<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q/A
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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 May 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 March 31, 2000 and June 30, 1999.............................................1
Consolidated Statements of Income for the three and nine months ended March 31, 2000 and 1999..................2
Consolidated Statements of Stockholders' Equity for the nine months ended March 31, 2000
and 1999................................................................................................3
Consolidated Statements of Cash Flow for the nine months ended March 31, 2000 and 1999.........................4
Notes to Consolidated Financial Statements.....................................................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................13
Item 3. Quantitative and Qualitative Disclosure about Market Risk..............................................49
</TABLE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1- Financial Information
American Business Financial Services, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollars in thousands)
<TABLE>
<CAPTION>
March 31, 2000 June 30, 1999
(Unaudited) (Note)
-------------- -------------
<S> <C> <C>
Assets
Cash and cash equivalents....................................... $ 45,399 $ 22,395
Loan and lease receivables, net
Available for sale........................................... 33,259 33,776
Other........................................................ 10,819 6,863
Interest-only strips............................................ 258,772 178,218
Receivable for sold loans and leases............................ 62,651 66,086
Prepaid expenses................................................ 4,412 1,671
Property and equipment, net..................................... 17,299 10,671
Servicing rights................................................ 66,081 43,210
Other assets.................................................... 35,065 33,411
---------- -----------
Total assets.................................................... $ 533,757 $ 396,301
========== ===========
Liabilities and Stockholders' Equity
Liabilities
Subordinated debt............................................... $ 329,038 $ 211,652
Warehouse lines and other notes payable......................... 57,302 58,691
Accounts payable and accrued expenses........................... 27,148 26,826
Deferred income taxes........................................... 26,198 16,604
Other liabilities............................................... 27,579 24,282
---------- -----------
Total liabilities .............................................. 467,265 338,055
========== ===========
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: 3,639,704 and 3,703,514 shares (including treasury
shares of 250,300 and 116,550).................................. 4 3
Additional paid-in capital...................................... 24,284 23,339
Accumulated other comprehensive income.......................... 3,663 3,354
Retained earnings............................................... 42,125 33,596
Treasury stock, 250,300 and 116,550 shares...................... (2,984) (1,446)
---------- -----------
67,092 58,846
Note receivable................................................. (600) (600)
---------- -----------
Total stockholders' equity...................................... 66,492 58,246
---------- -----------
Total liabilities and stockholders' equity...................... $ 533,757 $ 396,301
========== ===========
</TABLE>
Note: The balance sheet at June 30, 1999 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 Nine Months Ended
March 31, March 31,
------------------------- -------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues
Gain on sale of loans and leases.............. $ 23,412 $ 17,417 $ 63,025 $ 45,789
Interest and fees............................. 4,723 4,271 14,219 12,717
Interest accretion on interest-only strips.... 4,836 307 11,902 699
Servicing income.............................. 1,173 952 3,412 1,967
Other income.................................. 2 22 5 37
----------- ----------- ----------- -----------
Total revenues................................ 34,146 22,969 92,563 61,209
----------- ----------- ----------- -----------
Expenses......................................
Interest...................................... 10,112 6,126 26,175 15,674
Provision for credit losses................... 331 542 1,040 745
Employee related costs........................ 2,820 1,157 7,342 3,666
Sales and marketing........................... 6,081 5,830 19,945 15,083
General and administrative.................... 8,277 3,832 18,956 9,910
----------- ----------- ----------- -----------
Total expenses................................ 27,621 17,487 73,458 45,078
----------- ----------- ----------- -----------
Income before provision for income taxes...... 6,525 5,482 19,105 16,131
Provision for income taxes.................... 2,610 1,973 7,642 5,704
----------- ----------- ----------- -----------
Net income.................................... $ 3,915 $ 3,509 $ 11,463 $ 10,427
=========== =========== =========== ===========
Earnings per common share:
Basic...................................... $ 1.16 $ 0.95 $ 3.32 $ 2.82
Diluted.................................... $ 1.12 $ 0.92 $ 3.23 $ 2.74
Average common shares:
Basic...................................... 3,375 3,703 3,451 3,700
Diluted.................................... 3,502 3,806 3,538 3,810
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(amounts in thousands)
(unaudited)
<TABLE>
<CAPTION>
Common Stock
--------------------- Accumulated
Number of Additional Other
Shares Paid-In Comprehensive Retained Treasury Note
Outstanding Amount Capital Income Earnings Stock Receivable
----------- ------- ---------- -------------- -------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance June 30, 1999.................... 3,587 $ 3 $ 23,339 $ 3,354 $ 33,596 $ (1,446) $ (600)
Comprehensive income:
Net income............................. -- -- -- -- 11,463 -- --
Unrealized gains on investment
securities ........................... -- -- -- 309 -- -- --
------ ----- -------- -------- -------- -------- ------
Total comprehensive income............... -- -- -- 309 11,463 -- --
------ ----- -------- -------- -------- -------- ------
Exercise of stock options................ 61 1 211 -- -- -- --
Issuance on non-employee stock options... -- -- 130 -- -- -- --
Repurchase of treasury shares............ (259) -- -- -- -- (3,090) --
Cash dividends ($0.22 per share)......... -- -- -- -- (778) -- --
Stock dividend (5% of outstanding shares):
Issuance of treasury shares............ -- -- -- -- -- 1,552 --
Issuance of new shares................. -- -- 604 -- (2,156) -- --
------ ----- -------- -------- -------- -------- ------
Balance, March 31, 2000.................. 3,389 $ 4 $ 24,284 $ 3,663 $ 42,125 $ (2,984) $ (600)
====== ===== ======== ======== ======== ======== ======
Total
Stockholders'
Equity
------------
Balance June 30, 1999.................... $ 58,246
Comprehensive income:
Net income............................. 11,463
Unrealized gains on investment
securities ........................... 309
---------
Total comprehensive income............... 11,772
---------
Exercise of stock options................ 212
Issuance of non-employee stock options... 130
Repurchase of treasury shares............ (3,090)
Cash dividends ($0.22 per share)......... (778)
Stock dividend (5% of outstanding shares):
Issuance of treasury shares............ 1,552
Issuance of new shares................. (1,552)
---------
Balance, March 31, 2000.................. $ 66,492
=========
</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>
Nine Months Ended
March 31,
---------------------------
2000 1999
---------- ---------
<S> <C> <C>
Cash Flow from Operating Activities:
Net income......................................................... $ 11,463 $ 10,427
Adjustments to reconcile net income to net cash
used in operating activities:
Gain on sale of loans and leases............................. (63,025) (45,789)
Depreciation and amortization................................ 13,945 7,497
Interest accretion on interest-only strips................... (11,901) (699)
Provision for credit losses.................................. 1,040 745
Accounts written off, net ................................... (1,273) (761)
Loans and leases originated for sale............................... (844,365) (653,805)
Proceeds from sale of loans and leases............................. 788,638 599,738
Principal payments on loans and leases............................. 3,377 8,015
Increase in accrued interest and fees on
loan and lease receivables..................................... (3,956) (1,676)
Purchase of initial overcollateralization on
securitized loans and leases................................... (7,342) (3,724)
Required purchase of initial overcollateralization on
securitized loans and leases................................... (20,710) (11,490)
Cash flow from interest-only strips................................ 34,474 26,482
Decrease in receivable for loans and leases sold................... 13,361 2,537
Increase in prepaid expenses....................................... (2,741) (1,220)
Increase in accounts payable and accrued expenses.................. 322 5,720
Increase (decrease) in deferred income taxes....................... 9,403 (1,145)
Increase in loans in process....................................... 3,297 9,255
Decrease in other, net............................................. (1,195) (1,297)
--------- ---------
Net cash used in operating activities.............................. (77,188) (51,190)
--------- ---------
Cash Flows from Investing Activities:
Purchase of property and equipment, net........................ (9,758) (3,668)
Purchase of investment......................................... -- (646)
Principal receipts on investments.............................. 24 699
--------- ---------
Net cash used in investing activities.............................. (9,734) (3,615)
--------- ---------
</TABLE>
4
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow (continued)
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
---------------------------
2000 1999
---------- ---------
<S> <C> <C>
Cash Flow from Financing Activities:
Proceeds from issuance of subordinated debt..................... $ 177,055 $ 111,616
Redemptions of subordinated debt................................ (59,670) (44,022)
Net borrowings on revolving lines of credit..................... (10,225) 6,828
Borrowings, lease financing facility............................ 12,294 --
Principal payments on lease financing facility.................. (1,635) --
Principal payments on note payable, other....................... (1,822) (686)
Financing costs incurred........................................ (2,545) (2,218)
Cash dividend paid.............................................. (778) (405)
Exercise of employee stock options.............................. 212 10
Issuance of non-employee stock options.......................... 130 73
Repurchase of treasury stock.................................... (3,090) --
--------- ---------
Net cash provided by financing activities........................... 109,926 71,196
--------- ---------
Net increase in cash and cash equivalents....................... 23,004 16,391
Cash and cash equivalents, beginning of period.................. 22,395 4,486
--------- ---------
Cash and cash equivalents, end of period........................ $ 45,399 $ 20,877
========= =========
Supplemental disclosure of cash flow information Cash paid
during the period for:
Interest...................................................... $ 19,280 $ 13,302
Income taxes.................................................. $ 500 $ 2,755
</TABLE>
See accompanying note to consolidated financial statements.
5
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2000
1. Basis of Financial Statement Presentation
American Business Financial Services, Inc., together with its
subsidiaries (the "Company"), is a diversified retail financial service
organization operating throughout the United States. The Company
originates, sells and services loans to businesses secured by real
estate and other business assets and conventional first mortgage and
home equity loans, including loans to credit impaired borrowers secured
by first and second mortgages. In addition, the Company continues to
service its managed portfolio of business equipment leases, and to
originate a minimal amount of new leases. The Company also sells
subordinated debt securities to the public, the proceeds of which are
used to fund loan originations and the Company's operations.
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 nine month period ended March 31,
2000 are not necessarily indicative of financial results that may be
expected for the full year ended June 30, 2000. 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, 1999.
Certain prior period financial statement balances have been
reclassified to conform to the current period presentation. All prior
period outstanding share, average common share and earnings per common
share amounts have been retroactively adjusted to reflect the effect of
a 5% stock dividend declared August 18, 1999, and paid September 27,
1999.
Recent Accounting Pronouncements
In June 1999, the Financial Accounting Standards Board ("FASB") issued
the Statement of Financial Accounting Standards 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 entities 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, an unrecognized
firm commitment, an available for sale security, or a
foreign-currency-denominated forecasted transaction. At the time of
issuance SFAS No. 133 was to be effective on a prospective basis for
all fiscal quarters of fiscal years beginning after June 15, 1999.
Subsequently in August 1999, the FASB issued the Statement of Financial
Accounting Standards No. 137, which deferred the effective date of the
standard until years beginning after June 15, 2000. The adoption of
this standard is not expected to have a material effect on the
Company's financial condition or results of operations.
6
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2000
1. Basis of Financial Statement Presentation - (Continued)
In October 1999, the FASB issued Statement of Financial Accounting
Standards ("SFAS No. 134"), "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a
Mortgage Banking Enterprise". SFAS No. 134, which became effective
January 1, 1999, requires that after the securitization of a mortgage
loan held for sale, the resulting mortgage-backed security or other
retained interests be classified based on the Company's ability and
intent to hold or sell the investments. As a result, retained interests
previously classified as trading assets, as required by prior
accounting principles, had been reclassified to available for sale on
January 1, 1999.
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>
March 31, 2000 June 30, 1999
----------------- ----------------
<S> <C> <C>
Real estate secured loans................................. $ 14,111 $ 21,027
Leases, net of unearned income of $2,696 and $1,543....... 19,617 13,451
----------------- ----------------
33,728 34,478
Less: Allowance for credit losses on loans and leases
available for sale..................................... 469 702
----------------- ----------------
$ 33,259 $ 33,776
================= ================
</TABLE>
3. Interest-Only Strips
Activity for interest-only strips during the nine-month period ended
March 31, 2000 was as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Balance at beginning of period................................................ $ 178,218
Initial recognition of interest-only strips, including initial
overcollateralization of $7,342............................................ 81,917
Required purchases of additional overcollateralization........................ 20,710
Interest accretion............................................................ 11,901
Cash flow from interest-only strips........................................... (34,474)
Net adjustments to fair value................................................. 500
----------
Balance at end of period...................................................... $ 258,772
==========
</TABLE>
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 March 31, 2000, the
Company's investment in overcollateralization was $69.6 million.
7
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2000
4. Servicing Rights
Activity for servicing rights during the nine-month period ended March
31, 2000 was as follows (in thousands):
Balance at beginning of period...................... $ 43,210
Initial recognition of servicing rights............. 31,439
Amortization........................................ (8,568)
---------
Balance at end of period............................ $ 66,081
=========
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 March 31, 2000, no
valuation allowance for impairment was required.
5. Other Assets
Other assets were comprised of the following (in thousands):
<TABLE>
<CAPTION>
March 31, 2000 June 30, 1999
-------------- -------------
<S> <C> <C>
Goodwill, net of accumulated amortization of $2,814
and $1,913............................................. $ 15,450 $ 15,018
Financing costs, debt offering costs, net of accumulated
amortization of $5,014 and $3,903...................... 5,902 4,487
Due from securitization trusts for servicing related
activities............................................. 7,131 6,266
Investments held to maturity (mature April 2000
through April 2011).................................... 990 1,014
Real estate owned......................................... 1,781 843
Other..................................................... 3,811 5,783
---------- -----------
$ 35,065 $ 33,411
========== ===========
</TABLE>
8
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2000
6. Subordinated Debt and Warehouse Lines and Other Notes Payable
Subordinated debt was comprised of the following (in thousands):
<TABLE>
<CAPTION>
March 31, 2000 June 30, 1999
----------------- ----------------
<S> <C> <C>
Subordinated debentures (a)............................... $ 325,539 $ 206,918
Subsidiary subordinated debentures (b).................... 3,499 4,734
----------------- ----------------
Total subordinated debentures............................. $ 329,038 $ 211,652
================= ================
</TABLE>
Warehouse lines and other notes payable were comprised of the following
(in thousands):
<TABLE>
<CAPTION>
March 31, 2000 June 30, 1999
----------------- ----------------
<S> <C> <C>
Warehouse revolving line of credit (c).................... $ 31,774 $ 42,627
Warehouse revolving line of credit (d).................... -- 3,764
Warehouse revolving line of credit (e).................... 4,493 102
Revolving line of credit (f).............................. 5,000 5,000
Repurchase agreement (g).................................. 4,677 4,677
Lease funding facility (h)................................ 10,659 --
Senior subordinated debt (i).............................. -- 1,250
Other debt................................................ 699 1,271
----------------- ----------------
Total warehouse lines and other notes payable............. $ 57,302 $ 58,691
================= ================
</TABLE>
--------------------------
(a) Subordinated debentures due April 2000 through March 2009, interest rates
ranging from 6.15% to 12.90%; subordinated to all of the Company's
indebtedness.
(b) Subsidiary subordinated debentures due April 2000 through May 2003, interest
rates ranging from 9.00% to 11.99%; subordinated to all of the Company's
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) $20 million warehouse revolving line of credit expired January 2000,
interest rates at prime less 1.0% or LIBOR at the Company's option,
collateralized by lease receivables.
(e) $150 million warehouse line of credit expiring August 2000, 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 $150 million at March 31, 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 March 31, 2000, the Company had sold approximately $21.4 million in
principal amount of loans to the conduit facility and recognized gains on
those sales totaling approximately $2.1 million.
9
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2000
(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 April 2000, interest rate of LIBOR plus 0.5%,
collateralized by certain lease backed securities.
(h) Lease funding facility due April 2000 through December 2004, interest rate
of LIBOR plus 1.775%, collateralized by certain lease receivables.
(i) Senior subordinated debt due December 1999, interest rate of 12.0%,
subordinated to certain subsidiary's senior indebtedness.
7. 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 Nine Months Ended
March 31, March 31,
--------------------- ---------------------
2000 1999 2000 1999
-------- -------- -------- ---------
<S> <C> <C> <C> <C>
Earnings
(a) Net income.................................. $ 3,915 $ 3,509 $ 11,463 $ 10,427
Average Common Shares
(b) Average common shares outstanding........... 3,375 3,703 3,451 3,700
Average potentially dilutive shares......... 127 103 87 110
-------- -------- -------- ---------
(c) Average common and potentially dilutive
shares...................................... 3,502 3,806 3,538 3,810
======== ======== ======== =========
Earnings Per Common Share
Basic (a/b)...................................... $ 1.16 $ 0.95 $ 3.32 $ 2.82
Diluted (a/c).................................... $ 1.12 $ 0.92 $ 3.23 $ 2.74
</TABLE>
8. Segment Information
The Company has three operating segments: Loan Origination, Servicing,
and Investment Note Services.
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.
10
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
March 31, 2000
The Investment Note Services segment funds the Company's general
operating and lending activities through the offering of the Company's
subordinated debt securities.
All Other 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 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>
Investment
Nine months ended March 31, 2000 Loan Note Reconciling
(in thousands) Origination Services Servicing All Other Items Consolidated
----------- --------- --------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
External revenues:
Gain on sale of loan and leases. $ 63,025 $ -- $ -- $ -- $ -- $ 63,025
Interest income................. 3,760 -- -- 13,473 -- 17,233
Non-interest income............. 1,535 -- 10,770 -- -- 12,305
Inter-segment revenues............. -- 26,134 -- 7,699 (33,833) --
Operating expense:
Interest expense................ 19,136 19,402 168 13,603 (26,134) 26,175
Non-interest expense............ 25,822 6,190 6,085 5,048 -- 43,145
Depreciation and amortization... 1,458 4 155 2,521 -- 4,138
Inter-segment expense........... 7,699 -- -- -- (7,699) --
Income tax expense................. 5,682 215 1,745 -- -- 7,642
--------- -------- -------- --------- -------- ---------
Net income......................... $ 8,523 $ 323 $ 2,617 $ -- $ -- $ 11,463
========= ======== ======== ========= ======== =========
Segment assets..................... $ 116,870 $ 51,347 $ 67,370 $ 298,170 $ -- $ 533,757
========= ======== ======== ========= ======== =========
</TABLE>
11
<PAGE>
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
March 31, 2000
<TABLE>
<CAPTION>
Investment
Nine months ended March 31, 1999 Loan Note Reconciling
(in thousands) Origination Services Servicing All Other Items Consolidated
----------- --------- --------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
External revenues:
Gain on sale of loan and leases. $ 45,789 $ -- $ -- $ -- $ -- $ 45,789
Interest income................. 4,596 168 -- 1,700 -- 6,464
Non-interest income............. 4,382 89 4,485 -- -- 8,956
Inter-segment revenues............. -- 16,764 -- 14,493 (31,257) --
Operating expense:
Interest expense................ 12,752 10,247 209 9,230 (16,764) 15,674
Non-interest expense............ 14,390 4,035 1,647 6,355 -- 26,427
Depreciation and amortization... 978 1,187 204 608 -- 2,977
Inter-segment expense........... 14,114 379 -- -- (14,493) --
Income tax expense................. 4,431 415 858 -- -- 5,704
-------- -------- -------- --------- ---------- ---------
Net income......................... $ 8,102 $ 758 $ 1,567 $ -- $ -- $ 10,427
======== ======== ======== ========= ========== =========
Segment assets..................... $ 80,197 $ 39,399 $ 35,619 $ 172,185 $ -- $ 327,400
======== ======== ======== ========= ========== =========
</TABLE>
9. Legal Proceedings
On October 23, 1997, a class action suit was filed in the Superior
Court of New Jersey at Docket No. L-12066-97 against NJMIC by Alfred G.
Roscoe on behalf of himself and others similarly situated. Mr. Roscoe
sought certification that the action could be maintained as a class
action. He also sought unspecified compensatory damages and injunctive
relief. In his complaint, Mr. Roscoe alleged that NJMIC violated New
Jersey's Mortgage Financing on Real Estate Law, N.J. Stat. Ann.
46:10A-1 et seq., by requiring him and other borrowers to pay or
reimburse NJMIC for attorneys' fees and costs in connection with loans
made to them by NJMIC. Mr. Roscoe further asserted that NJMIC's alleged
actions violated New Jersey's Consumer Fraud Act, N.J. Stat. Ann.
56:8-1, et seq. and constituted common law fraud and deceit.
On February 24, 1998, after oral argument before the Superior Court, an
order was entered in favor of NJMIC and against Mr. Roscoe granting
NJMIC a Motion for Summary Judgment. Mr. Roscoe appealed to the
Superior Court of New Jersey - Appellate Division. Oral argument on the
appeal was heard on January 20, 1999 before a two-judge panel of the
Appellate Division. On February 3, 1999, the panel filed a per curiam
opinion affirming the Superior Court's ruling in favor of NJMIC.
On March 4, 1999, a Petition for Certification for review of the final
judgment of the Superior Court was filed with the Supreme Court of New
Jersey. NJMIC filed its Brief in Opposition to the Petition for
Certification on March 16, 1999, and Mr. Roscoe filed a reply brief.
On January 11, 2000 the Supreme Court entered an order which denied Mr.
Roscoe's Petition for Certification for review of the final judgment of
the Superior Court in favor of NJMIC and against Mr. Roscoe.
Accordingly, NJMIC has prevailed in this suit which has now been
concluded.
12
<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, 1999 incorporated by reference
in this Form 10-Q in their entirety.
Forward Looking Statements
When used in this Quarterly Report on Form 10-Q the words or phrases
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimate," "projected," or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements are subject to certain risks and
uncertainties, including but not limited to general economic conditions, changes
in interest rates, changes in future residential real estate values, regulatory
changes (legislative or otherwise) affecting the real estate market and mortgage
lending activities, competition, demand for our services, availability of
funding, loan payment rates, delinquency and default rates, changes in factors
influencing the loan securitization market and other risks identified in our
Securities and Exchange Commission filings. Such factors could affect our
financial performance and could cause the actual results for future periods to
differ materially from any opinion or statements expressed herein with respect
to future periods. As a result, we wish to caution readers not to place undue
reliance on any such forward looking statements, which speak only as of the date
made.
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 underlying 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 18
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.
13
<PAGE>
Due to the current rising interest rate environment, we 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 are addressing 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.
The 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 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 and "Risk Factors -- If
we are unable to sustain the levels of growth in revenues and earnings that we
experienced in the past, our future profits may be reduced and our ability to
repay the notes may be impaired."
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 $134.8 million in gross receivables at March 31, 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. See "Risk Factors -
Our lending business is subject to government regulation and licensing
requirements which may hinder our ability to operate profitably."
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.
For the nine months ended March 31, 2000, we completed securitizations
aggregating $711.0 million, consisting of $78.9 million in business purpose
loans, $622.9 million in home equity loans and $9.2 million in equipment leases.
In the first nine months of 1999, we completed securitizations aggregating
$532.7 million, consisting of $41.7 million in business purpose loans, $423.3
million in home equity loans and $67.7 million in equipment leases. These
securitizations generated non-cash gains on the sale of loans and leases of
$63.0 million for the nine months ended March 31, 2000 and $45.8 million for the
nine months ended March 31, 1999. Gain on sale of loans and leases resulting
from securitizations as a percentage of total revenues was 68.1% for the nine
months ended March 31, 2000 and 74.6% for the year ended June 30, 1999.
14
<PAGE>
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 or leases 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 and "Risk Factors -- Since we have historically experienced negative cash
flows from our operations and expect to do so in the foreseeable future, our
ability to repay the investment notes could be impaired.
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, 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.
Recent movements in market interest rates will 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 1.5%. During this period,
the average coupon on our loans securitized has increased 0.7%. The spread
between the average coupon rate on the loans and the pass-through rate to
investors could be reduced further if, for example, market interest rates
continue to increase. 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. See "Risk Factors -- A change in
market interest rates may result in a reduction in our profits and impair our
ability to repay the notes."
In addition, as the spread is reduced, we are required to increase the
level of overcollateralization which is required to provide additional
protection to trust investors. Decreased spread has contributed to an increase
in the required final overcollateralization amount by approximately 1.0% of the
initial balance of loans securitized. Since September 1999 the increase in the
overcollateralization amount negatively impacts the timing of the cash flows
from the interest-only strips. See "Securitization Accounting Considerations"
for a discussion of overcollateralization amounts.
15
<PAGE>
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 60.9% of our total assets at March 31, 2000. The value of our
interest-only strips totaled $258.8 million and the value of our servicing
rights totaled $62.7 million at March 31, 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.
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, profitably securitize
our loans 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 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.
The following table summarizes the volume of loan and lease
securitizations and whole loan sales for the nine months ended March 31, 2000
and 1999 (in millions):
Nine Months Ended
March 31,
-------------------------
Securitizations: 2000 1999
----------- -----------
Business loans................ $ 78.9 $ 41.7
Home equity loans............. 622.9 423.3
Equipment leases.............. 9.2 67.7
----------- -----------
Total...................... $ 711.0 $ 532.7
=========== ===========
Whole loan sales.............. $ 77.6 $ 83.9
=========== ===========
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 March
31, 2000, $329.0 million of subordinated debt was outstanding and warehouse and
line of credit facilities totaling $323.8 million were available, of which $81.5
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.
16
<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 March 31, 2000, investments in interest-only strips in
securitizations totaled $258.8 million including investments in
overcollateralization of $69.9 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 as 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 March 31, 2000, we had sold approximately $21.4 million in principal amount
of loans to the conduit facility and recognized gains on those sales totaling
approximately $2.1 million.
17
<PAGE>
The following table provides information regarding the nature and
principal balances of mortgage loans securitized in each trust, the securities
issued by each trust, and the overcollateralization requirements of each trust.
Summary of Selected Mortgage Loan Securitization Trust Information
Current Balances as of March 31, 2000
($ in millions)
<TABLE>
<CAPTION>
2000-1 1999-4 1999-3 1999-2 1999-1 1998-4 1998-3 1998-2
------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Original balance of loans securitized:
Business loans.......................................... $ 25 $ 25 $ 28 $ 30 $ 16 $ 9 $ 17 $ 15
Home equity loans....................................... 212 197 194 190 169 71 183 105
Total................................................... 237 222 222 220 185 80 200 120
Current balance of loans securitized:
Business loans.......................................... $ 25 $ 25 $ 26 $ 28 $ 15 $ 7 $ 14 $ 12
Home equity loans....................................... 211 194 188 178 148 59 147 69
Total................................................... 236 219 214 206 163 66 161 81
Weighted average coupon on loans securitized:
Business loans.......................................... 16.10% 16.05% 15.78% 15.79% 16.01% 16.04% 15.96% 15.93%
Home equity loans....................................... 11.39% 11.12% 10.95% 10.52% 10.69% 10.85% 10.78% 10.74%
Total................................................... 11.91% 11.69% 11.54% 11.24% 11.19% 11.40% 11.22% 11.51%
Percentage of first mortgage loans......................... 77% 79% 82% 88% 89% 89% 89% 85%
Weighted average loan-to-value............................. 78% 76% 76% 76% 77% 77% 78% 77%
Weighted average remaining term (months) on loans securitized 246 241 244 246 245 245 243 215
Original balance of Trust Certificates..................... $ 235 $ 220 $ 219 $ 219 $ 184 $ 79 $ 198 $ 118
Current balance of Trust Certificates...................... $ 234 $ 214 $ 208 $ 200 $ 155 $ 62 $ 151 $ 75
Weighted average pass-through interest rate to Trust
Certificate holders..................................... 7.71% 7.32% 7.34% 7.05% 6.56% 6.61% 6.26% 6.47%
Highest Trust Certificate pass-through rate................ 7.93% 7.68% 7.49% 7.13% 6.58% 7.08% 6.43% 6.85%
Overcollateralization requirements:
Required percentages:
Initial................................................. 0.75% 1.00% 1.00% 0.50% 0.50% 1.00% 1.00% 1.50%
Final target............................................ 5.95% 5.50% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Stepdown overcollateralization.......................... 11.90% 11.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%
Required Amounts:
Initial............................................... $ 2 $ 2 $ 2 $ 1 $ 1 $ 1 $ 2 $ 2
Final target.......................................... 14 12 11 11 9 4 10 6
Current Status:
Overcollateralization amount........................... $ 2 $ 4 $ 6 $ 7 $ 8 $ 4 $ 10 $ 6
Final target reached or anticipated date to reach...... 1/2001 5/2001 2/2001 12/2000 7/2000 Yes Yes Yes
Stepdown reached or anticipated date to reach.......... 1/2003 9/2003 7/2003 12/2002 7/2002 2/2001 2/2001 4/2001
Annual surety wrap fee..................................... 0.19% 0.21% 0.21% 0.19% 0.19% 0.20% 0.20% 0.22%
Servicing rights:
Original balance........................................ $ 10 $ 10 $ 10 $ 10 $ 8 $ 3 $ 7 $ 4
Current balance......................................... 10 9 9 9 6 2 5 3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1998-1 1997-2 1997-1 1996-2 1996-1
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Original balance of loans securitized:
Business loans.......................................... $ 16 $ 23 $ 22 $16 $ 13
Home equity loans....................................... 89 77 53 24 9
Total................................................... 105 100 75 40 22
Current balance of loans securitized:
Business loans.......................................... $ 10 $ 15 $ 10 $ 7 $ 5
Home equity loans....................................... 53 36 21 7 4
Total................................................... 63 51 31 14 9
Weighted average coupon on loans securitized:
Business loans.......................................... 15.95% 15.90% 15.89% 15.95% 15.83%
Home equity loans....................................... 11.11% 11.62% 11.44% 11.36% 10.63%
Total................................................... 11.88% 12.86% 12.92% 13.55% 13.48%
Percentage of first mortgage loans......................... 79% 72% 70% 69% 68%
Weighted average loan-to-value............................. 74% 72% 70% 67% 67%
Weighted average remaining term (months) on loans securitized 204 198 175 145 141
Original balance of Trust Certificates..................... $ 103 $ 98 $ 73 $ 39 $ 22
Current balance of Trust Certificates...................... $ 57 $ 44 $ 26 $ 11 $ 7
Weighted average pass-through interest rate to Trust
Certificate holders..................................... 6.68% 6.74% 7.37% 7.53% 7.95%
Highest Trust Certificate pass-through rate................ 7.15% 7.13% 7.53% 7.53% 7.95%
Overcollateralization requirements:
Required percentages:
Initial................................................. 1.50% 2.00% 3.00% 3.00% --
Final target............................................ 5.50% 7.00% 8.00% 10.00% 7.00%
Stepdown overcollateralization.......................... 11.00% 14.00% 16.00% 20.00% na
Required Amounts:
Initial............................................... $ 2 $ 2 $ 2 $ 1 $ --
Final target.......................................... 6 7 6 4 2
Current Status:
Overcollateralization amount........................... $ 6 $ 6 $ 5 $ 2 $ 2
Final target reached or anticipated date to reach...... Yes Yes Yes Yes Yes
Stepdown reached or anticipated date to reach.......... 11/2000 Yes Yes Yes na
Annual surety wrap fee..................................... 0.23% 0.26% 0.26% 0.28% na
Servicing rights:
Original balance........................................ $ 4 $ 4 $ 3 $ 2 $ 2
Current balance......................................... 3 3 2 1 1
</TABLE>
Na = not applicable
18
<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 11% discount rate 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. The discount rate for all periods presented
was consistent at 11% because we did not believe that a sufficient sustained
pattern of movement in interest rates occurred to warrant changing the discount
rate.
Other characteristics that support our 11% discount rate are as
follows:
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 spreads 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.
19
<PAGE>
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.
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 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. The assumptions for
prepayment rates and credit loss rates are compared to actual experience. The
length of time before a pool of mortgage loans reaches its expected constant
prepayment rate is referred to as the "prepayment ramp period." Through March
31, 2000, there were no adjustments to the initial assumptions, which continue
to be applied in subsequent reviews of the carrying values of the interest-only
strips and servicing rights. At the time of the sales, the initial assumptions
for prepayment rates and credit loss rates were representative of expectations
for the securitized portfolios' performance. Prior to fiscal year 2000, our
actual prepayment experience both quantitatively and qualitatively was not
sufficient to conclude that the final actual experience expected would be
materially different than the original prepayment assumptions used. For each of
the first three quarters of fiscal year 2000, the net effect of the differences
between the prepayment assumptions and the actual experience was not material.
Because we were continuing to accumulate more complete and accurate statistics,
and the impact of differences between the assumptions and actual experience was
not material, no adjustments were made to the prepayment assumptions through
March 31, 2000. The increase in the initial credit loss assumptions beginning
with the 1999-4 mortgage loan securitization resulted from an increase in the
percentage of second mortgage loans included in current year securitizations and
our concerns regarding the current high levels of real estate values. As shown
on the table "Summary of Selected Mortgage Loan Securitization Trust
Information" in "Securitization Accounting Considerations" the average
percentage of first mortgage loans securitized declined approximately 10% from
fiscal 1999 to fiscal 2000 securitizations. The current high real estate values
effect our loss assumptions on recent securitizations because should an economic
downturn occur, 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
1999-4 continues to support the initial credit loss assumptions for those
securitizations.
20
<PAGE>
Summary of Material Mortgage Loan Securitization
Valuation Assumptions and Actual Experience at March 31, 2000
($ in millions)
<TABLE>
<CAPTION>
2000-1 1999-4 1999-3 1999-2 1999-1 1998-4 1998-3 1998-2
------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-only strip discount rate:
Initial valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%
Servicing rights discount rate:
Initial valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%
Prepayment rates:
Initial assumption:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 10% 10% 10% 10% 10% 13% 13% 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..................................... 18 18 18 18 18 12 12 12
Current assumptions:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 10% 10% 10% 10% 10% 13% 13% 13%
Home equity loans..................................... 24% 24% 24% 24% 24% 24% 24% 24%
Ramp period (months):
Business loans........................................ 24 24 24 24 24 24 24 24
Home equity loans..................................... 18 18 18 18 18 12 12 12
CPR adjusted to reflect ramp:
Business loans........................................ 3.00% 3.61% 4.52% 5.43% 6.35% 9.09% 10.39% 11.70%
Home equity loans..................................... 2.00% 4.58% 8.45% 12.32% 16.19% 24% 24% 24%
Blended rate.......................................... 2.10% 4.47% 7.97% 11.38% 15.28% 22.39% 22.83% 22.20%
Actual CPR experience:
Business loans........................................ -- -- 2.14% 9.95% 5.73% 14.95% 8.34% 9.35%
Home equity loans..................................... -- 4.14% 5.90% 7.16% 9.47% 11.48% 11.99% 19.80%
Blended rate.......................................... -- 3.64% 5.47% 7.46% 9.13% 11.64% 11.69% 18.47%
Credit loss rates:
Annual credit loss rate:
Initial assumption.................................... 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Current assumption.................................... 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Actual experience..................................... -- -- 0.01% 0.01% 0.03% 0.17% 0.05% 0.18%
Cumulative credit loss rate:
Initial assumption.................................... 1.85% 1.35% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20%
Current assumption.................................... 1.85% 1.35% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20%
Cumulative experience to date......................... -- -- -- 0.01% 0.03% 0.24% 0.08% 0.32%
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% 0.75% 0.75%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1998-1 1997-2 1997-1 1996-2 1996-1
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Interest-only strip discount rate:
Initial valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0%
Servicing rights discount rate:
Initial valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation....................................... 11.0% 11.0% 11.0% 11.0% 11.0%
Prepayment rates:
Initial assumption:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 13% 13% 13% 13% 13%
Home equity loans..................................... 24% 24% 24% 24% 24%
Ramp period (months) (a):
Business loans........................................ 24 24 24 24 24
Home equity loans..................................... 12 12 12 12 12
Current assumptions:
Expected Constant Prepayment Rate (CPR):
Business loans........................................ 13% 13% 13% 13% 13%
Home equity loans..................................... 24% 24% 24% 24% 24%
Ramp period (months):
Business loans........................................ 24 24 24 24 24
Home equity loans..................................... 12 12 12 12 12
CPR adjusted to reflect ramp:
Business loans........................................ 13% 13% 13% 13% 13%
Home equity loans..................................... 24% 24% 24% 24% 24%
Blended rate.......................................... 22.21% 20.83% 20.25% 18.77% 17.99%
Actual CPR experience:
Business loans........................................ 16.38% 16.41% 18.05% 20.35% 19.67%
Home equity loans..................................... 20.74% 24.64% 25.09% 26.85% 18.15%
Blended rate.......................................... 20.94% 22.56% 22.95% 24.06% 19.02%
Credit loss rates:
Annual credit loss rate:
Initial assumption.................................... 0.25% 0.25% 0.25% 0.25% 0.25%
Current assumption.................................... 0.25% 0.25% 0.25% 0.25% 0.25%
Actual experience..................................... 0.25% 0.13% 0.18% 0.24% 0.09%
Cumulative credit loss rate:
Initial assumption.................................... 1.20% 1.20% 1.20% 1.20% 1.20%
Current assumption.................................... 1.20% 1.20% 1.20% 1.20% 1.20%
Cumulative experience to date......................... 0.53% 0.35% 0.54% 0.77% 0.36%
Servicing fees:
Contractual fees........................................ 0.50% 0.50% 0.50% 0.50% 0.50%
Ancillary fees.......................................... 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.
21
<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 March 31, 2000
($ in millions)
<TABLE>
<CAPTION>
1999-a 1998-a
----------- ------------
<S> <C> <C>
Original balance of leases securitized.................................. $ 82 $ 80
Current balance of leases securitized................................... $ 64 $ 36
Weighted average yield on leases securitized............................ 11.17% 12.09%
Weighted average remaining term (months) on leases securitized.......... 36 24
Original balance of Trust Certificates.................................. $ 78 $ 76
Current balance of Trust Certificates................................... $ 61 $ 33
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.................................................... 11.0% 11.0%
Current valuation.................................................... 11.0% 11.0%
Servicing rights discount rate:
Initial valuation.................................................... 11.0% 11.0%
Current valuation.................................................... 11.0% 11.0%
Prepayment rates..................................................... (a) (a)
Credit loss rates:
Annual credit loss rate:
Initial assumption................................................. 0.50% 0.50%
Current assumption................................................. 0.50% 0.50%
Actual experience.................................................. 0.45% 0.63%
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.
22
<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 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 March 31, 2000, servicing rights
totaled $66.1 million, compared to $43.2 million at June 30, 1999.
Results of Operations
Overview
For the nine months ended March 31, 2000, net income increased $1.1
million, or 9.9% to $11.5 million from $10.4 million for the same period in
1999. Basic earnings per share increased $0.50 to $3.32 for the nine months
ended March 31, 2000, on average common shares of 3,451,000, compared to $2.82
on average common shares of 3,700,000 for the same period in fiscal 1999.
Diluted earnings per share increased $0.49 to $3.23 for the nine months ended
March 31, 2000, on average common shares of 3,538,000 compared to $2.74 on
average common shares of 3,810,000 for the same period in 1999.
All fiscal 1999 average common share and earnings per common share
amounts have been retroactively adjusted to reflect the effect of a 5% stock
dividend declared August 18, 1999, and paid September 27, 1999.
The increases in net income and earnings per share for all periods
primarily resulted from increases in gains recorded on loans and leases
securitized and increases in fee income due to the increase in loans and leases
available for sale and securitized loans and leases for which servicing was
retained, referred to as the total managed portfolio. For the nine months ended
March 31, 2000, interest accretion earned on interest-only strips also
contributed significantly to the increases in net income and earnings per share.
See "--Nine Months Ended March 31, 2000 Compared to Nine Months Ended March 31,
1999" for a more detailed discussion of results of operations for the nine
months ended March 31, 2000.
23
<PAGE>
Dividends of $0.22 per share were paid for the nine months ended March
31, 2000 compared to dividends of $0.115 per share for the nine months ended
March 31, 1999. In the first quarter of fiscal 2000, we increased our quarterly
dividend by 40% to $0.07 per share and by an additional 14% to $0.08 per share
in the third quarter of fiscal 2000. The common dividend payout ratio based on
diluted earnings per share was 7.1% for the third quarter of fiscal 2000
compared to 5.4% for the third quarter of fiscal 1999.
Our business strategy is dependent upon our ability to increase loan
and lease 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. See "Risk Factors - If we are unable to
successfully implement our business strategy, our revenues may decrease which
could impair our ability to repay the notes."
Summary Financial Results
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
--------------------- Percentage --------------------- Percentage
2000 1999 Increase 2000 1999 Increase
--------- --------- ---------- --------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Total revenues................... $ 34,146 $ 22,969 48.7% $ 92,563 $ 61,209 51.2%
Total expenses................... $ 27,621 $ 17,487 58.0% $ 73,458 $ 45,078 63.0%
Net income....................... $ 3,915 $ 3,509 11.6% $ 11,463 $ 10,427 9.9%
Return on average equity......... 24.19% 27.48% 24.35% 28.88%
Return on average assets......... 3.06% 4.45% 3.29% 4.84%
Earnings per share:
Basic......................... $ 1.16 $ 0.95 22.1% $ 3.32 $ 2.82 17.7%
Diluted....................... $ 1.12 $ 0.92 21.7% $ 3.23 $ 2.74 17.9%
Dividends declared per share..... $ 0.08 $ 0.05 60.0% $ 0.22 $ 0.115 91.3%
</TABLE>
Net Income. For the third quarter of fiscal 2000, net income increased
$0.4 million, or 11.6%, to $3.9 million from $3.5 million for the third quarter
of fiscal 1999. Basic earnings per common share increased to $1.16 on average
common shares of 3,375,000 compared to $0.95 per share on average common shares
of 3,703,000 for the third quarter of fiscal 1999. Diluted earnings per common
share increased to $1.12 on average common shares of 3,502,000 compared to $0.92
per share on average common shares of 3,806,000 for the third quarter of fiscal
1999.
For the nine months ended March 31, 2000, net income increased $1.1
million, or 9.9%, to $11.5 million from $10.4 million for the nine months ended
March 31, 1999. Basic earnings per common share increased to $3.32 on average
common shares outstanding of 3,451,000 compared to $2.82 per share on average
common shares outstanding of 3,700,000 for the nine months ended March 31, 1999.
Diluted earnings per common share increased to $3.23 on average common shares
outstanding of 3,538,000 compared to $2.74 per share on average common shares
outstanding of 3,810,000 for the nine months ended March 31, 1999.
24
<PAGE>
Increases in net income and earnings per share primarily resulted from
the gains recorded on the higher volume of loans originated and securitized,
interest accretion earned on interest-only strips and increases in fee income
due to growth in the total managed portfolio.
As previously reported, our Board of Directors authorized the
repurchase of up to 10% of the outstanding shares of our common stock. On
January 24, 2000, the Board of Directors authorized the repurchase of an
additional 338,000 shares, representing 10.0% of the then outstanding shares.
The Company's Board of Directors initiated the stock repurchase program in view
of the price level of the Company's common stock which was at that time, trading
at below book value and its consistent earnings growth over fiscal 1998 and 1999
which did not result in a corresponding increase in the market value of our
common stock. In the third quarter of fiscal 2000, 18,000 shares were
repurchased representing 0.5% of the outstanding shares. For the first nine
months of fiscal 2000, 258,910 shares were repurchased representing 7.2% of the
outstanding shares at the beginning of the fiscal year. The impact of the share
repurchase program was an increase of diluted earnings per share by $0.05 for
the three month period ending March 31, 2000, and $0.09 for the nine-month
period ended March 31, 2000.
Total Revenues. For the third quarter of fiscal 2000, total revenues
increased $11.1 million, or 48.7%, to $34.1 million from $23.0 million for the
third quarter of fiscal 1999. For the first nine months of fiscal 2000, total
revenues increased $31.4 million, or 51.2%, to $92.6 million from $61.2 million
for the first nine months of fiscal 1999. 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 March 31,
2000, gains of $23.4 million were recorded on the securitization of $264.0
million of loans. This is an increase of $6.0 million, or 34.4%, over gains of
$17.4 million recorded on securitizations of $204.0 million of loans and leases
for the three months ended March 31, 1999.
For the nine months ended March 31, 2000, gains of $63.0 million were
recorded on securitizations of $711.0 million of loans and leases. This is an
increase of $17.2 million, or 37.6%, over gains of $45.8 million recorded on
securitizations of $532.7 million of loans and leases for the nine months ended
March 31, 1999.
The following table summarizes the volume of loan and lease
securitizations by type of loan securitized for the three and nine-month periods
ended March 31, 2000 and 1999 (in millions):
<TABLE>
<CAPTION>
Three Months ended Nine Months Ended
March 31, March 31,
--------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Business loans............................ $ 27.2 $ 16.4 $ 78.9 $ 41.7
Home equity loans......................... 236.8 168.6 622.9 423.3
Equipment leases.......................... -- 19.0 9.2 67.7
------------ ------------ ------------ ------------
Total.................................. $ 264.0 $ 204.0 $ 711.0 $ 532.7
============ ============ ============ ============
</TABLE>
The increase in securitization gains for the three months ended March
31, 2000 was primarily due to the higher volume of loans securitized as
reflected in the table above. The securitization gain as a percentage of loans
securitized, 8.9% for the three months ended March 31, 2000, was down from 9.2%
on loans securitized for the three months ended March 31, 1999. The gain
percentage for the three months ended March 31, 1999 including leases
securitized was 8.5%. The decrease in the gain percentage on loans securitized
for the three months ended March 31, 2000 was primarily due to a reduction in
the spread between the average coupon on loans securitized and the pass-through
25
<PAGE>
rate paid to investors and an increase in the credit loss assumption in the
fiscal 2000 loan securitizations. The unfavorable impact of these factors was
partially offset by the higher percentage of business loans securitized.
Business loans securitized, which have a higher coupon than home equity loans,
represented 10.3% of total loans securitized for the three months ended March
31, 2000, compared to 8.8% of total loans securitized for the three months ended
March 31, 1999. The higher percentage of business loans resulted in an increased
value of the interest-only strips generated from the pool of securitized loans.
See "Securitization Accounting Considerations" for more detail on average
coupons on loans securitized, pass-through rates paid to investors and credit
loss assumptions.
The increase in securitization gains for the nine months ended March
31, 2000 was also due to a higher volume of loans securitized as reflected in
the table above. The securitization gain as a percentage of loans securitized,
9.0% for the nine months ended March 31, 2000, was down from 9.2% on loans
securitized for the nine months ended March 31, 1999. Including leases
securitized, the gain percentages on loans and leases securitized for the nine
months ended March 31, 2000 and 1999 were 8.9% and 8.6%, respectively. The
decrease in the gain percentage on loans securitized for the nine months ended
March 31, 2000 was due to a reduction in the spread between the average coupon
on loans securitized and the pass-through rate paid to investors, increases in
the credit loss assumptions beginning with the 1999-4 mortgage loan
securitization and the impact of the January 1, 1999 adoption of the Statement
of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise" (SFAS No. 134). See "Securitization Accounting
Considerations" for more detail on average coupons on loans, pass-through rates
paid to investors and credit loss assumptions. The impact of SFAS No. 134 is
discussed below.
The increase in the initial credit loss assumptions beginning with the
1999-4 mortgage loan securitization resulted from an increase in the percentage
of second mortgage loans included in current year securitizations and our
concerns regarding the current high levels of real estate values. As shown on
the table "Summary of Selected Mortgage Loan Securitization Trust Information,"
in "Securitization Accounting Considerations" the average percentage of first
mortgage loans securitized declined approximately 10% from fiscal 1999 to fiscal
2000 securitizations. The current high real estate values effect our loss
assumptions on recent securitizations because should an economic downturn occur,
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
1999-4 continues to support the initial credit loss assumptions for those
securitizations.
The unfavorable impacts of the reduction in spread for the nine months
ended March 31, 2000, increases in credit loss assumptions beginning with the
1999-4 mortgage loan securitization, and the impact SFAS No. 134 were partially
offset by the following factors:
o A higher percentage of business loans securitized. For the nine
months ended March 31, 2000, business loans securitized, which
have a higher coupon than home equity loans, represented 11.2% of
total loans securitized, compared to 9.0% of total loans
securitized for the nine months ended March 31, 1999. The higher
percentage of business loans resulted in an increased value of the
interest-only strips generated from the pool of securitized loans.
26
<PAGE>
o A reduction in the annual prepayment rate assumption on business
loans and an increase in the length of the prepayment ramp period
for home equity loans. Due to increases in the volume of loans
originated with prepayment fees, we have reduced the 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, as discussed below, 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 have
lengthened the prepayment ramp period on home equity loans from 12
to 18 months beginning with the 1999-1 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 March 31, 1999, 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. See "Securitization
Accounting Considerations" for a comparison of the prepayment
assumptions used in our valuation of interest-only strips and
servicing rights to actual historical experience.
SFAS No. 134 requires that, after the securitization of a mortgage loan
held for sale, an entity classify the resulting mortgage-backed security or
other retained interests based on its ability and intent to hold or sell those
investments. In accordance with the provisions of SFAS No. 134, as of January 1,
1999, we reclassified our interest-only strips from trading securities to
available for sale securities. As available for sale securities, the difference
on the date of securitization between the fair value of an interest-only strip
and its allocated cost is recorded in stockholders' equity and reported as a
component of comprehensive income. Fair value adjustments of $5.9 million
pre-tax were recorded as a component of comprehensive income in the first six
months of fiscal 2000. In the first six months of fiscal 1999, which was prior
to the adoption of SFAS No. 134 and the resulting reclassification from trading
securities to available for sale securities, all differences on the date of
securitization between fair value and allocated cost of interest-only strips
were recognized in securitization gains. In the third quarters of fiscal 1999
and 2000 and the fourth quarter of fiscal 1999, fair value differences were
recognized as a component of comprehensive income. The adoption of SFAS No. 134
did not have a material effect on our financial condition.
The following schedule details our loan and lease originations (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
----------------------------- -----------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Business purpose loans............. $ 28,815 $ 16,771 $ 81,056 $ 42,721
Home equity loans.................. 265,966 169,725 700,294 500,121
Equipment leases................... 22 24,441 19,631 76,745
------------- ------------- ------------- -------------
$ 294,803 $ 210,937 $ 800,981 $ 619,587
============= ============= ============= =============
</TABLE>
27
<PAGE>
Loan originations for our subsidiary, American Business Credit, Inc.,
which offers business purpose loans secured by real estate, increased $12.0
million, or 71.8%, to $28.8 million for the third quarter of fiscal 2000 from
$16.8 million in the third quarter of fiscal 1999. For the nine months ended
March 31, 2000, loan originations increased $38.4 million, or 89.7%, to $81.1
million from $42.7 million for the nine months ended March 31, 1999. 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 $96.3 million, or 56.7%, to $266.0
million for the third quarter of fiscal 2000 from $169.7 million for the third
quarter of fiscal 1999. For the nine months ended March 31, 2000, loan
originations increased $200.2 million, or 40.0%, to $700.3 million from $500.1
million for the nine months ended March 31, 1999. 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. Interest and fee income for the third quarter of
fiscal 2000 increased $0.5 million, or 10.6%, to $4.7 million from $4.2 million
in the third quarter of fiscal 1999. For the nine months ended March 31, 2000,
interest and fee income increased $1.5 million, or 11.8%, to $14.2 million from
$12.7 million for the nine months ended March 31, 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 and lease originations.
Interest income decreased $0.1 million, or 5.5%, to $1.7 million for
the third quarter of fiscal 2000 from $1.8 million in the third quarter of
fiscal 1999. During the nine months ended March 31, 2000, interest income
decreased $0.5 million, or 7.5%, to $5.3 million from $5.8 million for the nine
months ended March 31, 1999. The decreases are attributable to a shortening of
the time loans remain on our balance sheet prior to securitization.
Fee income increased $0.6 million, or 23.0%, to $3.0 million from $2.4
million for the third quarter of fiscal 1999. For the nine months ended March
31, 2000, fee income increased $2.0 million, or 27.8%, to $8.9 million from $6.9
million for the nine months ended March 31, 1999. The increases for the three
and nine-month periods were the result of increases in the volume of loans
originated during the period. Loan origination related fees which are mainly
comprised of application fees and other fees collected in connection with the
loan approval and closing process increased $3.3 million or 73.4% for the nine
months ended March 31, 2000 from the nine months ended March 31, 1999 mainly due
to a 35.4% increase in loan originations in the current nine month period. This
increase was offset by a $0.7 million decrease in the collection of lease
origination related fees due to our de-emphasis of the leasing origination
business in the current fiscal year.
Included in fee income are premiums earned on whole loan sales.
Premiums on whole loan sales were $0.6 million for both of the three-month
periods ended March 31, 2000 and 1999. Premiums on whole loan sales decreased
17.6% to $1.4 million for the nine months ended March 31, 2000 from $1.7 million
for the nine months ended March 31, 1999. The decrease in premiums for the
nine-month period from the prior year nine-month period was due primarily to a
decrease in the volume of whole loan sales in the current year. The volume of
whole loan sales decreased 7.5% to $77.6 million for the nine months ended March
31, 2000 from $83.9 million for the nine months ended March 31, 1999. The
decrease was due to a decrease in the average premium earned on whole loan sales
in the current year.
28
<PAGE>
Interest Accretion on Interest-Only Strips. Interest accretion
represents the yield component of cash flows received on interest-only strips.
Interest accretion of $4.8 million was recorded in the three month period ended
March 31, 2000 and $11.9 million was recorded in the nine-month period ended
March 31, 2000, compared to $0.3 million in the three month period ended March
31, 1999 and $0.7 million in nine-month period ended March 31, 1999.
We currently 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.
Our methodology and assumptions are further described below.
The increase in interest accretion was affected by two factors. First,
the increases reflect growth of $93.0 million or 74.5% in the average balance of
interest-only strips from $124.8 million for the nine months ended March 31,
1999 to $217.9 million for the nine months ended March 31, 2000 and growth in
cash flow received from interest-only strips. Cash flows received on
interest-only strips were $14.5 million and $34.5 million, respectively, for the
three and nine-month periods ended March 31, 2000, compared to $10.6 million and
$26.5 million, respectively, for the three and nine-month periods ended March
31, 1999. As of June 30, 1998, only one of our existing securitizations had
satisfied its final target overcollateralization requirement and was generating
residual cash flow. As of March 31, 1999, five securitizations had met final
overcollateralization requirements and as of March 31, 2000, eight
securitizations had met final overcollateralization requirements. Meeting these
final targets as well as the fact that our more recent securitizations were much
larger resulted in a significant increase in cash flow to us from fiscal 1998 to
the present.
Second, prior to the fourth quarter of fiscal 1999, residual cash flows
to us were limited due to the lack of maturity of the securitizations underlying
our interest-only strips. As described above, as the securitizations matured,
meaning that the final overcollateralization requirements were met, we received
cash flow from a greater number of securitizations. During the period prior to
receiving significant cash flow from the securitizations, we recognized only a
portion of the estimated interest accretion earned on our interest-only strips.
This methodology reflected our uncertainty as to the timing and quantity of
future residual cash flow. Our estimate of the amount of interest accretion to
be recognized did not change until we received expected cash flow for a
sustained period of time. By the last quarter of fiscal 1999, more experience
with the securitization pools was acquired and on a gradual basis more
securitizations were performing as expected in meeting their final targets. At
that time, we were realizing consistent cash flow and based on this historical
experience, we recognized a greater percentage of the estimated interest
accretion earned by the securitizations. By the end of the first quarter 2000,
as an even greater number of securitizations were meeting final targets, again,
based on the sustained performance of the securitizations, we increased the
percentage of estimated interest accretion recognized. Both of these increases
reflected our increased certainty as to the amount of ongoing residual cash flow
to be received from the securitization trusts. Throughout fiscal 2000, the
interest accretion recognized by quarter as a percentage of cash flow from the
securitization trusts has remained stable.
29
<PAGE>
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 compensation. For the third quarter of fiscal 2000, servicing income
increased $0.2 million, or 23.2%, to $1.2 million, from $1.0 million for the
third quarter of fiscal 1999. For the nine months ended March 31, 2000,
servicing income increased $1.4 million, or 73.5%, to $3.4 million from $2.0
million for the nine months ended March 31, 1999.
The following table summarizes the components of servicing income for
the three months ended March 31, 2000 and 1999 and for the nine months ended
March 31, 2000 and 1999 (in millions):
<TABLE>
<CAPTION>
Three Months ended Nine Months Ended
March 31, March 31,
------------------------- -------------------------
2000 1999 2000 1999
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Contractual and ancillary fees.......... $ 3.7 $ 2.5 $ 12.0 $ 5.7
Amortization of servicing rights........ (2.5) (1.5) (8.6) (3.7)
--------- --------- ---------- ---------
Net servicing income.................... $ 1.2 $ 1.0 $ 3.4 $ 2.0
========= ========= ========== =========
</TABLE>
As an annualized percentage of the average managed portfolio, servicing
income for the quarter decreased to 0.31%, from 0.49% in the prior year. The
servicing income annualized percentage for the first nine months of fiscal 2000
was 0.34%, compared to 0.39% for the first nine months of fiscal 1999. These
decreases were the result of a decrease from the third quarter of fiscal 1999 in
the percentage of loans prepaying. In the three-month period ended March 31,
2000, prepayment fees collected as a percentage of the average managed portfolio
were 0.08% compared to 0.13% for the three-month period ended March 31, 1999. In
addition, amortization of the servicing rights was increased for some
securitization pools based on our quarterly analysis of actual ancillary fee
collection experience for each pool of loans in the securitization trust. In the
three-month period ended March 31, 2000, amortization as a percentage of the
average managed portfolio was 0.21% compared to 0.17% for the three-month period
ended March 31, 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 securitization pool and is recognized
in proportion to, and over the period of, estimated future servicing income on
that particular pool of loans or leases. As discussed above, during the third
quarter of fiscal 2000, fees collected for loan prepayments were lower than
anticipated due to our favorable prepayment experience. Amortization rates for
some pools of loans were increased to maintain a steady decrease in the
unamortized carrying value of the servicing rights during this period to offset
the lower volume of fees collected. This change increased amortization expense
by $0.2 million during the three months ended March 31, 2000. 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 recorded. To date, our valuation analysis has not indicated any impairment
and no valuation allowance has been required. Impairment is measured as the
excess of carrying value over fair value.
30
<PAGE>
Total Expenses. For the third quarter of fiscal 2000, total expenses
increased $10.1 million, or 58.0%, to $27.6 million from $17.5 million for the
third quarter of fiscal 1999. Total expenses increased $28.4 million, or 63.0%,
to $73.5 million for the nine months ended March 31, 2000 as compared to $45.1
million for the nine months ended March 31, 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, sales and marketing, 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 and Internet capabilities.
Interest Expense. For the third quarter of fiscal 2000, interest
expense increased $4.0 million, or 65.1%, to $10.1 million from $6.1 million for
the third quarter of fiscal 1999. The increase was attributable to an increase
in the amount of subordinated debt outstanding during the third quarter of
fiscal 2000, 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 March 31, 2000 was $300.2 million compared to $166.7 million during the
three months ended March 31, 1999. Average interest rates paid on subordinated
debt outstanding increased to 9.96% during the three months ended March 31, 2000
from 9.32% during the three months ended March 31, 1999. Rates offered on
subordinated debt increased in response to general increases in market rates and
to attract funds with a longer average maturity.
The average outstanding balances under warehouse and other lines of
credit were $111.5 million during the three months ended March 31, 2000,
compared to $130.5 million during the three months ended March 31, 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.
During the first nine months of fiscal 2000 interest expense increased
$10.5 million, or 67.0%, to $26.2 million from $15.7 million for the nine months
ended March 31, 1999. Average subordinated debt outstanding during the nine
months ended March 31, 2000 was $260.0 million compared to $143.5 million during
the nine months ended March 31, 1999. The average outstanding balances under
warehouse and other credit lines were $110.5 million during the nine months
ended March 31, 2000 compared to $99.2 million during the nine months ended
March 31, 1999. Average interest rates paid on subordinated debt increased to
9.67% for the first nine months of fiscal 2000 from 9.31% during the comparable
nine month period. Average rates paid on subordinated debt for the fiscal 2000
nine-month period increased due to the factors listed above.
Provision for Credit Losses. The provision for credit losses for the
third quarter of fiscal 2000 decreased $0.2 million, or 38.9%, to $0.3 million
from $0.5 million for the quarter ended March 31, 1999. The decrease was due to
decreased net charge-offs in the three months ended March 31, 2000. Net
charge-offs were $0.2 million in the three months ended March 31, 2000 compared
to $0.5 million in the three months ended March 31, 1999. The higher level of
charge-offs in the three months ended March 31, 1999 was attributable to losses
we recorded on securitized loans and leases which we repurchased from the
securitization trusts in the third quarter of fiscal 1999. 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 sales 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.
31
<PAGE>
The following table summarizes the principal balances of loans we have
repurchased from the mortgage loan securitization trusts for the nine months
ended March 31, 2000 and the three years ended June 30, 1999, 1998 and 1997. 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.
Summary of Loans Repurchased from Mortgage Loan Securitization Trusts
($ in thousands)
<TABLE>
<CAPTION>
1999-3 1999-1 1998-4 1998-3 1998-2 1998-1 1997-2 1997-1 1996-2 1996-1 Total
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Nine months ended March 31, 2000:
Business loans....................$ 101 $ -- $ -- $ -- $ -- $ -- $ -- $ 2,441 $ -- $ 259 $ 2,801
Home equity loans................. -- -- 363 106 2,189 165 -- 1,123 -- -- 3,946
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total..........................$ 101 $ -- $ 363 $ 106 $ 2,189 $ 165 $ -- $ 3,564 $ -- $ 259 $ 6,747
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Number of loans repurchased....... 1 -- 3 1 14 1 -- 35 -- 1 56
Year ended June 30, 1999:
Business loans....................$ -- $ -- $ -- $ -- $ -- $ 23 $ -- $ 51 $ -- $ -- $ 74
Home equity loans................. -- 35 15 311 -- 277 265 344 -- 25 1,272
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total...........................$ -- $ 35 $ 15 $ 311 $ -- $ 300 $ 265 $ 395 $ -- $ 25 $ 1,346
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Number of loans repurchased....... -- 1 1 2 -- 4 4 6 -- 1 19
Year ended June 30, 1998:
Business loans....................$ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 33 $ 264 $ -- $ 297
Home equity loans................. -- -- -- -- -- -- -- 57 144 -- 201
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total...........................$ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 90 $ 408 $ -- $ 498
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Number of loans repurchased....... -- -- -- -- -- -- -- 2 2 -- 4
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
32
<PAGE>
The provision for credit losses for the nine months ended March 31,
2000 increased $0.3 million, or 39.6%, to $1.0 million as compared to $0.7
million for the nine months ended March 31, 1999. The increase in the provision
for the nine-month period was primarily due to recording charge-offs of
delinquent leases in the second quarter of fiscal 2000.
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 $0.5 million at March 31, 2000 compared to $0.7
million at June 30, 1999. The changes in the allowance for credit losses are due
primarily to the write off of $1.0 million of equipment lease receivables in
fiscal 2000.
The following table summarizes the changes in the allowance for credit
losses by loan and lease type for the three and nine-month periods ended March
31, 2000 (in thousands):
<TABLE>
<CAPTION>
Business Home
Purpose Equity Equipment
Three Months Ended March 31, 2000 Loans Loans Leases Total
----------------------------------------- -------- -------- --------- --------
<S> <C> <C> <C> <C>
Balance at beginning of period........... $ 23 $ 160 $ 156 $ 339
Provision for credit losses.............. 108 (12) 235 331
(Charge-offs) recoveries, net............ (86) -- (115) (201)
-------- -------- -------- --------
Balance at end of period................. $ 45 $ 148 $ 276 $ 469
======== ======== ======== ========
Business Home
Purpose Equity Equipment
Nine Months Ended March 31, 2000 Loans Loans Leases Total
----------------------------------------- -------- -------- --------- --------
Balance at beginning of period........... $ 26 $ 243 $ 433 $ 702
Provision for credit losses.............. 192 (1) 849 1,040
(Charge-offs) recoveries, net............ (173) (94) (1,006) (1,273)
-------- -------- -------- --------
Balance at end of period................. $ 45 $ 148 $ 276 $ 469
======== ======== ======== ========
</TABLE>
Employee Related Costs. For the third quarter of fiscal 2000, employee
related costs increased $1.6 million, to $2.8 million, from $1.2 million in the
third quarter of fiscal 1999. For the nine months ended March 31, 2000, employee
related costs increased $3.6 million, to $7.3 million from $3.7 million for the
nine months ended March 31, 1999. These increases were primarily attributable to
an increase in the number of staff in the marketing, loan servicing and other
business support areas to support the growth in loan originations and total
managed portfolio.
33
<PAGE>
Sales and Marketing Expenses. For the third quarter of fiscal 2000,
sales and marketing expenses increased $0.3 million, or 4.3%, to $6.1 million
from $5.8 million for the third quarter of fiscal 1999. For the nine months
ended March 31, 2000, sales and marketing expenses increased $4.8 million, or
32.2%, to $19.9 million from $15.1 million for the nine months ended March 31,
1999. Expenses for direct mail advertising increased $3.9 million for the nine
months ended March 31, 2000 compared to the prior year nine-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 $2.4 million in the first
nine months of fiscal 2000 compared to the prior year nine-month period. In
addition, we increased the use of newspaper and periodical advertising by $1.1
million to generate additional sales of our loan products and subordinated debt
securities. The remaining increase in sales and marketing expense was due to
increased expenditures on various Internet and short-term telemarketing programs
undertaken by the loan origination operations and expenditures for various
corporate communications and initiatives. 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 and sales
of subordinated debt securities.
General and Administrative Expenses. For the third quarter of fiscal
2000, general and administrative expenses increased $4.5 million, or 116.0%, to
$8.3 million from $3.8 million for the third quarter of fiscal 1999. For the
nine months ended March 31, 2000, general and administrative expenses increased
$9.1 million, or 91.3%, to $19.0 million from $9.9 million for the nine months
ended March 31, 1999. 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, the volume of total loans and leases managed during fiscal 2000
and the continued building of support area infrastructure and Internet
capabilities.
34
<PAGE>
BALANCE SHEET INFORMATION
Balance Sheet Data:
(in thousands, except per share data)
<TABLE>
<CAPTION>
March 31, June 30,
2000 1999
------------- -------------
<S> <C> <C>
Cash and cash equivalents.................................................... $ 45,399 $ 22,395
Loan and lease receivables, net:
Available for sale........................................................ 33,259 33,776
Other..................................................................... 10,819 6,863
Interest-only strips......................................................... 258,772 178,218
Receivables for sold loans and leases........................................ 62,651 66,086
Servicing rights............................................................. 66,081 43,210
Total assets................................................................. 533,757 396,301
Subordinated debt............................................................ 329,038 211,652
Warehouse lines and other notes payable...................................... 57,302 58,691
Total liabilities............................................................ 467,265 338,055
Total stockholders' equity................................................... 66,492 58,246
Book value per common share.................................................. $ 19.62 $ 16.24
Debt to tangible equity (a)(d)............................................... 9.16x 7.83x
Adjusted debt to tangible equity (b)(d)...................................... 7.01x 7.01x
Subordinated debt to tangible equity (d)..................................... 6.4x 4.9x
Interest-only strips adjusted tangible equity (c)(d)........................ 2.6x 2.5x
</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 $137.5 million, or 34.7%, to $533.8 million at
March 31, 2000 from $396.3 million at June 30, 1999 primarily due to increases
in cash, interest-only strips and servicing rights.
Cash increased $23.0 million, or 102.7%, to $45.4 million from $22.4
million due to an increase in sales of subordinated debt during the third
quarter of fiscal 2000.
Interest-only strips, created in connection with securitizations,
increased $80.6 million, or 45.2%, to $258.8 million at March 31, 2000 from
$178.2 million at June 30, 1999. We completed $711.0 million in loan
securitizations during fiscal 2000, resulting in the recording of $81.9 million
of interest-only strips. In addition, for the first nine months of fiscal 2000,
interest accretion was $11.9 million and increases in the fair value of
interest-only strips reported in comprehensive income were $0.5 million. These
increases were partially offset by cash flow of $34.5 million received during
the nine-month period from securitization trusts. Cash receipts on interest-only
strips include purchases of additional overcollateralization of $28.1 million
for the nine months ended March 31, 2000. Purchases of additional
overcollateralization include $7.3 million paid to meet the initial
overcollateralization requirements of securitizations closed during the nine
months ended March 31, 2000 and $20.7 million withheld from excess cash flows by
securitization trusts to fund final overcollateralization levels. Total
overcollateralization balances included in interest-only and residual strips
were $69.6 million at March 31, 2000. See "Securitization Accounting
Consideration" for more information regarding overcollateralization requirement.
35
<PAGE>
The following table summarizes the purchases of overcollateralization
by trust for the nine months ended March 31, 2000 and years ended June 30, 1999
and 1998. See "Securitization Accounting Considerations" for a discussion of
overcollateralization requirements.
Summary of Mortgage Loan Securitization Overcollateralization Purchases
($ in thousands)
<TABLE>
<CAPTION>
Off-
Balance
Sheet
Facility 2000-1 1999-4 1999-3 1999-2 1999-1 1998-4 1998-3 1998-2
--------- ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C>
Nine months ended March 31, 2000
Initial overcollateralization................ $1,133 $1,776 $2,222 $2,211
Required purchased of additional
overcollateralization....................... -- 2,105 3,326 5,689 5,319 1,348 2,923
-------- ------ ------ ------ ------ ------ ------ ------ ------
Total..................................... $1,133 $1,776 $4,327 $5,537 $5,689 $ 5,319 $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 4,307
-------- ------ ------ ------ ------ ------ ------ ------ ------
Total..................................... -- -- -- -- $1,100 $ 2,649 $2,652 $7,076 $4,307
======== ====== ====== ====== ====== ====== ====== ====== ======
Year ended June 30, 1998:
Initial overcollateralization................ $1,801
Required purchases of additional
overcollateralization....................... 3
-------- ------ ------ ------ ------ ------ ------ ------ ------
Total..................................... -- -- -- -- -- -- -- -- $1,804
======== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
<PAGE>
[RESTUBBED]
<TABLE>
<CAPTION>
1998-1 1997-2 1997-1 1996-2 1996-1 Total
------ ------ ------ ------ ------ --------
<S> <C>
Nine months ended March 31, 2000
Initial overcollateralization................ $ 7,342
Required purchased of additional
overcollateralization....................... $20,710
------ ------ ------ ------ ------ -------
Total..................................... -- -- -- -- -- $28,052
====== ====== ====== ====== ====== =======
Year ended June 30, 1999:
Initial overcollateralization................ $ 4,825
Required purchases of additional
overcollateralization....................... 2,267 1,456 $16,682
------ ------ ------ ------ ------ -------
Total..................................... $2,267 $1,456 -- -- -- $21,507
====== ====== ====== ====== ====== =======
Year ended June 30, 1998:
Initial overcollateralization................ $1,575 $2,000 $ 5,376
Required purchases of additional
overcollateralization....................... 1,938 3,544 2,972 1,334 170 $ 9,961
------ ------ ------ ------ ------ -------
Total..................................... $3,513 $5,544 $2,972 $1,334 $170 $15,337
====== ====== ====== ====== ====== =======
</TABLE>
36
<PAGE>
Servicing rights increased $22.9 million, or 52.9%, to $66.1 million
from $43.2 million at June 30, 1999, due to the recording of $31.4 million of
mortgage servicing rights obtained in connection with loan securitizations,
partially offset by amortization of servicing rights of $8.6 million for the
nine months ended March 31, 2000.
Total liabilities increased $129.2 million, or 38.2%, to $467.3 million
from $338.1 million at June 30, 1999 due primarily to an increase in
subordinated debt outstanding. For the first nine months of fiscal 2000
subordinated debt increased $117.4 million, or 55.5%, to $329.0 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 6.4 times tangible equity at March 31, 2000,
compared to 4.9 times as of June 30, 1999. See "Liquidity and Capital Resources"
for further detail.
37
<PAGE>
Managed Portfolio Quality
The following table provides data concerning delinquency experience,
real estate owned and loss experience for the managed loan and lease portfolio
(dollars in thousands):
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999 September 30, 1999
--------------------- --------------------- ---------------------
Delinquency by Type Amount % Amount % Amount %
------------------------------------------- ---------- ------ ---------- ------ ---------- ------
<S> <C> <C> <C>
Business Purpose Loans
Total managed portfolio................... $ 205,590 $ 185,820 $ 165,827
========== ========== ==========
Period of delinquency:
31-60 days.............................. $ 1,302 .63% $ 605 .33% $ 710 .43%
61-90 days.............................. 990 .48 1,328 .71 1,165 .70
Over 90 days............................ 10,903 5.30 8,729 4.70 8,732 5.27
---------- ---- ---------- ---- ---------- ----
Total delinquencies..................... $ 13,195 6.41% $ 10,662 5.74% $ 10,607 6.40%
========== ==== ========== ==== ========== ====
REO....................................... $ 2,314 $ 3,211 $ 3,434
========== ========== ==========
Home Equity Loans
Total managed portfolio................... $1,356,772 $1,155,438 $1,006,075
========== ========== ==========
Period of delinquency:
31-60 days.............................. $ 5,965 .44% $ 8,272 .72% $ 5,614 .56%
61-90 days.............................. 4,814 .35 5,371 .46 4,807 .48
Over 90 days............................ 28,068 2.07 27,505 2.38 20,379 2.02
---------- ---- ---------- ---- ---------- ----
Total delinquencies..................... $ 38,847 2.86% $ 41,148 3.56% $ 30,800 3.06%
========== ==== ========== ==== ========== ====
REO ..................................... $ 12,146 $ 10,221 $ 8,873
========== ========== ==========
Equipment Leases
Total managed portfolio................... $ 134,854 $ 155,282 $ 168,973
========== ========== ==========
Period of delinquency:
31-60 days.............................. $ 597 .44% $ 612 .39% $ 300 .18%
61-90 days.............................. 524 .39 379 .24 236 .14
Over 90 days............................ 885 .66 817 .53 2,011 1.19
---------- ---- ---------- ---- ---------- ----
Total delinquencies..................... $ 2,006 1.49% $ 1,808 1.16% $ 2,547 1.51%
========== ==== ========== ==== ========== ====
Combined
------------------------------------------
Total managed portfolio................... $1,697,216 $1,496,540 $1,340,875
========== ========== ==========
Period of delinquency:
31-60 days.............................. $ 7,864 .46% $ 9,489 .63% $ 6,624 .50%
61-90 days.............................. 6,328 .37 7,078 .47 6,208 .46
Over 90 days............................ 39,856 2.35 37,051 2.48 31,122 2.32
---------- ---- ---------- ---- ---------- ----
Total delinquencies..................... $ 54,048 3.18% $ 53,618 3.58% $ 43,954 3.28%
========== ==== ========== ==== ========== ====
REO ..................................... $ 14,460 .85% $ 13,432 .90% $ 12,307 .92%
========== ==== ========== ==== ========== ====
Losses (recoveries experienced during the 3
month period (a)(b)
Loans................................... 751 .21% $ 686 .22% $ 770 .28%
==== ==== ====
Leases.................................. 212 .67% 893 2.62% (9) (.03)%
---------- ==== ---------- ==== ---------- ====
Total managed portfolio................. $ 963 .25% $ 1,579 .46% $ 761 .25%
========== ==== ========== ==== ========== ====
</TABLE>
-----------------------
(a) Percentage based on average total managed portfolio.
(b) Losses recorded on our books for loans owned by us including loans
repurchased from securitization trusts were $575,000 ($201,000 from
charge-offs through the allowance for credit losses and $374,000 for
write-downs of REO). Losses absorbed by loan securitization trusts were
$388,000 for the three months ended March 31, 2000. Losses recorded on our
books for loans owned by us including loans repurchased from securitization
trusts were $1.1 million and losses absorbed by loan securitization trusts
were $517,000 for the three months ended December 31, 1999. Losses recorded
on our books for loans owned by us including loans repurchased from
securitization trusts were $10,000 and losses absorbed by securitization
trusts were $751,000 for the three months ended September 30, 1999.
38
<PAGE>
Delinquent loans and leases. Total delinquencies (loans and leases with
payments past due greater than 30 days) in the total managed portfolio were
$54.0 million at March 31, 2000 compared to $53.6 million at December 31, 1999
and $44.0 million at September 30, 1999. Total delinquencies as a percentage of
the total managed portfolio (the "delinquency rate") were 3.18% at March 31,
2000 compared to 3.58% at December 31, 1999 and 3.28% at September 30, 1999 on a
total managed portfolio of $1.7 billion at March 31, 2000, $1.5 billion at
December 31, 1999 and $1.3 billion at September 30, 1999. Delinquent loans and
leases held as available for sale (which are included in total delinquencies) at
March 31, 2000 were $1.0 million, or 3.0%. In addition, at March 31, 2000, $2.3
million, or 6.9% of available for sale loans were on non-accrual status. See
"Risk Factors" in our Form 10-K for further discussion of risks associated with
potential increases in delinquencies.
Published statistics gathered from a national sample of sub-prime
mortgage companies by the Mortgage Information Corporation, have shown that
delinquency rates averaged 14.39% as of September 1999, as compared to our
current mortgage delinquency rate of 3.33% and September 30, 1999 delinquency
rate of 3.53%. Even when calculating our delinquency rates on a twelve-month
trailing basis, our delinquency rates were 5.3% at March 31, 2000, 6.1% at
December 31, 1999, and 6.2% at September 30, 1999. We believe that our
delinquency rate is in part the result of our centralized credit underwriting
structure, adherence to written underwriting standards and emphasis on
collections. Our collection processes are based on early identification of loans
and leases that have become credit problems, followed by an evaluation and
implementation of appropriate action to work out these loans and leases.
Real estate owned. Total real estate owned ("REO"), comprising
foreclosed properties and deeds acquired in lieu of foreclosure, increased to
$14.5 million, or 0.85% of the total managed portfolio at March 31, 2000
compared to $13.4 million or 0.90% and $12.3 million or 0.92%, respectively, at
December 31, 1999 and September 30, 1999. 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 March 31, 2000 was $1.8 million recorded in
our financial statements, and $12.7 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 third quarter of fiscal 2000, we
experienced net loan and lease charge-offs in our total managed portfolio of
$1.0 million. On an annualized basis, net loan charge-offs for the third quarter
of fiscal 2000 represent 0.25% 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 30% of
principal. 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.
39
<PAGE>
The following table summarizes net charge off experience recorded on
our books by loan type for the nine months ended March 31, 2000 (in thousands):
Nine Months Ended
March 31,
-----------------
2000
-----------------
Business purpose loans........................ $ 173
Home equity loans............................. 94
Equipment leases.............................. 1,006
-------
Total......................................... $ 1,273
=======
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 (generally 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).
Due to the current rising interest rate environment, we expect the
challenge to originate loans at rates that will maintain our current level of
profitability will increase. In addition, recent movements in market interest
rates may negatively impact the profitability of our securitizations due to
increases in rates demanded in the asset backed securities markets. We are
continuously monitoring market rate fluctuations, our product pricing, actions
of our competition and market trends in order to attempt to manage these changes
and maintain our current profitability on loan originations and securitizations.
See "Securitizations" for further detail.
40
<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 March 31, 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) $ 31,424 $ 30 $ 34 $ 39 $ 44 $ 1,687 $ 33,258 $ 34,522
Interest-only strips.................. 39,117 52,495 50,599 46,908 39,024 138,556 366,699 258,772
Servicing rights...................... 20,866 16,613 12,843 9,920 7,685 26,240 94,167 66,081
Investments held to maturity.......... 58 59 70 87 118 392 1,349 868
Rate Sensitive Liabilities:
Fixed interest rate borrowings........ $179,663 $ 72,915 $ 24,584 $ 10,443 $ 19,964 $ 22,168 $329,737 $327,848
Average interest rate................. 9.45% 10.61% 10.61% 10.82% 11.54% 11.73% 10.12%
Variable interest rate borrowings..... $ 46,345 $ 301 $ 2,881 $ 1,079 $ 5,997 $ -- $ 56,603 $ 56,603
Average interest rate................. 7.39% 7.91% 7.91% 7.91% 7.91% 0.00% 7.48%
</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
three-year maturity. We hedge potential rate changes in this security with
futures contracts on a similar underlying security. This provides strong
correlation between our hedge contracts and the ultimate pricing we will receive
on the subsequent securitization. The gain or loss derived from these hedging
transactions is deferred, reported in other assets or other liabilities and
recognized as an adjustment to the gains on sale of loans when the loans are
securitized. Cash flow related to hedging activities is reported as it occurs.
Gains or losses on terminated contracts are recognized in the period the
termination occurs. The effectiveness of our hedges are continuously monitored.
If correlation did not exist, the related gain or loss on the contract would be
recognized as an adjustment to income in the period incurred.
41
<PAGE>
During the nine-month period ended March 31, 2000, cash losses of $0.2
million, and cash gains of $0.3 million were incurred on hedging transactions
(futures contracts), and were recognized as a component of gains on sale
recorded on securitizations during the period. During fiscal 1999, net losses of
approximately $2.0 were incurred on hedging transactions (futures contracts),
and were recognized as reductions to the gains on sale for the securitizations
during the year.
The following schedule details outstanding hedge positions at March 31,
2000. There were no open hedge contracts at June 30, 1999. (in thousands):
Treasury Forward
Futures Treasury
Contracts Sales Total
--------- --------- ---------
Loans available for sale:
Notional Amount........................ $ 10,000 $ -- $ 10,000
Unrealized Losses...................... (40) -- (40)
Mortgage Conduit Facility Assets:
Notional Amount........................ 1,000 20,000 21,000
Unrealized Losses...................... (4) (78) (82)
Loan Commitments:
Notional Amount........................ 19,000 -- 19,000
Unrealized Losses...................... (77) -- (77)
-------- -------- --------
Total:
Notional Amount........................ $ 30,000 $ 20,000 $ 50,000
Unrealized Losses...................... (121) (78) (199)
======== ======== ========
If interest rates on Treasury securities decreased by 100 basis points,
the above hedge positions would result in a loss of approximately $1.5 million.
While Treasury 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 intend to expand the types of derivative financial
instruments we use to hedge interest rate risk. 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. The asset-backed security market is
moving toward pricing that is based on the Eurodollar and the interest rate swap
markets. As a result, we plan to incorporate Eurodollar futures and interest
rate swaps as part of our future hedging strategy. We believe the correlation
between hedging instruments and securitization pricing will strengthen under
this new pricing convention.
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. While Treasury rates and the
pass-through rate of securitizations are generally strongly correlated, this
correlation has not held in periods of financial market disruption.
Additionally, 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.
42
<PAGE>
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 March 31, 2000,
$143.6 million of debt issued by loan securitization trusts was floating rate
debt based on LIBOR, representing 9.38% of total debt issued by mortgage loan
securitization trusts. For the nine months ended March 31, 2000 increases in
one-month LIBOR resulted in a decrease in the fair value of our interest-only
strips of $2.9 million. In accordance with generally accepted accounting
principles, the changes in fair value were 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 $3.0 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 $6.8 million and the fair value of
servicing rights by approximately $1.6 million. See "Securitization Accounting
Considerations" for further information regarding these assumptions.
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 March 31, 2000 approximately $149.9 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.
43
<PAGE>
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 to meet these requirements 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. The
cash balances that we have built over the last 21 months are sufficient to cover
approximately 27% of the $167 million of subordinated debt maturities due within
one year. Cash balances have increased from $4.5 million at June 30, 1998, to
$22.4 million at June 30, 1999 and $45.4 million at March 31, 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.
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.
44
<PAGE>
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.
At March 31, 2000, a total of $329.0 million of subordinated debt was
outstanding, and warehouse and credit facilities totaling $323.1 million were
available, of which $81.8 million was drawn upon.
Subordinated Debt Securities. During the first nine months of fiscal
2000, we sold $117.4 million in principal amount of subordinated debt
securities, net of redemptions, with maturities ranging between one day and ten
years. As of March 31, 2000, $329.0 million of subordinated debt was
outstanding. Under a shelf registration statement declared effective by the
Securities and Exchange Commission on October 15, 1999, we registered $300.0
million of subordinated debt, of which $170.0 million was available for future
issuance at March 31, 2000. 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.
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 March 31, 2000, we were in compliance with the terms of all
loan covenants.
<TABLE>
<CAPTION>
Amount Amount
Amount Utilized-on Utilized-off
Committed Balance Sheet Balance Sheet
--------- ------------- -------------
<S> <C> <C> <C> <C>
Revolving credit facilities:
Warehouse revolving line of credit, expiring August 2000.... $ 150,000 $ 4,493 $21,407
Warehouse revolving line of credit, expiring October 2000... 150,000 31,774 --
--------- -------- -------
Total warehouse facilities.................................. 300,000 36,267 21,407
Revolving line of credit, expiring December 2000............ 5,000 5,000 --
Repurchase agreement........................................ 4,677 4,677 --
--------- -------- -------
Total revolving credit facilities........................... 309,677 45,944 21,407
Other credit facilities and notes payable:
Commercial paper conduit for lease production, maturity
matches underlying leases................................. 13,401 10,659 2,742
Other debt.................................................. 699 699 --
--------- -------- -------
Total credit facilities..................................... $ 323,777 $ 57,302 $24,149
========= ======== =======
</TABLE>
Our subsidiaries had an aggregate $100.0 million Interim Warehouse and
Security Agreements with Prudential Securities Credit Corporation expiring
August 31, 1999 to fund loan originations. The agreement was subsequently
increased to $150.0 million and extended to August 31, 2000. The obligations
under 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 $150 million at March 31, 2000.
45
<PAGE>
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 March 31, 2000, we had sold approximately
$21.4 million in principal amount of loans to the conduit facility and
recognized gains on those sales totaling approximately $2.1 million.
We, along with some of our subsidiaries, obtained a $150.0 million
warehouse credit facility from a syndicate of banks led by Chase Bank of Texas
N.A. expiring October 1, 2000. Under this warehouse facility, advances may be
obtained, subject to specific conditions described in the agreement, including
sublimits based upon the type of collateral securing the advance. Interest rates
on the advances are based upon 30-day LIBOR plus a margin. Obligations under the
facility are collateralized by specified pledged loans and other collateral
related thereto. The facility also requires us to meet specific financial ratios
and contains restrictive covenants, including covenants limiting loans to and
transactions with affiliates, the issuance of additional debt, and the types of
investments that can be purchased. At March 31, 2000, $31.8 million of this
facility was drawn upon.
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. At March 31, 2000, $5.0 million of this line of
credit was being utilized.
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.
Subsequent to March 31, 2000 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.
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As of March 31, 2000, $236.4 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.
Any 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. See note 14 of the notes to consolidated
financial statements for information regarding lease payments.
Year 2000 Update
Prior to December 31, 2000 the Company had performed various activities
to ensure our information technology systems and those of our significant
vendors were Year 2000 compliant. Since January 1, 2000 there have been no
disruptions to our operations due to Year 2000 related events.
Recent Accounting Pronouncements
Set forth below are recent accounting pronouncements which may have a
future effect on operations. These pronouncements should be read in conjunction
with the significant accounting policies, which have been adopted, that are set
forth in note 1 of the notes to the consolidated financial statements.
In June 1998, the Financial Accounting Standards Board ("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 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 specific 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, an unrecognized firm commitment, an
available for sale security, or a foreign-currency-denominated forecasted
transaction. At the time of issuance SFAS No. 133 was to be effective on a
prospective basis for all fiscal quarters of fiscal years beginning after June
15, 1999. Subsequently, the effective date of the standard was delayed until
years beginning after June 15, 2000. The adoption of this standard is not
expected to have a material effect on our financial condition or results of
operations.
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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." Additional quantitative
and qualitative disclosures regarding market risk are contained in the Company's
Form 10-K for the fiscal year ended June 30, 1999.
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American Business Financial Services, Inc. and Subsidiaries
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
------ ------------------------
10.l 2000-1 Securitization Agreement - the Sale and Servicing
Agreement, dated as of March 1, 2000, by and among Prudential
Securities Secured Financing Corporation, ABFS Mortgage Loan Trust
2000-1, Chase Bank of Texas, N.A., as collateral agent, The Chase
Manhattan Bank, as indenture trustee and American Business Credit,
Inc., as servicer.*
10.2 The Sale and Servicing Agreement dated as of March 1, 2000 by and
among ABFS Millenium, Inc., as Depositor, American Business
Credit, Inc., HomeAmerican Credit, Inc., d/b/a Upland Mortgage and
New Jersey Mortgage and Investment Corp., as Originators, American
Business Financial Services, Inc., as Guarantor, ABFS Mortgage
Loan Warehouse Trust, as Issuer, American Business Credit, Inc.,
as Servicer, and The Chase Manhattan Bank, as Indenture Trustee
and Collateral Agent.*
27 Financial Data Schedule.*
--------------------
* Previously filed.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended March 31,
2000.
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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 6, 2000 BY: /s/ Abert W. Mandia
--------------------------------------
Albert W. Mandia
Executive Vice President and Chief
Financial Officer
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