended September 30, 2000 was $405.5 million compared to $230.4 million during
the three months ended September 30, 1999. Average interest rates paid on
subordinated debt outstanding increased to 10.70% during the three months ended
September 30, 2000 from 9.42% during the three months ended September 30, 1999.
Rates offered on subordinated debt increased in response to general increases in
market rates in fiscal 2000 and to attract funds with a longer average maturity.
The average outstanding balances under warehouse and other lines of
credit were $56.7 million during the three months ended September 30, 2000,
compared to $119.7 million during the three months ended September 30, 1999.
This decrease was due to the increased utilization of proceeds from the sale of
subordinated debt to fund loan originations. Borrowings under warehouse lines of
credit are secured by mortgage loans and represent advances of cash to us,
usually at 98% of the principal amount of the mortgage loan used as collateral.
These borrowings are for a limited duration, generally no more than 270 days,
pending the ultimate sale of the mortgage loans through securitization or whole
loan sale, either of which will generate the proceeds necessary to retire the
borrowing.
34
<PAGE>
Provision for Credit Losses. The provision for credit losses for the
first quarter of fiscal 2001 increased $0.8 million, or 515.6%, to $0.9 million
from $0.1 million for the quarter ended September 30, 1999. The increase in the
provision for credit losses was due to higher charge-offs during the three
months ended September 30, 2000 and an increase in loans and leases available
for sale.
The following tables summarize the changes in the allowance for credit losses by
loan and lease type for the three month-periods ended September 30, 2000 and
1999 (in thousands):
<TABLE>
<CAPTION>
Business
Purpose Home Equity Equipment
Three Months Ended September 30, 2000 Loans Loans Leases Total
--------------------------------------------- ---------------- ------------------ --------------- ------------
<S> <C> <C> <C> <C>
Balance at beginning of period........... $ 462 $ 508 $ 319 $ 1,289
Provision for credit losses.............. 44 370 454 868
(Charge-offs) recoveries, net............ (1) (145) (415) (561)
-------- --------- --------- --------
Balance at end of period................. $ 505 $ 733 $ 358 $ 1,596
======== ========= ========= ========
</TABLE>
<TABLE>
<CAPTION>
Business
Purpose Home Equity Equipment
Three Months Ended September 30, 1999 Loans Loans Leases Total
--------------------------------------------- ---------------- ------------------ --------------- ------------
<S> <C> <C> <C> <C>
Balance at beginning of period........... $ 26 $ 243 $ 433 $ 702
Provision for credit losses.............. 19 91 31 141
(Charge-offs) recoveries, net............ (21) 2 9 (10)
-------- --------- --------- --------
Balance at end of period................. $ 24 $ 336 $ 473 $ 833
======== ========= ========= =======-
</TABLE>
The higher level of charge-offs in the three months ended September 30,
2000 was primarily attributable to losses we recorded on leases and to losses on
securitized loans which we repurchased from the securitization trusts. While we
are under no obligation to do so, at times we elect to repurchase some
foreclosed and delinquent loans from the securitization trusts. Under the terms
of the securitization agreements, repurchases are permitted only for foreclosed
and delinquent loans and the purchase prices are at the loans' outstanding
contractual balance. Under the terms of the trust agreements, a foreclosed loan
is one where we as servicer have initiated formal foreclosure proceedings
against the borrower and a delinquent loan is one that is 30 days or more past
due. The foreclosed and delinquent loans we typically elect to repurchase must
be 90 days or more delinquent and the subject of completed foreclosure
proceedings, or where a completed foreclosure is imminent. We elect to
repurchase loans in situations requiring more flexibility for the administration
and collection of these loans in order to maximize their economic recovery and
to avoid temporary discontinuations of residual or stepdown
overcollateralization cash flow from securitization trusts. The related
charge-offs on these repurchased loans are included in our provision for credit
losses in the period of charge-off. Our ability to repurchase these loans does
not disqualify us for sale accounting under SFAS No. 125 and other relevant
accounting literature because we are not required to repurchase any loan and our
ability to repurchase a loan is limited.
The following table summarizes the principal balances of loans we have
repurchased from the mortgage loan securitization trusts for the three months
ended September 30, 2000 and the three years ended June 30, 2000, 1999 and 1998.
All loans were repurchased at the contractual outstanding balances at the time
of repurchase. Mortgage loan securitization trusts are listed only if loan
repurchases occurred.
35
<PAGE>
Summary of Loans Repurchased from Mortgage Loan Securitization Trusts
($ in thousands)
<TABLE>
<CAPTION>
2000-2 2000-1 1999-3 1999-1 1998-4 1998-3 1998-2 1998-1 1997-2 1997-1
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Three months ended September 30, 2000:
Business loans...................... $ -- $ -- $ -- $ -- $ -- $ -- $ 215 $ 123 $ 245 $ --
Home equity loans................... 330 -- -- -- -- -- -- 870 873 --
------ ------ ------ ------ ------ ------ ----- ------ ------- ------
Total............................ $ 330 $ -- $ -- $ -- $ -- $ -- $ 215 $ 993 $ 1,118 $ --
====== ====== ====== ====== ====== ====== ===== ====== ======= ======
Number of loans repurchased......... 2 -- -- -- -- -- 1 13 11 --
Year ended June 30, 2000:
Business loans...................... $ -- $ -- $ 101 $ -- $ -- $ -- $ 827 $ -- $ 153 $2,441
Home equity loans................... -- 167 -- -- 363 106 2,588 165 84 1,123
------ ------ ------ ------ ------ ------ ----- ------ ------- ------
Total............................. $ -- $ 167 $ 101 $ -- $ 363 $ 106 $3,415 $ 165 $ 237 $3,564
====== ====== ====== ====== ====== ====== ====== ====== ======= ======
Number of loans repurchased......... -- 3 1 -- 3 1 24 1 6 35
Year ended June 30, 1999:
Business loans...................... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 23 $ -- $ 51
Home equity loans................... -- -- -- 35 15 311 -- 277 265 344
------ ------ ------ ------ ------ ------ ----- ------ ------- ------
Total............................. $ -- $ -- $ -- $ 35 $ 15 $ 311 $ -- $ 300 $ 265 $ 395
====== ====== ====== ====== ====== ====== ===== ====== ======= ======
Number of loans repurchased......... -- -- -- 1 1 2 -- 4 4 6
Year ended June 30, 1998:
Business loans...................... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 33
Home equity loans................... -- -- -- -- -- -- -- -- -- 57
------ ------ ------ ------ ------ ------ ----- ------ ------- ------
Total............................. $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 90
====== ====== ====== ====== ====== ====== ===== ====== ======= ======
Number of loans repurchased......... -- -- -- -- -- -- -- -- -- 2
</TABLE>
[RESTUB TABLE]
<TABLE>
<CAPTION>
1996-2 1996-1 Total
------ ------ -----
<S> <C> <C> <C>
Three months ended September 30, 2000:
Business loans...................... $ 66 $ 163 $ 812
Home equity loans................... -- -- 2,073
----- ----- ------
Total............................ $ 66 $ 163 $2,885
===== ===== ======
Number of loans repurchased......... 1 2 30
Year ended June 30, 2000:
Business loans...................... $ 337 $ 259 $4,118
Home equity loans................... 114 -- 4,710
----- ----- ------
Total............................. $ 451 $ 259 $8,828
===== ===== ======
Number of loans repurchased......... 6 1 81
Year ended June 30, 1999:
Business loans...................... $ -- $ -- $ 74
Home equity loans................... -- 25 1,272
----- ----- ------
Total............................. $ -- $ 25 $1,346
===== ===== ======
Number of loans repurchased......... -- 1 19
Year ended June 30, 1998:
Business loans...................... 264 $ -- $ 297
Home equity loans................... 144 -- 201
----- ----- ------
Total............................. $ 408 $ -- $ 498
===== ===== ======
Number of loans repurchased......... 2 -- 4
</TABLE>
36
<PAGE>
An allowance for credit losses for available for sale loans and leases
is maintained primarily to account for loans and leases that are delinquent and
are expected to be ineligible for sale into a future securitization. The
allowance is calculated based upon management's estimate of the expected
collectibility of loans and leases outstanding based upon a variety of factors,
including but not limited to, periodic analysis of the available for sale loans
and leases, economic conditions and trends, historical credit loss experience,
borrowers ability to repay, and collateral considerations. Although we maintain
an allowance for credit losses at the level we consider adequate to provide for
potential losses, there can be no assurances that actual losses will not exceed
the estimated amounts or that an additional provision will not be required. The
allowance for credit losses was $1.6 million, or 2.1% of gross receivables, at
September 30, 2000 compared to $1.3 million, or 2.8% of gross receivables, at
June 30, 2000.
Employee Related Costs. For the first quarter of fiscal 2001, employee
related costs increased $4.9 million, to $6.9 million, from $2.0 million in the
first quarter of fiscal 2000. The increase was primarily attributable to
increased costs to service and collect the larger total managed portfolio,
increased costs to support the growth in loan originations, and a reduction in
the amount of employee related loan origination costs deferred and capitalized
in accordance with SFAS No. 91. The total managed portfolio at September 30,
2000 was $2.1 billion, a 59% increase over the total managed portfolio of $1.3
billion at September 30, 1999. Loan originations for the three months ended
September 30, 2000 were $311 million, compared to $247 million for the three
months ended September 30, 1999.
SFAS No. 91, "Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases,"
requires that certain direct loan origination costs related to the time spent
successfully originating loans be deferred and recorded as an addition to the
cost basis of loans originated. These costs are then recognized as a reduction
of the gain on sale recorded at the time loans are securitized. Because of
efficiencies and productivity gains achieved in our loan origination businesses,
we have reviewed and revised our estimates of costs related to time spent
successfully originating loans and have lowered the amount of employee related
costs previously deferred and capitalized. See "Gain on Sale of Loans and
Leases."
Sales and Marketing Expenses. For the first quarter of fiscal 2001,
sales and marketing expenses decreased $1.5 million, or 20.4%, to $5.7 million
from $7.2 million for the first quarter of fiscal 2000. Expenses for direct mail
advertising increased $0.9 million for the three months ended September 30, 2000
compared to the prior year three-month period due to increased use of targeted
direct mail programs for our loan products. These targeted programs are
considered to be more cost effective than the television and radio advertising
campaigns utilized into the second quarter of fiscal 2000. Television and radio
advertising costs decreased by $2.1 million in the first three months of fiscal
2001 compared to the prior year three-month period. Subject to market
conditions, we plan to selectively increase the funding for advertising in
markets where we believe we can generate significant additional increases in
loan originations.
General and Administrative Expenses. For the first quarter of fiscal
2001, general and administrative expenses increased $5.3 million, or 117.6% to
$9.9 million from $4.5 million for the first quarter of fiscal 2000. The
increases were primarily attributable to increases in rent, telephone, office
supplies and equipment, expenses associated with real estate owned, professional
fees, investments in systems and technology and other expenses incurred as a
result of the previously discussed growth in loan originations and the volume of
total managed loans and leases and the continued building of support area
infrastructure and Internet capabilities.
37
<PAGE>
BALANCE SHEET INFORMATION
Balance Sheet Data:
(in thousands, except per share data)
<TABLE>
<CAPTION>
September 30, June 30,
2000 2000
--------------- ---------------
<S> <C> <C>
Cash and cash equivalents.................................................... $ 68,927 $ 69,751
Loan and lease receivables, net:
Available for sale........................................................ 76,291 44,132
Other..................................................................... 14,481 13,002
Interest-only strips......................................................... 304,012 277,872
Servicing rights............................................................. 82,539 74,919
Receivables for sold loans and leases........................................ 15,258 51,283
Total assets................................................................. 627,740 592,668
Subordinated debt............................................................ 417,244 390,676
Warehouse lines and other notes payable...................................... 55,010 50,842
Total liabilities............................................................ 564,616 530,553
Total stockholders' equity................................................... 63,124 62,115
Book value per common share.................................................. $ 18.99 $ 18.69
Debt to tangible equity (a)(d)............................................... 12.0x 11.6x
Adjusted debt to tangible equity (b)(d)...................................... 8.8x 8.3x
Subordinated debt to tangible equity (d)..................................... 8.9x 8.6x
Interest-only strips adjusted tangible equity (c)(d)........................ 2.8x 2.6x
</TABLE>
(a) Total liabilities to tangible equity.
(b) Total liabilities less cash and secured borrowings to tangible equity.
(c) Interest-only and residual strips less overcollateralization interests to
tangible equity plus subordinated debt with a remaining maturity greater
than 5 years.
(d) Tangible equity is calculated as total stockholders' equity less goodwill.
Total assets increased $35.0 million, or 5.9%, to $627.7 million at
September 30, 2000 from $592.7 million at June 30, 2000 primarily due to
increases in Loans and leases available for sale, Interest-only strips and
Servicing rights.
Loans and leases available for sale increased $32.2 million, or 72.9%,
to $76.3 million from $44.1 million due to a higher level of originations and a
lower level of securitizations during the first quarter of fiscal 2001.
Activity of our Interest-only strips for the three months ended
September 30, 2000 was as follows (in thousands).
<TABLE>
<CAPTION>
<S> <C>
Balance at beginning of period...................................................................... $ 277,872
Initial recognition of interest-only strips, including initial overcollateralization of $2,331...... 27,545
Requiried purchases of additional overcollateralization............................................. 9,649
Interest accretion.................................................................................. 5,598
Cash flow from interest-only strips................................................................. (17,251)
Net adjustments to fair value....................................................................... 599
----------
Balance at end of period............................................................................ $304,012
==========
</TABLE>
The following table summarizes the purchases of overcollateralization
by trust for the three months ended September 30, 2000 and years ended June 30,
2000, 1999 and 1998. See "Securitization Accounting Considerations" for a
discussion of overcollateralization requirements.
38
<PAGE>
Summary of Mortgage Loan Securitization Overcollateralization Purchases
($ in thousands)
<TABLE>
<CAPTION>
Off-Balance
Sheet
Facilities 2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998-4 1998-3
----------- ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Three months ended September 30, 2000
Initial overcollateralization................ $ 1,720 $ 611
Required purchases of additional
overcollateralization...................... -- 2,568 $ 1,584 $ 1,941 $ 1,793 $ 1,615
-------- ------- ------- ------- ------- ------- ------- ----- ------ ------
Total..................................... $ 1,720 -- $ 3,179 $ 1,584 $ 1,941 $ 1,793 $ 1,615 -- -- --
======== ======= ======= ======= ======= ======= ======= ===== ====== ======
Year Ended June 30, 2000
Initial overcollateralization................ $ 2,909 $ 2,114 $ 1,776 $ 2,222 $ 2,211
Required purchases of additional
overcollateralization...................... -- -- 2,303 4,040 5,125 $ 7,585 $6,601 $1,348 $2,923
-------- ------- ------- ------- ------- ------- ------- ------ ------ ------
Total..................................... $ 2,909 -- $2,114 $ 4,079 $ 6,262 $ 7,336 $ 7,585 $6,601 $1,348 $2,923
======== ======= ======= ======= ======= ======= ======= ====== ====== ======
Year ended June 30, 1999:
Initial overcollateralization................ $ 1,100 $ 925 $ 800 $2,000
Required purchases of additional
overcollateralization...................... -- 1,724 1,852 5,076
-------- ------- ------- ------- ------- ------- ------- ------ ------ ------
Total..................................... -- -- -- -- -- -- $ 1,100 $2,649 $2,652 $7,076
======== ======= ======= ======= ======= ======= ======= ====== ====== ======
Year ended June 30, 1998:
Initial overcollateralization................
Required purchases of additional
overcollateralization......................
-------- ------- ------- ------- ------- ------- ------- ------ ------ ------
Total..................................... -- -- -- -- -- -- -- -- -- --
======== ======= ======= ======= ======= ======= ======= ====== ====== ======
</TABLE>
39
<PAGE>
Summary of Mortgage Loan Securitization
Overcollateralization Purchases (Continued)
($ in thousands)
<TABLE>
<CAPTION>
1998-2 1998-1 1997-2 1997-1 1996-2 1996-1 Total
------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Three months ended September 30, 2000
Initial overcollateralization................ $ 2,331
Required purchases of additional
overcollateralization...................... $ 140 $ 8 $ 9,649
-------- -------- -------- -------- -------- ------ -------
Total..................................... -- -- -- -- $ 140 $ 8 $11,980
======== ======== ======== ======== ======== ====== =======
Year Ended June 30, 2000
Initial overcollateralization................ $11,232
Required purchases of additional
overcollateralization...................... $29,925
-------- -------- -------- -------- -------- ------ -------
Total..................................... -- -- -- -- -- -- $41,157
======== ======== ======== ======== ======== ====== =======
Year ended June 30, 1999:
Initial overcollateralization................ $ 4,825
Required purchases of additional
overcollateralization...................... $ 4,307 $ 2,267 $ 1,456 $16,682
-------- -------- -------- -------- -------- ------ -------
Total..................................... $ 4,307 $ 2,267 $ 1,456 -- -- -- $21,507
======== ======== ======== ======== ======== ====== =======
Year ended June 30, 1998:
Initial overcollateralization................ $ 1,801 $ 1,575 $ 2,000 $ 5,376
Required purchases of additional
overcollateralization...................... 3 1,938 3,544 $ 2,972 $ 1,334 $ 170 $ 9,961
-------- -------- -------- -------- -------- ------ -------
Total..................................... $ 1,804 $ 3,513 $ 5,544 $ 2,972 $ 1,334 $ 170 $15,337
======== ======== ======== ======== ======== ====== =======
</TABLE>
40
<PAGE>
Servicing rights increased $7.6 million, or 10.2%, to $82.5 million
from $74.9 million at June 30, 2000, due to the recording of $11.3 million of
mortgage servicing rights obtained in connection with loan securitizations,
partially offset by amortization of servicing rights of $3.8 million for the
three months ended September 30, 2000.
Total liabilities increased $34.1 million, or 6.4%, to $564.6 million
from $530.6 million at June 30, 2000 due primarily to an increase in
subordinated debt outstanding. For the first three months of fiscal 2001
subordinated debt increased $26.5 million, or 6.8%, to $417.2 million due to
sales of subordinated debt used to fund loan originations, operating activities,
repayments of maturing subordinated debt and investments in systems and
technology. Subordinated debt was 8.9 times tangible equity at September 30,
2000, compared to 8.6 times as of June 30, 2000. See "Liquidity and Capital
Resources" for further detail.
41
<PAGE>
Managed Portfolio Quality
The following table provides data concerning delinquency experience, real
estate owned and loss experience for the loan and lease portfolio serviced
(dollars in thousands):
<TABLE>
<CAPTION>
September 30, 2000 June 30, 2000 March 31, 2000
-------------------------- ------------------------ ------------------------
Amount % Amount % Amount %
Delinquency by Type -------------- -------- ------------- ------ ------------- -------
<S> <C> <C> <C> <C> <C> <C>
Business Purpose Loans
Total managed portfolio............. $ 240,054 $ 221,546 $ 205,590
============ =========== ===========
Period of delinquency:
31-60 days...................... $ 1,550 .65% $ 908 .41% $ 1,302 .63%
61-90 days...................... 1,227 .51 1,757 .79 990 .48
Over 90 days.................... 13,851 5.77 11,362 5.13 10,903 5.30
------------ ----- ----------- ----- ----------- -----
Total delinquencies............. $ 16,628 6.93% $ 14,027 6.33% $ 13,195 6.41%
============ ===== =========== ===== =========== =====
REO................................. $ 1,319 $ 1,299 $ 2,314
============ =========== ===========
Home Equity Loans
Total managed portfolio............. $ 1,786,801 $ 1,578,038 $ 1,356,772
============ =========== ===========
Period of delinquency:
31-60 days...................... $ 5,942 .33% $ 6,596 .42% $ 5,965 .44%
61-90 days...................... 7,116 .40 5,659 .36 4,814 .35
Over 90 days.................... 30,117 1.69 27,600 1.75 28,068 2.07
------------ ----- ----------- ----- ----------- -----
Total delinquencies............. $ 43,175 2.42% $ 39,855 2.53% $ 38,847 2.86%
============ ===== =========== ===== =========== =====
REO................................. $ 13,428 $ 11,823 $ 12,146
============ =========== ===========
Equipment Leases
Total managed portfolio............. $ 105,458 $ 118,956 $ 134,854
============ =========== ===========
Period of delinquency:
31-60 days...................... $ 705 .67% $ 475 .40% $ 597 .44%
61-90 days...................... 347 .33 478 .40 524 .39
Over 90 days.................... 696 .66 992 .83 885 .66
------------ ----- ----------- ----- ----------- -----
Total delinquencies............. $ 1,748 1.66% $ 1,945 1.63% $ 2,006 1.49%
============ ===== =========== ===== =========== =====
Combined
Total managed portfolio............. $ 2,132,313 $ 1,918,540 $ 1,697,216
============ =========== ===========
Period of delinquency:
31-60 days...................... $ 8,197 .38% $ 7,979 .42% $ 7,864 .46%
61-90 days...................... 8,690 .41 7,894 .41 6,328 .37
Over 90 days.................... 44,664 2.09 39,954 2.08 39,856 2.35
------------ ----- ----------- ----- ----------- -----
Total delinquencies............. $ 61,551 2.88% $ 55,827 2.91% $ 54,048 3.18%
============ ===== =========== ===== =========== =====
REO................................. $ 14,747 .69% $ 13,122 .68% $ 14,460 .85%
============ ===== =========== ===== =========== =====
Losses experienced during the
three month period(a)(b) :
Loans........................... $ 2,265 .48% $ 1,116 .27% $ 751 .21%
===== ===== =====
Leases.......................... 453 1.79% 239 .84% 212 .67%
------------ ===== ----------- ===== ----------- =====
Total managed portfolio......... $ 2,718 .54% $ 1,355 .31% $ 963 .25%
============ ===== =========== ===== =========== =====
</TABLE>
(a) Percentage based on annualized losses and average managed portfolio.
(b) Losses recorded on our books for loans owned by us including loans
repurchased from securitization trusts were $1.3 million ($0.6 million from
charge-offs through the provision for loan losses and $0.7 million for write
downs of real estate owned) and losses absorbed by loan securitization trusts
were $1.4 million for the three months ended September 30, 2000. Losses recorded
on our books for loans owned by us including loans repurchased from
securitization trusts were $515,000 and losses absorbed by loan securitization
trusts were $840,000 for the three months ended June 30, 2000. Losses recorded
on our books for loans owned by us including loans repurchased from
securitization trusts were $575,000 and losses absorbed by loan securitization
trusts were $388,000 for the three months ended March 31, 2000.
42
<PAGE>
Delinquent loans and leases. Total delinquencies (loans and leases with
payments past due greater than 30 days) in the total managed portfolio were
$61.6 million at September 30, 2000 compared to $55.8 million at June 30, 2000
and $54.0 million at March 31, 2000. Total delinquencies as a percentage of the
total managed portfolio (the "delinquency rate") were 2.88% at September 30,
2000 compared to 2.91% at June 30, 2000 and 3.18% at March 31, 2000 on a total
managed portfolio of $2.1 billion at September 30, 2000, $1.9 billion at June
30, 2000 and $1.7 billion at March 31, 2000. Delinquent loans and leases held as
available for sale (which are included in total delinquencies) at September 30,
2000 were $3.1 million, or 4.0%. In addition, at September 30, 2000, $4.1
million, or 5.3% of available for sale loans were on non-accrual status.
Real estate owned. Total real estate owned ("REO"), comprising
foreclosed properties and deeds acquired in lieu of foreclosure, increased to
$14.7 million, or 0.69% of the total managed portfolio at September 30, 2000
compared to $13.1 million or 0.68% and $14.5 million or 0.85%, respectively, at
June 30, 2000 and March 31, 2000. The increase in the volume of REO reflects the
seasoning of the managed portfolio and the results of loss mitigation
initiatives of quick repossession of collateral through accelerated foreclosure
processes and "Cash For Keys" programs. Cash for Keys is a program utilized in
select situations, when collateral values of loans support the action, a
delinquent borrower may be offered a monetary payment in exchange for the deed
to a property held as collateral for a loan. This process eliminates the need to
initiate a formal foreclosure process, which could take many months.
Included in total REO at September 30, 2000 was $2.4 million recorded
in our financial statements, and $12.3 million in loan securitization trusts.
Property acquired by foreclosure or in settlement of loan and lease receivables
is recorded in our financial statements at the lower of the cost basis in the
loan or fair value of the property less estimated costs to sell.
Loss experience. During the first quarter of fiscal 2001, we
experienced net loan and lease charge-offs in our total managed portfolio of
$2.7 million. On an annualized basis, net loan charge-offs for the first quarter
of fiscal 2001 represent 0.54% of the total managed portfolio. Loss severity
experience on delinquent loans generally has ranged from 5% to 15% of principal
and loss severity experience on REO generally has ranged from 25% to 35% of
principal. The increase in losses experienced as a percentage of the total
managed portfolio for the three months ended September 30, 2000 was primarily
attributable to losses experienced from four mortgage loan securitization trusts
including losses on several bulk sale transactions and settlements on long-time
delinquent credits having loss severity above normally experienced levels.
Additionally, the months of July, August and September historically have been
active months in the market for REO and we made use of this demand to dispose of
REO. The credit loss assumptions in two mortgage loan securitizations have been
increased to reflect the higher level of losses experienced. We believe the
estimates of credit loss assumptions for our other mortgage loan securitizations
remain reasonable. See "Securitization Accounting Considerations" for more
detail on credit loss assumptions compared to actual loss experience.
The business purpose loans we originate have average loan-to-value
ratios of 61.0%. The home equity loans we originate have average loan to value
ratios of 78.0% and the predominant share of our home mortgage products are
first liens as opposed to junior lien loans. We believe these factors may
mitigate some potential losses on our managed portfolio.
43
<PAGE>
INTEREST RATE RISK MANAGEMENT
A primary market risk exposure that we face is interest rate risk.
Profitability and financial performance is sensitive to changes in U.S. Treasury
yields, LIBOR yields and the spread between the effective rate of interest
received on loans and leases available for sale or securitized (all fixed
interest rates) and the interest rates paid pursuant to credit facilities or the
pass-through rate to investors for interests issued in connection with
securitizations. A substantial and sustained increase in market interest rates
could adversely affect our ability to originate and purchase loans. The overall
objective of our interest rate risk management strategy is to mitigate the
effects of changing interest rates on profitability and the fair value of
interest rate sensitive balances (primarily loans and leases available for sale,
interest-only strips, servicing rights and subordinated debt).
During times of increasing market rates, we would expect our ability to
originate loans at rates that will maintain our current level of profitability
will become more difficult than during a stable or falling interest rate
environment. We address this challenge by carefully monitoring our product
pricing, the actions of our competition and market trends in order to continue
to originate loans in as profitable a manner as possible.
A rising rate environment could also unfavorably impact our liquidity
and capital resources. Rising interest rates could impact our short-term
liquidity by widening investor spread requirements in pricing future
securitizations, increasing the levels of overcollateralization in future
securitizations, limiting our access to borrowings in the capital markets and
limiting our ability to sell our subordinated debt securities at favorable
interest rates. In a rising interest rate environment, short-term and long-term
liquidity could also be impacted by increased interest costs on all sources of
borrowed funds, including the subordinated debt, and by reducing interest rate
spreads on our securitized loans, which would reduce our cash flows. See
"Liquidity and Capital Resources" for a discussion of both long and short-term
liquidity.
44
<PAGE>
Interest Rate Sensitivity. The following table provides information
about financial instruments that are sensitive to changes in interest rates. For
interest-only strips and servicing rights, the table presents projected
principal cash flows utilizing assumptions including prepayment and default
rates. See "Securitization Accounting Considerations" for more information on
these assumptions. For debt obligations, the table presents principal cash flows
and related average interest rates by expected maturity dates (dollars in
thousands):
<TABLE>
<CAPTION>
Amount Maturing After September 30, 2000
-----------------------------------------------------------------------------
Months Months Months Months Months There- Fair
1 to 12 13 to 24 25 to 36 37 to 48 49 to 60 after Total Value
------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Rate Sensitive Assets:
Loans and leases available for sale (a) $ 73,477 $ 32 $ 36 $ 41 $ 46 $ 2,659 $ 76,291 $ 77,239
Interest-only strips.................. 41,394 55,803 58,480 55,728 49,246 172,491 433,142 304,012
Servicing rights...................... 27,150 22,240 17,351 13,481 10,462 33,318 124,002 82,539
Investments held to maturity.......... 59 63 77 100 145 528 972 855
Investments available for sale........ 713 - - - - - 713 735
Rate Sensitive Liabilities:
Fixed interest rate borrowings........ $190,446 $101,786 $ 57,790 $ 19,250 $ 20,109 $ 28,228 $417,609 $418,008
Average interest rate................. 10.05% 11.37% 11.69% 11.42% 12.20% 12.25% 10.92%
Variable interest rate borrowings..... $ 46,602 $ 1,237 $ 1,663 $ 2,618 $ 2,051 $ 474 $ 54,645 $ 54,645
Average interest rate................. 8.77% 8.90% 8.90% 8.90% 8.90% 8.90% 8.79%
</TABLE>
(a) For purposes of this table, all loans and leases which qualify for
securitization are reflected as maturing within twelve months, since loans
and leases available for sale are generally held for less than three months
prior to securitization.
Loans and Leases Available for Sale. Gain on sale of loans may be
unfavorably impacted to the extent fixed rate available for sale mortgage loans
are held prior to securitization. A significant variable affecting the gain on
sale of loans in a securitization is the spread between the average coupon rate
on fixed rate loans, and the weighted average pass-through rate to investors for
interests issued in connection with the securitization. Although the average
loan coupon rate is fixed at the time the loan is originated, the pass-through
rate to investors is not fixed until the pricing of the securitization which
occurs just prior to the sale of the loans. If market rates required by
investors increase prior to securitization of the loans, the spread between the
average coupon rate on the loans and the pass-through rate to investors may be
reduced or eliminated, which could have a material adverse effect on our results
of operations and financial condition. We estimate that each 0.1% reduction in
the spread reduces the gain on sale of loans as a percentage of loans
securitized by approximately 0.25%.
Hedging strategies may be utilized in an attempt to mitigate the effect
of changes in interest between the date rate commitments on loans are made and
the date the fixed rate pass-through certificates to be issued by a
securitization trust are priced, a period typically less than 90 days. These
strategies include the utilization of derivative financial instruments such as
futures and forward pricing on securitizations. The nature and quality of
hedging transactions are determined based on various factors, including market
conditions and the expected volume of mortgage loan originations and purchases.
At the time the contract is executed, derivative contracts are specifically
designated as hedges of mortgage loans, loan commitments or of our residual
interests in mortgage loans in our conduit facility to be included in the next
subsequent securitization. The mortgage loans, loan commitments and mortgage
loans underlying residual interests in mortgage conduit pools consist of
essentially similar pools of fixed rate loans and loan commitments,
collateralized by real estate (primarily residential real estate) with similar
maturities and similar credit characteristics. Fixed rate pass-through
certificates issued by securitization trusts are generally priced to yield a
spread above a benchmark rate based on U.S. Treasury securities with a
45
<PAGE>
three-year maturity. The U.S. Treasury Department has embarked on a repurchase
program as a result of budget surpluses resulting in less liquidity in the
Treasury market. As a result the asset backed security market is moving toward
pricing that is based on the Eurodollar and the interest rate swap markets.
Therefore, we have incorporated Eurodollar futures into our hedging program. We
hedge potential rate changes in Treasury securities and Eurodollars with futures
contracts on similar underlying securities. This has provided strong correlation
between our hedge contracts and the ultimate pricing we will receive on the
subsequent securitization. The unrealized gain or loss derived from these
derivative financial instruments, which are designated as fair value hedges, is
reported in earnings as it occurs with an offsetting adjustment to the fair
value of the item hedged. Cash flow related to hedging activities is reported as
it occurs. The effectiveness of our hedges are continuously monitored. If
correlation did not exist, the related gain or loss on the hedged item no longer
would be recognized as an adjustment to income.
In June 1998, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment
(fair value hedge), (b) a hedge of the exposure to variable cash flows of a
forecasted transaction (cash flow hedge), or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation. If a derivative is a hedge,
depending on the nature of the hedge designation, changes in the fair value of a
derivative are either offset against the change in the fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be recognized in
earnings immediately.
SFAS No. 133 is effective on a prospective basis for all fiscal
quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS No.
133 on July 1, 2000 resulted in the cumulative effect of a change in accounting
principal of $15 thousand pre-tax being recognized as expense in the
Consolidated Statement of Income for the three months ended September 30, 2000.
Due to the immateriality of the cumulative effect of adopting SFAS No. 133, the
$15 thousand pre-tax expense is included in general and administrative expense
in the Consolidated Statement of Income. The tax effects and earnings per share
amounts related to the cumulative effect of adopting SFAS No. 133 are not
material.
For the three months ended September 30, 2000, the Company recorded a
loss on the fair value of derivative financial instruments of $784 thousand
which was offset by a gain of $882 thousand in the fair value of mortgage loans,
loan commitments and residual interests in mortgage loans, resulting in a net
gain of $98 thousand for the period.
46
<PAGE>
The following schedule details outstanding hedge positions at September
30, 2000 (in thousands):
<TABLE>
<CAPTION>
Eurodollar Forward
Futures Treasury
Contracts Sales Total
----------- ------------- ------------
<S> <C> <C> <C>
Loans available for sale:
Notional Amount................................ $ 35,000 $ -- $ 35,000
Unrealized Losses.............................. (293) -- (293)
Mortgage Conduit Facility Assets:
Notional Amount................................ 60,000 25,000 85,000
Unrealized Losses.............................. (534) (192) (726)
---------- -------- ---------
Total:
Notional Amount................................ $ 95,000 $ 25,000 $ 120,000
Unrealized Losses.............................. (827) (192) (1,019)
========== ======== =========
</TABLE>
There were no hedges of loan commitments at September 30, 2000.
If market interest rates decreased by 100 basis points, the above hedge
positions would result in a loss of approximately $3.6 million. While Treasury
rates, Eurodollar rates and the pass-through rate of securitizations are
generally strongly correlated, this correlation has not held in periods of
financial market disruptions (e.g. the so-called Russian Crisis in the later
part of 1998).
In the future, we may expand the types of derivative financial
instruments we use to hedge interest rate risk to include interest rate swaps or
other types of futures contracts.
We may use hedging in an attempt to mitigate the effect of changes in
market value of fixed rate mortgage loans held for sale. However, an effective
interest rate risk management strategy is complex and no such strategy can
completely insulate us from interest rate changes. Poorly designed strategies or
improperly executed transactions may increase rather than mitigate risk. In
addition, hedging involves transaction and other costs. Such costs could
increase as the period covered by the hedging protection increases. It is
expected that such loss would be offset by income realized from securitizations
in that period or in future periods. As a result, we may be prevented from
effectively hedging fixed rate loans held for sale, without reducing income in
current or future periods due to the costs associated with hedging activities.
Interest-Only Strips and Servicing Rights. A portion of the
certificates issued to investors by securitization trusts are floating interest
rate certificates based on one-month LIBOR plus a spread. The fair value of the
excess cash flow we will receive from these trusts would be affected by any
changes in rates paid on the floating rate certificates. At September 30, 2000,
$127.5 million of debt issued by loan securitization trusts was floating rate
debt based on LIBOR, representing 7.3% of total debt issued by mortgage loan
securitization trusts. In accordance with generally accepted accounting
principles, the changes in fair value are recognized as part of net adjustments
to other comprehensive income, which is a component of retained earnings. It is
estimated that a 1.0% increase in one-month LIBOR would decrease the fair value
of interest-only strips by approximately $6.0 million.
A significant change in market interest rates could increase or
decrease the level of loan prepayments, thereby changing the size of the total
managed loan portfolio and the related projected cash flows. Higher than
anticipated rates of loan prepayments could require a write down of the fair
value of related interest-only strips and servicing rights, adversely impacting
earnings during the period of adjustment. Revaluation of our interest-only
strips and servicing rights are periodically performed. As part of the
revaluation process, assumptions used for prepayment rates are monitored against
actual experience and adjusted if warranted. It is estimated that a 100 basis
point increase in prepayment rates (for example, from 24% to 25% on home equity
loans and from 10% to 11% on business loans) would decrease the fair value of
interest-only strips by approximately $6.6 million and the fair value of
servicing rights by approximately $1.6 million. See "Securitization Accounting
Considerations" for further information regarding these assumptions.
47
<PAGE>
We attempt to minimize prepayment risk on interest-only strips and
servicing rights by requiring prepayment fees on business purpose loans and home
equity loans, where permitted by law. Currently, approximately 95% of business
purpose loans and 80% of home equity loans in the total managed portfolio are
subject to prepayment fees.
Subordinated Debt. We also experience interest rate risk to the extent
that as of September 30, 2000 approximately $227.1 million of our liabilities
were comprised of fixed rate subordinated debt with scheduled maturities of
greater than one year. To the extent that market interest rates demanded for
subordinated debt increase in the future, the rates paid on replacement debt
could exceed rates currently paid thereby increasing interest expense and
reducing net income.
Liquidity and Capital Resources
Because we have historically experienced negative cash flows from
operations, our business requires continual access to short and long-term
sources of debt to generate the cash required to fund our operations. Our cash
requirements include funding loan originations and capital expenditures,
repaying existing subordinated debt, paying interest expense and operating
expenses, and in connection with our securitizations, funding
overcollateralization requirements and servicer obligations. At times, we have
used cash to repurchase our common stock and could in the future use cash for
unspecified acquisitions of related businesses or assets.
Borrowings against warehouse and credit facilities provide the primary
funding source for loan originations. These borrowings represent cash advanced
to us for a limited duration, generally no more than 270 days, and are secured
by the loans. The ultimate sale of the loans through securitization or whole
loan sale generates the cash proceeds necessary to repay the borrowings under
these facilities. See "Credit Facilities" below for a more detailed description
on these facilities.
Cash flow from operations and the issuance of subordinated debt fund
our remaining cash requirements discussed above. We rely significantly on our
ability to issue subordinated debt since our cash flow from operations is not
sufficient to meet these requirements. Our cash requirements include the
obligation to repay maturing subordinated debt. In the process of growing our
businesses over the last three years, we have issued subordinated debt to
partially fund that growth and to partially fund maturities of subordinated
debt. We expect that our historical levels of negative cash flow from operations
will decline in the future and then become positive as the rate of increase in
our operating cash expenditures begins to level, then decline due to an expected
decrease in the rate of growth in loan production and as we realize efficiencies
in the infrastructure and loan production channels we have been building and as
the cash flows from our interest-only strips increase. Cash flows from
operations for the three months ended September 30, 2000 were impacted by the
increase in loans available for sale. We retained, rather than securitized,
approximately $45 million of loans originated during the three months ended
September 30, 2000. While this reduced cash flow in the quarter, it will provide
flexibility in structuring future securitizations and contribute to interest
income. Our cash balances are sufficient to cover approximately 36.2% of the
$190.1 million of subordinated debt maturities due within one year. Cash
balances have increased from $4.5 million at June 30, 1998 to $22.3 million at
June 30, 1999 to $68.9 million at September 30, 2000.
We continue to significantly rely on access to the asset-backed
securities market through securitizations to generate cash proceeds for the
repayment of borrowings under warehouse and credit facilities and to create our
interest-only strips and servicing rights which will provide future cash flows.
It is our expectation that future cash flows from our interest-only strips and
servicing rights will generate more of the cash flows required to meet
maturities of our subordinated debt.
48
<PAGE>
A significant portion of our loan originations are non-conforming
mortgages to subprime borrowers. Some participants in the non-conforming
mortgage industry have experienced greater than anticipated losses on their
securitization interest-only strips and servicing rights due to the effects of
increased delinquencies, increased credit losses and increased prepayment rates,
resulting in some competitors exiting the business or recording valuation
allowances or write-downs for these conditions. As a result, some participants
experienced restricted access to capital required to fund loan originations, and
have been precluded from participation in the asset-backed securitization
market. However, we have maintained our ability to obtain funding and to
securitize loans. Factors that have minimized the effect of adverse market
conditions on our business include our ability to originate loans through
established retail channels, focus on credit underwriting, assessment of
prepayment fees on loans, diversification of lending in the home equity and
business loan markets and the ability to raise capital through sales of
subordinated debt securities pursuant to a registered public offering. Subject
to economic, market and interest rate conditions, we intend to continue to
transact additional securitizations for future loan originations. Any delay or
impairment in our ability to securitize loans, as a result of market conditions
or otherwise, could adversely affect our liquidity and results of operations.
Additionally, we act as the servicer of the loans and leases
securitized and in that capacity will be obligated to advance funds in some
circumstances which may create greater demands on our cash flow than either
selling loans with servicing released or maintaining a portfolio of loans and
leases. When borrowers are delinquent in making monthly payments on mortgage
loans included in a securitization trust, we are required to advance interest
for the delinquent loans if we deem that the advances will be ultimately
recoverable. These advances require funding from our capital resources, but have
priority of repayment from the succeeding month's mortgage loan payments.
To a limited extent, we intend to continue to augment the interest and
fee income earned on loans and leases by selling loans and leases in whole loan
sales to unrelated third parties. These transactions also create additional
liquid funds available for lending activities.
Subordinated Debt Securities. During the first three months of fiscal
2001, we sold $26.6 million in principal amount of subordinated debt securities,
net of redemptions, with maturities ranging between one day and ten years. As of
September 30, 2000, $417.2 million of subordinated debt was outstanding. Under a
shelf registration statement declared effective by the Securities and Exchange
Commission on October 30, 2000, we registered an additional $350.0 million of
subordinated debt. The proceeds from sales of subordinated debt securities will
be used to fund general operating and lending activities and maturities of
subordinated debt. We intend to meet our obligation to repay such debt as it
matures with cash flow from operations, cash flows from interest-only strips,
and cash generated from additional debt financing. The utilization of funds for
the repayment of such obligations should not adversely affect operations.
49
<PAGE>
Credit Facilities. The following is a description of the warehouse and
line of credit facilities that are utilized to fund origination of loans and our
operations. All of our on balance sheet facilities are senior in right of
payment to the subordinated debt. The warehouse revolving lines of credit are
secured by loan and lease receivables. The other credit facilities are secured
with interest-only strips or other assets. The warehouse credit agreements
require that we maintain specific covenants regarding net worth, leverage and
other standards. At September 30, 2000, we were in compliance with the terms of
all loan covenants.
<TABLE>
<CAPTION>
Amount Amount
Amount Utilized-on Utilized-off
(in thousands) Committed Balance Sheet Balance Sheet
-------------- -------------- --------------
<S> <C> <C> <C>
Revolving credit facilities:
Warehouse revolving line of credit, expiring September 2001. $ 250,000 $ -- $ 33,312
Warehouse revolving line of credit, expiring October 2000... 150,000 29,071 Na
Warehouse revolving line of credit, expiring December 2000.. 25,000 9,118 Na
------------- ------------- -------------
Total warehouse facilities.................................. 425,000 38,189 33,312
Mortgage funding facility, expiring July 2001............... 200,000 Na 73,534
Revolving line of credit, expiring December 2000............ 5,000 5,000 Na
Repurchase agreement........................................ 3,314 3,314 Na
------------- ------------- -------------
Total revolving credit facilities........................... 633,314 46,503 106,846
Other credit facilities and notes payable:
Commercial paper conduit for lease production, maturity
Matches underlying leases................................. 9,708 8,142 1,506
Other debt.................................................. 365 365 Na
------------- ------------- -------------
Total credit facilities..................................... $ 643,387 $ 55,010 $ 108,352
============= ============= =============
</TABLE>
Na - not applicable for facility
Our subsidiaries have an aggregate $250.0 million Interim Warehouse and
Security Agreements with Prudential Securities Credit Corporation expiring
September 2001 to fund loan originations. The obligations described in these
agreements are guaranteed by us. Under these agreements, the subsidiaries may
fund loan originations by obtaining advances subject to specific conditions,
which bear interest at a specified margin over LIBOR rate. The obligations
described in these agreements are collateralized by pledged loans. In March of
2000, these agreements were amended to provide for the sale of loans into an
off-balance sheet conduit facility. The combination of on-balance sheet
borrowings against the warehouse facility to fund loan originations and the
amount of loans sold into the off-balance sheet conduit facility at any point in
time is limited to $250 million.
The sale into the off-balance sheet conduit facility involves a
two-step transfer that qualifies for sale accounting under SFAS No. 125. First,
we sell the loans to a special purpose entity which has been established for the
limited purpose of buying and reselling the loans. Next, the special purpose
entity sells the loans to a qualified special purpose entity (the "facility")
for cash proceeds generated by its sale of notes to a third party purchaser. We
have no obligation to repurchase the loans and neither the third party note
purchaser nor the facility has a right to require such repurchase. The facility
has the option to re-securitize the loans, ordinarily using longer-term
certificates. If the loans are not re-securitized by the facility, the third
party note purchaser has the right to securitize or sell the loans. Under this
arrangement, the loans have been isolated from us and our subsidiaries, and, as
a result, the transfer to the conduit facility is treated as a sale for
financial reporting purposes. As of September 30, 2000, we had sold
approximately $33.3 million in principal amount of loans to the conduit facility
and recognized gains on those sales totaling approximately $1.5 million.
50
<PAGE>
We, along with some of our subsidiaries, had a $150.0 million warehouse
credit facility from a syndicate of banks led by Chase Bank of Texas N.A. which
expired October 1, 2000. Interest rates on the advances under this facility were
based upon 30-day LIBOR plus a margin. Obligations under the facility are
collateralized by specified pledged loans and other collateral related thereto.
Given the increase in the Prudential facility from $150.0 million to $250.0
million and the new $200.0 million facility from UBS Warburg, we intend to renew
the facility at a reduced amount. We are currently negotiating a new credit
facility with Chase Bank Texas N.A. No assurance can be given that this new
credit facility will be extended or, if extended, such extension will be on the
same terms described above.
Our subsidiaries, American Business Credit, HomeAmerican Credit and New
Jersey Mortgage obtained a $25 million warehouse line of credit facility from
Residential Funding Corporation which expires December 31, 2000. Under this
warehouse facility, advances may be obtained, subject to specific conditions
described in the agreements. Interest rates on the advances are based on LIBOR
plus a margin. The obligations under this agreement are collateralized by
pledged loans. The facility requires us to meet specific financial ratios
described in the agreement and contains other restrictive covenants.
We and our subsidiaries, American Business Credit, HomeAmerican Credit,
and New Jersey Mortgage established a $200.0 million facility, which provides
for the sale of loans into an off-balance sheet funding facility with UBS
Principal Finance, LLC, an affiliate of UBS Warburg. The sale into the
off-balance sheet conduit facility involves a two-step transfer that qualifies
for sale accounting under SFAS No. 125. First, we sell the loans to a special
purpose entity which has been established for the limited purpose of buying and
reselling the loans. Next, the special purpose entity sells the loans to a
qualified special purpose entity ("the facility") for cash proceeds generated by
its sale of notes to a third party purchaser. We have no obligation to
repurchase the loans except under certain conditions where loans do not conform
to representations and warranties made by us at the time of sale, and neither
the third party note purchaser nor the sponsor has a right to require such
repurchase. The facility has the option to re-securitize the loans, ordinarily
using longer-term certificates. If the facility fails to re-securitized the
loans within a specified period, the third party note purchaser has the right to
securitize or sell the loans. Under this arrangement, the loans have been
isolated from us and our subsidiaries; and, as a result, transfers to the
conduit facility will be treated as sales for financial reporting purposes. As
of September 30, 2000, we had sold approximately $73.5 million in principal
amount of loans to the conduit facility and recognized gains on those sales
totaling approximately $8.7 million.
In December 1998, we and our subsidiaries, American Business Credit,
HomeAmerican Credit and New Jersey Mortgage entered into an agreement with Chase
Bank pursuant to which Chase Bank committed to extend $5.0 million of credit in
the form of a Security Agreement against the Class R Certificate of the ABFS
Mortgage Loan Trust 1998-2. Under the Chase Bank line of credit American
Business Credit, Home American Credit and New Jersey Mortgage may borrow up to
$5.0 million, subject to specific conditions described in the agreement, which
extensions of credit shall bear interest at the LIBOR rate plus a margin. The
agreement expires December 31, 2000 unless accelerated upon an event of default
as described in such agreement.
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The commercial paper conduit for lease production provided for sale of
equipment leases using a pooled securitization. After January 2000, the facility
was no longer available for sales of equipment leases. The facility permitted us
to sell leases in a two-step transfer that qualified for sale accounting under
SFAS No. 125. First, we sold the leases to a special purpose entity which has
been established for the limited purpose of buying and reselling the leases.
Next the special purpose entity sold the leases to a qualified special purpose
entity (the "facility") for cash. The facility is sponsored by a major financial
institution which has the option to re-securitize the leases, ordinarily using
longer-term certificates. Should a longer-term securitization not occur, the
leases would remain in the commercial paper conduit until their contractual
termination. We have no obligation to repurchase the leases and neither the
facility nor the sponsor has a right to require such repurchase. The final two
transfers into this facility in the amount of $10.6 million were accounted for
as a financing transaction. The leases transferred in those final transfers were
retained on our balance sheet and the financing raised by the commercial paper
conduit was recorded as debt on the balance sheet.
As of September 30, 2000, $245.1 million of debt was scheduled to
mature during the next twelve months which was mainly comprised of maturing
subordinated debt and warehouse lines of credit. We currently expect to
refinance the maturing debt through extensions of maturing debt or new debt
financing and, if necessary, may retire the debt through cash flow from
operations and loan sales or securitizations. Despite the current use of
securitizations to fund loan growth, we are also dependent upon other borrowings
to fund a portion of our operations. We intend to continue to utilize debt
financing to fund operations in the future.
A failure to renew or obtain adequate funding under a warehouse credit
facility, or other borrowings, or any substantial reduction in the size or
pricing in the markets for loans, could have a material adverse effect on our
results of operations and financial condition. To the extent we are not
successful in maintaining or replacing existing financing, we may have to
curtail loan production activities or sell loans rather than securitize them,
thereby having a material adverse effect on our results of operations and
financial condition.
We lease our corporate headquarters facilities under a five-year
operating lease expiring in July 2003 at a minimum annual rental of
approximately $2.2 million. We also lease a facility in Roseland, New Jersey
under an operating lease expiring July 2003 at an annual rental of $0.8 million.
The corporate headquarters and Roseland leases have a renewal provision at an
increased annual rental. In addition, branch offices are leased on a short-term
basis in various cities throughout the United States. The leases for the branch
offices are not material to operations.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. See "Interest Rate Risk Management" for a discussion of the
impact of adopting SFAS 133.
In September 2000, the Financial Accounting Standards Board ("FASB")
issued the Statement of Financial Accounting Standards No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
("SFAS No. 140"). SFAS No. 140 replaces FASB Statement No. 125, also titled
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." SFAS No. 140 revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures, but it carries over most of FASB Statement No.
125's provisions without reconsideration.
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SFAS No. 140 provides accounting and reporting standards for transfers
and servicing of financial assets and extinguishments of liabilities. Those
standards are based on consistent application of a financial-components approach
that focuses on control. Under that approach, after a transfer of financial
assets, an entity recognizes the financial and servicing assets it controls and
the liabilities it has incurred, derecognizes financial assets when control has
been surrendered, and derecognizes liabilities when extinguished. This statement
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings.
SFAS No. 140 is effective on a prospective basis for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. This statement is effective for recognition and reclassification
of collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. Disclosures about
securitization and collateral accepted need not be reported for periods ending
on or before December 15, 2000, for which financial statements are presented for
comparative purposes. This Statement is to be applied prospectively with certain
exceptions. Other than those exceptions, earlier or retroactive application of
its accounting provisions is not permitted. The adoption of this standard is not
expected to have a material effect on the Company's financial condition or
results of operations.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Interest Rate Risk Management."
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description of Agreement
------ ------------------------
27 Financial Data Schedule.
(b) Reports on Form 8-K:
During the quarter ended September 30, 2000 the Company filed a
current report on September 28, 2000 which was amended by a
current report on Form 8-K/A on October 10, 2000, reporting
information under Item 5 with respect to a delay in filing the
Company's Annual Report on Form 10-K.
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SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
AMERICAN BUSINESS FINANCIAL SERVICES, INC.
DATE: November 14, 2000 BY: /s/ Albert W. Mandia
----------------- ----------------------------
Albert W. Mandia
Executive Vice President and
Chief Financial Officer
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