ARCADIA FINANCIAL LTD
10-Q, 1999-11-10
SHORT-TERM BUSINESS CREDIT INSTITUTIONS
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

 
/x/		  
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 1999

Commission file number 0-20526


ARCADIA FINANCIAL LTD.
(Exact name of registrant as specified in its charter)

Minnesota   41-1664848
(State or other jurisdiction
Of incorporation or organization)		   (I.R.S. Employer
Identification Number)

7825 Washington Avenue South, Minneapolis, MN 55439-2435
(Address of principal executive offices)      (Zip Code)

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 8, 1999 was 39,443,693.


FORM 10-Q INDEX

 
    
   Page
Part I   FINANCIAL INFORMATION    
Item 1.   Consolidated Financial Statements   3
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations   11
Item 3.   Quantitative and Qualitative Disclosures About Market Risk   23
 
Part II		  
 		  
OTHER INFORMATION		  
 		  
 
Item 1.   Legal Proceedings   24
Item 2.   Changes in Securities and Use of Proceeds   24
Item 3.   Defaults Upon Senior Securities   25
Item 4.   Submission of Matters to a Vote of Security Holders   25
Item 5.   Other Information   25
Item 6.   Exhibits and Reports on Form 8-K   25
 
SIGNATURES		  
 		  
28
 
EXHIBIT INDEX		  
 		  
29

    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

    Certain statements under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Form 10-Q constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may be identified by the use of terminology such as "may," "will," "expect," "anticipate," "estimate," "should," or "continue" or the negative thereof or other variations thereon or comparable terminology. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or from those results presently anticipated or projected. Such factors include, among other things, the following: increased delinquency and loan loss rates; accounting changes; regulatory changes; interest rate fluctuations; difficulties or delays in the securitization of automobile loans; availability of adequate debt and/or equity financing; general economic and business conditions; and other matters set forth under the caption "Cautionary Statements" in exhibit 99.1 to the Company's June 30, 1999 Quarterly Report on Form 10-Q, filed July 28, 1999.

ARCADIA FINANCIAL LTD.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands, except share and per share amounts)

   September 30, 1999
   December 31, 1998
  
ASSETS  
Cash and cash equivalents   $ 6,322   $ 6,326  
Restricted cash     9,771     4,501  
Due from securitization trust     —     62,081  
Auto loans held for sale     162,585     17,899  
Retained interest in securitized assets     629,115     587,946  
Furniture, fixtures and equipment     15,743     17,511  
Other assets     31,840     31,419  
   
 
 
Total assets   $ 855,376   $ 727,683  
   
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY  
Amounts due under warehouse facilities   $ 126,860   $ —  
Senior notes     367,420     366,657  
Subordinated notes     82,548     51,898  
Capital lease obligations     2,704     3,384  
Accounts payable and accrued liabilities     26,253     36,935  
   
 
 
Total liabilities     605,785     458,874  
   
 
 
 
Commitments and contingencies		  
 		  
 		  
 		  
 		  
 		  
 		  
 
 
Shareholders' equity:		  
 		  
 		  
 		  
 		  
 		  
 		  
 
Capital stock, $.01 par value, 100,000,000 shares authorized:              
Common stock 39,443,693 and 39,156,888 shares issued and outstanding, respectively     395     392  
Additional paid-in capital     326,202     324,565  
Accumulated other comprehensive income (loss)     (33,343 )   18,550  
Retained deficit     (43,663 )   (74,698 )
   
 
 
Total shareholders' equity     249,591     268,809  
   
 
 
Total liabilities and shareholders' equity   $ 855,376   $ 727,683  
   
 
 

See notes to unaudited consolidated financial statements.

ARCADIA FINANCIAL LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

 
   Three Months Ended
September 30,
   Nine Months Ended September 30,
  
(Dollars in thousands, except per share amounts)

   1999
   1998
   1999
   1998
  
Revenues:                          
Net interest margin   $ 23,889   $ 22,675   $ 67,500   $ 63,593  
Gain (loss) on sale of loans     16,671     20,667     70,175     (39,631 )
Servicing fee income     23,755     21,236     67,986     61,086  
   
 
 
 
 
Total revenues     64,315     64,578     205,661     85,048  
Expenses:                          
Salaries and benefits     18,543     16,387     56,468     50,387  
General and administrative and other operating expenses     23,554     26,966     73,121     93,491  
   
 
 
 
 
Total operating expenses     42,097     43,353     129,589     143,878  
Long-term debt and other interest expense     13,938     12,926     41,061     38,619  
   
 
 
 
 
Total expenses     56,035     56,279     170,650     182,497  
   
 
 
 
 
Operating income (loss) before income taxes and cumulative effect     8,280     8,299     35,011     (97,449 )
Related income tax benefit     —     —     —     (9,235 )
   
 
 
 
 
Income (loss) before cumulative effect     8,280     8,299     35,011     (88,214 )
Cumulative effect of change in accounting, net of taxes of $0     —     —     (3,976 )   —  
   
 
 
 
 
Net Income (loss)     8,280     8,299     31,035     (88,214 )
   
 
 
 
 
Other comprehensive income (loss):                          
Net unrealized gain (loss) on retained interests in securitized assets     12,278     7,631     (51,893 )   10,736  
Income tax benefit     —     —     —     (2,271 )
   
 
 
 
 
      12,278     7,631     (51,893 )   13,007  
   
 
 
 
 
Comprehensive Income (loss)     20,558     15,930     (20,858 )   (75,207 )
   
 
 
 
 
Basic Earnings Per Share:                          
Income before cumulative effect     0.21     0.21     0.89     (2.26 )
Cumulative (loss) effect     —     —     (0.10 )   —  
   
 
 
 
 
Net income (loss)     0.21     0.21     0.79     (2.26 )
   
 
 
 
 
Diluted Earnings Per Share:                          
Income before cumulative effect     0.21     0.21     0.88     (2.26 )
Cumulative (loss) effect     —     —     (0.10 )   —  
   
 
 
 
 
Net income (loss)   $ 0.21   $ 0.21   $ 0.78   $ (2.26 )
   
 
 
 
 
Weighted average shares outstanding:                          
Basic     39,395,014     39,142,050     39,324,308     39,031,668  
Diluted     40,353,565     39,279,813     39,944,512     39,031,668  

See notes to unaudited consolidated financial statements.

ARCADIA FINANCIAL LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
   Nine Months Ended
September 30,
  
(Dollars in thousands)

   1999
   1998
  
Cash flows from operating activities:              
Net income (loss)   $ 31,035   $ (88,214 )
Adjustments to reconcile net income to net cash used in operating activities:              
Depreciation and amortization     8,355     8,044  
Provision for losses     2,200     2,364  
Gain on Sale of Equipment     (36 )   —  
(Increase) decrease in assets:              
Automobile loans held for sale:              
Purchases of automobile loans     (1,810,621 )   (1,731,546 )
Sales of automobile loans     1,700,605     1,714,710  
Repayments of automobile loans     25,211     43,561  
Restricted Cash     (5,270 )   (1,231 )
Retained interest in securitized assets     (93,062 )   22,510  
Due from securitization trusts     —     8,823  
Prepaid expenses and other assets     (2,165 )   340  
Decrease in liabilities:              
Deferred income taxes     —     (11,506 )
Accounts payable and accrued liabilities     (10,681 )   (584 )
   
 
 
Total cash used in operating activities     (154,429 )   (32,729 )
Cash flows from investing activities:              
Proceeds from sales of furniture, fixtures and equipment     1,104     —  
Purchase of furniture, fixtures and equipment     (5,098 )   (4,704 )
Collections on subordinated certificates     687     758  
   
 
 
Total cash used in investing activities     (3,307 )   (3,946 )
Cash flows from financing activities:              
Net proceeds from issuance of Common Stock     902     1,038  
Proceeds from borrowings under warehouse facilities     1,772,808     2,067,182  
Repayment of borrowings under warehouse facilities     (1,645,948 )   (2,040,219 )
Unsecured subordinated notes, net     30,650     (1,870 )
Reduction of capital lease obligations     (680 )   (1,633 )
   
 
 
Total cash provided by financing activities     157,732     24,498  
   
 
 
Net decrease in cash and cash equivalents     (4 )   (12,177 )
Cash and cash equivalents at beginning of period     6,326     18,946  
   
 
 
Cash and cash equivalents at end of period   $ 6,322   $ 6,769  
   
 
 
Supplemental disclosures of cash flow information:              
Non cash activities:              
Additions to capital leases   $ 99     —  
Cash paid for:              
Interest   $ 58,412   $ 55,233  

See notes to unaudited consolidated financial statements.

ARCADIA FINANCIAL LTD.

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

(Unaudited)

 
   For the Nine Months Ended September 30, 1999
  
(Dollars in thousands, except share amounts)

   Number of Common Shares
   Common Par Value
   Additional Paid in Capital
   Accumulated Other Comprehensive Income
   Retained (Deficit)
   Total
  
Balance, December 31, 1998   39,156,888   $ 392   $ 324,565   $ 18,550   $ (74,698 ) $ 268,809  
Exercise of options and warrants   83,666     1     445                 446  
Issuance of Common Stock:                                    
Benefit plans   203,139     2     455                 457  
Amortization of deferred compensation               737                 737  
Unrealized loss on retained interest in securitized assets                     (51,893 )         (51,893 )
Net income                           31,035     31,035  
   
 
 
 
 
 
 
Balance, September 30, 1999   39,443,693   $ 395   $ 326,202   $ (33,343 ) $ (43,663 ) $ 249,591  
   
 
 
 
 
 
 

See notes to unaudited consolidated financial statements.

ARCADIA FINANCIAL LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE QUARTER ENDED SEPTEMBER 30, 1999

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 1998 Annual Report on Form 10-K filed March 24, 1999.

    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, 1998 balances to conform to current period presentation.

    In conformity with generally accepted accounting principles, management utilizes assumptions and estimates that affect the reported value of finance income receivable and the gain on sale of automobile receivables. Such assumptions include, but are not limited to, estimates of loan prepayments, defaults, recovery rates and present value discount. The Company uses a combination of its own historical experience, industry statistics and expectation of future performance to determine such estimates. The Company's estimation process is evaluated on a regular basis and modified when deemed necessary. Modifications to the estimation process may result in changes in estimates utilized to determine the carrying value of retained interest in securitized assets. Actual results may differ from the Company's estimates due to numerous factors both within and beyond the control of Company management. Changes in these factors could require the Company to revise its assumptions concerning the amount of voluntary prepayments, the frequency and/or severity of defaults and the recovery rates associated with the disposition of repossessed vehicles, as well as other assumptions. The financial statement effects of changes in such estimates are reflected in the results of operations of the period of change. The range of assumptions, as well as actual performance, is reflective of the risk characteristics of the loans within specific securitization pools.

2. Changes in Accounting Method

    Effective January 1, 1999 the Company changed its accounting method for recognition of sales of asset-backed securities. Previously, the Company recognized sales of asset-backed securities once an irrevocable commitment had been received, the loans to be sold had been identified and segregated from loans held for sale, and cash proceeds had been placed in the trust by a third party. The Company now records sales of asset-backed securities upon physical settlement, which generally occurs within 5 to 10 days of the segregation of the loans to be sold.

3. Retained Interest in Securitized Assets

    The following table sets forth the components of retained interest in securitized assets:

(Dollars in thousands)

   At
September 30,
1999
   At
December 31,
1998
  
Estimated future excess cash flows on loans sold, net of estimated prepayments(1)   $ 1,294,821   $ 1,195,466  
Deferred servicing income     (103,445 )   (101,996 )
Reserve for loan losses     (386,048 )   (415,401 )
   
 
 
Undiscounted cash flows on loans sold, net of estimated prepayments     805,328     678,069  
Discount to present value     (176,213 )   (90,123 )
   
 
 
    $ 629,115   $ 587,946  
   
 
 
Reserve for loan losses as a percentage of securitized servicing portfolio     7.57 %   8.18 %
(1)
Includes restricted cash deposits in securitization spread accounts of $354.2 million and $227.7 million at September 30, 1999 and December 31, 1998, respectively.

    The following represents the roll-forward of the retained interests in securitized assets balance:

(Dollars in thousands)

    
  
Balance, December 31, 1998   $ 587,946  
Present value of estimated future cash flows from current period securitizations     190,972  
Interest earned on spread accounts     11,833  
Accretion of discount on estimated future cash flows     42,835  
Unrealized loss on retained assets     (51,893 )
Less:        
Excess cash flows released to the Company(1)     (152,578 )
   
 
Balance, September 30, 1999   $ 629,115  
   
 
(1)
Pursuant to an arrangement between the Company and its provider of asset-backed securities insurance, if any insured securitization trust exceeds a 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. Under such arrangement, the Company had approximately $5.8 million pledged and deposited in restricted accounts at September 30, 1999. Such pledged amounts are included in restricted cash. Restrictions on the pledged amounts may be lifted if the portfolio performance for the related securitization trusts tests are met and maintained as defined in the arrangement, the violations are waived, or the loans within the securitization trust are repurchased by the Company at the end of the securitization term.

4. Other Assets

(Dollars in thousands)

   At
September 30,
1999
   At
December 31,
1998
Advances due to servicer   $ 5,612   $ 5,967
Deferred debt issuance costs     9,053     10,110
Investment in subordinated certificates     1,186     1,873
Servicing fee receivable     5,174     4,841
Prepaid expenses     1,435     1,717
Other assets     9,380     6,911
   
 
    $ 31,840   $ 31,419
   
 

5. Subordinated Notes

(Dollars in thousands)

   At
September 30,
1999
   At
December 31,
1998
Senior subordinated notes, Series 1996-A   $ 30,000   $ 30,000
Junior subordinated notes     52,548     21,898
   
 
    $ 82,548   $ 51,898
   
 

6. Earnings Per Share

    The following table sets forth the computation of basic and diluted earnings per share for each of the three and nine month periods ended September 30:

 
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
  
(Dollars in thousands, except share amounts)

   1999
   1998
   1999
   1998
  
Numerator:                          
Net income (loss) from operations before cumulative effect   $ 8,280   $ 8,299   $ 35,011   $ (88,214 )
   
 
 
 
 
Denominator:                          
Denominator for basic earnings per share—weighted average shares     39,395,014     39,142,050     39,324,308     39,031,668  
Dilutive effect of options and warrants(1)     958,551     137,763     620,204     —  
   
 
 
 
 
Denominator for diluted earnings per share—adjusted weighted average shares     40,353,565     39,279,813     39,944,512     39,031,668  
   
 
 
 
 
Basic income (loss) before cumulative effect   $ 0.21   $ 0.21   $ 0.89   $ (2.26 )
   
 
 
 
 
Diluted income (loss) before cumulative effect   $ 0.21   $ 0.21   $ 0.88   $ (2.26 )
   
 
 
 
 

(1)
For the three and nine months ended September 30, 1999 and 1998, there were 5.0 million, 6.1 million, 6.6 million, and 5.1 million options and warrants respectively, that were excluded from the computation of diluted earnings per share because the impact was anti-dilutive.


Item 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

    Substantially all of the Company's revenues are derived from the purchase, securitization and servicing of consumer automobile loans originated in 45 states primarily by car dealers affiliated with major foreign and domestic manufacturers. Loans are purchased through 17 regional buying centers (or "hubs") located in 14 states, supplemented by a network of dealer development representatives ("DDRs") which develop and maintain relationships with car dealers operating within each "hub's" immediate market area or in surrounding market areas referred to as "spokes." Credit approval and loan processing are generally performed at the "hub" or at the Company's headquarters in Minneapolis, Minnesota. The Company acts as the servicer of all loans originated and securitized by it in return for a monthly servicing fee. To perform its servicing responsibilities the Company operates a national customer service center in Minneapolis, Minnesota and four regional collection centers located in Charlotte, North Carolina; Dallas, Texas; Denver, Colorado; and Minneapolis, Minnesota.


Three and Nine Months Ended September 30, 1999 and 1998

Results of Operations

    Effective January 1, 1999 the Company changed its accounting method for recognition of sales of asset-backed securities. Previously, the Company recognized sales of asset-backed securities once an irrevocable commitment had been received, the loans to be sold had been identified and segregated from loans held for sale, and cash proceeds had been placed in the trust by a third party. The Company now records sales of asset-backed securities upon physical settlement, which generally occurs within 5 to 10 days of the segregation of the loans to be sold.

    Net Interest Margin.  The components of net interest margin for each of the three and nine months ended September 30 were:

 
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
  
(Dollars in thousands)

   1999
   1998
   1999
   1998
  
Interest income on loans, net   $ 6,734   $ 7,947   $ 21,255   $ 20,979  
Interest income on short-term investments and other cash accounts     1,861     2,538     5,610     8,485  
Accretion of present value discount     15,494     12,885     42,835     36,493  
Provision for credit losses on loans held for sale     (200 )   (695 )   (2,200 )   (2,364 )
   
 
 
 
 
Net interest margin   $ 23,889   $ 22,675   $ 67,500   $ 63,593  
   
 
 
 
 

    Net Interest Margin increased 5% for the three months ended September 30, 1999 compared to the three months ended September 30, 1998, and increased 6% for the nine months ended September 30, 1999 compared to the same period in 1998. The increase in net margin for the three and nine months ended September 30, 1999 compared to the same periods in 1998 is primarily due to increased accretion in present value discount reflecting the growth in the Company's Retained Interest in Securitized Assets.

    A 4% and 5% increase in loan purchasing volume (see table below) during the three and nine months ended September 30, 1999, respectively, resulted in (i) a higher average monthly balance of loans held for sale, on which the Company earns interest income until such loans are securitized ($298.8 million and $278.8 million, respectively, up from $210.3 million and $189.5 million in the same periods of 1998, respectively) and (ii) the rise in the weighted average gross interest rate spread earned on such loans held for sale. During the three and nine months ended September 30, 1999, the weighted average gross interest rate spread rose to 11.65% and 11.93%, respectively, compared with 11.02% and 11.16%, respectively, during the same periods in 1998.

    The Company's loan purchasing volume for each of the three and nine months ended September 30 are set forth in the table below.

 
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
(Dollars in thousands)

   1999
   1998
   1999
   1998
Total automobile loans purchased   $ 594,871   $ 570,021   $ 1,807,027   $ 1,726,874

    Gain on Sale of Loans.  During the three months ended September 30, 1999, gain on sale of loans declined 19% compared to the same period in 1998 primarily due to a permanent impairment adjustment to two of the Company's 22 outstanding securitizations that totaled $6.7 million. See "Financial Condition—Retained Interest in Securitized Assets" below.

    During the nine months ended September 30, 1998 the Company recognized a pre-tax charge on sale of loans of $114.5 million resulting in a loss on the sale of loans of $39.6 million. Included in the Gain on Sale of Loans for the nine months ended September 30, 1999 is a $1.3 million loss on $3.6 million of loans sold that the Company had been unable to sell in the secondary markets through securitization.

    The following table summarizes the Company's gross interest rate spreads for each of the three and nine-month periods ended September 30:

 
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
  
 
   1999
   1998
   1999
   1998
  
Initial weighted average APR of loans securitized   17.15 % 16.81 % 17.24 % 16.97 %
Initial weighted average securitization rate   6.80   5.64   6.40   5.87  
   
 
 
 
 
Gross interest rate spread(1)   10.35 % 11.17 % 10.84 % 11.10 %
   
 
 
 
 
(1)
Before gains/losses on hedging transactions.

    The Company enters into hedging transactions to manage its gross interest rate spread on loans held for sale. The Company sells forward U.S. Treasuries that most closely parallel the average life of its portfolio 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. These up-front cash receipts or payments are offset in future periods through the realization of a lower or higher spread, respectively, established at the time of pricing the hedged transaction. During the first nine months of 1999, the Company's hedging activities generated net cash flows to the Company of $4.5 million compared to a net use of cash during the same period a year ago of $16.8 million. There were no unrealized losses outstanding at September 30, 1999.

    In the second quarter of 1999, the Company changed several factors and assumptions utilized in determining the gain on sale of asset-backed securities. First, based on the mix of vehicles and the relative risk associated with loans sold during the quarter, management increased the estimated cumulative default rate to 16.03% from the prior quarter rate of 15.15%. Second, the Company has continued to experience a recovery rate in excess of 48% on the sale of repossessed vehicles during 1998 and 1999 and therefore the Company increased its estimated recovery rate to 48% from the prior rate of 45%. During the three months ended September 30, 1999, the Company further refined the recovery rate assumption to 49%. Finally, based on a review of industry-reported discount rates in the consumer finance markets, the Company increased the discount rate used to estimate the present value of the future excess cash flows to be released from spread accounts to 15%. Increasing the overall discount rate on an existing securitization transaction has the effect of increasing an unrealized loss, while increasing the rate on a new securitization transaction defers a greater portion of the gain to the Company from that transaction.

    Any unamortized balance of participations paid to dealers is included in the cost basis of loans at the time they are securitized and is recorded as a reduction to gain on sale. Participations paid as a percentage of the principal balance of loans purchased were 2.99% and 2.96%, respectively, during the three and nine months ended September 30, 1999, compared to 2.94% and 2.87%, respectively, in the same periods a year ago.

    Gain on sale of loans has been adjusted for net realized gains on hedging transactions of $1.6 million and $4.5 million during the three and nine months ended September 30, 1999, compared with net realized losses of $8.4 million and $16.8 million, respectively, in the same periods a year ago. The hedging losses that were charged against gain on sale of loans in 1998 were primarily due to the downward movement of treasury rates.

    Servicing Fee Income.  The components of servicing fee income for each of the three and nine months ended September 30 were:

 
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
(Dollars in thousands)

   1999
   1998
   1999
   1998
Contractual servicing fee income   $ 14,940   $ 14,577   $ 43,823   $ 42,756
Other servicing income     8,815     6,659     24,163     18,330
   
 
 
 
Total servicing fee income   $ 23,755   $ 21,236   $ 67,986   $ 61,086
   
 
 
 

    The Company earns contractual servicing fee income for servicing loans sold to securitization trusts in securitizations. Contractual servicing income is earned at rates ranging from 1% to 1.25% per annum on the outstanding principal balance of the loans in the relevant trust. The Company's servicing fee approximates adequate compensation as defined by SFAS 125 and therefore, the Company has not recorded a servicing asset or liability at September 30, 1999. The growth in contractual servicing fee income is primarily related to an increase in the average servicing portfolio outstanding (see table below).

    Other servicing income consists primarily of collection fees earned by the Company as servicer of the loans. The rise in other servicing income is principally due to an increase in document fees collected, and an increase in fees associated with certain customer payment services utilized for collecting delinquent accounts.

    The following table reflects the growth in the Company's servicing portfolio from September 30, 1998 to September 30, 1999:

 
   At September 30,
(Dollars in thousands, except as noted)

   1999
   1998
Principal balance of automobile loans held for sale   $ 159,672   $ 20,785
Principal balance of loans serviced under securitizations     5,101,122     5,117,013
   
 
Servicing portfolio   $ 5,260,794   $ 5,137,798
   
 
Average unpaid principal balance (actual dollars)   $ 11,076   $ 11,480
Number of loans serviced     474,989     447,542

    The Company's servicing portfolio (measured by principal balance) increased 2% from September 30, 1998 to September 30, 1999, reflecting loan purchases and subsequent securitizations, partially offset by defaults, prepayments and scheduled repayments. The decline in average outstanding balance of loans at September 30, 1999 compared to September 30, 1998 reflects an increase in the proportion of used to new cars financed by the Company and a reduction in the average loan-to-value ratio on loan purchases resulting from the Company's more selective buying practices.

    Operating Expenses.  During each of the three and nine months ended September 30, 1999, salaries and benefits increased 12% from the same periods a year ago. The increase in salaries and benefits is primarily due to an enhanced incentive program for collectors and an increase in FTE's, partially offset by lower overtime compensation resulting from centralizing the Company's collection operations during 1998.

    Other operating costs, including administrative, occupancy, depreciation and amortization, origination, servicing and collection expenses, decreased 14% and 22% for the three and nine months ended September 30, 1999, respectively, compared with the same periods in 1998. Included in operating costs during the nine months ended September 30, 1998 is a pre-tax charge of approximately $10.5 million related to the elimination of the Company's retail remarketing program and other organizational changes designed to improve operating efficiency. Excluding this charge, other operating costs decreased 11% for the nine months ended September 30, 1999. The decrease is primarily attributable to lower repossession and remarketing expenses due to the elimination of the Company's retail remarketing program.

    Income Taxes.  The Company did not record an income tax provision during the three and nine months ended September 30, 1999, due to the utilization of net operating loss carryforwards.

    Impact of Year 2000.  The Company recognizes that the arrival of the Year 2000 poses a unique worldwide challenge to the ability of all computer based applications to recognize the date change from December 31, 1999 to January 1, 2000, potentially causing miscalculations, system failures and other operational problems.

    One of the Company's most critical operating systems is its loan accounting system. In July 1997, an internal implementation team along with outside consultants was assigned to evaluate, select, and implement a new installment loan accounting system and various sub-systems (the "ILA system") in connection with an initiative to replace and enhance the Company's key operating systems. One of the requirements for consideration was that the new ILA system be Year 2000 compliant. In late 1997, a contract was signed with a nationally recognized vendor to provide the Company with such a system. The contract warrants, among other things, that the core software system being purchased is fully Year 2000 compliant. The new Installment Loan Accounting system was installed in production at the Company during September 1999. Extensive testing was done prior to that time to insure that the system was delivered as specified by the Company including Year 2000 compliance. Further verification of the Year 2000 compliance of the system is planned to be completed before the end of 1999.

    In addition, in early 1998 the Company formed a dedicated project team to conduct an extensive analysis of the impact that the Year 2000 issue might have on its automated information systems (exclusive of the ILA system), business support systems and facility operating systems. The project team has been responsible for the prioritization of Year 2000 tasks, development of implementation plans, and the establishment of timetables for completion and testing of all necessary modifications. As a result, the Company has initiated the replacement, modification or reprogramming of Year 2000 non-compliant hardware and software and since 1997 has required that all new hardware and software be certified as Year 2000 compliant prior to purchase. To assist in this process, the Company engaged an independent company to aid in the remediation of non-compliant programs. The modification, reprogramming, testing and implementation of the Company's non-compliant programs were completed in the first quarter of 1999. All Year 2000 testing was executed in an isolated systems environment dedicated for Year 2000 issues.

    The Company has expended approximately $840,000 for its Year 2000 through September 30, 1999. These costs do not include amounts related to the implementation of the ILA system or other hardware and software purchases which the Company had planned to acquire and which are not directly related to, or the purchase of which has not been accelerated because of, the Year 2000 issue. Consistent with the Company's capitalization policy, the cost of such non-Year 2000 hardware and software purchases will be capitalized and amortized over their expected useful lives.

    Ultimately, the potential impact of the Year 2000 issue will depend not only on the success of the corrective measures that the Company undertakes, but also on the way in which the Year 2000 issue is addressed by its business partners, service providers, utility providers, governmental agencies and other entities with which the Company does business. In an effort to minimize the impact any third-party Y2K failure might have on business operations, the Company has completed the development of contingency plans for critical business functions related to its Year 2000 efforts. All critical business processes have been evaluated for dependency on applications that might have a Year 2000 related failure either internally or externally. The impact of such a failure was assessed both from a financial and a process perspective. Based on the impact and the amount of time that a failure could be tolerated, contingency plans have been put in place. We believe these contingency plans will protect the Company from any major business disruptions related to Year 2000 failures by the Company or any of the Company's key service providers.

    The Company believes that it has an effective plan in place to resolve the Year 2000 issue in a timely manner. Nearly all of the tasks defined in its Year 2000 plan have been completed. The Company plans to continuously monitor the status of completion of its Year 2000 plan and, based on such information, will develop contingency plans as necessary. In the event that the Company does not complete any additional phases of its plan, the Company may be unable to perform its key operating activities, such as the purchase of loans and the invoicing, collecting and application of obligor repayments. In addition, the Company could be subject to litigation for computer systems failure such as improper application of repayments and resulting incorrect credit reporting to credit bureaus. Finally, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The amount of potential liability and lost revenue cannot reasonably be estimated at this time.

    The foregoing discussion regarding Year 2000, including the discussion of the timing and effectiveness of implementation and cost of the Company's Year 2000 project, contains forward-looking statements, which are based on management's best estimates derived using various assumptions. These forward-looking statements involve inherent risks and uncertainties, and actual results could differ materially from those contemplated by such statements. Factors that might cause material difference include, but are not limited to, the continued availability of key Year 2000 personnel, and the Company's ability to respond to unforeseen Year 2000 complications. Such material differences could result in, among other things, business disruption, operational problems, financial loss, legal liability and similar risks.

Financial Condition

    Due From Securitization Trust.  The decrease in due from securitization trust is due primarily to the timing of loans transferred to securitization trusts combined with an accounting method change to recognition of gain upon physical settlement (see "Changes in Accounting Method").

    Auto Loans Held for Sale.  The Company's portfolio of auto loans held for sale increased to $162.6 million at September 30, 1999, compared with $17.9 million at December 31, 1998, due primarily to the timing of loans transferred to securitization trusts combined with an accounting change to recognition of gain upon physical settlement (see "Changes in Accounting Method"). An increase in loan purchasing volume during the first nine months of 1999 compared with the same period in 1998 also contributed to the increase in auto loans held for sale.

    The Company carries its loans held for sale at the lower of amortized cost (principal amount outstanding) or market. The Company intends to securitize all loans that are purchased. Normally, loans purchased during the quarter are securitized during that quarter or the first month of the following quarter. The Company provides an allowance for credit losses relating to non-performing loans that are not eligible to be securitized. Over time, some of the non-performing loans will become performing loans and will then be securitized. The remainder will be sold by the Company to third parties at a discount to the Company's amortized cost. The allowance for credit losses represents the Company's estimate (based on historical experience) of the discount that would be required if the non- performing loans were sold at the balance sheet date. The allowance for credit losses is increased by charging the provision for credit losses (disclosed as a component of net interest margin) and decreased by actual losses incurred on the loans held for sale. For balance sheet purposes, the Company nets the credit loss allowance against loans held for sale.

    The following table illustrates the allowance for credit losses on loans held for sale over the last four quarters:

(Dollars in thousands)

   September 30, 1999
   June 30, 1999
   March 31, 1999
   December 31, 1998
  
Beginning Balance   $ 1,113   $ 459   $ 292   $ 13  
Provision for Losses     200     1,100     900     900  
Net Charge-offs     (170 )   (446 )   (733 )   (621 )
   
 
 
 
 
Ending Balance   $ 1,143   $ 1,113   $ 459   $ 292  
   
 
 
 
 

    Retained Interest in Securitized Assets.  Retained interests in securitized assets increased to $629.1 million at September 30, 1999 from $587.9 million at December 31, 1998. This increase is primarily due to amounts capitalized upon completion of securitization transactions during 1999 related to the present value of estimated cash flows partially offset by excess cash flows released to the Company from securitization trusts. The increase for the year is also offset by temporary fair value adjustments taken against Retained Interest during the year.

    The Company records unrealized gains or losses attributable to the change in the fair value of the Retained Interest in each securitization until realized. The unrealized gains or losses are recorded in "Accumulated other comprehensive income," a component of shareholders' equity. The Company is not aware of an active market for the purchase or sale of Retained Interest, and accordingly, the Company determines the estimated fair value of the Retained Interest by discounting the expected cash flows to be released from the securitization trusts using a discount rate which the Company believes is commensurate with the risks involved. The discount rate used by the Company is currently 15%.

    A permanent impairment adjustment to the carrying value of the Retained Interest may be required if the present value (determined using a risk-free interest rate) of an individual Retained Interest is less than its carrying value. This determination is made on a disaggregated (pool by pool) basis. Permanent impairment adjustments are recorded as a component of Gain on Sale of Loans. During the three months ended September 30, 1999, the Company recorded permanent impairments totaling $6.7 million for two of its 22 residual interests. Changes in assumptions, adverse experience, restructuring of cash flows or simply an increase in the risk free rate could trigger impairments in the remaining residual interests. For example, a 0.25% increase in the risk free rate would create a permanent impairment of the September 30, 1999 Retained Interests of $9.7 million, absent any other change. As of September 30, 1999, the Company has recorded both negative and positive fair value adjustments of $50 million and $17 million, respectively. This entire amount is reflected in the Statement of Shareholders' Equity as unrealized gain or loss. If a permanent impairment occurs in the future, the impaired residual interest(s) will be written down to their then fair value which will be determined using a discount rate of 15%. All residual interests are currently reflected on the Company's balance sheet at their fair value. Once a residual interest has been written down to a new fair value, the residual interest will yield 15% immediately thereafter.

    For both temporary and permanent impairments, the Company's management evaluates all of the assumptions used to record the original Gain on Sale of Loans and Retained Interest in Securitized Assets.

    Accounts Payable and Accrued Liabilities.  Accounts payable and accrued liabilities decreased 29% to $26.3 million at September 30, 1999 as compared with $36.9 million at December 31, 1998. This decrease primarily reflects the semi-annual payment in September 1999 of accrued interest associated with the Company's Senior Notes.


Delinquency, Credit Loss and Repossession Experience

    The following tables describe delinquency, credit loss and repossession experience of the Company's servicing portfolio 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 disposition of automobiles are charged against applicable allowances, which management reviews on a monthly basis. There can be no assurance that future delinquency, credit loss and repossession experience will be comparable to that set forth below.

 
   September 30, 1999
   December 31, 1998
  
(Dollars in thousands)

   Amount
   Percent
   Amount
   Percent
  
Delinquent contracts:                      
31-60 days   $ 121,993   2.32 % $ 130,135   2.55 %
Greater than 60 days     67,512   1.28 %   62,879   1.23 %
   
 
 
 
 
    $ 189,505   3.60 % $ 193,014   3.78 %
In repossession     46,013   0.88 %   50,809   1.00 %
   
 
 
 
 
    $ 235,518   4.48 % $ 243,823   4.78 %
   
 
 
 
 
(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.

 
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
  
(Dollars in thousands)

   1999
   1998
   1999
   1998
  
Average servicing portfolio   $ 5,246,953   $ 5,133,325   $ 5,180,146   $ 5,062,745  
Average number of loans     472,621     444,285     463,962     431,694  
Number of charge-offs     9,077     9,125     26,020     25,399  
 
Gross charge-offs(2)		  
 		  
$		  
55,218		  
 		  
$		  
60,896		  
 		  
$		  
179,052		  
 		  
$		  
192,322		  
 
Recoveries(3)     4,415     5,841     19,494     13,589  
   
 
 
 
 
Net losses   $ 50,803   $ 55,055   $ 159,558   $ 178,733  
   
 
 
 
 
Annualized gross charge-offs as a percentage of average servicing portfolio     4.21 %   4.75 %   4.61 %   5.07 %
Annualized net losses as a percentage of average servicing portfolio     3.87 %   4.29 %   4.11 %   4.71 %

(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)
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.

(3)
Includes post-disposition amounts received on previously charged off loans.

    The Company's delinquency rate has declined compared to December 31, 1998, in part because of a recovery from the normal seasonal pressure on collection efforts, which is generally highest in the fourth quarter of the year. Management also believes that the decrease in the delinquency rate reflects improvements in the Company's collections and servicing functions implemented during 1998 and the first nine months of 1999.

    Annualized gross charge-offs and net losses during the nine month period ended September 30, 1998, include a charge of 0.57% representing the impact of a write-down of current inventory resulting from a revision to the estimate of net realizable value and the write-off of all remaining problem loans from one of the Company's original consignment dealers with which it has since ceased doing business. The increase in gross charge-offs for the three and nine months ending September 30, 1999 compared to the same periods in 1998 (excluding the write-down charge) reflects the utilization of only wholesale disposition channels for the sale of repossessed vehicles following the Company's discontinuation of its retail remarketing program. Although recovery rates on the sale of vehicles through wholesale channels is generally lower than those realized through retail distribution channels, management believes that its decision in June 1998 to discontinue its retail remarketing operations has enabled it to better manage its level of repossessed inventory due to the increase in the speed at which repossessed vehicles can be liquidated, and as a result has improved the timing of excess cash flows released to the Company from securitization trusts.


Liquidity

    The Company's business requires substantial cash to support its operating activities. The principal cash requirements include (i) the purchase and financing of automobile loans pending securitization, (ii) payment of dealer participations, (iii) deposits of cash held from time to time in restricted accounts to support securitizations and warehouse facilities and other securitization expenses, (iv) interest advances to securitization trusts, (v) the cost of 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, from excess cash flow received from securitization trusts and fees earned through servicing of loans held by such trusts. The Company has experienced a negative cash flow basis and expects to continue to do so in the near future. The Company has historically 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 expects that it will require additional capital in the future to fund continued negative operating cash flows, 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 operations. See "Capital Resources."

    Purchase and Financing of Automobile Loans.  Automobile loan purchases represent the Company's most significant cash flow requirement. The Company purchased $1.8 billion of loans during the first nine months of 1999 compared to $1.7 billion during the same period in 1998. The Company funds the purchase price of loans primarily through the use of warehouse facilities. However, because the warehouse facilities limit the advance rate to less than 100% of the loans being purchased, the Company is required to fund the remainder of all purchases with other available cash resources prior to securitization.

    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. When loans are securitized, the related dealer participation is included in the cost basis of the loans and subsequently recovered over the estimated life of the related loan through the return to the Company of excess cash flow from the securitization trust. Participations paid by the Company to dealers during the nine months ended September 30, 1999 were $53.4 million, or approximately 2.99% of the principal balance of loans purchased, compared with $49.5 million, or approximately 2.87% of loans purchased, during the same period in 1998.

    Spread Account and Securitization Expenses.  In connection with securitizations, the Company is required to fund spread accounts related to each transaction. The Company primarily funds these spread accounts by foregoing receipt of excess cash flow until these spread accounts exceed predetermined levels. In addition, for some securitizations the Company has been required to provide initial cash deposits into the spread accounts that have ranged from zero to 4.5% of the principal balance of the loans securitized. In connection with securitizations completed during 1998 and the first half of 1999, the Company was able to eliminate or significantly reduce the amount of cash required for initial deposits in exchange for an increase in the insurance premiums paid to Financial Security Assurance Inc. ("FSA"), the Company's provider of asset-backed securities insurance. However, for the third quarter securitization transactions and possibly for future securitization transactions, FSA is requiring the Company to deposit a higher level of initial cash deposits into the spread accounts, and has also imposed higher maximum levels for the spread accounts where FSA provides asset-backed securities insurance. Even if the Company is able to make alternative arrangements, the Company expects that this will increase the Company's need for cash to fund securitization activity.

    The Company's securitization trusts had $354.2 million of restricted cash in spread accounts at September 30, 1999, compared with $227.7 million at December 31, 1998. The increase in restricted cash in spread accounts reflects the continued securitization of loan purchases and the related accumulation of excess cash flows to levels defined within each securitization agreement, partially offset by the release of excess cash flows from securitization trusts spread accounts which have reached the required levels. In addition to the restricted cash noted above, spread accounts were further supported by $30.5 million and $18.5 million of reinsurance contracts at September 30, 1999 and December 31, 1998, respectively, purchased by the Company's asset-backed securities insurance provider in connection with the initial deposit arrangement discussed above, as well as an additional $45.0 million in reinsurance contracts related to the early release of $60.0 million of cash from spread accounts during 1998. The $45.0 million will be replenished in the relevant spread accounts, and the amount of reinsurance reduced by the level of monthly cash releases from the spread accounts of $5.0 million in October 1999, $6.0 million in November 1999, $4.0 million in December 1999, $3.0 million per month from January through July of 2000, and $2.0 million per month from August through October of 2000.

    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.

    Interest Advances to Securitization Trusts.  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 from borrowers. In accordance with the relevant servicing agreements, the Company makes advances only in the event it expects to recover such advances through the ultimate payments from the obligor over the life of the loan or proceeds from dispositions of repossessed vehicles.

    Repossessed Inventory.  At September 30, 1999, the approximate realizable value of repossessed inventory managed or owned by the Company and held for resale was $25.6 million, compared with $32.7 million at December 31, 1998. The rate at which repossessed inventory is sold impacts cash available for deposit to spread accounts from securitization trusts and, consequently, the excess cash potentially available for distribution to the Company. At September 30, 1999, repossessed inventory was 0.5% of the total servicing portfolio compared with 0.6% at December 31, 1998. Any improvement in cash due to an increase in the inventory turnover rate may be partially reduced by lower recoveries realized through the exclusive use of wholesale auctions after December 31, 1998, and generally lower wholesale used car prices.

    Interest Expense.  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. The Company also incurs interest expense related to both short-term and long-term debt obligations.

    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 prior to securitization. During the first nine months of 1999, the Company received $152.6 million of excess cash flow, compared with $103.6 million during the first nine months of 1998. The Company has entered into an arrangement with its provider of asset-backed insurance which provides that, if any insured securitization trust exceeds its 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. At September 30, 1999 an aggregate $5.8 million of cash released from spread accounts was restricted pursuant to this arrangement. Restrictions on the pledged amounts may be lifted if the portfolio performance tests for the related securitization trusts are met and maintained as defined in the arrangement, the violations are waived, or the loans within the securitization trusts are repurchased at the end of the securitization term. There can be no assurance that the restrictions will be lifted or, absent amendments to the portfolio performance tests, that additional performance tests will not be exceeded, thereby increasing the level of excess cash which must be pledged. A significant increase in the level of cash pledged under this arrangement could significantly limit the Company's ability to fund the purchase and securitization of loans.

    While delinquencies have stayed in a consistent range, the Company experienced an increase in delinquencies during the third quarter as compared to the second quarter. This increase has been attributed to seasonality and an installment loan system conversion that took place during September 1999.

    Loan portfolio delinquency, default and net loss rates that are poorer than portfolio performance tests could result in a decrease in or interruption of excess cash flow available to us. Each insured securitization trust has portfolio performance tests that relate to levels of delinquencies, defaults and net losses on the loans in the trust. These portfolio performance tests require that the loan portfolio of each insured securitization trust have:


If the loans in any trust perform worse than is required by any of these tests, the amount of cash that has to be retained in the related spread account or accounts increases significantly until the loan portfolio has performed at the required levels for a specified period, generally three to five months. Any violation will decrease available excess cash flow for that time period. FSA as provider of financial guaranty insurance can waive a violation of these portfolio performance tests. We have an arrangement with FSA under which, if loan portfolio performance is poorer than the portfolio performance test levels, our subsidiary ARFC may make a pledge of cash that has the effect of preventing the violation of the portfolio performance test. Some trusts have exceeded these portfolio performance tests in the past, and some trusts were still in excess of these tests at September 30, 1999, but this arrangement has prevented a violation. It has also, however, reduced the amount of cash that would have been available to us for use if we had received a waiver of the violation. An increase in loan delinquencies, cumulative defaults or net losses could result in one or more additional existing securitization trusts exceeding one or more of the portfolio performance tests unless the portfolio performance test levels are changed. FSA is not required either to continue its arrangement with us or to make any future violations of portfolio performance test levels and might not do so if additional trusts were to perform more poorly than required.

    Servicing Fees.  The Company receives servicing fees for servicing securitized loans included in various securitization trusts. The servicing fee for loans in securitization trusts ranges from one percent to 1.25 percent of the outstanding principal balance on loans in the relevant trust. The Company also receives collection fees, such as late payment fees and insufficient fund charges. During the nine months ended September 30, 1999 and 1998, the Company received cash for such services in the amount of $68.0 million and $61.1 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 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 on a short-term basis primarily through warehouse facilities. At September 30, 1999, the Company had three warehouse facilities in place with various financial institutions and institutional lenders with an aggregate capacity of $700.0 million, of which $573.1 million was available. Proceeds from securitizations, generally received within seven to ten days following the cut-off date established for the securitization transaction, are applied to repay amounts outstanding under warehouse facilities. Two of the Company's warehouse facilities with a capacity of $550.0 million were renewed in the third quarter. FSA provides credit enhancement with respect to one of these facilities in the form of a financial guaranty insurance policy guaranteeing certain payments. This policy will be reduced from $400.0 million to $200.0 million on February 15, 2000; at the same time the capacity of the facility will be reduced from $400.0 million to $200.0 million. This facility will expire on July 12, 2000. The second warehouse facility that was renewed during the third quarter has $150 million of capacity and will expire in September 2000. In October the third warehouse facility of $150 million, was extended to January 15, 2000.

    Securitization Program.  An important capital resource for the Company has been its ability to realize the value of its automobile loans in the secondary markets through securitizations.

    The following table summarizes the Company's securitization transactions during the nine months ended September 30, 1999, all of which were publicly issued and rated "AAA/Aaa".

Date
   Original Balance
   Remaining Balance as of September 30, 1999
   Remaining Balance as Percentage of Original Balance
   Current Weighted Average APR
   Weighted Average Securitization Rate
   Current Gross Interest Rate Spread
  
(Dollars in thousands)

    
    
    
    
    
    
  
1999—A   $ 550,000   $ 474,172   86.21 % 17.39 % 5.95 % 11.44 %
1999—B     650,000     606,522   93.31 % 17.25 % 6.39 % 10.86 %
1999—C(1)     600,000     432,835   72.14 % 17.16 % 6.99 % 10.17 %
   
 
                 
    $ 1,800,000   $ 1,513,529                  
   
 
                 

(1)
As of September 30, 1999 the Company had delivered $438.5 million of automobiles loans for the 1999-C securitization transaction and $161.5 million of cash remained in the pre-funded portion of the trust.

    If in the future the Company is unable to obtain financial guaranty insurance policies, or determines that they are too expensive, it could reduce the Company's ability to sell the asset-backed securities the Company sponsors and also reduce the price at which it is able to sell them. All of the securitizations the Company has sponsored since March 1993 and one of the Company's current "warehouse" credit facilities have utilized credit enhancements in the form of financial guaranty insurance policies issued by FSA. These financial guaranty insurance policies have resulted in those asset-backed securities being rated "AAA/Aaa." The Company believes that this rating has made those securities easier to sell than securities with a lower rating and has enhanced the price at which they have been sold. The Company also believes that the use of this form of credit enhancement was cheaper than alternative forms available to it at the time. However, FSA is not required to insure the securitizations the Company sponsors and may not continue to do so. In June 1999, FSA advised the Company that it expects to modify its requirements for any future securitization transaction with respect to which it provides financial guaranty insurance. These modifications could significantly increase the cash cost to the Company of using FSA as the provider of credit enhancement for future securitizations. The Company is currently examining its options in this regard, which may include issuing uninsured asset-backed securities with other credit enhancement features. If the Company were to do this, some of those securities are likely to receive a rating that is somewhat lower than "AAA/Aaa," which could reduce the Company's ability to sell those securities at prices comparable to those received in the past.

    Historically, the Company has utilized various debt and equity financings to offset negative operating cash flows and support its operations.

    The Company has a program to sell unsecured subordinated notes (the "Junior Subordinated Notes") to be offered to the public from time to time (the "Note Program"). Issuance of Junior Subordinated Notes under the Note Program is subject to restrictions under the Company's Senior Note indenture. The Note Program currently offers Junior Subordinated Notes extendible by the investor having maturities of 90 and 180 days and one year after the date of issue and fixed-term Junior Subordinated Notes having maturities of one, two, three, four, five and 10 years after the date of issue. Interest rates on any newly issued Junior Subordinated Notes are based on market conditions. The Company may adjust interest rates on extendible Junior Subordinated Notes at any rollover date. During the first nine months of 1999 proceeds from the issuance of Junior Subordinated Notes, net of repayments at maturity, were $30.7 million.


Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

    Because the Company's funding strategy is dependent upon the issuance of interest-bearing securities and the incurrence of debt, fluctuations in interest rates impact the Company's profitability. Therefore, the Company employs various hedging strategies to minimize the risk of interest rate fluctuations. See "Management's Discussion and Analysis—Capital Resources—Hedging Strategy" for additional information regarding such market risks.


PART II—OTHER INFORMATION


Item 1. Legal Proceedings

    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 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, an 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 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.

    Another case which was filed November 8, 1996, Powel et al. V. Arcadia Financial Ltd. et al., involved a complaint by approximately 200 borrowers who purchased vehicles from a dealer which sold certain of Arcadia's repossessed vehicles on a consignment basis. The plaintiffs in this case alleged that Arcadia was either directly or vicariously liable for damages incurred as a result of the consignment dealer's alleged wrongful actions. The Company resolved the claims by such borrowers through the mediation process in June 1998. However, prior to the dismissal of those plaintiff's action, an additional three plaintiffs entered the case. Since the entry of those three plaintiffs, an additional 200 borrowers have also been added as named plaintiffs. The Company intends to defend the case 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.

    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 those various matters currently pending will not result in any material adverse effect on the Company's financial condition, results of operations or liquidity.

    Under the applicable Securities and Exchange Commission rules, there is no further new information with respect to legal proceedings that the Company is required to report in connection with this Quarterly Report on Form 10-Q.


Item 2. Changes in Securities and Use of Proceeds

    None


Item 3. Defaults Upon Senior Securities

    None


Item 4. Submission of Matters to a Vote of Security Holders

    None


Item 5. Other Information

    None


Item 6. Exhibits and Reports on Form 8-K

    (a) Exhibits

    The following exhibits are filed in response to Item 601 of Regulation S-K.


EXHIBIT INDEX

Exhibit No.
   Description
3.1   Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).
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, 1998).
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   Amendment No. 1 to Rights Agreement, dated January 16, 1998, to 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 4.1 to the Company's Current Report on Form 8-K dated January 8, 1998 and filed January 20, 1998).
4.3   Amendment No. 2 to Rights Agreement, dated October 5, 1998, to 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 4.1 to the Company's Current Report on Form 8-K dated September 30, 1998 and filed October 8, 1998).
4.4   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) .
4.5   Instrument of Resignation, Appointment and Acceptance, dated as of August 13, 1998, among the Company, Norwest Bank Minnesota, National Association, as Resigning Trustee, and Marine Midland Bank, as Successor Trustee, relating to the Company's Unsecured Extendible Notes and Fixed Term Notes (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-3, File No. 333-60531).
4.6   First Supplemental Indenture dated as of August 13, 1998, to Indenture dated as of July 1, 1994 as amended and restated by that First Amendment and Restatement dated as of April 28, 1995 and as further amended by that Instrument of Resignation, Appointment and Acceptance dated as of August 13,1998, between the Company and Marine Midland Bank, as Trustee, relating to the Company's Unsecured Extendible Notes and Fixed Term Notes (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-3, File No. 333-60531).
4.7   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).
4.8   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).
4.9   Indenture dated as of March 12, 1997, between the Company and Norwest Bank Minnesota, National Association, as Trustee, relating to the Company's 111/2% Senior Notes due 2007 (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).
4.10   First Supplemental Indenture, dated as of March 12, 1997 between the Company and Norwest Bank Minnesota, National Association, as Trustee, relating to $300,000,000 of the Company's 111/2% Senior Notes due 2007 issued March 12, 1997 (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).
4.11   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).
4.12   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).
4.13   Form of 111/2% 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) .
4.14   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).
4.15   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, relating to $75,000,000 of the Company's 111/2% Senior Notes due 2007 issued October 8, 1997 (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   Insurance and Indemnity agreement, dated as of September 22, 1999, among Financial Security Assurance, Inc. ("FSA"), Arcadia Automobile Receivables Trust 1999-C, Arcadia Receivables Finance Corp. ("ARFC") and the Registrant (filed herewith).
10.2   Spread Account Agreement dated as of March 25, 1993, as amended and restated as of September 22, 1999, by and among the Registrant, ARFC, FSA and Norwest Bank Minnesota, National Association (filed herewith).
10.3   Series 1999-C Supplement, dated as of September 22, 1999, to Spread Account Agreement dated as of March 25, 1993, as amended and restated as of September 22, 1999, among the Registrant, ARFC, FSA and Norwest Bank Minnesota, National Association, as trustee and as collateral agent (filed herewith).
10.4   Amendment No. 2, dated as of October 7, 1999, to Receivables Transfer Agreement, dated as of October 16, 1998, by and among Arcadia Receivables Finance Corp. V, the Registrant, Park Avenue Receivables Corporation and The Chase Manhattan Bank (filed herewith).
10.5   Credit Suisse First Boston, September 2, 1999, letter amending the Receivables Financing Agreement and fee letter dated as of September 24, 1998, for the $150,000,000 warehouse facility (filed herewith) .
27.1   Financial Data Schedule (filed herewith).

    (b) Reports on Form 8-K

    On June 16, 1999, the Company filed a Current Report on Form 8-K dated June 7, 1999, for the Arcadia Automobile Receivables Trust, 1999-A Servicer's Certificate dated June 15, 1999.


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.

Signature
   Title
   Date
 
 		  
 		  
 		  
 		  
 
Richard A. Greenawalt		   Director and Chief Executive Officer
(Principal Executive Officer)		   November 10, 1999
 
John A. Witham		  
 		  
Executive Vice President and Chief Financial Officer (Principal Financial Officer)		  
 		  
November 10, 1999
 
Brian S. Anderson		  
 		  
Senior Vice President, Corporate Controller and Assistant Secretary (Principal Accounting Officer)		  
 		  
November 10, 1999


EXHIBIT INDEX

Exhibit No.
   Description
3.1   Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998).
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, 1998).
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   Amendment No. 1 to Rights Agreement, dated January 16, 1998, to 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 4.1 to the Company's Current Report on Form 8-K dated January 8, 1998 and filed January 20, 1998).
4.3   Amendment No. 2 to Rights Agreement, dated October 5, 1998, to 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 4.1 to the Company's Current Report on Form 8-K dated September 30, 1998 and filed October 8, 1998).
4.4   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).
4.5   Instrument of Resignation, Appointment and Acceptance, dated as of August 13, 1998, among the Company, Norwest Bank Minnesota, National Association, as Resigning Trustee, and Marine Midland Bank, as Successor Trustee, relating to the Company's Unsecured Extendible Notes and Fixed Term Notes (incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-3, File No. 333-60531).
4.6   First Supplemental Indenture dated as of August 13, 1998, to Indenture dated as of July 1, 1994 as amended and restated by that First Amendment and Restatement dated as of April 28, 1995 and as further amended by that Instrument of Resignation, Appointment and Acceptance dated as of August 13,1998, between the Company and Marine Midland Bank, as Trustee, relating to the Company's Unsecured Extendible Notes and Fixed Term Notes (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-3, File No. 333-60531).
4.7   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).
4.8   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).
4.9   Indenture dated as of March 12, 1997, between the Company and Norwest Bank Minnesota, National Association, as Trustee, relating to the Company's 111/2% Senior Notes due 2007 (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).
4.10   First Supplemental Indenture, dated as of March 12, 1997 between the Company and Norwest Bank Minnesota, National Association, as Trustee, relating to $300,000,000 of the Company's 111/2% Senior Notes due 2007 issued March 12, 1997 (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).
4.11   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).
4.12   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).
4.13   Form of 111/2% 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) .
4.14   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).
4.15   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, relating to $75,000,000 of the Company's 111/2% Senior Notes due 2007 issued October 8, 1997 (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   Insurance and Indemnity agreement, dated as of September 22, 1999, among Financial Security Assurance, Inc. ("FSA"), Arcadia Automobile Receivables Trust 1999-C, Arcadia Receivables Finance Corp. ("ARFC") and the Registrant (filed herewith).
10.2   Spread Account Agreement dated as of March 25, 1993, as amended and restated as of September 22, 1999, by and among the Registrant, ARFC, FSA and Norwest Bank Minnesota, National Association (filed herewith) .
10.3   Series 1999-C Supplement, dated as of September 22, 1999, to Spread Account Agreement dated as of March 25, 1993, as amended and restated as of September 22, 1999, among the Registrant, ARFC, FSA and Norwest Bank Minnesota, National Association, as trustee and as collateral agent (filed herewith).
10.4   Amendment No. 2, dated as of October 7, 1999, to Receivables Transfer Agreement, dated as of October 16, 1998, by and among ARFC, the Registrant, Park Avenue Receivables Corporation and The Chase Manhattan Bank (filed herewith).
10.5   Credit Suisse First Boston, September 2, 1999, letter amending the Receivables Financing Agreement and fee letter dated as of September 24, 1998, for the $150,000,000 warehouse facility (filed herewith) .
27.1   Financial Data Schedule (filed herewith).

QuickLinks

FORM 10-Q INDEX
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Three and Nine Months Ended September 30, 1999 and 1998
Delinquency, Credit Loss and Repossession Experience
Liquidity
Capital Resources
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

PART II—OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
EXHIBIT INDEX

SIGNATURES

EXHIBIT INDEX



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