<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
<TABLE>
<S> <C>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
</TABLE>
For the quarter ended September 30, 1997 Commission file number 0-20526
------------------------
ARCADIA FINANCIAL LTD.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
MINNESOTA 41-1664848
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification
organization) Number)
</TABLE>
7825 WASHINGTON AVENUE SOUTH, MINNEAPOLIS, MN 55439-2435
(Address of principal executive office)
Registrant's telephone number, including area code (612) 942-9880
------------------------
Indicate by checkmark whether the Registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ____
The number of shares of the Common Stock of the registrant outstanding as of
November 5, 1997 was 38,116,501.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
FORM 10-Q INDEX
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements.............................................................. 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 12
PART II OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 24
Item 2. Changes in Securities.......................................................................... 24
Item 3. Defaults Upon Senior Securities................................................................ 24
Item 4. Submission of Matters to a Vote of Security Holders............................................ 24
Item 5. Other Information.............................................................................. 24
Item 6. Exhibits and Reports on Form 8-K............................................................... 24
SIGNATURES................................................................................................. 28
EXHIBIT INDEX.............................................................................................. 29
</TABLE>
The financial information for the interim periods presented herein is
unaudited. In the opinion of management, all adjustments necessary (which are of
a normal recurring nature) have been included for a fair presentation of the
results of operations. The results of operations for an interim period are not
necessarily indicative of the results that may be expected for a full year or
any other interim period.
SAFE HARBOR STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Form 10-Q for quarter ended September 30, 1997 contains certain
forward-looking statements as defined in the Private Securities Litigation
Reform Act of 1995, which can be identified by the use of forward-looking
terminology such as "may," "will," "expect," "anticipate," "estimate," "should"
or "continue" or the negative thereof or other variations thereon or comparable
terminology. The matters set forth under the captions "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Cautionary
Statements" herein and "Cautionary Statements" in Exhibit 99.1 filed herewith
constitute cautionary statements identifying important factors with respect to
such forward-looking statements, including certain risks and uncertainties, that
could cause actual results to differ materially from those in such
forward-looking statements.
2
<PAGE>
ARCADIA FINANCIAL LTD.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1997 1996
--------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 17,720 $ 16,057
Due from securitization trust............................... 149,430 177,076
Auto loans held for sale.................................... 55,630 36,285
Finance income receivable................................... 353,019 362,916
Restricted cash in spread accounts.......................... 226,566 142,977
Furniture, fixtures and equipment........................... 17,269 13,630
Other assets................................................ 32,622 29,289
--------------- --------------
Total assets.......................................... $ 852,256 $ 778,230
--------------- --------------
--------------- --------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Amounts due under warehouse facilities...................... $ 126,263 $ 111,140
Senior term notes........................................... 291,886 145,000
Subordinated notes.......................................... 51,294 53,689
Capital lease obligations................................... 5,942 7,729
Deferred income taxes....................................... 16,394 54,387
Accounts payable and accrued liabilities.................... 16,495 13,192
--------------- --------------
Total liabilities..................................... 508,274 385,137
Commitments and contingencies
Shareholders' equity:
Capital stock, $.01 par value, 100,000,000 shares
authorized:
Common stock 38,116,501 and 36,416,802 shares issued and
outstanding, respectively............................. 381 364
Additional paid-in capital................................ 322,866 310,187
Retained earnings......................................... 20,735 82,542
--------------- --------------
Total shareholders' equity............................ 343,982 393,093
--------------- --------------
Total liabilities and shareholders' equity............ $ 852,256 $ 778,230
--------------- --------------
--------------- --------------
</TABLE>
See notes to unaudited consolidated financial statements.
3
<PAGE>
ARCADIA FINANCIAL LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
REVENUES:
Net interest margin.................................... $ 20,122 $ 18,079 $ 57,617 $ 45,464
Gain on sale of loans, net of $98.0 million special
charge in March 1997................................. 28,788 30,113 (22,640) 80,794
Servicing fee income................................... 12,155 7,474 32,680 19,774
Other non-interest income.............................. 2,599 1,406 6,983 4,579
------------ ------------ ------------ ------------
Total revenues....................................... 63,664 57,072 74,640 150,611
EXPENSES:
Salaries and benefits.................................. 16,230 10,286 45,823 28,196
General and administrative and other operating
expenses............................................. 24,471 13,107 74,446 35,150
------------ ------------ ------------ ------------
Total operating expenses............................. 40,701 23,393 120,269 63,346
Long-term debt and other interest expense.............. 10,400 6,660 28,642 18,609
------------ ------------ ------------ ------------
Total expenses....................................... 51,101 30,053 148,911 81,955
------------ ------------ ------------ ------------
Operating income (loss) before income taxes and
extraordinary item................................... 12,563 27,019 (74,271) 68,656
Income tax expense (benefit)........................... 4,774 9,862 (28,292) 25,706
------------ ------------ ------------ ------------
Income (loss) before extraordinary item................ 7,789 17,157 (45,979) 42,950
Extraordinary item..................................... -- -- (15,828) --
------------ ------------ ------------ ------------
Net income (loss)...................................... $ 7,789 $ 17,157 $ (61,807) $ 42,950
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
PRIMARY EARNINGS PER SHARE:
Net income (loss) per common share before extraordinary
item................................................. $ 0.20 $ 0.47 $ (1.17) $ 1.32
Extraordinary item per common share.................... -- -- (0.41) --
------------ ------------ ------------ ------------
Net income (loss) per common share..................... $ 0.20 $ 0.47 $ (1.58) $ 1.32
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
FULLY DILUTED EARNINGS PER SHARE:
Net income (loss) per share before extraordinary
item................................................. $ 0.20 $ 0.44 $ (1.17) $ 1.20
Extraordinary item per share........................... -- -- (0.41) --
------------ ------------ ------------ ------------
Net income (loss) per share............................ $ 0.20 $ 0.44 $ (1.58) $ 1.20
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average common and common equivalent shares
outstanding:
Primary................................................ 39,231,961 35,896,149 39,221,089 31,564,219
Fully diluted.......................................... 39,412,220 39,423,446 39,309,403 35,851,933
</TABLE>
See notes to unaudited consolidated financial statements.
4
<PAGE>
ARCADIA FINANCIAL LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................................................... $ (61,807) $ 42,950
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization...................................................... 5,163 3,052
(Gain) Loss on sales of furniture, fixtures and equipment.......................... (9) 147
(Increase) decrease in assets:
Automobile loans held for sale:
Purchases of automobile loans.................................................. (2,323,464) (2,009,930)
Sales of automobile loans...................................................... 2,276,335 2,067,225
Repayments of automobile loans................................................. 27,784 42,336
Finance income receivable........................................................ 9,897 (121,952)
Restricted cash in spread accounts............................................... (83,589) (58,491)
Due from securitization trusts................................................... 27,646 (188,373)
Prepaid expenses and other assets................................................ 350 (6,919)
Increase (decrease) in liabilities:
Deferred income taxes............................................................ (37,993) 25,705
Accounts payable and accrued liabilities......................................... 3,303 10,237
------------ ------------
Total cash used in operating activities...................................... (156,384) (194,013)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchase of furniture, fixtures and equipment.................................... (7,055) (2,746)
Purchase of subordinated certificates................................................ -- (1,869)
Collections on subordinated certificates............................................. 1,187 817
------------ ------------
Total cash used in investing activities...................................... (5,868) (3,798)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of Common Stock........................................... 2,976 150,879
Payment of dividends on 8% Convertible Preferred Stock............................... -- (1,152)
Proceeds from borrowings under warehouse facilities.................................. 2,559,245 1,297,228
Repayment of borrowings under warehouse facilities................................... (2,544,122) (1,285,272)
Subordinated notes, net proceeds (repayments)........................................ (2,395) 40,558
Repayments of long-term debt......................................................... (145,000) --
Proceeds from issuance of Senior Notes............................................... 300,000 --
Deferred debt issuance cost, net..................................................... (4,870) (338)
Reduction of capital lease obligations............................................... (1,919) (1,839)
------------ ------------
Total cash provided by financing activities.................................. 163,915 200,064
------------ ------------
Net increase in cash and cash equivalents............................................ 1,663 2,253
Cash and cash equivalents at beginning of period..................................... 16,057 1,340
------------ ------------
Cash and cash equivalents at end of period........................................... $ 17,720 $ 3,593
------------ ------------
------------ ------------
Supplemental disclosures of cash flow information:
Non cash activities:
Additions to capital leases...................................................... $ 132 $ 5,964
Cash paid for:
Interest......................................................................... $ 36,669 $ 20,062
</TABLE>
See notes to unaudited consolidated financial statements.
5
<PAGE>
ARCADIA FINANCIAL LTD.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
---------------------------------------------------------
NUMBER OF ADDITIONAL
COMMON COMMON PAR PAID IN RETAINED
SHARES VALUE CAPITAL EARNINGS TOTAL
--------- ------------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996............ 36,416,802 $ 364 $ 310,187 $ 82,542 $ 393,093
Issuance of options and warrants...... -- -- 8,590 -- 8,590
Exercise of options and warrants...... 1,495,539 15 2,392 -- 2,407
Issuance of Common Stock:
Benefit plans....................... 204,160 2 566 -- 568
Amortization of deferred
compensation........................ -- -- 1,131 -- 1,131
Net income............................ -- -- -- (61,807) (61,807)
--------- ----- --------- --------- ---------
BALANCE, SEPTEMBER 30, 1997........... 38,116,501 $ 381 $ 322,866 $ 20,735 $ 343,982
--------- ----- --------- --------- ---------
--------- ----- --------- --------- ---------
</TABLE>
See notes to unaudited consolidated financial statements.
6
<PAGE>
ARCADIA FINANCIAL LTD.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The interim financial statements have been prepared
by the Company pursuant to the rules and regulations of the Securities and
Exchange Commission applicable to quarterly reports on Form 10-Q. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although management
believes that the disclosures present fairly the financial position of the
Company and its subsidiaries for the periods presented. These financial
statements should be read in conjunction with the audited consolidated financial
statements and related notes and schedules included in the Company's 1996 Annual
Report on Form 10-K filed February 10, 1997.
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Certain reclassifications have been made to the September 30, 1996 and
December 31, 1996 balances to conform to current period presentation.
FINANCE INCOME RECEIVABLE. In April 1997, the Company changed its
accounting policy with respect to valuation of repossessed vehicles. This policy
requires the Company to record the estimated realizable value of repossessed
vehicles at amounts which approximate that which is expected to be achieved
through wholesale disposition. See Management's Discussion and Analysis--SPECIAL
CHARGES for additional discussion.
Effective January 1, 1997 the Company is required to account for gains on
sale of loans in accordance with Statement of Financial Accounting Standards No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("SFAS 125"). The Company's implementation of
SFAS 125 incorporates the change in accounting policy discussed above in
determining the fair value of assets retained by the Company. In addition, the
Company has applied a discount rate in determining the present value of
estimated future cash flows that reflects its revised estimates of the yields
required by purchasers of similar financial instruments. Exclusive of the effect
of the change in accounting policy discussed above, the implementation of SFAS
125 did not have a significant effect on the Company's accounting for gains on
sale of loans.
EARNINGS PER SHARE. In February 1997, the Financial Accounting Standards
Board issued Statement No. 128, "Earnings per Share," ("SFAS 128") which is
required to be adopted on December 31, 1997. At that time, the Company will be
required to change the method currently used to compute earnings per share (EPS)
and to restate all prior periods. SFAS 128 replaces the presentation of primary
EPS with a presentation of basic EPS and fully diluted EPS with diluted EPS.
Basic EPS, unlike primary EPS, excludes dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted EPS gives effect to all dilutive
potential
7
<PAGE>
ARCADIA FINANCIAL LTD.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
common shares outstanding during the period. The proforma basic and diluted EPS
of the Company, for the three and nine months ended September 30, 1997 and 1996,
are presented below:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
--------- --------- --------- ---------
Basic.......................................................................... $ 0.20 $ 0.50 $ (1.60) $ 1.43
Diluted........................................................................ $ 0.20 $ 0.44 $ (1.58) $ 1.21
</TABLE>
2. FINANCE INCOME RECEIVABLE
The following table sets forth the components of finance income receivable.
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
(DOLLARS IN THOUSANDS)
Estimated cash flows on loans sold, net of estimated prepayments.......... $ 687,720 $ 549,876
Deferred servicing income................................................. (86,611) (59,473)
Reserve for loan losses................................................... (218,280) (95,005)
------------- ------------
Undiscounted cash flows on loans sold, net of estimated prepayments....... 382,829 395,398
Discount to present value................................................. (29,810) (32,482)
------------- ------------
$ 353,019 $ 362,916
------------- ------------
------------- ------------
Reserve for loan losses as a percentage of servicing portfolio............ 4.52% 2.51%
</TABLE>
The following represents the roll-forward of the finance income receivable
balance:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C>
BALANCE, DECEMBER 31, 1996................................................................ $ 362,916
Estimated cash flows on loans sold, net of estimated prepayments........................ 187,299
Recognition of present value effect of discounted cash flows............................ 16,603
Less:
Excess cash flows deposited to spread accounts (1)...................................... (115,799)
Change in estimate of future recovery rates (2)......................................... (98,000)
------------
BALANCE, SEPTEMBER 30, 1997............................................................... $ 353,019
------------
------------
</TABLE>
- ------------------------
(1) Includes approximately $2.3 million of cash released to the Company from
remaining spread account balances associated with three securitization
transactions initiated in 1993 and closed out during 1997.
(2) Refer to Management's Discussion and Analysis--SPECIAL CHARGES.
8
<PAGE>
ARCADIA FINANCIAL LTD.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
3. RESTRICTED CASH IN SPREAD ACCOUNTS
The following represents the roll-forward of restricted cash in spread
accounts:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C>
BALANCE, DECEMBER 31, 1996.................................................................. $ 142,977
Excess cash flows deposited to spread accounts............................................ 115,799
Initial spread account deposits........................................................... 19,375
Interest earned on spread accounts........................................................ 7,311
Less:
Excess cash flows released to the Company (1)............................................. (58,896)
----------
BALANCE, SEPTEMBER 30, 1997................................................................. $ 226,566
----------
----------
</TABLE>
- ------------------------
(1) Includes $14.5 million that has been restricted pursuant to an arrangement
between the Company and its provider of asset-backed securities insurance.
Such arrangement provides that, if any insured securitization trust exceeds
the specified portfolio performance test as defined within the trust
agreement, the Company may, in lieu of retaining excess cash from that
securitization trust in the related spread accounts, pledge an equivalent
amount of cash, which has the effect of preventing the violation of the
portfolio performance test. Such pledged amounts are included in cash and
cash equivalents. Restrictions on the pledged amounts may be lifted if the
portfolio performance tests are met and maintained for the related
securitization trusts as defined in the arrangement, the violations are
waived, or the loans within the securitization trust are repurchased by the
Company.
4. OTHER ASSETS
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------ -----------------
<S> <C> <C>
(DOLLARS IN THOUSANDS)
Advances due to servicer................................................... $ 5,008 $ 8,140
Deferred debt issuance costs............................................... 9,308 4,438
Investment in subordinated certificates.................................... 3,142 4,329
Servicing fee receivable................................................... 4,106 3,121
Prepaid expenses........................................................... 1,814 2,755
Servicing assets........................................................... 3,724 --
Other assets............................................................... 5,520 6,506
------- -------
$ 32,622 $ 29,289
------- -------
------- -------
</TABLE>
9
<PAGE>
ARCADIA FINANCIAL LTD.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
5. SUBORDINATED NOTES
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------ -----------------
<S> <C> <C>
(DOLLARS IN THOUSANDS)
Senior subordinated notes, Series 1996-A................................... $ 30,000 $ 30,000
Junior subordinated notes.................................................. 21,294 23,689
------- -------
$ 51,294 $ 53,689
------- -------
------- -------
</TABLE>
6. SENIOR NOTES
In March 1997, the Company sold to the public $300.0 million aggregate
principal amount of 11.50% Senior Notes, due 2007 (the "Senior Notes") and
received net proceeds of approximately $291.2 million. Each Senior Note includes
a detachable warrant, and such warrant when exercised entitles the holders to
acquire an aggregate of 2,052,000 shares of the Company's common stock. Interest
on the Senior Notes is payable semi-annually on March 15 and September 15 of
each year, beginning September 15, 1997. The Senior Notes may not be redeemed
prior to March 15, 2002. At any time on such date or thereafter, the Company may
at its option elect to redeem the Senior Notes, in whole or in part, at a
premium ranging from 105.75% to 101.92% of the principal amount of Senior Notes
redeemed between the years 2002-2004, respectively, or 100% thereof on or after
March 15, 2005, plus accrued interest to and including the redemption date. The
Senior Notes are general, unsecured obligations of the Company and will rank
pari passu in right of payment to all existing and future senior debt (as
defined in the indenture governing the Senior Notes). Approximately $173.5
million of the net proceeds from the issuance of the Senior Notes was used to
repurchase and covenant defease the Company's 13% Senior Term Notes (including a
prepayment premium and accrued interest) and the remainder made available for
working capital. The premium paid for the early extinguishment of debt
(approximately $20.3 million) and the charge-off of remaining capitalized debt
financing costs (approximately $3.2 million) were recognized and accounted for
as an extraordinary item.
7. SHAREHOLDERS' EQUITY
As discussed in Note No. 6 above, the Company issued warrants to purchase an
aggregate of 2,052,000 shares of the Company's common stock in connection with
its issuance of Senior Notes. The fair value of the warrants on the date of
issue, as determined by the Company, has been recognized as a component of
additional paid-in capital. In October 1997, the Company announced that the
warrants will detach from the Senior Notes and will trade separately from the
Senior Notes as of October 10, 1997. The warrants are exercisable at a price of
$11.00 per share.
8. SUBSEQUENT EVENTS
In October 1997, the Company sold to the public $75.0 million aggregate
principal amount of 11.50% Senior Notes, due 2007 (the "Notes") and received net
proceeds of approximately $71.2 million. Interest on the Notes is payable
semi-annually on March 15 and September 15 of each year, beginning March 15,
1998. The Notes may not be redeemed prior to March 15, 2002. At any time on such
date or thereafter, the Company may at its option elect to redeem the Notes, in
whole or in part, at a premium ranging from
10
<PAGE>
ARCADIA FINANCIAL LTD.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
8. SUBSEQUENT EVENTS (CONTINUED)
105.75% to 101.92% of the principal amount of Notes redeemed between the years
2002-2004, respectively, or 100% thereof on or after March 15, 2005, plus
accrued interest to and including the redemption date. The Notes are general,
unsecured obligations of the Company and will rank pari passu in right of
payment to all existing and future senior debt (as defined in the indenture
governing the Senior Notes). The net proceeds from the issuance of the Notes
will be used to support the purchase of automobile loans, for working capital
and for other general corporate purposes.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Substantially all of the Company's earnings are derived from the purchase,
securitization and servicing of consumer automobile loans originated in 43
states primarily by car dealers affiliated with major foreign and domestic
manufacturers. Loans are purchased through 18 regional buying centers serving as
"hubs," supplemented by a network of dealer development representatives
("DDRs"). DDRs generate loans in "hubs" or "spokes" (a market outside the
specific area of a "hub"), while credit approval and loan processing are
generally performed at the "hub" or at the Company's headquarters in
Minneapolis, Minnesota. The Company services loans through its national customer
service center and four regional collection centers.
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
RESULTS OF OPERATIONS
SPECIAL CHARGES. Included in the Company's financial results during the
nine month period ended September 30, 1997 are two special charges taken in
March 1997. These charges include a non-cash after-tax charge of approximately
$63.9 million, due primarily to a change in accounting estimate and
modifications to the Company's retail disposition strategy, and an extraordinary
charge of approximately $15.8 million, net of tax, due to the early
extinguishment of the Company's 13% Senior Term Notes, due 2000 (see
Management's Discussion and Analysis--EXTRAORDINARY ITEM).
Approximately $60.8 million of the $63.9 million after-tax charge is due to
(i) a change in estimated recovery rates on current repossessed inventory and
anticipated future inventory arising from existing securitization transactions,
and (ii) a change in the Company's accounting policy with respect to the
estimated recovery rate realized upon disposition of repossessed inventory. The
remaining $3.1 million after-tax charge relates to various litigation and
severance charges (see Management's Discussion and Analysis--OPERATING
EXPENSES).
The recovery rate on repossessed inventory is measured by the liquidation
amount realized on the repossessed vehicles as a percentage of the outstanding
principal balance of the charged-off loans associated with the repossessed
vehicles. The Company's change in estimated recovery rates was based, in part,
on a decline in the weighted average recovery rate experienced by the Company
during the first three months of 1997. During the first quarter of 1997, the
weighted average recovery rate on repossessed vehicles declined to approximately
70% from approximately 83% for the year ended December 31, 1996. This reduction
in recovery rates primarily reflects increased liquidation of repossessed
inventory through wholesale auctions. The Company increased its use of wholesale
auctions after a review by the Company's new chief executive officer and other
members of management conducted in mid-March 1997 indicated that based on the
number of retail dispositions during the first half of March 1997 the Company's
current retail distribution channels were not sufficient to liquidate vehicles
at a pace satisfactory to management and would not, in the foreseeable future,
be adequate to exceed the number of additional repossessions expected each
month. In order to reduce the Company's repossessed inventory to a level more
acceptable to management, the Company sold a significantly increased number of
repossessed vehicles at wholesale auctions during the last half of March 1997.
As a result, the Company sold approximately 35% of first quarter sales of
repossessed vehicles through wholesale auctions, as compared with 30% during the
calendar year 1996. The Company's recovery rates were also affected during the
first quarter of 1997 due to lower pricing of repossessed vehicles sold through
the Company's retail distribution channels in an attempt to accelerate the
liquidation of repossessed vehicles while maintaining consistent credit quality.
Estimated recovery rates are also determined by an analysis of anticipated
recovery trends in future periods. Based on its evaluation of certain events
occurring late in the first quarter of 1997, the Company
12
<PAGE>
believes that recovery rates are not likely to increase above the level
experienced during the first quarter of 1997 and that certain events may cause a
further decline in these rates in future periods. As explained above, the
Company does not believe that it has sufficient capacity to sell an increasing
number of repossessed vehicles through its current network of retail consignment
dealers. Accordingly, the Company expects to control the size of its repossessed
inventory by continuing to increase the use of wholesale auctions to dispose of
repossessed vehicles. In April 1997, the Company's new chief executive officer
completed a review of the Company's retail disposition strategy. Consequently,
based on the recommendation of the new chief executive officer, the Company
adopted modifications to its retail disposition strategy that are intended to
reduce liquidity requirements of this strategy and establish more efficient
operating procedures. The Company's retail disposition strategy generally
requires it to hold a repossessed vehicle in inventory for a longer period of
time than would a wholesale disposition strategy, and as a consequence delays
the receipt of excess cash flows from securitization trusts following default of
a loan. In light of this, the Company has established a policy that limits the
length of time a repossessed vehicle may be held for resale through retail
channels. The limitation on the length of time a repossessed vehicle is held for
sale is intended to reduce delays in cash flow, but may reduce overall recovery
rates due to an increased use of wholesale auctions. Under the modified retail
disposition strategy, the Company intends to measure the effectiveness of the
strategy by the program's profitability as compared to a wholesale disposition
strategy. Management of the retail disposition program will be accountable for
optimizing the recovery rates on the repossessed inventory and achieving
acceptable profitability levels. As a result, it is expected that managers
responsible for the modified retail disposition program will increase the use of
wholesale auctions to control inventory size and the costs associated with the
operation of the program. The Company's retail disposition strategy, as
modified, is relatively new and evolving, and therefore, the Company's
management has concluded that recoveries under the program are uncertain and may
be subject to further change.
In addition, the Company anticipated a continued softening of the used car
market and therefore lower retail and wholesale prices. Factors contributing to
this market softening include the recent start-up of superstore competition and
forecasted levels of used lease vehicles that will be available in the market.
Further, the Company considered the risk of potentially higher interest rates
which have a direct impact on pricing of vehicles. The Company concluded that,
for the reasons described above, future recovery rates (after giving effect to
related costs) will be lower for the foreseeable future than those reflected in
the Company's prior accounting estimates. In light of these items, the Company
elected to record an after-tax charge of approximately $45.3 million in March
1997 which reflected an adjustment of current inventory and estimated reduction
to future cash flows due to lower expected recovery rates on future inventory
arising from existing securitization trusts.
At the same time as the Company changed its estimated recovery rates, the
Company also deemed it appropriate to review its accounting policy concerning
the valuation of repossessed vehicles in light of the modifications to its
retail disposition strategy and other factors. As a result of this review, the
Company has decided to change its accounting policy concerning the valuation of
repossessed vehicles. This change in policy requires the Company to record all
current and expected repossessed vehicles at recovery rates that reflect
expected values to be achieved through wholesale auctions (which the Company
currently believes to be approximately 60% of principal balance outstanding),
regardless of the specific asset disposition strategy to be employed. To the
extent actual results are more favorable than estimates, greater recoveries are
reflected in current period earnings when the vehicles are liquidated. As a
consequence of this policy change, the Company's results of operations will
depend, in part, on sales prices for used vehicles in wholesale auctions.
Decline in wholesale recovery rates may adversely effect the Company's
results unless offset by higher retail recovery rates during the period. The
Company believes that the revised accounting policy will better reflect its
modified retail disposition strategy and, accommodate a better understanding by
users of the Company's financial statements. Moreover, the Company believes this
change in accounting policy provides a financial presentation that is more
comparable to other consumer finance companies and
13
<PAGE>
responds to recent events in the consumer finance industry which, the Company
believes, provides further evidence that lower estimated recovery rates are
appropriate. For these reasons, the Company believes the change in accounting
policy adopted in April 1997 reflects a preferable application of generally
accepted accounting principles. Because the change in policy is inseparable from
the estimation process referred to above, it is appropriate to reflect the
effect of the change in accounting policy of approximately $15.5 million
after-tax, as a reduction to current period earnings.
NET INTEREST MARGIN. The components of net interest margin for each of the
three and nine months ended September 30 were:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Interest income on loans, net of interest expense on warehouse
facilities.......................................................... $ 9,260 $ 9,161 $ 26,391 $ 21,801
Interest income on short-term investments, spread accounts and other
cash accounts....................................................... 6,238 4,105 16,504 11,140
Recognition of present value discount................................. 5,671 5,048 16,603 13,001
Provision for credit losses on loans held for sale.................... (1,047) (235) (1,881) (478)
--------- --------- --------- ---------
Net interest margin................................................. $ 20,122 $ 18,079 $ 57,617 $ 45,464
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
Net interest margin increased 11% and 27% during the three and nine months
ended September 30, 1997, respectively, compared with the same periods in 1996.
The rise in net interest margin is primarily due to (i) growth in the average
balance of loans held for sale pending securitization, (ii) wider net interest
rate spreads earned on loans held for sale and (iii) interest earned on spread
accounts and other securitization related cash accounts, partially offset by an
increase in the provision for credit losses on loans held for sale.
The Company's loan purchasing volume for each of the three and nine months
ended September 30 are set forth in the table below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
---------- ---------- ------------ ------------
(DOLLARS IN THOUSANDS)
Premier...................................................... $ 326,087 $ 438,792 $ 1,087,825 $ 1,362,185
Classic...................................................... 434,230 279,433 1,192,865 647,429
---------- ---------- ------------ ------------
Total loans purchased........................................ $ 760,317 $ 718,225 $ 2,280,690 $ 2,009,614
---------- ---------- ------------ ------------
---------- ---------- ------------ ------------
</TABLE>
The rise in loan purchasing volume and timing of securitization transactions
during the three and nine months ended September 30, 1997 resulted in an
increase in the average monthly balance of loans held for sale, on which the
Company earns interest income until such loans are securitized, to $258.1
million and $254.4 million, respectively, up from $242.5 million and $221.2
million in the same periods of 1996, respectively. During the three and nine
months ended September 30, 1997, the weighted average net interest rate spread
earned on loans held for sale pending securitization rose to 10.43% and 10.08%
respectively, compared with 8.98% and 8.47%, respectively, during the same
periods in 1996. The rise in net interest rate spread is principally due to an
increase in the average annual percentage rates ("APR") paid by obligors due to
the Company's continued expansion of its Classic loan program.
14
<PAGE>
Interest income on short-term investments, spread accounts and other cash
accounts established in connection with securitization transactions increased
52% and 48% for the three and nine months ended September 30, 1997,
respectively, compared with the same periods during 1996. This increase is
primarily due to growth in the average balances of spread accounts and other
securitization related cash accounts resulting from higher securitization
volume. Income from the recognition of present value discount also grew due to
the increased volume of securitizations.
GAIN ON SALE OF LOANS. Revenues provided from gain on sale of loans
declined 4% during the three months ended September 30, 1997 compared to the
same period of 1996. The reduction in gain on sale reflects an increase in the
loss rate, servicing fee and discount factor assumptions utilized in the
computation of gain on sale. (See Management's Discussion and Analysis--SPECIAL
CHARGES for discussion of change in estimates). This impact was partially offset
by a 2% increase in loan securitization volume and a 185 basis point widening of
the gross interest rate spread earned on loans securitized (see table of gross
interest rates below). As a result of the change in estimates noted above, gain
on sale of loans as a percentage of loans securitized fell to 3.82% during the
third quarter of 1997 compared to 4.09% in the same period a year ago. The
Company believes that this percentage should increase over the next few quarters
as interest spreads continue to widen resulting from a continued expansion of
the Classic loan program and refinement of the Company's pricing strategy.
Although management believes that increased interest rate spreads can be
achieved, material factors affecting interest rate spreads are difficult to
estimate and could cause management's expectations to be materially inaccurate.
Such factors include changes in consumer interest rates and demand for
automobile securitization transactions.
Included in gain on sale of loans during the nine months ended September 30,
1997 is a non-recurring pre-tax charge to gain on sale of loans of $98.0 million
resulting in a year-to-date loss on sale of loans of $22.6 million (See
Management's Discussion and Analysis--SPECIAL CHARGES). The Company securitized
$2.3 billion of loans held for sale during the nine months ended September 30,
1997, compared with $2.0 billion in the same period a year ago. The Company
realized a gain on sale of these loans of approximately $75.4 million, before
the non-recurring charge compared with $80.8 million realized during the same
period of 1996. The reduction in gain on sale of loans during the first nine
months of 1997, before the non-recurring charge, is primarily due to an increase
in the loss rate, servicing fee and discount factor assumptions utilized in the
Company's computation of gain on sale. See Management's Discussion and
Analysis--SPECIAL CHARGES for discussion of change in estimates.
The following table summarizes the Company's gross interest rate spreads for
each of the three and nine months ended September 30:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
--------- --------- --------- ---------
Weighted average APR of loans securitized................... 16.25% 14.77% 15.85% 14.34%
Weighted average securitization rate........................ 6.37 6.74 6.46 6.39
--------- --------- --------- ---------
Gross interest rate spread (1).............................. 9.88% 8.03% 9.39% 7.95%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
- ------------------------
(1) Before gains/losses on hedging transactions.
Any unamortized balance of participations paid to dealers is expensed at the
time the related loans are securitized and recorded as a reduction to gain on
sale. Due to the increased proportion of Classic loan purchases, which generally
require lower participation rates than Premier loans, and a reduction in the
maximum participation rate allowable under the Premier program, participations
paid as a percentage of the principal balance of loans purchased declined to
3.08% and 3.16% during the three and nine months ended September 30, 1997,
compared to 3.33% and 3.52%, respectively, in the same periods a year ago.
15
<PAGE>
Gain on sale of loans also reflects realized losses on hedging transactions
of $4.0 million and $4.3 million during the three and nine months ended
September 30, 1997, compared to realized gains of $1.2 million and $4.6 million,
respectively, in the same periods a year ago.
SERVICING FEE INCOME. The Company's servicing fee income increased to $12.2
million during the three months ended September 30, 1997 from $7.5 million in
the same three months in 1996. For the nine months ended September 30, 1997,
servicing fee income was $32.7 million compared with $19.8 million for the same
period in 1996. The increase in servicing fee income was directly related to an
increase in the average servicing portfolio outstanding and due to an increase
in the contractual servicing rate beginning with the third quarter 1997
securitization transaction. The following table reflects the growth in the
Company's servicing portfolio from September 30, 1996 to September 30, 1997.
<TABLE>
<CAPTION>
AT SEPTEMBER 30,
--------------------------
<S> <C> <C>
1997 1996
------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT AS NOTED)
Principal balance of automobile loans held for sale............... $ 57,023 $ 21,104
Principal balance of loans serviced under securitizations......... 4,767,605 3,373,470
------------ ------------
Servicing portfolio............................................... $ 4,824,628 $ 3,394,574
------------ ------------
------------ ------------
Average unpaid principal balance (actual dollars)................. $ 12,248 $ 12,537
Number of loans serviced.......................................... 393,926 270,759
</TABLE>
OTHER NON-INTEREST INCOME. The Company's other non-interest income rose to
$2.6 million during the three months ended September 30, 1997 from $1.4 million
in the same three months in 1996. For the nine months ended September 30, 1997,
other non-interest income was $7.0 million compared with $4.6 million for the
same period in 1996. The rise in other non-interest income is principally due to
increases in income from late fees and insufficient fund charges reflecting the
increase in delinquency rates and growth in the servicing portfolio (See
Management's Discussion and Analysis--DELINQUENCY, CREDIT LOSS AND REPOSSESSION
EXPERIENCE).
OPERATING EXPENSES. During the three and nine months ended September 30,
1997, salary and benefit expenses increased 58% and 63%, respectively, from the
same periods a year ago. The increase in salaries and benefits is primarily
attributable to an increase in the number of employees to 1,545 at September 30,
1997 from 1,003 at September 30, 1996. Increased staffing has been necessary to
accommodate the rise in loan purchasing volume and the subsequent servicing of
such loans and reflects additional associates hired to staff four new regional
collection centers opened from October through December of 1996.
Other operating costs, including administrative, occupancy, depreciation and
amortization, origination, servicing and collection expenses, increased 87% and
112% during the three and nine months ended September 30, 1997, respectively,
compared to the same periods of 1996. The increase in other operating costs is
primarily due to the expansion of the regional collection and buying centers,
the rise in loan and collection expenses as a result of the higher percentage of
Classic program loans in the portfolio and the seasoning of the Company's
existing servicing portfolio, and the growth in loan purchasing. As loan
purchasing volume increases, the Company incurs incremental increases in costs
associated with the underwriting, servicing and collecting of such loans. Also
included in the operating costs during the first nine months of 1997 is a
one-time pre-tax charge of approximately $5.0 million recorded in March. This
special charge was primarily related to legal costs associated with defending
litigation against the Company as well as costs associated with resolving legal
issues involving improper practices at certain of the Company's initial
consignment dealers. The Company has since terminated its business relationship
with such dealers. Also included in the special charge were severance expenses
for certain former executives of the Company.
16
<PAGE>
LONG-TERM DEBT AND OTHER INTEREST EXPENSE. Long-term debt and other
interest expense increased 56% and 54% during the three and nine months ended
September 30, 1997, respectively, compared to the same periods in 1996. These
increases are primarily due to the issuance of $300.0 million of 11.5% Senior
Notes in March 1997, partially offset by the concurrent extinguishment of $145.0
million of 13% Senior Term Notes in March 1997.
EXTRAORDINARY ITEM. In March 1997, the Company issued $300.0 million 11.5%
Senior Notes and utilized approximately $173.5 million to repurchase and
covenant defease the Company's $145.0 million 13% Senior Term Notes, including
accrued interest of $7.9 million and a premium of approximately $20.3 million.
These charges and additional professional fees incurred to retire such debt have
been treated as an extraordinary item, net of tax.
FINANCIAL CONDITION
FINANCE INCOME RECEIVABLE. Finance income receivable decreased to $353.0
million at September 30, 1997 from $362.9 million at December 31, 1996. This 3%
decrease reflects a non-recurring $98.0 million pre-tax charge during the first
quarter of 1997 (See Management's Discussion and Analysis--SPECIAL CHARGES)
partially offset by amounts capitalized upon completion of the Company's first,
second, and third quarter securitizations related to the present value of
estimated cash flows.
DEFERRED INCOME TAX. Deferred income taxes declined to $16.4 million at
September 30, 1997 from $54.4 million at December 31, 1996. This decrease
reflects the recognition of a tax benefit from the first quarter loss from
operations and extraordinary charge, partially offset by the income tax
provision of $8.3 million incurred since the first quarter.
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES. Accounts payable and accrued
liabilities increased 25% to $16.5 million at September 30, 1997 as compared
with $13.2 million at December 31, 1996. This increase is partly due to
increased accruals for salaries and various operating expenses reflecting the
continued growth in the Company's staffing and servicing portfolio. In addition,
the Company recorded accruals during the first quarter of 1997 related to
severance agreements for certain former executives. The severance accruals are
reversed as payments are made over the term of the severance agreements.
17
<PAGE>
DELINQUENCY, CREDIT LOSS AND REPOSSESSION EXPERIENCE
The following tables describe the Company's delinquency, credit loss and
repossession experience for the periods indicated. A delinquent loan may result
in the repossession and foreclosure of the collateral for the loan. Losses
resulting from repossession and foreclosure of loans are charged against
applicable allowances.
DELINQUENCY EXPERIENCE (1):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------------- -------------------------
<S> <C> <C> <C> <C>
NUMBER OF NUMBER OF
LOANS BALANCE LOANS BALANCE
----------- ------------ ----------- ------------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Servicing portfolio at end of period......................... 393,926 $ 4,824,628 302,450 $ 3,791,857
Delinquencies:
31-60 days................................................. 6,331 $ 77,911 3,884 $ 47,225
61-90 days................................................. 2,055 25,657 1,255 15,877
91 days or more............................................ 2,945 35,161 2,911 37,019
----------- ------------ ----------- ------------
Total automobile loans delinquent 31 or more days............ 11,331 $ 138,729 8,050 $ 100,121
Delinquencies as a percentage of number of loans and amount
outstanding at end of period (2)........................... 2.88% 2.88% 2.66% 2.64%
Amount in repossession (3)................................... 5,379 $ 48,563 4,651 $ 64,929
----------- ------------ ----------- ------------
Total delinquencies and amount in repossession (2)........... 16,710 $ 187,292 12,701 $ 165,050
----------- ------------ ----------- ------------
----------- ------------ ----------- ------------
</TABLE>
- ------------------------
(1) All amounts and percentages are based on the principal amount scheduled to
be paid on each loan. The information in the table includes previously sold
loans which the Company continues to service.
(2) Amounts shown do not include loans which are less than 31 days delinquent.
(3) Amount in repossession represents financed automobiles which have been
charged-off but not yet liquidated.
CREDIT LOSS/REPOSSESSION EXPERIENCE (1):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
------------ ------------ ------------ ------------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Average servicing portfolio outstanding during the
period................................................. $ 4,661,818 $ 3,194,633 $ 4,318,830 $ 2,822,414
Average number of loans outstanding during the period.... 379,681 255,881 349,480 227,276
Number of charge-offs.................................... 6,843 3,884 17,208 10,146
Gross charge-offs (2).................................... $ 38,681 $ 9,432 $ 118,352 $ 22,994
Recoveries (3)........................................... 2,468 1,842 6,881 4,448
------------ ------------ ------------ ------------
Net losses............................................... $ 36,213 $ 7,590 $ 111,471 $ 18,546
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Annualized gross charge-offs as a percentage of average
servicing portfolio.................................... 3.32% 1.18% 3.65% 1.09%
Annualized net losses as a percentage of average
servicing portfolio.................................... 3.11% 0.95% 3.44% 0.88%
</TABLE>
- ------------------------
(1) All amounts and percentages are based on the principal amount scheduled to
be paid on each loan. The information in the table includes previously sold
loans which the Company continues to service.
18
<PAGE>
(2) Gross charge-offs represent principal amounts which management estimated to
be uncollectable after the consideration of anticipated proceeds from the
disposition of repossessed assets and selling expenses. Anticipated proceeds
are based on an amount which management believes the company can receive
through wholesale distribution channels, currently 60% of the loan value at
date of charge-off. Prior to March 31, 1997, the Company estimated proceeds
based on the anticipated disposition strategy for each vehicle (wholesale or
retail disposition).
(3) Includes post-disposition amounts received on repossessed assets, net of
selling expenses.
The Company's delinquency rate at September 30, 1997, increased compared to
December 31, 1996, reflecting the continued expansion of the Classic loan
program and seasoning of the Company's existing servicing portfolio. Management
anticipates that delinquency rates will continue to increase during the next
several quarters. The number of repossessed vehicles has increased since
December 31, 1996, reflecting a continued rise in defaults due to growth of the
Company's portfolio and seasoning of loans purchased under the Company's Classic
loan program. The net realizable value of the repossessed inventory has declined
due to the Company's revised policy with respect to inventory valuation (see
Management's Discussion and Analysis--SPECIAL CHARGES). Under its new policy,
repossessions are recorded at a value which approximates that which the Company
believes can be achieved through wholesale distribution channels (regardless of
the distribution strategy ultimately utilized). This change in valuation policy
has resulted in significantly higher gross charge-off and net loss percentages
compared with the prior year due to a valuation adjustment to existing inventory
at the time the policy was adopted and the application of such policy beginning
in the second quarter of 1997. Gross charge-off and net loss percentages have
also increased from the first quarter (on a pre-adjusted basis) due to the
continued rise in Classic loan volume, the seasoning of the existing portfolio,
a recent increase in the rate of turnover for the Company's servicing and
collection personnel and also the effect of selling an increased proportion of
repossessed vehicles through wholesale auctions. Since the first quarter of
1997, the Company has liquidated approximately 47% of all repossessed vehicles
sold through wholesale auctions compared to 35% in the first quarter of 1997.
LIQUIDITY
The Company's business requires substantial cash to support its operating
activities. The principal cash requirements include (i) amounts necessary to
purchase and finance automobile loans pending securitization, (ii) dealer
participations, (iii) cash held from time to time in restricted spread accounts
to support securitizations and other securitization expenses, (iv) interest
advances to securitization trusts, (v) repossessed inventory, and (vi) interest
expense. The Company also uses significant amounts of cash for operating
expenses. The Company receives cash principally from interest on loans held
pending securitization, excess cash flow received from securitization trusts and
from fees earned through servicing of loans held by such trusts. The Company has
operated on a negative operating cash flow basis and expects to continue to do
so in the near future. The Company has historically funded, and expects to
continue to fund, these negative operating cash flows, subject to limitations in
various debt covenants, principally through borrowings from financial
institutions, sales of equity securities and sales of senior and subordinated
notes, among other resources, although there can be no assurance that the
Company will have access to capital markets in the future or that financing will
be available to satisfy the Company's operating and debt service requirements or
to fund its future growth. See "Capital Resources."
PRINCIPAL USES OF CASH IN OPERATING ACTIVITIES
PURCHASES AND FINANCING OF AUTOMOBILE LOANS. Automobile loan purchases
represent the Company's most significant cash flow requirement. The Company
funds the purchase price of loans primarily through the use of warehouse
facilities. However, because advance rates under the warehouse facilities
generally provide funds from 90% to 97% of the principal balance of the loans,
the Company is required to fund the remainder of all purchases prior to
securitization with other available cash resources. The Company purchased $2.3
billion of loans during the first nine months of 1997 compared to $2.0 billion
during the same period in 1996.
19
<PAGE>
DEALER PARTICIPATIONS. Consistent with industry practice, the Company pays
dealers participations for selling loans to the Company. These participations
typically require the Company to advance an up-front amount to dealers.
Participations paid by the Company to dealers during the nine months ended
September 30, 1997 were $72.1 million, or approximately 3.16% of the principal
balance of loans purchased, compared with $70.8 million, or approximately 3.52%
of loans purchased, during the same period in 1996. The decrease in dealer
participation as a percentage of loans purchased reflects the growth in volume
in Classic loans (which are generally associated with lower dealer
participations) and a reduction in the maximum allowable participation paid for
Premier loans.
SECURITIZATION OF AUTOMOBILE LOANS. In connection with securitizations, the
Company is required to fund spread accounts related to each transaction. The
Company funds these spread accounts by foregoing receipt of excess cash flow
until these spread accounts exceed predetermined levels. In addition, the
Company has been required to provide initial cash deposits into the spread
accounts for certain securitizations. In connection with the third quarter 1997
securitization, the Company and its asset-backed securities insurance provider
entered into an arrangement whereby the Company agreed to pay a higher insurance
rate in lieu of providing an initial deposit. The Company had $226.6 million of
restricted cash in spread accounts at September 30, 1997, compared with $143.0
million at December 31, 1996. The increase in restricted cash in spread accounts
reflects the Company's growth in securitization volume and the accumulation of
excess cash flows and initial deposits related to such securitizations.
The Company also incurs certain expenses in connection with securitizations,
including underwriting fees, credit enhancement fees, trustee fees and other
costs, which approximate 0.5% of the principal amount of the asset-backed
securities sold into the securitizations.
NET INTEREST MARGIN. Although the Company records net interest margin as
earned, a significant portion of the interest income component is generally
received in cash from excess cash flow, while the interest expense component
(primarily warehousing interest) is paid prior to securitization.
ADVANCES DUE TO SERVICER. As the servicer of loans sold in securitizations,
the Company periodically makes interest advances to the securitization trusts to
provide for temporary delays in the receipt of required interest payments by
borrowers. In accordance with servicing agreements, the Company makes advances
only in the event it expects to recover them through the ultimate payments from
the obligor on the loan. Beginning in December 1996, the Company's servicing
agreements were modified to require interest advances only when the related loan
is 31 days delinquent or greater.
REPOSSESSED INVENTORY. At September 30, 1997, repossessed inventory managed
or owned by the Company and held for resale was $48.6 million, compared with
$64.9 million at December 31, 1996. The rate of repossessed inventory turnover
impacts cash available for spread accounts under securitization trusts and,
consequently, the excess cash available for distribution to the Company. At
September 30, 1997, repossessed inventory was 1.0% of the total servicing
portfolio compared with 1.7% at December 31, 1996. This reduction is primarily
the result of the Company's April 1997 modification to its retail disposition
strategy with a goal of increasing its rate of repossessed inventory turnover
(See Management's Discussion and Analysis--SPECIAL CHARGES). Any improvement in
excess cash flows due to an increase in the inventory turnover rate may be
partially reduced by lower recoveries realized through an increased use of
wholesale auctions.
PRINCIPAL SOURCES OF CASH IN OPERATING ACTIVITIES
EXCESS CASH FLOW. The Company receives excess cash flow from securitization
trusts, including the realization of gain on sale, the recovery of dealer
participations, and the recovery of accrued interest receivable earned, but not
yet collected, on loans held for sale. Recovery of dealer participations and
accrued interest receivable, which occur throughout the life of the
securitization, result in a reduction of the finance income receivable and,
because they have been considered in the original determination of the
20
<PAGE>
gain on sale of loans, have no effect on the Company's results of operations in
the year in which the participations and interest are recovered from the
securitization trust. During the first nine months of 1997, the Company received
$59.0 million of excess cash flow, compared with $28.9 million during the same
nine months in 1996. The Company received an additional $2.3 million and $2.5
million of cash during the first nine months of 1997 and 1996, respectively,
which was released from spread accounts associated with certain securitization
transactions closed-out during such periods. Included in the 1997 cash released
from spread accounts is $14.5 million of cash which is restricted pursuant to an
arrangement between the Company and its asset-backed securities insurance
provider.
SERVICING FEES. The Company also receives servicing fees for servicing
securitized loans held under certain warehouse facilities and for the loans
included in various securitization trusts. The servicing fee for loans in
securitization trusts is equal to one percent per annum of the outstanding
principal balance of the loans for all securitizations entered into prior to
September 1997 and 1.25 percent per annum on loans included in its third quarter
1997 securitization. During the nine months ended September 30, 1997 and 1996,
the Company received cash for such servicing in the amount of $31.7 million and
$18.9 million, respectively. Servicing fee income is reflected in the Company's
revenues as earned.
CAPITAL RESOURCES
The Company finances the acquisition of automobile loans primarily through
(i) warehouse facilities, pursuant to which loans are sold or financed generally
on a temporary basis and (ii) the securitization of loans, pursuant to which
loans are sold as asset-backed securities. Additional financing is required to
fund the Company's operations.
WAREHOUSE FACILITIES. Automobile loans held for sale are funded primarily
through warehouse facilities. At September 30, 1997, the Company had warehouse
facilities in place with various financial institutions and institutional
lenders with an aggregate capacity of $647.7 million, of which $521.4 million
was available. Proceeds from securitizations, generally received within seven to
ten days following the cut-off date established for the transaction, are applied
to repay amounts outstanding under warehouse facilities.
SECURITIZATION PROGRAM. An important capital resource for the Company has
been its ability to sell automobile loans in the secondary markets through
securitizations. The following table summarizes the Company's securitization
transactions for the nine months ended September 30, 1997, all of which were
publicly issued and rated "AAA/Aaa".
<TABLE>
<CAPTION>
REMAINING
BALANCE REMAINING CURRENT
AS BALANCE AS A CURRENT WEIGHTED GROSS
OF SEPT. PERCENTAGE OF WEIGHTED AVERAGE INTEREST
ORIGINAL 30, ORIGINAL AVERAGE SECURITIZATION RATE
DATE BALANCE 1997 BALANCE APR RATE SPREAD
- -------------------------- --------- --------- ------------- --------- ------------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
March 1997................ $ 775,000 $ 657,088 84.79% 15.56% 6.54% 9.02%
June 1997................. 775,000 717,679 92.60% 15.85% 6.50% 9.35%
September 1997 (1)........ 775,000 681,014 87.87% 16.31% 6.36% 9.95%
--------- ---------
$2,325,000 $2,055,781
--------- ---------
--------- ---------
</TABLE>
- ------------------------
(1) As of September 30, 1997, the Company had delivered $688.9 million of
automobile loans and $86.1 million cash remained in the pre-funded portion
of the trust.
HEDGING STRATEGY
The Company enters into hedging transactions to manage its gross interest
rate spread on loans held for sale. The Company sells forward US Treasuries that
most closely parallel the average life of its portfolio
21
<PAGE>
of loans held for sale. Hedging gains and losses are recognized as a component
of the gain on sale of loans on the date such loans are sold. To the extent
hedging gains or losses are significant, the resulting up-front cash payments or
receipts may impact the Company's liquidity. The Company receives the up-front
gains or losses back over time through a higher or lower spread at the time of
securitization. At September 30, 1997, the Company had unrealized losses on
hedge contracts of $5.2 million.
OTHER CAPITAL RESOURCES
Historically, the Company has utilized various debt and equity financings to
offset negative operating cash flows and support its operations.
In March 1997, the Company sold $300 million 11.50% Senior Notes, due 2007.
Net proceeds received from the offering of the Senior Notes approximated $291.2
million.
In October 1997, the Company sold $75 million 11.5% Senior Notes, due 2007.
Net proceeds received from the offering of the Senior Notes approximated $71.2
million.
CAUTIONARY STATEMENTS
Information or statements provided by the Company from time to time may
contain certain "forward-looking information" including information relating to
anticipated earnings per share, anticipated returns on equity, anticipated
growth in automobile loan purchases, anticipated net interest margins,
anticipated loan securitizations and gain on sale, anticipated operations costs
and employment growth and anticipated delinquency, loan loss and repossession
experience. The cautionary statements provided below and in Exhibit 99.1 filed
herewith are being made pursuant to the provisions of the Private Securities
Litigation Reform Act of 1995 (the "Act") and with the intention of obtaining
the benefits of the "safe harbor" provisions of the Act for any such
forward-looking information. Many of the following important factors discussed
below, as well as other factors, have also been discussed in the Company's prior
public filings.
The Company cautions readers that any forward-looking information provided
by the Company is not a guarantee of future performance and that actual results
may differ materially from those in the forward-looking information as a result
of various factors, including but not limited to:
- The effects of increased delinquency rates and loan loss rates, including
further write downs of finance income receivable and decreases in cash
flow from securitization trusts in the event certain portfolio performance
tests are violated.
- The effects of "seasoning" of the Company's loan portfolio and increased
use of the Company's Classic loan program, each of which are likely to
adversely affect the Company's level of delinquencies and losses, which
may require higher loss reserves and decrease cash flow from
securitization trusts in the event certain portfolio performance tests are
violated.
- The effects of the Company's modified retail disposition program, which
may result in an increased use of wholesale dispositions for repossessed
inventory and potentially lower recovery rates.
- The effects of interest rate fluctuations on the Company's net interest
margin and the value of its assets and liabilities; the continued legal or
commercial availability of techniques (primarily hedging) used by the
Company to manage the risk of such fluctuations and the continuing
operational viability of those techniques and the accounting and
regulatory treatment of such instruments.
- Difficulties or delays in the securitization of the Company's automobile
loans and the resulting impact on the cost and availability of such
funding. Such difficulties and delays may result from changes in the
availability of credit enhancement in securitizations, the current legal,
regulatory, accounting and tax environment and adverse change in the
performance of the securitized loans.
22
<PAGE>
- Changes in the availability, amount, cost and other terms of warehouse
financing to purchase loans.
- The amount, and rate of growth in, the Company's expenses (including
employee and marketing expenses); the effects of changes within the
Company's organization or in its compensation and benefit plans; and the
impact of unusual items resulting from the Company's ongoing evaluation of
its business strategies, asset valuations and organizational structures.
- The availability, amount, type and cost of debt or equity financing for
the Company to support negative operating cash flows and any changes to
that financing, including any impact from changes in the Company's debt
ratings.
- The effects of changes in economic conditions which may increase the risk
of default on automobile loans, increase the number of customers seeking
protection under bankruptcy laws, reduce demand for automobile loans, and
reduce demand for used cars through retail channels.
- The effects of intense competition from financial institutions, such as
banks, other automobiles finance companies, thrifts, leasing companies and
captive finance companies owned by automobile manufacturers.
- The costs and other effects of legal and administrative cases and
proceedings, settlements and investigations, claims and changes in those
items, developments or assertions by or against the Company or its
subsidiaries; adoptions of new, or changes in existing, accounting
policies and practices and the application of such policies and practices.
23
<PAGE>
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 25, 1997, the United States District Court for the District of
Minnesota issued an order consolidating the shareholder suits described in the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997,
into one action, In re Olympic Financial Ltd. Securities Litigation. Plaintiffs
in the consolidated action allege that during the period from July 20, 1995
through March 3, 1997 the defendants, in violation of federal securities laws,
engaged in a scheme that had the effect of artificially inflating, maintaining
and otherwise manipulating the value of the Company's Common Stock by, among
other things, making baseless, false and misleading statements about the current
state and future prospects of the Company, particularly with respect to the
Classic program and the refinancing of repossessed automobiles. Plaintiffs
allege that this scheme included making false and misleading statements and/or
concealing material adverse facts. The consolidated action is in the preliminary
stages and the parties have not begun discovery. The Company has reviewed the
complaint in the consolidated action and believes that the consolidated action
is without merit and intends to defend it vigorously. There can, however, be no
assurance that the Company will prevail in such defense or that any order,
judgement, settlement or decree arising out of this litigation will not have a
material adverse effect on the Company's financial condition, results of
operations or liquidity.
The nature of the Company's business is such that it is routinely a party or
subject to other items of pending or threatened litigation, including litigation
involving actions against borrowers to collect amounts on loans or to repossess
vehicles and litigation challenging the terms of loans purchased by the Company.
Although the ultimate outcome of certain of these matters cannot be predicted,
management of the Company believes, based upon information currently available
and the advice of counsel, that the resolution of these various matters will not
result in any material adverse effect on the Company or its results of
operations.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURING HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
The following exhibits are filed in response to Item 601 of Regulation S-K.
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
3.1 Restated Articles of Incorporation of the Company, as amended
(incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1997).
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
3.2 Restated Bylaws of the Company, as amended (incorporated by reference to
Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997).
4.1 Rights Agreement dated as of November 1, 1996, between the Company and
Norwest Bank Minnesota, National Association, as Rights Agent
(incorporated by reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A filed November 7, 1996).
4.2 First Amendment and Restatement, dated as of April 28, 1995 of Indenture,
dated July 1, 1994, between the Company and Norwest Bank Minnesota,
National Association, as Trustee, relating to the Company's Unsecured
Extendible Notes and Fixed Term-Notes, including forms of Notes
(incorporated by reference to Exhibit No. 4.8.1 to Post-Effective
Amendment No. 2 on Form S-3 to the Company's Registration Statement on
Form S-1, File No. 33-81512).
4.3 Indenture, dated as of April 28, 1995, between the Company and Norwest
Bank Minnesota, National Association, as Trustee, relating to the
Company's 13% Senior Notes due 2000 (incorporated by reference to
Exhibit 4.5 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1995).
4.4 First Supplemental Indenture, dated as of August 11, 1995, to Indenture,
dated as of April 28, 1995, between the Company and Norwest Bank
Minnesota, National Association, as Trustee, relating to the Company's
13% Senior Notes due 2000 (incorporated by reference to Exhibit 4.6 to
the Company's Annual Report on Form 10-K for the year ended December 31,
1995).
4.5 Second Supplemental Indenture dated as of March 11, 1997 to Indenture
dated as of April 28, 1995 between the Company and Norwest Bank
Minnesota, National Association (incorporated by reference to Exhibit
4.7 to the Company's current report on Form 8-K dated March 12, 1997 and
filed March 18, 1997).
4.6 Indenture dated as of March 15, 1996, between the Company and Norwest Bank
Minnesota, National Association, as Trustee, relating to the Company's
Subordinated Notes, Series 1996-A due 2001 (incorporated by reference to
Exhibit 4.5 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996).
4.7 First Supplemental Indenture, dated as of March 15, 1996, to Indenture,
dated as of March 15, 1996, between the Company and Norwest Bank
Minnesota, National Association, as Trustee, relating to the Company's
Subordinated Notes, Series 1996-A due 2001 (incorporated by reference to
Exhibit 4.6 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996).
4.8 Indenture dated as of March 12, 1997, between the Company and Norwest Bank
Minnesota, National Association, as Trustee (incorporated by reference
to Exhibit 4.1 to the Company's Current Report on Form 8-K dated March
12, 1997 and filed March 18, 1997).
4.9 First Supplemental Indenture, dated as of March 12, 1997 between the
Company and Norwest Bank Minnesota, National Association, as Trustee
(incorporated by reference to Exhibit 4.2 to the Company's Current
Report on Form 8-K dated March 12, 1997 and filed March 18, 1997).
4.10 Warrant Agreement, dated as of March 12, 1997 by and between the Company
and Norwest Bank Minnesota, National Association, as Warrant Agent
(incorporated by reference to Exhibit 4.3 to the Company's Current
Report on Form 8-K dated March 12, 1997 and filed March 18, 1997).
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
4.11 Form of Unit (incorporated by reference to Exhibit 4.4 to the Company's
Current Report on Form 8-K dated March 12, 1997 and filed March 18,
1997).
4.12 Form of 11.5% Senior Notes due March 15, 2007 (incorporated by reference
to Exhibit 4.5 to the Company's Current Report on Form 8-K dated March
12, 1997 and filed March 18, 1997).
4.13 Form of Initial Warrant Certificate (incorporated by reference to Exhibit
4.6 to the Company's Current Report on Form 8-K dated March 12, 1997 and
filed March 18, 1997).
4.14 Second Supplemental Indenture, dated as of October 8, 1997, to Indenture,
dated as of March 12, 1997, between the Company and Norwest Bank
Minnesota, National Association, as Trustee, including form of Notes
(incorporated by reference to Exhibit 4.1 to the Company's Current
Report on Form 8-K dated October 8, 1997, filed October 15, 1997).
10.1 First Amendment, dated as of August 9, 1997, to Note Purchase Agreement,
dated as of December 3, 1996, among Arcadia Financial Ltd. (formerly
known as Olympic Financial Ltd.), Arcadia Receivables Conduit Corp.,
Receivable Capital Corporation and Bank of America National Trust and
Savings Association (incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K dated October 1, 1997, filed
October 1, 1997).
10.2 First Amendment, dated as of August 4, 1997, to Repurchase Agreement,
dated as of December 3, 1996, by and between Arcadia Receivables Conduit
Corp. and Arcadia Receivables Finance Corp. (incorporated by reference
to Exhibit 10.2 to the Company's Current Report on Form 8-K dated
October 1, 1997, filed October 1, 1997).
10.3 First Amendment, dated as of August 4, 1997 to Servicing Agreement, dated
as of December 3, 1996, among Arcadia Receivables Conduit Corp., Arcadia
Financial Ltd. (formerly known as Olympic Financial Ltd.), in its
individual capacity and as Servicer, and Bank of America National Trust
and Savings Association (incorporated by reference to Exhibit 10.3 to
the Company's Current Report on Form 8-K dated October 1, 1997, filed
October 1, 1997).
10.4 First Amendment, dated as of August 1, 1997, to the Insurance and
Indemnity Agreement, dated as of December 3, 1996, among Financial
Security Assurance Inc., Arcadia Receivables Conduit Corp., Arcadia
Receivables Finance Corp. and Arcadia Financial Ltd. (formerly known as
Olympic Financial Ltd.), as Servicer (incorporated by reference to
Exhibit 10.4 to the Company's Current Report on Form 8-K dated October
1, 1997, filed October 1, 1997).
10.5 Amended and Restated Trust Agreement, dated as of July 31, 1997, between
Arcadia Receivables Finance Corp. II and Wilmington Trust Company
(incorporated by reference to Exhibit 10.5 to the Company's Current
Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.6 Amended and Restated Indenture, dated as of July 31, 1997, between Olympic
Automobile Receivables Warehouse Trust and Norwest Bank Minnesota,
National Association (incorporated by reference to Exhibit 10.6 to the
Company's Current Report on Form 8-K dated October 1, 1997, filed
October 1, 1997).
10.7 Amended and Restated Receivables Purchase Agreement and Assignment, dated
as of July 31, 1997, between Arcadia Receivables Finance Corp. II and
Arcadia Financial Ltd. (incorporated by reference to Exhibit 10.7 to the
Company's Current Report on Form 8-K dated October 1, 1997, filed
October 1, 1997).
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
10.8 Amended and Restated Sale and Servicing Agreement, dated as of July 31,
1997, among Olympic Automobile Receivables Warehouse Trust, Arcadia
Receivables Finance Corp. II, Arcadia Financial Ltd. And Norwest Bank
Minnesota, National Association (incorporated by reference to Exhibit
10.8 to the Company's Current Report on Form 8-K dated October 1, 1997,
filed October 1, 1997).
10.9 Amended and Restated Custodian Agreement, dated as of July 31, 1997, among
Arcadia Financial Ltd., Norwest Bank Minnesota, National Association,
and Olympic Automobile Receivables Warehouse Trust (incorporated by
reference to Exhibit 10.9 to the Company's Current Report on Form 8-K
dated October 1, 1997, filed October 1, 1997).
10.10 Amended and Restated Note Purchase Agreement, dated as of July 31, 1997,
among Olympic Automobile Receivables Warehouse Trust, Arcadia Financial
Ltd., Delaware Funding Corporation and Morgan Guaranty Trust Company of
New York (incorporated by reference to Exhibit 10.10 to the Company's
Current Report on Form 8-K dated October 1, 1997, filed October 1,
1997).
10.11 Amended and Restated Certificate Purchase Agreement, dated as of July 31,
1997, among Olympic Automobile Receivables Warehouse Trust, Arcadia
Financial Ltd., each Purchaser (as defined) and Morgan Guaranty Trust
Company of New York (incorporated by reference to Exhibit 10.11 to the
Company's Current Report on Form 8-K dated October 1, 1997, filed
October 1, 1997).
10.12 Asset Purchase Agreement, dated as of July 31, 1997, among Morgan Guaranty
Trust Company of New York and certain parties listed therein
(incorporated by reference to Exhibit 10.12 to the Company's Current
Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.13 Series 1997-C Supplement, dated as of September 18, 1997, to spread
Account Agreement dated as of March 25, 1993, as amended and restated as
of June 1, 1997, among Arcadia Financial Ltd., Arcadia Receivables
Finance Corp., Financial Security Assurance, Inc., The Chase Manhattan
Bank and Norwest Bank Minnesota, National Association (incorporated by
reference to Exhibit 10.13 to the Company's Current Report on Form 8-K
dated October 1, 1997, filed October 1, 1997).
10.14 Insurance and Indemnity Agreement, dated as of September, 18, 1997, among
Financial Assurance Inc., Arcadia Automobile Receivables Trust, 1997-C,
Arcadia Receivables Finance Corp. and Arcadia Financial Ltd.
(incorporated by reference to Exhibit 10.14 to the Company's Current
Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.15 Form of Indemnification Agreement by and between the Company and certain
of its officers and directors (incorporated by reference to Exhibit
10.15 to the Company's Current Report on Form 8-K dated October 1, 1997,
filed October 1, 1997).
11.1 Computation of Earnings Per Share (filed herewith).
27.1 Financial Data Schedule (filed herewith).
99.1 Cautionary Statement (filed herewith).
</TABLE>
(b) REPORTS ON FORM 8-K
On September 24, 1997, the Company filed a Current Report on Form 8-K dated
June 5, 1997, reporting certain information with regard to the Company's
performance as servicer of Olympic Automobile Receivables Trust, 1996-C.
27
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARCADIA FINANCIAL LTD.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------- ------------------------------------------------ ----------------------
<C> <S> <C>
/s/ RICHARD A. GREENAWALT President, Chief Executive Officer, and Director November 13, 1997
-------------------------------
Richard A. Greenawalt
/s/ JOHN A. WITHAM Executive Vice President and Chief Financial November 13, 1997
------------------------------- Officer (Principal Financial Officer)
John A. Witham
/s/ BRIAN S. ANDERSON Senior Vice President, Corporate Controller and November 13, 1997
------------------------------- Assistant Secretary (Principal Accounting
Brian S. Anderson Officer)
</TABLE>
28
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------- -----------------------------------------------------------------------------------------------------
<C> <S>
3.1 Restated Articles of Incorporation of the Company, as amended (incorporated by reference to Exhibit
3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
3.2 Restated Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
4.1 Rights Agreement dated as of November 1, 1996, between the Company and Norwest Bank Minnesota,
National Association, as Rights Agent (incorporated by reference to Exhibit 1 to the Company's
Registration Statement on Form 8-A filed November 7, 1996).
4.2 First Amendment and Restatement, dated as of April 28, 1995 of Indenture, dated July 1, 1994, between
the Company and Norwest Bank Minnesota, National Association, as Trustee, relating to the Company's
Unsecured Extendible Notes and Fixed Term-Notes, including forms of Notes (incorporated by reference
to Exhibit No. 4.8.1 to Post-Effective Amendment No. 2 on Form S-3 to the Company's Registration
Statement on Form S-1, File No. 33-81512).
4.3 Indenture, dated as of April 28, 1995, between the Company and Norwest Bank Minnesota, National
Association, as Trustee, relating to the Company's 13% Senior Notes due 2000 (incorporated by
reference to Exhibit 4.5 to the Company's Annual Report on Form 10-K for the year ended December 31,
1995).
4.4 First Supplemental Indenture, dated as of August 11, 1995, to Indenture, dated as of April 28, 1995,
between the Company and Norwest Bank Minnesota, National Association, as Trustee, relating to the
Company's 13% Senior Notes due 2000 (incorporated by reference to Exhibit 4.6 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1995).
4.5 Second Supplemental Indenture dated as of March 11, 1997 to Indenture dated as of April 28, 1995
between the Company and Norwest Bank Minnesota, National Association (incorporated by reference to
Exhibit 4.7 to the Company's current report on Form 8-K dated March 12, 1997 and filed March 18,
1997).
4.6 Indenture dated as of March 15, 1996, between the Company and Norwest Bank Minnesota, National
Association, as Trustee, relating to the Company's Subordinated Notes, Series 1996-A due 2001
(incorporated by reference to Exhibit 4.5 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996).
4.7 First Supplemental Indenture, dated as of March 15, 1996, to Indenture, dated as of March 15, 1996,
between the Company and Norwest Bank Minnesota, National Association, as Trustee, relating to the
Company's Subordinated Notes, Series 1996-A due 2001 (incorporated by reference to Exhibit 4.6 to
the Company's Annual Report on Form 10-K for the year ended December 31, 1996).
4.8 Indenture dated as of March 12, 1997, between the Company and Norwest Bank Minnesota, National
Association, as Trustee (incorporated by reference to Exhibit 4.1 to the Company's Current Report on
Form 8-K dated March 12, 1997 and filed March 18, 1997).
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------- -----------------------------------------------------------------------------------------------------
<C> <S>
4.9 First Supplemental Indenture, dated as of March 12, 1997 between the Company and Norwest Bank
Minnesota, National Association, as Trustee (incorporated by reference to Exhibit 4.2 to the
Company's Current Report on Form 8-K dated March 12, 1997 and filed March 18, 1997).
4.10 Warrant Agreement, dated as of March 12, 1997 by and between the Company and Norwest Bank Minnesota,
National Association, as Warrant Agent (incorporated by reference to Exhibit 4.3 to the Company's
Current Report on Form 8-K dated March 12, 1997 and filed March 18, 1997).
4.11 Form of Unit (incorporated by reference to Exhibit 4.4 to the Company's Current Report on Form 8-K
dated March 12, 1997 and filed March 18, 1997).
4.12 Form of 11.5% Senior Notes due March 15, 2007 (incorporated by reference to Exhibit 4.5 to the
Company's Current Report on Form 8-K dated March 12, 1997 and filed March 18, 1997).
4.13 Form of Initial Warrant Certificate (incorporated by reference to Exhibit 4.6 to the Company's
Current Report on Form 8-K dated March 12, 1997 and filed March 18, 1997).
4.14 Second Supplemental Indenture, dated as of October 8, 1997, to Indenture, dated as of March 12, 1997,
between the Company and Norwest Bank Minnesota, National Association, as Trustee, including form of
Notes (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated
October 8, 1997, filed October 15, 1997).
10.1 First Amendment, dated as of August 9, 1997, to Note Purchase Agreement, dated as of December 3,
1996, among Arcadia Financial Ltd. (formerly known as Olympic Financial Ltd.), Arcadia Receivables
Conduit Corp., Receivable Capital Corporation and Bank of America National Trust and Savings
Association (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K
dated October 1, 1997, filed October 1, 1997).
10.2 First Amendment, dated as of August 4, 1997, to Repurchase Agreement, dated as of December 3, 1996,
by and between Arcadia Receivables Conduit Corp. and Arcadia Receivables Finance Corp. (incorporated
by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated October 1, 1997,
filed October 1, 1997).
10.3 First Amendment, dated as of August 4, 1997 to Servicing Agreement, dated as of December 3, 1996,
among Arcadia Receivables Conduit Corp., Arcadia Financial Ltd. (formerly known as Olympic Financial
Ltd.), in its individual capacity and as Servicer, and Bank of America National Trust and Savings
Association (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K
dated October 1, 1997, filed October 1, 1997).
10.4 First Amendment, dated as of August 1, 1997, to the Insurance and Indemnity Agreement, dated as of
December 3, 1996, among Financial Security Assurance Inc., Arcadia Receivables Conduit Corp.,
Arcadia Receivables Finance Corp. and Arcadia Financial Ltd. (formerly known as Olympic Financial
Ltd.), as Servicer (incorporated by reference to Exhibit 10.4 to the Company's Current Report on
Form 8-K dated October 1, 1997, filed October 1, 1997).
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.5 Amended and Restated Trust Agreement, dated as of July 31, 1997, between Arcadia Receivables Finance
Corp. II and Wilmington Trust Company (incorporated by reference to Exhibit 10.5 to the Company's
Current Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.6 Amended and Restated Indenture, dated as of July 31, 1997, between Olympic Automobile Receivables
Warehouse Trust and Norwest Bank Minnesota, National Association (incorporated by reference to
Exhibit 10.6 to the Company's Current Report on Form 8-K dated October 1, 1997, filed October 1,
1997).
10.7 Amended and Restated Receivables Purchase Agreement and Assignment, dated as of July 31, 1997,
between Arcadia Receivables Finance Corp. II and Arcadia Financial Ltd. (incorporated by reference
to Exhibit 10.7 to the Company's Current Report on Form 8-K dated October 1, 1997, filed October 1,
1997).
10.8 Amended and Restated Sale and Servicing Agreement, dated as of July 31, 1997, among Olympic
Automobile Receivables Warehouse Trust, Arcadia Receivables Finance Corp. II, Arcadia Financial Ltd.
And Norwest Bank Minnesota, National Association (incorporated by reference to Exhibit 10.8 to the
Company's Current Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.9 Amended and Restated Custodian Agreement, dated as of July 31, 1997, among Arcadia Financial Ltd.,
Norwest Bank Minnesota, National Association, and Olympic Automobile Receivables Warehouse Trust
(incorporated by reference to Exhibit 10.9 to the Company's Current Report on Form 8-K dated October
1, 1997, filed October 1, 1997).
10.10 Amended and Restated Note Purchase Agreement, dated as of July 31, 1997, among Olympic Automobile
Receivables Warehouse Trust, Arcadia Financial Ltd., Delaware Funding Corporation and Morgan
Guaranty Trust Company of New York (incorporated by reference to Exhibit 10.10 to the Company's
Current Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.11 Amended and Restated Certificate Purchase Agreement, dated as of July 31, 1997, among Olympic
Automobile Receivables Warehouse Trust, Arcadia Financial Ltd., each Purchaser (as defined) and
Morgan Guaranty Trust Company of New York (incorporated by reference to Exhibit 10.11 to the
Company's Current Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.12 Asset Purchase Agreement, dated as of July 31, 1997, among Morgan Guaranty Trust Company of New York
and certain parties listed therein (incorporated by reference to Exhibit 10.12 to the Company's
Current Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
10.13 Series 1997-C Supplement, dated as of September 18, 1997, to spread Account Agreement dated as of
March 25, 1993, as amended and restated as of June 1, 1997, among Arcadia Financial Ltd., Arcadia
Receivables Finance Corp., Financial Security Assurance, Inc., The Chase Manhattan Bank and Norwest
Bank Minnesota, National Association (incorporated by reference to Exhibit 10.13 to the Company's
Current Report on Form 8-K dated October 1, 1997, filed October 1, 1997).
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.14 Insurance and Indemnity Agreement, dated as of September, 18, 1997, among Financial Assurance Inc.,
Arcadia Automobile Receivables Trust, 1997-C, Arcadia Receivables Finance Corp. and Arcadia
Financial Ltd. (incorporated by reference to Exhibit 10.14 to the Company's Current Report on Form
8-K dated October 1, 1997, filed October 1, 1997).
10.15 Form of Indemnification Agreement by and between the Company and certain of its officers and
directors (incorporated by reference to Exhibit 10.15 to the Company's Current Report on Form 8-K
dated October 1, 1997, filed October 1, 1997).
11.1 Computation of Earnings Per Share (filed herewith).
27.1 Financial Data Schedule (filed herewith).
99.1 Cautionary Statement (filed herewith).
</TABLE>
32
<PAGE>
EXHIBIT 11.1
ARCADIA FINANCIAL LTD.
COMPUTATION OF EARNINGS PER SHARE
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
---------- ---------- ---------- ----------
PRIMARY:
Income (loss) before extraordinary item and preferred
dividends...................................................... $ 7,789 $ 17,157 $ (45,979) $ 42,950
Less preferred dividends......................................... -- (345) -- (1,152)
---------- ---------- ---------- ----------
Net income (loss) before extraordinary item applicable to common
stock.......................................................... 7,789 16,812 (45,979) 41,798
Less extraordinary item.......................................... -- -- (15,828) --
---------- ---------- ---------- ----------
Net income (loss) applicable to common stock................... $ 7,789 $ 16,812 $ (61,807) $ 41,798
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average number of commons shares outstanding............ 38,740,077 33,478,304 38,615,060 29,231,401
Net effect of assumed exercise of stock options and warrants..... 491,884 2,417,845 606,029 2,332,818
---------- ---------- ---------- ----------
Weighted average primary shares................................ 39,231,961 35,896,149 39,221,089 31,564,219
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income (loss) per common share before extraordinary item..... $ 0.20 $ 0.47 $ (1.17) $ 1.32
Extraordinary item per common share.............................. -- -- (.41) --
---------- ---------- ---------- ----------
Net income (loss) per common share............................. $ 0.20 $ 0.47 $ (1.58) $ 1.32
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
FULLY DILUTED:
Income (loss) before extraordinary item and preferred
dividends...................................................... $ 7,789 $ 17,157 (45,979) $ 42,950
Less extraordinary item.......................................... -- -- (15,828) --
---------- ---------- ---------- ----------
Net income (loss), as adjusted................................. $ 7,789 $ 17,157 $ (61,807) $ 42,950
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average number of common shares outstanding............. 38,740,077 33,478,304 38,615,060 29,231,401
Net effect of assumed exercise of stock options and warrants..... 672,143 2,618,135 694,343 2,852,736
Net effect of assumed conversion of 8% Cumulative Convertible
Exchangeable Preferred stock................................... -- 3,327,007 -- 3,767,796
---------- ---------- ---------- ----------
Weighted average fully diluted shares.......................... 39,412,220 39,423,446 39,309,403 35,851,933
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income (loss) per common share before extraordinary item..... $ 0.20 $ 0.44 $ (1.17) $ 1.20
Extraordinary item per common share.............................. -- -- (0.40)(a) --
---------- ---------- ---------- ----------
Net income (loss) per common share............................. $ 0.20 $ 0.44 $ (1.57)(a) $ 1.20
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
- ------------------------
(a) Weighted average shares under the fully diluted computation have an
anti-dilutive effect in a loss situation, for reporting purposes, therefore,
fully diluted EPS will be shown equal to primary EPS.
33
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
ON PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 17,720
<SECURITIES> 0
<RECEIVABLES> 784,645
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 24,936
<DEPRECIATION> 7,667
<TOTAL-ASSETS> 852,256
<CURRENT-LIABILITIES> 0
<BONDS> 349,122
0
0
<COMMON> 381
<OTHER-SE> 343,601
<TOTAL-LIABILITY-AND-EQUITY> 852,256
<SALES> 0
<TOTAL-REVENUES> 63,664
<CGS> 0
<TOTAL-COSTS> 40,701
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 10,400
<INCOME-PRETAX> 12,563
<INCOME-TAX> 4,774
<INCOME-CONTINUING> 7,789
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,789
<EPS-PRIMARY> 0.20
<EPS-DILUTED> 0.20
</TABLE>
<PAGE>
CAUTIONARY STATEMENT
ARCADIA FINANCIAL LTD. (THE "COMPANY"), OR PERSONS ACTING ON BEHALF OF THE
COMPANY, OR OUTSIDE REVIEWERS RETAINED BY THE COMPANY MAKING STATEMENTS ON
BEHALF OF THE COMPANY, OR UNDERWRITERS OF THE COMPANY'S SECURITIES, FROM TIME TO
TIME, MAY MAKE, IN WRITING OR ORALLY, "FORWARD-LOOKING STATEMENTS" AS DEFINED
UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 (THE "ACT"). THIS
CAUTIONARY STATEMENT, WHEN USED IN CONJUNCTION WITH AN IDENTIFIED
FORWARD-LOOKING STATEMENT, IS FOR THE PURPOSE OF QUALIFYING FOR THE "SAFE
HARBOR" PROVISIONS OF THE ACT AND IS INTENDED TO BE A READILY AVAILABLE WRITTEN
DOCUMENT THAT CONTAINS FACTORS WHICH COULD CAUSE RESULTS TO DIFFER MATERIALLY
FROM SUCH FORWARD-LOOKING STATEMENTS. THESE FACTORS ARE IN ADDITION TO ANY OTHER
CAUTIONARY STATEMENTS, WRITTEN OR ORAL, WHICH MAY BE MADE OR REFERRED TO IN
CONNECTION WITH ANY SUCH FORWARD-LOOKING STATEMENT.
THE FOLLOWING MATTERS, AMONG OTHERS, MAY HAVE A MATERIAL ADVERSE EFFECT ON
THE BUSINESS, FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR
PROSPECTS, FINANCIAL OR OTHERWISE, OF THE COMPANY. REFERENCE TO THIS CAUTIONARY
STATEMENT IN THE CONTEXT OF A FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE
DEEMED TO BE A STATEMENT THAT ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT
OR STATEMENTS.
LIQUIDITY AND ACCESS TO CAPITAL RESOURCES
NEGATIVE OPERATING CASH FLOWS. The Company's business requires substantial
cash to support the payment of dealer participations, the funding of spread
accounts in connection with securitizations, the purchase of loans pending
securitization, the financing of repossessed inventory and other cash
requirements, in addition to debt service and dividends. These cash requirements
increase as the volume of the Company's loan purchases increases. To the extent
that increases in the volume of loan purchases and securitizations provide
income, a substantial portion of such income is received by the Company in cash
over the life of the loans. The Company has operated historically on a negative
operating cash flow basis and expects to continue to do so for so long as the
Company's volume of loan purchases continues to grow. As a result of the
Company's historical growth rate, the Company has used increasingly larger
amounts of cash than it has generated from its operating activities. The Company
has funded these negative operating cash flows principally through borrowings
from financial institutions, sales of equity securities and sales of senior and
subordinated notes. The Company's ability to execute its growth strategy depends
upon its continued ability to obtain substantial additional long-term debt and
equity capital through access to the capital markets or otherwise. There can be
no assurance that the Company will have access to the capital markets when
needed or will be able to obtain financing upon terms reasonably satisfactory to
the Company. Factors which could affect the Company's access to the capital
markets, or the costs of such capital, include changes in interest rates,
general economic conditions, the perception in the capital markets of the
Company's business, results of operations, leverage, financial condition and
business prospects, and the performance of the Company's securitization trusts.
In addition, covenants with respect to the Company's debt securities and credit
facilities may significantly restrict the Company's ability to incur additional
indebtedness and to issue new classes of preferred stock.
POTENTIAL INABILITY TO REFINANCE EXISTING INDEBTEDNESS. The Company's
ability to repay its outstanding indebtedness at maturity may depend on its
ability to refinance such indebtedness, which could be adversely affected if the
Company does not have access to the capital markets for the sale of additional
debt or equity through public offerings or private placements on terms
reasonably satisfactory to the Company. See "Negative Operating Cash Flows"
above.
1
<PAGE>
DEPENDENCE ON WAREHOUSE FINANCING. The Company depends on warehouse
facilities with financial institutions or institutional lenders to finance its
purchase of loans on a short-term basis pending securitization. At August 31,
1997, the Company had $647.7 million of warehouse facilities through
institutionally managed asset-backed commercial paper conduits, of which $287.8
million was available. These facilities expire in December 1997 and July 1998,
subject to renewal or extension at the lenders' option. Implementation of the
Company's growth strategy requires continued availability of warehouse
facilities and may require increases in the capacity of warehouse facilities.
There can be no assurance that such financing will be available on terms
reasonably satisfactory to the Company. The inability of the Company to arrange
additional warehouse facilities or to extend or replace existing facilities when
they expire would have a material adverse effect on the Company's business,
financial condition and results of operations and on the Company's outstanding
securities.
DEPENDENCE ON SECURITIZATION. The Company has relied upon its ability to
aggregate and sell loans as asset-backed securities in the secondary market to
generate cash proceeds for repayment of warehouse facilities and to purchase new
loans from dealers. Since inception, the Company has securitized approximately
$8.1 billion of automobile loans. At August 31, 1997, approximately $4.2 billion
of these loans were outstanding and in September 1997 the Company completed an
additional $775.0 million securitization. Accordingly, adverse changes in the
Company's asset-backed securities program or in the asset-backed securities
market for automobile receivables generally could materially adversely affect
the Company's ability to purchase and resell loans on a timely basis and upon
terms reasonably satisfactory to the Company. The Company endeavors to effect
public securitizations of its loans on at least a quarterly basis. However,
market and other considerations, including the conformity of loans to insurance
company and rating agency requirements, could affect the timing of such
transactions. Any delay in the sale of loans beyond a quarter-end would
eliminate the related gain on sale in the given quarter and adversely affect the
Company's reported earnings for such quarter. All of the Company's
securitizations since March 1993 and one of the Company's warehouse facilities
have utilized credit enhancement in the form of financial guaranty insurance
policies issued by FSA to achieve "AAA/Aaa" ratings with respect to the
asset-backed securities. The Company believes that financial guaranty insurance
policies reduce the costs of the securitizations and such warehouse facility
relative to alternative forms of credit enhancements available to the Company.
The Company has committed to use FSA for future credit enhancement on insured
securitizations through 1998 in consideration for certain limitations on FSA
insurance premiums. FSA is not required to insure Company-sponsored
securitizations and there can be no assurance that it will continue to do so or
that future Company-sponsored securitizations will be similarly rated.
LOAN PERFORMANCE RISKS
POTENTIAL NEGATIVE EFFECTS ON FINANCIAL CONDITION, RESULTS OF OPERATIONS AND
LIQUIDITY. The Company's business, financial condition, results of operations
and liquidity depend, to a material extent, on the performance of loans
purchased and sold by the Company. When such loans are sold in securitizations,
the Company recognizes gain on sale. Finance income receivable, the Company's
principal asset, has been calculated using assumptions concerning future
default, prepayment and net loss rates on securitized loans that are consistent
with the Company's historical experience and market conditions and present value
discount rates that the Company believes would be requested by an unrelated
purchaser of an identical stream of estimated cash flows. Management believes
that the Company's estimates of excess cash flow were reasonable at the time
each gain on sale of loans was recorded. However, the actual rates of default
and/or prepayment and/or net loss on such loans may exceed those estimated for
purposes of calculating the Company's finance income receivable and consequently
may adversely affect anticipated future excess cash flow. The Company
periodically reviews its default, prepayment and net loss assumptions in
relation to current performance of the loans and market conditions, and, if
necessary, writes down the balance of finance income receivable. The Company
made a significant adjustment to its finance income receivable at March 31, 1997
after completing such a review, primarily relating to the recovery rates on
repossessed vehicles and the Company's disposition strategy. The Company's
business, financial condition, results of
2
<PAGE>
operations and liquidity could be materially adversely affected by such
adjustments in the future. No assurance can be given that loan losses and
prepayments will not exceed the Company's estimates or that finance income
receivable could be sold at its stated value on the balance sheet, if at all.
POSSIBLE RESTRICTIONS ON CASH FLOW FROM SECURITIZATIONS. The Company's
future liquidity and financial condition, and its ability to finance the growth
of its business and to repay or refinance its indebtedness, will depend to a
material extent on distributions of excess cash flow from securitization trusts.
The Company's agreements with FSA provide that the Company must maintain in a
spread account for each insured securitization trust specified levels of excess
cash during the life of the trust. These spread accounts are initially funded
out of initial deposits or cash flows from the related trust. Thereafter, during
each month, excess cash flow due to Arcadia Receivables Finance Corp. (formerly
Olympic Receivables Finance Corp.) ("ARFC"), from all insured securitization
trusts is first used to replenish any spread account deficiencies and is then
distributed to the Company. The timing and amount of distributions of excess
cash from securitization trusts varies based on a number of factors, including
but not limited to loan delinquencies, defaults and net losses, the rate of
turnover of repossession inventory and recovery rates, the ages of loans in the
portfolio, prepayment experience and required spread account levels. A
deterioration of the Company's loan delinquencies, cumulative defaults or net
losses, or a build-up in repossession inventory, or the continuing increase in
the proportion of repossession inventory sold in the wholesale auction markets,
or the increase in loans entering the seasoning period, could reduce excess cash
available to the Company. At August 31, 1997, the Company had an aggregate of
$222.9 million of restricted cash in spread accounts. There can be no assurance
that in the future the Company will not experience an interruption of excess
cash flow from ARFC, which could adversely affect the Company's ability to pay
its obligations, including the Notes.
Each insured securitization trust has certain portfolio performance tests
relating to levels of delinquency, defaults and net losses on the loans in such
trust based in part on the relative percentage of Premier and Classic loans.
Portfolio performance tests require that the loan portfolio of each insured
securitization trust (i) have an average delinquency ratio not equal to or in
excess of a specified percentage, (ii) have a cumulative default rate not equal
to or in excess of specified percentages which vary based on the aging of the
loan portfolio, and (iii) have a cumulative net loss rate not equal to or in
excess of specified percentages which vary based on the aging of the loan
portfolio. If any of these tests are exceeded (a "violation"), the amount
required to be retained in the spread account related to such securitization
trust will be increased to an amount generally equal to the greater of 10% of
the outstanding balance of loans or 1% of the original balance of loans held by
the securitization trust. As a consequence, a violation generally will decrease
excess cash flow available from such securitization trust until loan portfolio
performance has returned to the required limits for a specified period,
generally three to five months, unless waived by FSA. FSA and the Company have
an arrangement under which, if any insured securitization trust exceeds the
specified portfolio performance tests, ARFC may, in lieu of retaining the excess
cash from that securitization trust in the related spread account, pledge an
equivalent amount of cash, which has the effect of preventing the violation of
the portfolio performance test. Although certain trusts, primarily those that
contained loans originated in 1995, exceeded portfolio performance tests in the
first eight months of 1997 and are still in excess of such tests, this
arrangement with FSA has prevented a violation, although it has reduced the
amount of cash that would otherwise have been available to the Company if the
Company had sought and received a waiver of such violation from FSA. A
deterioration of the Company's delinquencies, cumulative defaults or net losses
would result in one or more additional existing securitization trusts exceeding
one or more of these tests in the absence of changes to the trigger levels.
There can be no assurance that, in such event, waivers will be available from
FSA permitting payments to ARFC.
Upon the occurrence of certain events with respect to any series of
asset-backed securities insured by FSA, including the failure to meet loan
portfolio performance tests of the nature described above but at significantly
higher levels, or upon a breach of the collateral coverage requirements of the
FSA-insured warehouse facility (an "Insurance Agreement Event of Default"), the
Company will be in default under its
3
<PAGE>
insurance agreement with FSA. Upon an Insurance Agreement Event of Default,
unless waived by FSA, FSA may suspend distributions of cash flow from the
related securitization trust and all other FSA-insured trusts (including the
FSA-insured warehouse facility) until the asset-backed securities have been
redeemed, capture excess cash flow from performing trusts, increase its premiums
and replace the Company as servicer with respect to all FSA-insured trusts.
There can be no assurance that a further deterioration of the Company's loan
delinquencies, gross charge-offs and net losses would not result in an Insurance
Agreement Event of Default, which could adversely affect the Company's ability
to satisfy its obligations, including the Notes. Certain of the Company's
securitization trusts exceeded such insurance agreement thresholds prior to 1996
and the Company obtained waivers from FSA to permit distributions of cash to
ARFC. There can be no assurance that in the future, if such thresholds are
exceeded, waivers will be available.
In addition, the spread account for each securitization is
cross-collateralized to the spread accounts established in connection with the
Company's other securitization trusts (including the FSA-insured warehouse
facility) such that excess cash flow from a performing securitization trust may
be used to support negative cash flow from, or to replenish a deficient spread
account in connection with, a nonperforming securitization trust, thereby
further restricting excess cash flow available to ARFC. If excess cash flow from
all insured securitization trusts is not sufficient to replenish all such spread
accounts, no cash flow would be available to the Company from ARFC for that
month. In January 1996, approximately $0.5 million of the Company's $63.6
million of restricted cash in spread accounts at December 31, 1995 under insured
securitization trusts was utilized for payments on related asset-backed
securities due to insufficient current cash flow in four such securitization
trusts. Excess cash flows from the other securitization trusts were not
sufficient to replenish such withdrawals and, consequently, the Company did not
receive excess cash flow from Olympic Receivables Finance Corp. (the predecessor
of ARFC) during that month. In February 1996, current excess cash flows again
began releasing to the Company. There can be no assurance that in the future the
Company will not experience an interruption of excess cash flow from ARFC such
as occurred in January 1996, which could adversely affect the Company's ability
to pay its obligations, including the Notes. FSA also has a collateral security
interest in the stock of ARFC. If FSA were to foreclose on such security
interest following an event of default under an insurance agreement with respect
to a securitization trust (including the FSA-insured warehouse facility), FSA
could preclude payment of dividends by ARFC to the Company, thereby eliminating
the Company's right to receive distributions of excess cash flow from all the
FSA-insured securitization trusts. The Company's right to service the loans sold
in securitizations insured by FSA is also generally subject to the discretion of
FSA. Accordingly, there can be no assurance that the Company will continue as
servicer for such loans and receive related servicing fees.
Any increase in limitations on cash flow available to the Company from ARFC
(including any increase in the amount of cash pledged under the arrangement with
FSA), inability to obtain any necessary waivers from FSA or termination of
servicing arrangements could materially adversely affect the Company's cash flow
and liquidity, and, ultimately, its business, financial condition and results of
operations and its outstanding securities.
IMPACT OF PORTFOLIO GROWTH AND PRODUCT MIX. The Company has experienced
rapid growth in its loan servicing portfolio, although the rate of such growth
has slowed in 1997. Historically, the statistical incidence of delinquencies and
defaults in connection with automobile loans tends to vary over the age of the
loan. For example, statistically, loans that are between six and fourteen months
old have had a higher likelihood of being delinquent or defaulting than loans
with similar credit characteristics that are three months old. Accordingly, to
the extent that portfolio growth results in a servicing portfolio containing
disproportionately more loans originated within the prior six months, the
current and historical delinquency and default rates of loans in the servicing
portfolio may understate future delinquency and default rates. Also, there can
be no assurance that the Company's transition from centralized to regional
servicing and collection will not adversely affect the rate of loan
delinquencies and defaults.
4
<PAGE>
In addition, to the extent the Company offers new loan products which
involve different underwriting policies, the delinquency and default rates of
the Company's servicing portfolio may change. The Company has instituted a
tiered pricing system and has periodically increased the authorized amount of
loans purchased under its Classic program involving borrowers who do not meet
all of the underwriting standards in the Company's Premier program and are
charged rates of interest higher than those under the Company's Premier program.
The Company increased its purchase of loans under the Classic program from 17%
of the principal amount of loans purchased in 1995 to 36% in 1996 and to 50%
during the six months ended June 30, 1997, and in the month of June 1997, 54% of
loans purchased were Classic loans. As a result of the increases in Classic
loans as a proportion of the Company's portfolio, there has been an increase in
the rates of, and reserves for, delinquencies, repossessions and losses
historically reported by the Company. The expansion of the Classic loan program
and seasoning of the Company's existing servicing portfolio will likely continue
to cause the Company's loan performance statistics to show higher delinquencies,
gross charge-offs and net losses when compared with historical performance even
if such loan performance statistics are consistent with the Company's reserves
for loan losses.
To estimate future delinquency, repossession and loss experience on its
loans, the Company uses a combination of factors, including actual loan
performance experience for that loan program, and industry experience on loans
with similar credit characteristics. However, there can be no assurance that its
loans will perform under varying economic conditions in the manner estimated by
the Company. Any increase in delinquency, repossession and loss rates related to
its loans above the rates estimated by the Company could have a material adverse
effect on the Company's business, financial condition and results of operations,
as well as its liquidity. In addition, certain of the Company's loan products
which produce higher delinquency, repossession and loss rates than initially
expected may continue to have an impact on the Company's overall loan
performance, even after being discontinued or modified, until the initially
generated loans mature beyond the six- to fourteen-month period. In 1996, the
Company discontinued a Classic loan product directed at first-time credits and
modified a Classic program for financing the sale of its repossessed inventory
in retail markets, each of which had experienced higher than expected
delinquency, repossession and loss rates.
EXTENSIONS AND AMENDMENTS. Like others in the industry, the Company gives
certain obligors extensions or amendments to loan terms in certain
circumstances, including when the Company believes such obligors will thereby be
more likely to repay their loans, and losses on such loans can be reduced. Loans
that have been extended or amended generally present substantially higher
default risks than loans that have neither of these characteristics. Primarily
as a result of the expansion of the Classic program (which involves higher
credit risks than the Premier program), the portion of the Company's servicing
portfolio which exhibits one or both of these characteristics has increased.
Extensions and amendments (in the aggregate) averaged approximately 2.7% of the
servicing portfolio per month in 1996 and 1.9% per month in 1995, and with
seasonal peaks occurring during the Christmas holiday season. Extensions and
amendments (in the aggregate) averaged approximately 3.4% per month for the
first eight months of 1997, compared to 2.7% per month for the first eight
months of 1996, and in the months of July and August 1997 were 3.0% and 2.7%,
respectively, compared to 2.9% and 2.8% in the months of July and August 1996,
respectively. The Company believes that one reason for the 1997 increase in
extensions and amendments as a percentage of the servicing portfolio is the
slower rate of growth in the size of the Company's portfolio, which results in a
higher percentage of loans of the age that are more likely to be extended or
amended. Any continued slowing of growth could contribute to a further increase
in such statistics. The Company considers these characteristics when
establishing its loss reserves. In certain circumstances, loans that have been
extended or amended have the effect of removing the related loan from delinquent
status.
POTENTIAL NEGATIVE IMPACT OF COVENANTS UNDER FINANCE AGREEMENTS. Increases
in loan delinquency and loss rates with respect to any securitization trust may
result in the trust's portfolio exceeding the various pool performance levels
established by FSA, thereby restricting or cutting off cash distributions to
ARFC from the securitization spread accounts. See "Cash Flow from
Securitizations" above. In addition, such
5
<PAGE>
increases may cause the Company to exceed certain pool performance tests
established in other agreements governing its indebtedness. If at the end of any
month the Portfolio Loss Ratio (as defined) exceeds 3.5% (which is calculated
excluding the effect of the Company's March 1997 special charge), the Company's
Delinquency Rates (as defined) exceed 3.5%, the Warehousing Loss Ratio (as
defined) exceeds 1.0%, or the Average Net Excess Spread (as defined) is not less
than 4.0%, an event of default will occur under one of the Company's outstanding
warehouse facilities. The delinquency level is calculated as a percentage of
outstanding principal balance of all automobile loans owned or securitized by
the Company as to which a payment is more than thirty days past due. Upon the
occurrence of an event of default under such warehouse facility, the lending
banks under such facility would have no further obligation to extend additional
credit. Furthermore, any such event of default or acceleration may trigger
cross-defaults under other outstanding indebtedness of the Company and may
result in the acceleration of amounts due thereunder. The increase in Classic
loans, among other things, has increased the risk that the Company may trigger
its Portfolio Loss Ratio covenants in the future.
RESALE AND FINANCING OF REPOSSESSIONS The Company relies significantly upon
the resale of its repossession inventory through retail markets, primarily
retail used car consignment lots. During the six months ended June 30, 1997,
approximately 55% of repossessed vehicles sold were liquidated through retail
markets, compared with 70% in 1996 and 40% in 1995. This strategy delays the
Company's excess cash flow during the period repossessions are held in inventory
pending resale, which is typically a longer period of time than for wholesale
auctions. In addition, the Company's repossession inventory has increased as a
percentage of its servicing portfolio due to the increase in the rate of loan
defaults and the Company's transition from using a few large retail consignment
lots for repossession sales to using multiple retail consignment lots. At August
31, 1997, the Company had $54.8 million of repossessed inventory, compared with
$49.0 million at June 30, 1997, $64.9 million at December 31, 1996, and $17.7
million at December 31, 1995.
As of March 31, 1997, the Company took an after-tax charge of $60.8 million
due primarily to a reduction in the estimated recovery rates on then current
repossessed inventory and anticipated future inventory arising from then
existing securitization transactions to 60% of principal balance outstanding (as
discussed in the Company's Quarterly Reports on Form 10-Q for the quarters ended
March 31, 1997 and June 30, 1997). The Company selected this 60% recovery rate
on the basis of the recovery rate the Company believes it could achieve if all
of its repossession inventory, including those higher value vehicles that are
ultimately sold through retail channels, were sold through wholesale channels.
In addition, the Company changed its accounting policy with respect to the
estimated recovery rate realized upon disposition of repossessed inventory to
estimate recovery rates based on such wholesale values and to record any
recoveries in excess of such levels at the time such excess recoveries are
realized. Since the Company changed its strategy at the end of the first quarter
of 1997, the Company's overall recovery rate (for both wholesale and retail
sales) has averaged approximately 62.5%. There can be no assurance that a change
in the proportions of vehicles sold through retail and wholesale channels or any
further softening of used car markets will not require additional adjustments to
repossession inventory or estimated recovery rates used to calculate finance
income receivable, which could be required if the Company's recovery rate were
to decline further. Futhermore, with the significant increase in the number of
repossessions, the Company has increased purchases of loans that finance resales
of repossessions to new buyers. Delinquency, gross charge-off and net loss rates
associated with loans on repossessed automobiles have historically been
substantially in excess of the same statistics associated with the Company's
remaining servicing portfolio. There can be no assurance that management's
recent efforts to improve the Company's retail repossession finance program will
be successful. If and to the extent the Company further modifies its current
disposition strategy with respect to use of the wholesale auction markets, this
modification could decrease recovery rates and increase net losses.
POTENTIAL NEGATIVE IMPACT OF INCREASE IN PERSONAL BANKRUPTCIES. Recent
media reports have suggested an increase in the number of personal bankruptcy
filings and the Company has in recent months
6
<PAGE>
experienced a slight increase in the proportion of its servicing portfolio
representing loans to borrowers who have filed for bankruptcy protection. A
continuation or increase in such trend could contribute to greater default and
net loss rates than the Company has historically experienced.
ECONOMIC CONDITIONS
MARKET CONDITIONS. Periods of economic slowdown or recession, whether
general, regional or industry-related, may increase the risk of default on
automobile loans and may have an adverse effect on the Company's business,
financial condition and results of operations. Such periods also may be
accompanied by decreased consumer demand for automobiles, resulting in reduced
demand for automobile loans and declining values of automobiles securing
outstanding loans, thereby weakening collateral coverage and increasing the
possibility of losses in the event of default. In addition, recent reports of
increases in consumer bankruptcy filings and default rates on consumer credit
during a period of economic growth indicate that the impact of consumer behavior
on default rates is not limited to periods of economic slowdown or recession.
The increased proportion of loans under the Company's Classic program has
increased the Company's sensitivity to changes in economic conditions.
Significant increases in the inventory of used automobiles during recessionary
economies may depress the prices at which repossessed automobiles may be sold or
delay the timing of such sales. A continuation of the recent softening of the
used car market as the result of factors including the recent start-up of
superstore competition or forecasted levels of used lease vehicles that will be
available in the market could have a similar effect on prices for and timing of
sales of repossession inventory. There can be no assurance that the used
automobile markets will be adequate for the sale of the Company's repossessed
automobiles and any material deterioration of such markets could increase the
Company's loan losses or reduce recoveries from the sale of repossession
inventory. In addition, the Company has channeled a significant portion of its
repossession inventory through retail resale markets instead of wholesale
markets, including the financing of such retail sales through its Classic
program, which had the effect of reducing the Company's loan losses while
increasing repossession inventory and delaying cash flow recovered from
inventory turnover. There can be no assurance that the Company will continue to
use such retail resale channels, that it will be able to realize such benefits
to loan losses in the future or that its inventories will not reach levels at
which they cannot readily be liquidated through such channels. Any such event
might have an adverse effect on loan loss levels.
INTEREST RATES. The Company's profitability may be directly affected by the
level of and fluctuations in interest rates, which affect the Company's gross
interest rate spread. The Company monitors the interest rate environment and
employs prefunding or other hedging strategies designed to mitigate the impact
of changes in interest rates on its gross interest rate spread. However, there
can be no assurance that the profitability of the Company would not be adversely
affected during any period of changes in interest rates.
LABOR MARKET CONDITIONS. The Company's ability to manage portfolio
delinquency, default and loss rates is dependent on its ability to attract and
retain qualified servicing and collection personnel. In recent months, low
unemployment rates driven by economic growth and the continued expansion of the
consumer credit markets have contributed to an increase in employee turnover
rate, especially among the Company's collection personnel. Continued high
turnover relative to historical levels, or an inability to attract and retain
replacement personnel, could have an adverse effect on the Company's portfolio
delinquency, default and net loss rates and, ultimately, its financial
condition, results of operations and liquidity.
LITIGATION
On March 4, 1997 a shareholder commenced an action against the Company and
certain named directors and officers of the Company entitled Taran v. Olympic
Financial Ltd. et al. in the United States District Court for the District of
Minnesota. Four similar lawsuits, three of them in the United States District
Court for the District of Minnesota (Frank Dibella, on behalf of himself and all
others similarly
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situated vs. Olympic Financial Ltd. et al., Michael Diemer vs. Olympic Financial
Ltd. et al. and Howard Pisnoy vs. Olympic Financial Ltd. et al.) and one in the
United States District Court for the Eastern District of New York (North River
Trading, LLC, and Allan Farkas, and All Others Similarly Situated vs. Olympic
Financial Ltd. et al.) were filed after that time. These suits have been
consolidated in one suit, In re Olympic Financial Ltd. Securities Litigation, in
the United States District Court for the District of Minnesota. Plaintiffs in
the consolidated action allege that during the period from July 20, 1995 through
March 3, 1997 the defendants, in violation of federal securities laws, engaged
in a scheme that had the effect of artificially inflating, maintaining and
otherwise manipulating the value of the Company's Common Stock by, among other
things, making baseless, false and misleading statements about the current state
and future prospects of the Company, particularly with respect to the Classic
program and the refinancing of repossessed automobiles. Plaintiffs allege that
this scheme included making false and misleading statements and/or concealing
material adverse facts. The consolidated action is in the preliminary stages and
the parties have not begun discovery. The Company has reviewed the complaint in
the consolidated action and believes that the consolidated action is without
merit and intends to defend it vigorously. There can, however, be no assurance
that the Company will prevail in such defense or that any order, judgment,
settlement or decree arising out of this litigation will not have a material
adverse effect on the Company's financial condition, results of operations or
liquidity.
MANAGEMENT OF GROWTH
The growth of the Company's servicing portfolio has resulted in increased
demands on the Company's personnel and systems. The Company's ability to
support, manage and control continued growth is dependent upon, among other
things, its ability to hire, train, supervise and manage its larger workforce.
Furthermore, the Company's ability to manage portfolio delinquency and loss
rates is dependent upon the maintenance of efficient collection and repossession
procedures and adequate staffing therefor. There can be no assurance that the
Company will have trained personnel and systems adequate to support such growth.
In 1996 the Company opened four regional collection centers and has taken a
number of initiatives to improve its servicing and collection performance. There
can be no assurance that these efforts will be successful.
COMPETITION
The business of financing automobiles is highly competitive. Existing and
potential competitors include well-established financial institutions, such as
banks, other automobile finance companies, small loan companies, thrifts,
leasing companies and captive finance companies owned by automobile
manufacturers, such as General Motors Acceptance Corporation, Chrysler Credit
Corp. and Ford Motor Credit Company. Many of these competitors have greater
financial, technical and marketing resources than the Company and from time to
time offer special buyer incentives in the form of below-market interest rates
on certain classes of vehicles. Many of such competitors also have longstanding
relationships with automobile dealers and some of such major competitors provide
other forms of financing to automobile dealers, including dealer floor plan
financing and leasing, which is not provided by the Company. There can be no
assurance that the Company will be able to compete successfully with such
competitors.
REGULATION
The Company's business is subject to numerous federal and state consumer
protection laws and regulations, which, among other things: (i) require the
Company to obtain and maintain certain licenses and qualifications; (ii) limit
the interest rates, fees and other charges the Company is allowed to charge;
(iii) limit or prescribe certain other terms of the Company's automobile loan
contracts; (iv) require specific disclosures; and (v) define the Company's
rights to repossess and sell collateral. The Company believes it is in
substantial compliance with all such laws and regulations, and that such laws
and regulations have had no material effect on the Company's ability to operate
its business. Changes in existing laws or regulations,
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or in the interpretation thereof, or the promulgation of any additional laws or
regulations, could have a material adverse effect on the Company's business,
financial condition and results of operations and upon its outstanding
securities.
SHARES ELIGIBLE FOR FUTURE SALES
Additional shares of Common Stock may be issued upon the exercise of
outstanding stock options and the exercise of outstanding warrants. Certain
holders thereof have registration rights with respect to such shares. The
Company has registered pursuant to such rights the sale from time to time of up
to 5,923,364 shares of Common Stock when, as and if issued upon the exercise of
outstanding warrants. Such issuances, or the resale of the Common Stock so
acquired, could have an adverse effect on the market price of the Company's
Common Stock.
UNDESIGNATED SHARES; ANTI-TAKEOVER CONSIDERATIONS
The authorized and unissued stock of the Company, other than shares reserved
for issuance pursuant to options and warrants, consists of undesignated shares.
The Board of Directors, without any action by the Company's shareholders, is
authorized to designate and issue the undesignated shares in such classes or
series as it deems appropriate and to establish the rights, preferences and
privileges of such shares, including dividend, liquidation and voting rights.
The Company has adopted a shareholder rights plan to deter a hostile takeover.
Further, certain provisions of the Minnesota Business Corporation Act may
operate to discourage a negotiated acquisition or unsolicited takeover of the
Company. Each or any of the foregoing could have the effect of entrenching the
Company's directors, impeding or deterring an unsolicited tender offer or
takeover proposal regarding the Company and thereby depriving the then current
shareholders of the ability to sell their shares at a premium over the market
price, or otherwise adversely affecting the voting power, dividend, liquidation
and other rights of holders of Common Stock.
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