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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NO. 1-12109
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DELTA FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 11-3336165
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1000 WOODBURY ROAD, SUITE 200, 11797
WOODBURY, NEW YORK
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (516) 364-8500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
COMMON STOCK, PAR VALUE $.01 PER SHARE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities 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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of March 5, 1997, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of $21.375, was
approximately $100,448,502.
As of March 5, 1997, the Registrant had 15,372,288 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III, items 10, 11, 12 and 13 are incorporated by reference to Delta
Financial Corporation's definitive proxy statement to stockholders which will be
filed with the Securities and Exchange Commission no later than 120 days after
December 31, 1996.
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PART I
ITEM 1. BUSINESS
Delta Financial Corporation, operating through its wholly-owned subsidiary
Delta Funding Corporation, is a specialty consumer finance company that engages
in originating, acquiring, selling and servicing home equity loans. Delta
Financial Corporation was incorporated in 1996 to acquire all of the outstanding
stock of Delta Funding Corporation, which has operated since 1982 (collectively
Delta Financial Corporation and Delta Funding Corporation are herein referred to
as 'Delta' or the 'Company').
Delta focuses on lending to individuals who generally have impaired or
limited credit profiles or higher debt to income ratios and typically have
substantial equity in their homes. Management believes that these borrowers have
largely been unsatisfied by the more traditional sources of mortgage credit
which underwrite loans to conventional guidelines established by FNMA and FHLMC.
The Company makes loans to these borrowers for such purposes as debt
consolidation, home improvement, refinancing or education, and these loans are
primarily secured by first mortgages on one- to four-family residential
properties.
Delta originates home equity loans through licensed mortgage brokers and
other real estate professionals ('brokers') who submit loan applications on
behalf of the borrower ('Brokered Loans'). Delta also purchases from approved
mortgage bankers and financial institutions ('correspondents') loans that
conform to Delta's underwriting guidelines ('Correspondent Loans'). For the year
ended December 31, 1996, the Company originated and purchased approximately $659
million of loans, of which approximately $322 million were originated through
its network of brokers and $337 million were purchased through its network of
correspondents.
For the year ended December 31, 1996, Delta sold a total of $630 million of
loans, including $615 million through three real estate mortgage investment
conduit ('REMIC') securitizations. Each of these three securitizations was
credit-enhanced by an insurance policy provided through a monoline insurance
company to receive ratings of Aaa from Moody's Investors Service, Inc.
('Moody's') and AAA from Standard & Poor's Ratings Group, a division of The
McGraw-Hill Companies, Inc. ('Standard & Poor's'). A portion of the Company's
revenue from securitizations is recognized as gain on sale of loans, which
represents the present value of the difference between (i) the weighted average
interest rate charged by the Company to its borrowers and (ii) the weighted
average interest rate paid to the investors who purchased the asset-backed
securities in excess of normal loan servicing fees, a loan loss reserve, and
other recurring fees (the 'Excess Servicing Spread'), represented by the
interest-only and residual certificates. The Company recognizes such gain on
sale of loans in the year that such loans are sold, although cash (representing
the Excess Servicing Spread and servicing fees) is received by the Company over
the lives of the loans.
The remaining $15 million of loans were sold to institutional purchasers on
a wholesale basis without recourse. Revenue is recognized as a gain on sale of
loans, which represents the premiums earned by the Company on all such loans
sold. These premiums are received and recognized in the same year that the loans
are sold. The Company sells loans through securitizations and on a whole loan
basis to enhance its operating leverage and liquidity, to minimize financing
costs and to reduce its exposure to fluctuations in interest rates.
Since its inception, the Company has serviced substantially all of the
loans it has originated and purchased, including all of those that it has
subsequently sold through securitizations. Management believes that servicing
this portfolio enhances certain operating efficiencies and provides an
additional and profitable revenue stream that is less cyclical than the business
of originating and purchasing loans. As of December 31, 1996, the Company's loan
servicing portfolio totaled $933 million.
The Company's business strategy is to increase profitably the volume of its
loan originations and purchases and the size of its servicing portfolio by (i)
continuing to provide top quality service to its network of brokers and
correspondents, (ii) maintaining its underwriting standards, (iii) further
penetrating its established markets and recently-entered markets and expanding
into new geographic markets, (iv) broadening its product offerings, (v)
continuing its investment in origination and servicing systems and (vi)
strengthening its loan production capabilities through acquisitions.
1
HOME EQUITY LENDING OPERATIONS
OVERVIEW
Delta's consumer finance activities consist of originating, acquiring,
selling and servicing mortgage loans. These loans are primarily secured by first
mortgages on one- to four-family residences. Once loan applications have been
received, the underwriting process completed and the loans funded or purchased,
Delta typically packages the loans in a portfolio and sells the portfolio
through a securitization. Delta retains the right to service the loans that it
securitizes. To a lesser extent, the Company sells loans on a whole loan basis
with servicing released.
LOAN ORIGINATION AND PURCHASES
The Company increased its loan originations and purchases by 129% to $658.8
million in 1996 from $287.8 million in 1995, which was an increase of 140% over
1994 production of $119.7 million.
Delta currently originates and purchases the majority of its loans in 21
states through its network of approximately 1,000 brokers and correspondents.
The following table shows the sources of the Company's loan originations
and purchases for the periods shown:
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
BROKER:
Principal balance.......................................................... $321,733 $175,738 $ 81,407
Average principal balance per loan......................................... $ 85 $ 76 $ 66
Combined weighted average initial loan-to-value ratio(1)................... 67.7% 62.3% 54.8%
Weighted average interest rate............................................. 11.1% 11.4% 11.7%
CORRESPONDENT:
Principal balance.......................................................... $337,033 $112,065 $ 38,341
Average principal balance per loan......................................... $ 73 $ 70 $ 68
Combined weighted average initial loan-to-value ratio(1)................... 69.8% 64.5% 56.2%
Weighted average interest rate............................................. 11.7% 12.4% 13.0%
TOTAL LOAN PURCHASES AND ORIGINATIONS:
Principal balance.......................................................... $658,766 $287,803 $119,748
Average principal balance per loan......................................... $ 78 $ 74 $ 67
Combined weighted average initial loan-to-value ratio(1)................... 68.8% 63.2% 55.2%
Weighted average interest rate............................................. 11.4% 11.8% 12.1%
PERCENTAGE OF LOANS SECURED BY:
First Mortgage............................................................. 93.8% 89.6% 88.0%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the
lesser of the purchase price or the appraised value of the mortgage property
at origination. The weighted average initial loan-to-value ratio of loan
secured by a second mortgage is determined by taking the sum of the loan
secured by the first and second mortgages and dividing by the lesser of the
purchase price or the appraised value of the mortgage property at
origination.
2
The following table shows channels of loan originations and purchases on a
quarterly basis for the fiscal quarters shown:
THREE MONTHS ENDED
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DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1996 1996 1996 1996
------------ ------------- -------- ---------
(DOLLARS IN THOUSANDS)
BROKER:
Number of Brokered Loans................................. 1,160 1,047 804 782
Principal balance........................................ $ 98,534 $ 87,579 $ 69,231 $ 66,389
Average principal balance per loan....................... $ 85 $ 84 $ 86 $ 85
Combined weighted average initial loan-to-value
ratio(1).............................................. 68.7% 67.7% 67.1% 66.8%
Weighted average interest rate........................... 11.1% 11.4% 11.1% 10.4%
CORRESPONDENT:
Number of Correspondent Loans............................ 2,005 1,145 787 703
Principal balance........................................ $145,176 $ 83,385 $ 59,099 $ 49,373
Average principal balance per loan....................... $ 72 $ 73 $ 75 $ 70
Combined weighted average initial loan-to-value
ratio(1).............................................. 71.4% 69.9% 67.2% 68.1%
Weighted average interest rate........................... 11.6% 11.8% 11.9% 11.8%
TOTAL LOAN PURCHASES AND ORIGINATIONS:
Total number of loans.................................... 3,165 2,192 1,591 1,485
Principal balance........................................ $243,710 $ 170,964 $128,330 $ 115,762
Average principal balance per loan....................... $ 77 $ 78 $ 81 $ 78
Combined weighted average initial loan-to-value
ratio(1).............................................. 68.8% 68.8% 67.1% 67.4%
Weighted average interest rate........................... 11.4% 11.6% 11.5% 11.0%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser of
the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of loan secured by
a second mortgage is determined by taking the sum of the loan secured by the
first and second mortgages and dividing by the lesser of the purchase price or
the appraised value of the mortgage property at origination.
The following table shows lien position, weighted average interest rates
and loan-to-value ratios for the periods shown:
YEAR ENDED DECEMBER 31,
------------------------
1996 1995 1994
---- ---- ----
FIRST MORTGAGE:
Percentage of total purchases and originations............................ 93.8% 89.6% 88.0%
Weighted average interest rate............................................ 11.4% 11.8% 12.1%
Weighted average initial loan-to-value ratio(1)........................... 68.9% 63.2% 54.8%
SECOND MORTGAGE:
Percentage of total purchases and originations............................ 6.2% 10.4% 12.0%
Weighted average interest rate............................................ 11.5% 11.9% 12.1%
Weighted average initial loan-to-value ratio(1)........................... 66.6% 62.9% 57.0%
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(1) The weighted average initial loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the lesser of
the purchase price or the appraised value of the mortgage property at
origination. The weighted average initial loan-to-value ratio of loan secured by
a second mortgage is determined by taking the sum of the loan secured by the
first and second mortgages and dividing by the lesser of the purchase price or
the appraised value of the mortgage property at origination.
3
The following table shows the geographic distribution of loan purchases and
originations for the periods indicated:
YEAR ENDED DECEMBER 31,
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STATE 1996 1995 1994
- ------------------------------------------------------------------ ---- ---- ----
New York.......................................................... 54.9% 73.8% 80.9%
New Jersey........................................................ 7.1% 8.1% 10.6%
Illinois.......................................................... 4.6% 2.2% 0.9%
Pennsylvania...................................................... 4.3% 4.3% 3.0%
Ohio.............................................................. 3.9% 0.9% 0.1%
Michigan.......................................................... 3.5% 0.7% 1.0%
Massachusetts..................................................... 3.3% 0.8% 0.0%
Florida........................................................... 2.5% 0.5% 0.3%
North Carolina.................................................... 1.8% 1.4% 0.1%
Tennessee......................................................... 1.7% 0.3% 0.0%
Connecticut....................................................... 1.6% 1.2% 1.7%
Georgia........................................................... 1.4% 0.1% 0.0%
All Other......................................................... 9.4% 5.7% 1.4%
Broker and Correspondent Marketing. Throughout its history Delta has been
successful in establishing and maintaining relationships with brokers and
correspondents interested in offering non-conforming mortgage products to their
clientele, and management believes that this success is primarily attributable
to the quality of service the Company provides to its network of brokers and
correspondents.
Delta typically initiates contact with a broker or correspondent through
Delta's Business Development Department which is comprised of 20 business
development representatives. The business development representatives are
responsible for soliciting and developing the Company's broker and correspondent
networks within their geographic territory by frequently visiting the broker or
correspondent to understand their needs, communicating the Company's
underwriting guidelines and disseminating new product information and pricing
changes. Business development representatives are compensated with a base salary
and commissions based on the volume of loans purchased or originated as a result
of their efforts.
Before a broker or correspondent becomes part of Delta's network, it must
go through an approval process. Once approved, brokers and correspondents may
immediately begin submitting applications and/or loans to Delta.
To be approved, a broker must demonstrate that it is properly licensed and
registered in the state in which it seeks to transact business, submit to a
credit check, and sign a standard broker agreement with Delta. A correspondent
is eligible to submit loans to Delta for purchase only after an extensive
investigation of the prospective correspondent's lending operations including an
on-site visit, a review of the correspondent's financial statements for the
prior two years, a credit report on the correspondent, a review of sample loan
documentation and business references provided by the correspondent. Once
approved, Delta requires that each correspondent sign an agreement of purchase
and sale in which the correspondent makes representations and warranties
governing both the mechanics of doing business with Delta and the quality of the
loan submissions themselves. Delta also performs an annual review of each
approved correspondent in order to ensure continued compliance with legal
requirements and that lending operations and financial information continue to
meet Delta's standards. In addition, Delta regularly reviews the on-going
performance of loans originated or purchased through its brokers or
correspondents.
Brokers. For the year ended December 31, 1996, the Company's broker
network accounted for $321.7 million, or 49%, of Delta's loan purchases and
originations compared to $175.7 million, or 61%, of Delta's loan purchases and
originations for the year ended December 31, 1995 and $81.4 million, or 68%, of
Delta's loan purchases and originations for the year ended December 31, 1994. No
single broker contributed more than 11.4%, 6.2% or 5.6% of Delta's total
purchases or originations in the years ended December 31, 1996, 1995 and 1994,
respectively.
To process loan applications submitted by brokers, Delta's broker
originations area is organized into teams, consisting of loan officers and
processors, which are generally assigned to specific brokers. Because Delta
operates in a highly competitive environment where brokers may submit the same
loan application to several prospective lenders simultaneously, Delta strives to
provide brokers with a rapid and informed response. Loan officers analyze the
application and provide the broker with a preliminary approval, subject to final
underwriting
4
approval, or a denial, typically within one business day. If the application is
approved by the Company's underwriters, a 'conditional approval' will be issued
to the broker with a list of specific conditions to be met and additional
documents to be supplied prior to funding the loan. The loan officer and
processor team will then work directly with the submitting broker to collect the
requested information and meet all underwriting conditions. In most cases, the
Company funds loans within 14 to 21 days after preliminary approval of the loan
application. In the case of a denial, Delta will make all reasonable attempts to
ensure that there is no missing information concerning the borrower or the
application that might change the decision on the loan. The Company compensates
its loan officers, who on a loan-by-loan basis are the primary relationship
contacts with the brokers, predominantly on a commission basis.
Correspondents. For the year ended December 31, 1996, Delta's
correspondent network accounted for $337.0 million, or 51%, of Delta's loans
purchases and originations compared to $112.1 million, or 39%, of Delta's loan
purchases and originations for the year ended December 31, 1995 and $38.3
million, or 32%, of Delta's loan purchases and originations for the year ended
December 31, 1994. No single correspondent contributed more than 6.3%, 6.3% or
7.7% of Delta's total loan purchases and originations in 1996, 1995 or 1994,
respectively.
An approved correspondent is a licensed mortgage banker or savings and loan
who sells loans to Delta which the correspondent has originated, processed,
closed and funded in its own name in conformity with Delta's underwriting
standards. The loans are sold to Delta either on an individual flow basis or in
block sales. When selling on a flow basis, a correspondent will typically seek a
pre-approval from Delta prior to closing the loan, and Delta will approve the
loan based on a partial or full credit package, stipulating for any items needed
to complete the package in adherence to Delta's underwriting guidelines. On a
block sale, a correspondent will offer a group of loans to Delta for sale (not
necessarily loans that have been pre-approved), and Delta will underwrite and
purchase those loans in the block that meet Delta's underwriting criteria.
LOAN UNDERWRITING
All of Delta's brokers and correspondents are provided with the Company's
underwriting guidelines. Loan applications received from brokers and
correspondents are classified according to certain characteristics, including
but not limited to: condition and location of the collateral, credit history of
the applicant, ability to pay, loan-to-value ratio and general stability of the
applicant in terms of employment history and time in residence. Delta has
established classifications with respect to the credit profile of the applicant,
and each loan is placed into one of four letter ratings 'A' through 'D', with
subratings within those categories. Terms of loans made by Delta, as well as
maximum loan-to-value ratios and debt-to-income ratios, vary depending on the
classification of the applicant. Loan applicants with less favorable credit
ratings are generally offered loans with higher interest rates and lower
loan-to-value ratios than applicants with more favorable credit ratings. The
general criteria used by Delta's underwriting staff in classifying loan
applicants are set forth below.
5
DELTA'S UNDERWRITING CRITERIA
'A' RISK
EXCELLENT CREDIT 'B' RISK 'C' RISK 'D' RISK
HISTORY GOOD OVERALL CREDIT GOOD TO FAIR CREDIT FAIR TO POOR CREDIT
--------------------- --------------------- --------------------- ---------------------
Existing mortgage
history.............. Current at Current at Up to 30 days Mortgage rating not a
application time and application time and delinquent at factor
a maximum of two a maximum of four application time and
30-day late payments 30-day late payments a maximum of four
in the last 12 months in the last 12 months 30-day late payments,
two 60-day late
payments and one
90-day late payment
in the last 12 months
Other credit......... Minor 30-day late Some slow pays Slow pays, some open Not a factor.
items allowed with a allowed but majority delinquencies Derogatory credit
letter of of credit and allowed. Isolated must be paid with
explanation; no open installment debt paid charge-offs, proceeds. Must
collection accounts, as agreed. Small collection accounts demonstrate ability
charge-offs, isolated charge-offs, or judgments case- to pay
judgments collections, or by-case
judgments allowed
case-by-case
Bankruptcy
filings.............. Discharged more than Discharged more than Discharged more than May be open at
four years prior to three years prior to one year prior to closing, but must be
closing and excellent closing and excellent closing and good paid off with
re-established credit re-established reestablished credit proceeds
credit
Debt Service to
Income ratio......... Generally 45% or less Generally 50% or less Generally 50% or less Generally 50% or less
Maximum loan-to-value
ratio:
Owner-occupied....... Generally 80% (up to Generally 80% (up to Generally 75% (up to Generally 65% (up to
90%*) for a one- to 85%*) for a one- to 80%*) for a one- to 70%*) for a one- to
four-family residence four-family residence four-family residence four-family residence
Non-owner occupied... Generally 70% (up to Generally 70% (up to Generally 65% (up to Generally 55% (up to
80%*) for a one- to 80%*) for a one- to 75%*) for a one- to 60%*) for a one- to
four-family residence four-family residence four-family residence four-family residence
Employment........... Minimum 2 years Minimum 2 years Minimum 2 years No minimum required
employment in the employment in the employment in the
same field same field same field
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* On an exception basis
6
Delta uses the foregoing categories and characteristics as guidelines only.
On a case-by-case basis, the Company may determine that the prospective borrower
warrants an exception, if sufficient compensating factors exist. Examples of
such compensating factors are: low loan-to-value ratio, low debt ratio,
long-term stability of employment and/or residence, excellent payment history on
past mortgages, or a significant reduction in monthly housing expenses.
The following table sets forth certain information with respect to Delta's
loan purchases and originations by borrower classification, along with weighted
average coupons, for the periods shown.
PERCENT
YEAR CREDIT TOTAL OF TOTAL WAC(1) WLTV(2)
- ----- ------ -------- -------- ------ -------
1996 A $219,550 33.4% 10.6% 72.1%
B 234,589 35.6 11.2 70.2
C 156,296 23.7 12.2 65.7
D 48,331 7.3 13.8 56.9
-------- -------- ------ -------
Totals $658,766 100.0% 11.4% 68.8%
-------- -------- ------ -------
-------- -------- ------ -------
1995 A $ 89,830 31.3% 10.7% 66.8%
B 124,954 43.4 11.6 64.5
C 37,190 12.9 12.8 59.6
D 35,831 12.4 14.5 53.2
-------- -------- ------ -------
Totals $287,805 100.0% 11.8% 63.2%
-------- -------- ------ -------
-------- -------- ------ -------
1994 A $ 35,121 29.4% 10.8% 58.9%
B 38,575 32.2 11.7 56.4
C 25,562 21.3 12.8 52.9
D 20,490 17.1 14.3 49.3
-------- -------- ------ -------
Totals $119,748 100.0% 12.1% 55.2%
-------- -------- ------ -------
-------- -------- ------ -------
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(1) Weighted Average Coupon ('WAC').
(2) Weighted Loan-to-Value Ratio ('WLTV').
Assessment of an applicant's ability and willingness to pay is one of the
principal elements in distinguishing Delta's lending specialty from methods
employed by traditional lenders, such as savings and loans and commercial banks.
All lenders utilize debt ratios and loan-to-value ratios in the approval
process. Many lenders simply use software packages to score an applicant for
loan approval and fund the loan after auditing the data provided by the
borrower. Delta employs experienced non-conforming mortgage loan credit
underwriters to scrutinize the applicant's credit profile and to evaluate
whether an impaired credit history is a result of adverse circumstances or a
continuing inability or unwillingness to meet credit obligations in a timely
manner. Personal circumstances including divorce, family illnesses or deaths and
temporary job loss due to layoffs and corporate downsizing will often impair an
applicant's credit record.
Delta has a staff of 46 underwriters, with an average of more than seven
years of non-conforming underwriting experience. At present, all final
underwriting functions are centralized in the Woodbury, New York and Atlanta,
Georgia offices. Delta does not delegate underwriting authority to any broker or
correspondent. Delta's Underwriting Department functions independently of its
Business Development and Mortgage Origination Departments and does not report to
any individual directly involved in the origination process. No underwriter at
Delta is compensated on an incentive or commission basis.
Delta has instituted underwriting checks and balances that are designed to
ensure that every loan is reviewed and approved by a minimum of two
underwriters, with certain higher loan amounts requiring a third approval.
Management believes that by requiring each file be seen by a minimum of two
underwriters, a high degree of accuracy and quality control is ensured
throughout the underwriting process and before funding.
Delta's underwriting of every loan submitted consists not only of a
thorough credit review, but also (i) a separate appraisal review conducted by
Delta's Appraisal Review Department, and (ii) a full compliance review, to
ensure that all documents have been properly prepared, all applicable
disclosures given in a timely fashion, and proper compliance with all federal
and state regulations. Appraisals are performed by third party, fee-based
appraisers or by the Company's staff appraisers and generally conform to current
FNMA/FHLMC secondary
7
market requirements for residential property appraisals. Each such appraisal
includes, among other things, an inspection of the exterior of the subject
property and, where available, data from sales within the preceding 12 months of
similar properties within the same general location as the subject property. In
addition, in certain situations, the Company also obtains broker price opinions
from independent real estate agents.
Delta performs a thorough appraisal review on each loan prior to closing or
prior to purchasing. While Delta recognizes that the general practice by
conventional mortgage lenders is to perform only drive-by appraisals after
closings, management believes this practice does not provide sufficient
protection. In addition to reviewing each appraisal for accuracy, the Company
accesses other sources to validate sales used in the appraisal to determine
market value. These sources include: interfacing with Multiple Listing Services
and Comps, Inc. to access current sales and listing information; its own
in-house database which contains comparable sales from all appraisals ordered by
Delta during the past eight years; and other sources for verification, including
broker price opinions and market analyses by local real estate agents.
Post closing, in addition to its normal due diligence, the Company randomly
selects one out of every ten appraisals, and performs a drive-by appraisal. This
additional step gives the Company an added degree of comfort with respect to
appraisers with which the Company has had limited experience. Delta actively
tracks all appraisers from which it accepts appraisals for quality control
purposes and does not accept work from appraisers who have not conformed to its
review standards.
Upon completion of a Brokered Loan's underwriting and processing, the
closing of the loan is scheduled with a closing attorney or agent approved by
Delta. The closing attorney or agent is responsible for completing the loan
closing transaction in accordance with applicable law and Delta's operating
procedures. Title insurance that insures Delta's interest as mortgagee and
evidence of adequate homeowner's insurance naming Delta as an additional insured
party are required on all loans.
The Company performs a post-funding quality control review to monitor and
evaluate the Company's loan origination policies and procedures. The Quality
Control Department is separate from the Underwriting Department and reports
directly to a member of senior management. At least 10% of all loan originations
and purchases are subjected to a full quality control re-underwriting and
review, the results of which are reported to senior management on a monthly
basis. Discrepancies noted by this review are analyzed and corrective actions
are instituted. A typical full quality control re-underwriting and review
currently includes: (a) obtaining a new drive-by appraisal for each property;
(b) running a new credit report from a different credit report agency; (c)
reviewing loan applications for completeness, signatures, and for consistency
with other processing documents; (d) obtaining new written verification of
income and employment; (e) obtaining new written verification of mortgage to
reverify any outstanding mortgages; and (f) analyzing the underwriting and
program selection decisions. The quality control process is updated from time to
time as the Company's policies and procedures change.
LOAN SALES
Delta sells substantially all the loans it originates or purchases through
one of two methods: (i) securitizations, which involve the private placement or
public offering of pass-through mortgage-backed securities, and (ii) whole loan
sales, which include the sale of blocks of individual loans to institutional or
individual investors. Since 1991, the Company has sold approximately $1.2
billion of the loans it originated or purchased through securitization and $54.6
million through whole loan sales.
Securitizations. During 1996, Delta completed 3 securitizations totaling
$615 million. The following table sets forth certain information with respect to
Delta's securitizations by offering size, including prefunded amounts, weighted
average pass-through rate and credit rating of securities sold.
INITIAL
OFFERING SIZE WEIGHTED AVERAGE CREDIT RATING OF
SECURITIZATION COMPLETED (MILLIONS) PASS-THROUGH RATE SECURITIES SOLD(1)
- -------------------------------------------------- --------- ------------- ----------------- ------------------
1996-1............................................ 06/12/96 $ 225.0 6.60% AAA/Aaa
1996-2............................................ 09/26/96 $ 180.0 6.66% AAA/Aaa
1996-3............................................ 12/27/96 $ 210.0 6.41% AAA/Aaa
- ------------------
(1) Ratings by Standard & Poor's and Moody's, respectively
8
When Delta securitizes loans, it sells a portfolio of loans to a trust (the
'Home Equity Loan Trust') and issues classes of certificates representing an
undivided ownership interest in the Home Equity Loan Trust. In its capacity as
servicer for each securitization, the Company collects and remits principal and
interest payments to the appropriate Home Equity Loan Trust which in turn passes
through payments to certificate owners. For each of the 1996 securitizations,
Delta retained 100% of the interests in the interest-only and residual classes
of certificates and management contemplates continuing to do so in the future.
Each Home Equity Loan Trust has the benefit of a financial guaranty
insurance policy from a monoline insurance company, which insures the timely
payment of interest and the ultimate payment of principal of the investor
certificate. In addition to such insurance policies, the Excess Servicing is
applied as an additional payment of principal of the investor certificates,
thereby accelerating the amortization of the investor certificates relative to
the amortization of the loans. This use of the Excess Servicing creates
over-collateralization (i.e., the principal amount of the loans exceeds the
principal amount of the investor certificates). Once the level of over-
collateralization reaches a pre-determined level set by the monoline insurance
company, the use of Excess Servicing to create over-collateralization stops
unless it subsequently becomes necessary to again obtain or maintain the
required level of over-collateralization. Over-collateralization is intended to
create a source of cash (the payments on the 'extra' loans) to absorb losses
prior to making a claim on the financial guaranty insurance policy. To date, no
claims have been made on the financial guarantee insurance policies for any of
the Company's securitizations.
Delta may be required either to repurchase or to replace loans which do not
conform to the representations and warranties made by Delta in the pooling and
servicing agreement entered into when the portfolio of loans are sold through a
securitization. To date, Delta has not had to make any such repurchases or
replacements. Delta intends to continue to conduct loans sales through
securitization, either in private placements or in public offerings, when market
conditions are attractive for such loan sales.
Whole Loan Sales Without Recourse. The Company has determined from time to
time that some of its 'A' loans and higher loan-to-value ratio loans receive
better execution by being sold on a whole loan, non-recourse basis to third
party institutions. The Company intends to continue this practice as long as it
is deemed to be more profitable for the Company. For the years ended December
31, 1996, 1995 and 1994, Delta sold $15.3 million, $17.6 million and $12.0
million of loans, respectively, on a whole loan, non-recourse basis, which
represents 2.3%, 6.1% and 9.9%, respectively, of its originations and purchases.
LOAN SERVICING AND COLLECTIONS
Delta has been servicing loans since its inception in 1982, and Delta has
serviced or is servicing substantially all of the loans that it has originated
or purchased. Servicing involves, among other things, collecting payments when
due, remitting payments of principal and interest and furnishing reports to the
current owners of the loans and enforcing such owners' rights with respect to
the loans, including, recovering delinquent payments, instituting foreclosure
and liquidating the underlying collateral. The Company receives a servicing fee
for servicing residential mortgage loans of 0.50% per annum (0.65% per annum on
all securitizations completed before and including the 1996-1 securitization) on
the declining principal balance of all loans sold through securitization and on
the declining principal balance of the loans sold to investors on a recourse
basis, which servicing fees are collected out of the monthly mortgage payments.
Management believes that servicing the Company's own portfolio enhances certain
operating efficiencies and provides an additional and profitable revenue stream
that is less cyclical than the business of originating and purchasing loans. As
of December 31, 1996, Delta had a loan servicing portfolio of $933.0 million.
Delta services all loans out of its headquarters in Woodbury, New York,
utilizing a leading 'in-house' loan servicing system ('LSAMS') which it
purchased in 1994 and implemented in 1995. LSAMS replaced Delta's former
'service bureau' loan servicing system, and has provided Delta with considerably
more flexibility to adapt the system to Delta's specific needs as a
nonconforming home equity lender. As such, Delta has achieved significant cost
efficiencies by automating a substantial number of previously manual servicing
procedures and functions since its conversion to LSAMS on July 1, 1995.
Management believes that even greater cost efficiencies can be realized through
further automation provided by LSAMS, which runs on an IBM AS-400 base.
9
At the same time that it upgraded its primary servicing system, Delta
purchased a default management sub-servicing system ('TPLS') with separate
'modules' for foreclosure, bankruptcy, and REO to provide it with the ability to
more efficiently monitor and service loans in default. These sub-servicing
modules provide detailed tracking of all key events in foreclosure and
bankruptcy on a loan-by-loan and portfolio-wide basis; the ability to track and
account for all pre- and post-petition payments received in bankruptcy from the
borrower and/or trustee; and the ability to monitor, market and account for all
aspects necessary to liquidate an REO property after foreclosure. Additionally,
Delta's Management Information Systems Department has created a market value
analysis program to run with LSAMS, and provides Delta with the ability to
monitor its equity position on a loan-by-loan and/or portfolio-wide basis.
Centralized controls and standards have been established by Delta for the
servicing and collection of mortgage loans in its portfolio. Delta revises such
policies and procedures from time to time in connection with changing economic
and market conditions and changing legal and regulatory requirements.
Delta's collections policy is designed to identify payment problems
sufficiently early to permit Delta to quickly address delinquency problems and,
when necessary, to act to preserve equity in a pre-foreclosure property. Delta
believes that these policies, combined with the experience level of its
underwriters and the independent appraisers it engages, help to reduce the
incidence of charge-offs of a first or second mortgage loan.
Borrowers are billed on a monthly basis in advance of the due date.
Collection procedures commence upon identification of a past due account by
Delta's automated servicing system. If timely payment is not received, LSAMS
automatically places the loan in the assigned collector's 'auto queue' and
collection procedures are generally initiated on the day immediately following
the payment due date for chronic late payers, or the day immediately following
the end of the grace period for those borrowers who usually pay within the grace
period. The account remains in the queue unless and until a payment is received,
at which point LSAMS automatically removes the loan from that collector's auto
queue until the next month's payment is due and/or becomes delinquent.
When a loan appears in a collector's auto queue, a collector will telephone
to remind the borrower that a payment is due. Follow-up telephone contacts are
attempted until the account is current or other payment arrangements have been
made. Standard form letters are utilized when attempts to reach the borrower by
telephone fail and/or, in some circumstances, to supplement the phone contacts.
During the delinquency period, the collector will continue to contact the
borrower. Company collectors have computer access to telephone numbers, payment
histories, loan information and all past collection notes. All collection
activity, including the date collection letters were sent and detailed notes on
the substance of each collection telephone call, is entered into a permanent
collection history for each account on LSAMS. Additional guidance with the
collection process is derived through frequent communication with Delta's senior
management.
For those loans in which collection efforts have been exhausted without
success, the Pre-foreclosure Manager recommends the loans be sent to foreclosure
at one of two Foreclosure Committee Meetings held each month. At each such
committee meeting, the Pre-foreclosure Manager meets with the Servicing Manager,
the Foreclosure Manager and a member of the Executive Department, to determine
whether foreclosure proceedings are appropriate, based upon their analysis of
all relevant factors, including a market value analysis, reason for default and
efforts by the borrower to cure the default.
Regulations and practices regarding the liquidation of properties (e.g.,
foreclosure) and the rights of a borrower in default vary greatly from state to
state. As such, all foreclosures are assigned to outside counsel, located in the
same state as the secured property. Bankruptcies filed by borrowers are
similarly assigned to appropriate local counsel. All aspects of foreclosures and
bankruptcies are closely monitored by Delta through its TPLS sub-servicing loan
system and through monthly status reports from attorneys.
Prior to foreclosure sales, Delta performs an in-depth market value
analysis on all defaulted loans. This analysis includes: (i) a current valuation
of the property; (ii) an evaluation of the amount owed, if any, for real estate
taxes; (iii) an evaluation of the amount owed, if any, to a senior mortgagee;
and (iv) estimated carrying costs, brokers' fee, repair costs and other related
costs associated with real estate owned properties. Delta bases the amount it
will bid at foreclosure sales on this analysis.
10
If Delta acquires title to a property at a foreclosure sale or otherwise,
the REO Department immediately takes responsibility for the file by obtaining an
estimate of the sale price of the property by sending at least two local real
estate brokers to inspect the premises, and then hiring one to begin marketing
the property. If the property is not vacant when acquired, local eviction
attorneys are hired to commence eviction proceedings and/or negotiations are
held with occupants in an attempt to get them to vacate without incurring the
additional time and cost of eviction. Repairs are performed if it is determined
that they will increase the net liquidation proceeds, taking into consideration
the cost of repairs, the carrying costs during the repair period and the
marketability of the property both before and after the repairs.
Delta's loan servicing software also tracks and maintains homeowners'
insurance information and tax and insurance escrow information. Expiration
reports listing all policies scheduled to expire within the next 15 days are
generated bi-weekly. When policies lapse, a letter is issued advising the
borrower of such lapse and notifying the borrower that Delta will obtain
force-placed insurance at the borrower's expense. Delta also has an insurance
policy in place that provides coverage automatically for Delta in the event that
Delta fails to obtain force-placed insurance.
The following table sets forth information relating to the delinquency and
loss experience of Delta for its servicing portfolio of mortgage loans
(including mortgage loans serviced for others) for the periods indicated.
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1995 1994
------------ ------------ ------------
Total Outstanding Principal Balance (at period end)............. $932,958,188 $468,846,079 $310,228,743
Average Outstanding(1).......................................... $667,368,565 $373,384,417 $300,678,046
DELINQUENCY (at period end)
30-59 Days:
Principal Balance............................................. $ 54,582,550 $ 35,052,951 $ 22,569,938
Percent of Delinquency(2)..................................... 5.85% 7.48% 7.28%
60-89 Days:
Principal Balance............................................. $ 14,272,587 $ 8,086,230 $ 6,398,055
Percent of Delinquency(2)..................................... 1.53% 1.72% 2.06%
90 Days or More:
Principal Balance............................................. $ 9,224,525 $ 6,748,061 $ 6,517,506
Percent of Delinquency(2)..................................... 0.99% 1.44% 2.10%
Total Delinquencies:
Principal Balance............................................. $ 78,079,663 $ 49,887,242 $ 35,485,499
Percent of Delinquency(2)..................................... 8.37% 10.64% 11.44%
FORECLOSURES
Principal Balance............................................. $ 34,765,638 $ 23,506,751 $ 20,768,336
Percent of Foreclosures by Dollar(2).......................... 3.73% 5.01% 6.69%
REO (at end of period).......................................... $ 5,672,811 $ 4,020,295 $ 1,926,922
Net Gains/(Losses) on liquidated loans.......................... $ (2,866,204) $ (2,142,099) $ (687,090)
Percentage of Net Gains/(Losses) on liquidated loans (based on
Average Outstanding Balance).................................. (0.43%) (0.57%) (0.23%)
- ------------------
(1) Calculated by summing the actual outstanding principal balances at the end
of each month and dividing the total by the number of months in the
applicable period.
(2) Percentages are expressed based upon the total outstanding principal balance
at the end of the indicated period.
COMPETITION
As an originator and purchaser of mortgage loans, the Company faces intense
competition, primarily from mortgage banking companies, commercial banks, credit
unions, savings and loans, credit card issuers and finance companies. Many of
these competitors in the financial services business are substantially larger
and have more capital and other resources than the Company. Competition can take
many forms, including convenience in obtaining a loan, service, marketing and
distribution channels and interest rates. Furthermore, the current level of
11
gains realized by the Company and its competitors on the sale of the type of
loans originated and purchased is attracting additional competitors into this
market with the effect of lowering the gains that may be realized by the Company
on future loan sales. In addition, greater investor acceptance of securities
backed by loans comparable to the Company's mortgage loans and greater
availability of information regarding the prepayment and default experience of
such loans creates greater efficiencies in the market for such securities. Such
efficiencies may create a desire for even larger transactions giving companies
with greater volumes of originations a competitive advantage. In addition, a
more efficient market for such securities may lead certain investors to purchase
securities backed by other types of assets where potential returns may be
greater. Competition may be affected by fluctuations in interest rates and
general economic conditions. During periods of rising rates, competitors which
have 'locked in' low borrowing costs may have a competitive advantage. During
periods of declining rates, competitors may solicit the Company's borrowers to
refinance their loans. During economic slowdowns or recessions, the Company's
borrowers may have new financial difficulties and may be receptive to offers by
the Company's competitors.
Furthermore, certain large national finance companies and conforming
mortgage originators have announced their intention to adapt their conforming
origination programs and allocate resources to the origination of non-conforming
loans. In addition, certain of these larger mortgage companies and commercial
banks have begun to offer products similar to those offered by the Company,
targeting customers similar to those of the Company. The entrance of these
competitors into the Company's market could have a material adverse effect on
the Company's results of operations and financial condition.
REGULATION
Delta's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is subject to
various laws and judicial and administrative decisions imposing requirements and
restrictions on part or all of its operations. Delta's consumer lending
activities are subject to the Federal Truth-in-Lending Act and Regulation Z
(including the Home Ownership and Equity Protection Act of 1994), the Equal
Credit Opportunity Act of 1974, as amended (ECOA), the Fair Credit Reporting Act
of 1970, as amended, the Real Estate Settlement Procedures Act (RESPA), and
Regulation X, the Home Mortgage Disclosure Act and the Federal Debt Collection
Practices Act, as well as other federal and state statutes and regulations
affecting Delta's activities. Delta is also subject to the rules and regulations
of, and examinations by HUD and state regulatory authorities with respect to
originating, processing, underwriting and servicing loans. These rules and
regulations, among other things, impose licensing obligations on Delta,
establish eligibility criteria for mortgage loans, prohibit discrimination,
provide for inspections and appraisals of properties, require credit reports on
loan applicants, regulate assessment, collection, foreclosure and claims
handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to
comply with these requirements can lead to loss of approved status, termination
or suspension of servicing contracts without compensation to the servicer,
demands for indemnifications or mortgage loans repurchases, certain rights of
rescission for mortgage loans, class action lawsuits and administrative
enforcement actions. Delta believes that it is in compliance in all material
respects with applicable federal and state laws and regulations.
ENVIRONMENTAL MATTERS
To date, Delta has not been required to perform any investigation or clean
up activities, nor has it been subject to any environmental claims. There can be
no assurance, however, that this will remain the case in the future. In the
ordinary course of its business, Delta from time to time forecloses on
properties securing loans. Although Delta primarily lends to owners of
residential properties, there is a risk that Delta could be required to
investigate and clean up hazardous or toxic substances or chemical releases at
such properties after acquisition by Delta, and may be held liable to a
governmental entity or to third parties for property damage, personal injury and
investigation and cleanup costs incurred by such parties in connection with the
contamination. In addition, the owner or former owners of a contaminated site
may be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from such property.
12
EMPLOYEES
As of December 31, 1996, the Company had approximately 346 employees
(full-time and part-time), 313 of whom were working at its Woodbury, New York
headquarters. The Company is not subject to any collective bargaining
agreements. The Company considers its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company's executive and administrative headquarters, including its
servicing operation and full service production office, are located in Woodbury,
New York, where the Company leases approximately 57,500 square feet of office
space at an aggregate annual rent of approximately $1,045,000. The lease
provides for certain scheduled rent increases and expires in 2004.
The Company also leases space for its a full service office in Atlanta,
Georgia, full-processing offices in Chicago, Illinois and Warwick, Rhode Island,
and business development offices in New Jersey, Missouri, Virginia,
Pennsylvania, Ohio (2), and Michigan (2). The terms of the leases vary as to
duration and escalation provisions, with the latest expiring in 2001.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of the Company's business involves the collection of
numerous accounts, the validity of liens and compliance with state and federal
lending laws, the Company is subject to numerous claims and legal actions in the
ordinary course of its business. While it is impossible to estimate with
certainty the ultimate legal and financial liability with respect to such claims
and actions, the Company believes that the aggregate amount of such liabilities
will not result in monetary damages which in the aggregate would have a material
adverse effect on the financial condition or results of the Company.
Several class-action lawsuits have been filed recently against a number of
consumer finance companies alleging that the compensation of mortgage brokers
through the payment of yield spread premiums violates various federal and state
consumer protection laws. On March 18, 1997, the Company received notice that it
had been named in a lawsuit filed in Federal District Court, E.D.N.Y., alleging
that the Company's compensation of mortgage brokers by means of yield spread
premiums violates, among other things, the Federal Real Estate Settlement
Procedures Act. The complaint seeks (i) certification of a class of plaintiffs,
(ii) an injunction against payment of yield spread premiums by the Company and
(iii) unspecified compensatory and punitive damages (including attorney's fees).
Management believes the Company has meritorious defenses and intends to defend
this suit, but the Company has not yet answered the complaint and cannot
estimate with any certainty its ultimate legal or financial liability, if any,
with respect to the alleged claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 4, 1996, prior to the Company's initial public offering, by
unanimous written consent the stockholders of Delta approved the Company's 1996
Stock Option Plan.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock was listed on the New York Stock Exchange (the
'NYSE') under the symbol 'DFC' on November 1, 1996. The following table sets
forth for the periods indicated the range of the high and low closing sales
prices for the Company's Common Stock on the NYSE.
1996 HIGH LOW
- ------------------------------------------------------------------------------ ---- ---
Fourth Quarter (from 11/1/96)................................................. $25 1/4 $18
On March 5, 1997, the Company had approximately 47 stockholders of record.
This number does not include beneficial owners holding shares through nominee or
'street' names. The Company believes the number of beneficial stockholders is in
excess of 3,000.
DIVIDEND POLICY
The Company did not pay any dividends in 1996 and, in accordance with its
present general policy, has no present intention to pay cash dividends.
14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS EXCEPT FOR PER SHARE DATA)
INCOME STATEMENT DATA:
Revenues:
Net gain on sale of mortgage loans........ $ 46,525 $ 15,383 $ 6,661 $ 7,639 $ 4,757
Interest.................................. 16,372 13,588 9,839 9,156 13,402
Servicing fees............................ 5,368 2,855 2,183 2,101 1,892
Other..................................... 5,266 4,309 3,114 3,617 5,413
---------- ---------- ---------- ---------- ----------
Total revenues......................... $ 73,531 $ 36,135 $ 21,797 $ 22,513 $ 25,464
---------- ---------- ---------- ---------- ----------
Expenses:
Payroll and related costs................. $ 16,509 $ 12,876 $ 8,815 $ 9,268 $ 10,713
Interest.................................. 11,298 7,964 3,735 2,915 4,536
General & administrative.................. 12,236 10,709 7,238 6,670 6,905
---------- ---------- ---------- ---------- ----------
Total expenses......................... $ 40,043 $ 31,549 $ 19,788 $ 18,853 $ 22,154
---------- ---------- ---------- ---------- ----------
Income before income taxes and extraordinary
item...................................... 33,488 4,586 2,009 3,660 3,310
Provision for income taxes(1)............... 9,466 -- -- -- --
---------- ---------- ---------- ---------- ----------
Income before extraordinary item............ 24,022 4,586 2,009 3,660 3,310
Extraordinary item:
Gain on extinguishment of debt............ 3,168 -- -- -- --
---------- ---------- ---------- ---------- ----------
Net income.................................. $ 27,190 $ 4,586 $ 2,009 $ 3,660 $ 3,310
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Unaudited pro forma information:
Provision for pro forma income taxes before
extraordinary item(1)(2).................. 14,400 1,972 864 1,574 1,423
---------- ---------- ---------- ---------- ----------
Pro forma income before extraordinary
item(1)(2)................................ $ 19,088 $ 2,614 $ 1,145 $ 2,086 $ 1,887
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Per share data
Pro forma earnings per share of common
stock(1)(2)(3)......................... $ 1.46 $ 0.21 $ 0.09 $ 0.17 $ 0.15
Pro forma weighted average number of
shares outstanding(3).................. 13,083,327 12,629,182 12,629,182 12,629,182 12,629,182
SELECTED BALANCE SHEET DATA:
Loans held for sale......................... $ 83,677 $ 63,816 $ 48,833 $ 41,703 $ 47,079
Interest-only and residual certificates..... 83,073 25,310 7,514 2,204 --
Capitalized mortgage servicing rights....... 11,412 3,831 2,421 3,491 5,705
Total assets................................ 232,736 139,612 98,589 81,143 80,775
---------- ---------- ---------- ---------- ----------
Warehouse financing and other borrowings.... $ 95,482 $ 82,756 $ 52,491 $ 36,780 $ 42,659
Investor payable............................ 22,569 14,272 11,091 8,687 4,959
Total liabilities........................... 139,218 109,779 70,425 52,793 54,891
---------- ---------- ---------- ---------- ----------
Stockholders' equity........................ $ 93,518 $ 29,833 $ 28,164 $ 28,350 $ 25,884
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
- ------------------
(1) Prior to October 31, 1996, Delta Funding Corporation was treated as an S
corporation for federal and state income tax purposes. As a result, the
Company's historical earnings prior to such date had been taxed directly to
the former shareholders of Delta Funding Corporation (the 'Former
Shareholders') and not to the Company.
(2) The pro forma presentation reflects a provision for income taxes, as if the
Company had always been a C corporation, at an assumed tax rate of 43%.
(3) Reflects the effect of 10,653,000 shares issued to the Former Shareholders
and the effect of the issuance of 4,600,000 shares of Common Stock issued in
the Company's initial public offering, 1,976,182 of which are treated as if
they had always been outstanding to give effect to certain S corporation
distributions paid to the Former Shareholders.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company and accompanying Notes to
Consolidated Financial Statements set forth therein.
RECENT GROWTH
The Company has experienced significant growth in the last few years,
particularly since January 1, 1995. Management believes that this growth is
primarily attributable to (i) the Company's geographic expansion of its
operations, (ii) the Company's further penetration into its established markets,
and (iii) the Company's increased access to additional funding sources through
larger warehouse agreements which enabled the Company to accumulate larger pools
of loans for sales through securitizations.
The Company's recent and rapid growth may have a somewhat distortive impact
on certain of the Company's ratios and financial statistics and may make
period-to-period comparisons difficult. In light of the Company's growth,
historical performance of the Company's earnings may be of limited relevance in
predicting future performance. Furthermore, the Company's financial statistics
may not be indicative of the Company's results in future periods. Any credit or
other problems associated with the large number of loans originated and
purchased in the recent past may not become apparent until sometime in the
future.
To date, the Company has not experienced any significant seasonal
variations in loan originations and purchases.
CERTAIN ACCOUNTING CONSIDERATIONS
INTEREST-ONLY AND RESIDUAL CERTIFICATES
The Company derives a substantial portion of its income by recognizing gain
on sale of loans sold through securitizations, represented by the interest-only
and residual certificates that the Company retains. In securitizations, the
Company sells loans that it has originated or purchased to a trust for a cash
purchase price and the interest-only and residual certificates. The cash
purchase price is raised through an offering by the trust of pass-through
certificates representing regular interests in the trust. Following the
securitizations, the purchasers of the pass-through certificates receive the
principal collected and the investor pass-through interest rate on the principal
balance, while the Company receives the Excess Servicing, which represents the
present value of the excess of the interest rate payable by an obligor on a loan
over the interest rate passed through to the purchasers of the regular-interest
certificates, less the Company's normal servicing fee and other recurring fees.
The capitalized Excess Servicing is represented on the Company's balance sheet
in the form of the interest-only and residual certificates, and these
certificates are reduced as cash distributions are received. The interest-only
and residual certificates are accounted for as trading securities in accordance
with Statement of Financial Accounting Standards ('SFAS') No. 115, 'Accounting
for Certain Investments in Debt and Equity Securities,' and as such they are
recorded at their fair value. Changes in fair value of the interest-only and
residual certificates are reflected in the statement of operations. Fair value
of the interest-only and residual certificates is determined based on various
economic factors, including considerations of loan type, size, date of
origination, interest rate, term, collateral value and geographic location.
Higher than anticipated rates of loan prepayments or losses would require the
Company to write down the fair value of the interest-only and residual
certificates, adversely impacting earnings. To date, the Company has not been
required to write down the value of any interest-only and residual certificate
it holds.
SFAS NO. 91
In December 1986, the Financial Accounting Standards Board ('FASB') issued
SFAS No. 91, 'Accounting for Non-Refundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases' ('SFAS No.
91'). SFAS No. 91 establishes the accounting for nonrefundable fees and costs
associated with lending, committing to lend, or purchasing a loan or a group of
loans.
Under SFAS No. 91, loan origination fees and direct loan origination costs
are recognized as an adjustment of the loan's yield over the earlier of the life
of the related loan or the sale of the loan. In effect, SFAS No. 91 requires
that origination fees be offset by their related direct loan costs and that net
deferred fees be recognized
16
over the earlier of the life of the loan or the sale of the loan, whether the
loan is sold through securitization or on a whole loan basis.
Prior to the second quarter of 1996, the Company generally sold loans
through securitization on a semiannual basis and, as such, carried a larger
inventory of loans on its books from quarter to quarter and from year to year,
which resulted in more significant SFAS No. 91 adjustments being made during
those periods. The Company contemplates that in the future it will continue to
sell substantially all of its loan originations and purchases on a quarterly
basis primarily through securitizations and, to a lesser extent, on a whole loan
basis. This practice should minimize the amount of loans being held in inventory
and, therefore, minimize the effects of SFAS No. 91 on the Company's financial
statements.
MORTGAGE SERVICING RIGHTS
In May 1995, the FASB issued SFAS No. 122, 'Accounting for Mortgage
Servicing Rights,' which amends SFAS No. 65 'Accounting for Certain Banking
Activities.' Effective January 1, 1995, the Company adopted SFAS No. 122.
Because SFAS No. 122 prohibits retroactive application to years prior to
adoption thereof, the Company's historical financial results for periods prior
to 1995 have not been restated and, accordingly, are not directly comparable to
the financial results for 1995 and 1996.
SFAS No. 122 requires mortgage banking entities to recognize as a separate
asset the rights to service mortgage loans for others, regardless of how those
servicing rights are acquired. Mortgage banking entities that acquire or
originate loans and subsequently sell or securitize those loans and retain the
mortgage servicing rights are required to allocate the total cost of the loans
to the mortgage servicing rights and the mortgage loans without the mortgage
servicing rights. The Company determines fair value based upon the present value
of estimated net future servicing revenues less the estimated cost to service
loans, adjusted based on the same assumptions used on the gain on sale
calculation. The cost allocated to these servicing rights is amortized in
proportion to and over the period of estimated net future cash flows related to
servicing income. As a result of the adoption of SFAS No. 122, the Company will
recognize in the future greater revenues at the time a loan is sold and smaller
revenues during the period such loan is serviced. To this end, adoption of SFAS
No. 122 resulted in additional income recorded as gain on sale of approximately
$8.3 million during the year ended 1996 and $2.1 million during the year ended
1995.
SFAS No. 122 also requires impairment evaluations of all amounts
capitalized as servicing rights, including those purchased before the adoption
of SFAS No. 122, based upon the fair value of the underlying servicing rights.
The Company periodically performs these evaluations on a disaggregated basis for
the predominant risk characteristics of the underlying loans which are loan
type, term, credit quality and interest rate. The continuing effects of SFAS No.
122 on the Company's financial position and results of operations will depend on
several factors, including, among other things, the amount of acquired or
originated loans sold or securitized, the type, term and credit quality of loans
and estimates of future prepayment rates.
TERMINATION OF S CORPORATION STATUS AND INCOME TAXES
On October 31, 1996, in contemplation of the Company's initial public
offering, Delta Funding Corporation terminated its status as an S corporation.
The Former Shareholders of Delta Funding Corporation, pursuant to the terms of a
contribution agreement, contributed their shares of capital stock in Delta
Funding Corporation to the Company in exchange for 10,653,000 shares,
representing all of the then-outstanding Common Stock of the Company (the
'Exchange').
In connection with the termination of Delta Funding Corporation's S
corporation status, Delta Funding Corporation made final S corporation
distributions and the Company used $32.6 million of the net proceeds of the
initial public offering to pay such distributions.
As an S corporation, Delta Funding Corporation's income, whether or not
distributed, was taxed at the shareholder level for federal and state tax
purposes. The pro forma provision for income taxes in the accompanying
statements of income shows results as if the Company had always been a C
corporation, with an effective tax rate of 43%.
The Company incurred a $3.9 million deferred tax liability as a result of
its conversion from an S corporation to a C corporation on October 31, 1996.
17
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
Revenues
Total revenues increased $37.4 million, or 103%, to $73.5 million in 1996
from $36.1 million in 1995. The increase in revenues was primarily due to the
increase in loan originations and purchases and a corresponding increase in the
amount of loans sold through securitizations.
Net Gain on Sale of Mortgage Loans. Net gain on sale of mortgage loans
increased $31.1 million, or 202%, to $46.5 million in 1996 from $15.4 million in
1995. This increase was the result of higher loan originations and purchases,
resulting in an increased amount of loans sold through securitizations. Total
loan originations and purchases increased $371.0 million, or 129%, to $658.8
million in 1996 from $287.8 million in 1995. The Company sold or securitized
$630.4 million of loans in 1996 compared to $247.6 million in 1995, with a
weighted average net gain on sale of 7.4% and 6.2%, respectively.
Interest Income. Interest income increased $2.8 million, or 20%, to $16.4
million in 1996 from $13.6 million in 1995. The increase in interest income was
primarily due to a higher average balance of loans held for sale during 1996
resulting from the increases in loan originations and purchases, but was
partially offset due to the shorter holding period which the mortgage loans
remained in inventory during 1996. The Company completed three securitizations
during 1996 versus two securitizations in 1995. The weighted average interest
rate on loans held for sale was 11.40% for both 1996 and 1995.
Servicing Income. Servicing income increased $2.5 million, or 88%, to $5.4
million in 1996 from $2.9 million in 1995. This increase was primarily due to
higher loan servicing volume, which resulted in increased contractual and
ancillary service fees. During 1996, the average balance of mortgage loans
serviced by the Company increased 79% to $667.4 million from $373.4 million
during 1995.
Other Income. Other income increased $1.0 million, or 22%, to $5.3 million
in 1996 from $4.3 million in 1995. This increase was primarily due to an
increase in loan origination fees, which is the primary component of other
income. The Company generates loan origination fees on loans originated through
its broker network. During 1996, broker loan originations increased by $146.0
million, or 83%, to $321.7 million from $175.7 million in 1995. Loan origination
fees increased at a slower rate than broker loan originations primarily because
the Company earned lower average origination fees per loan.
Expenses
Total expenses increased $8.5 million, or 27%, to $40.0 million for 1996
from $31.5 million in 1995. The increase in expenses was primarily the result of
increased interest expense on loans held for sale and higher operating expenses
associated with the additional personnel required to process the greater number
of loan originations and purchases. Total expenses increased at a much slower
rate than total revenues, primarily due to efficiencies realized from the
Company's investment in technology, experienced staff and economies of scale.
Payroll Expense. Payroll expense increased $3.6 million, or 28%, to $16.5
million for 1996, from $12.9 million for 1995. The increase was primarily due to
increased staffing in the Company's originations area associated with the
increase in loan originations and purchases, as well as the Company's expansion
into new and existing markets. As of December 31, 1996, the Company employed 346
full- and part-time persons as compared to 255 full- and part-time persons as of
December 31, 1995.
Interest Expense. Interest expense increased $3.3 million, or 42%, to
$11.3 million in 1996 from $8.0 million in 1995. The increase in interest
expense was attributable to the interest costs associated with both a higher
balance of loans pending sale during 1996, resulting from increases in loan
originations and purchases during the period, and an increase in the excess
servicing receivable financing during 1996. The Company had financings against
its Excess Servicing receivables (residual and interest-only certificates) of
$47.0 million as of December 31, 1996 compared to $16.2 million as of December
31, 1995. Interest expense was partially offset by lower cost of funds on the
Company's floating rate borrowings which are based on 1 month Libor. The average
one-month libor rate was on average 0.52% lower during 1996 than during 1995.
18
General and Administrative Expenses. General and administrative expenses,
which consist primarily of office and administration, rent, and health care and
insurance, increased $1.5 million, or 14%, to $12.2 million in 1996 from $10.7
million in 1995. The increase in general and administrative expenses was
primarily due to expenses incurred in connection with the increases in loan
originations and purchases, and increased employee benefit expenses.
Extraordinary Gain
In May 1996, the Company closed out its long-term $31.7 million warehouse
facility with a European financial institution at a 10% discount. As a result,
the Company realized an extraordinary gain of $3.17 million for the year ended
December 31, 1996.
Income Taxes
Prior to October 31, 1996, Delta Funding Corporation was treated as an S
corporation for federal and state income tax purposes. As a result, the
Company's historical earnings prior to such date had been taxed directly to the
Former Shareholders of Delta Funding and not to the Company.
On October 31, 1996, in conjunction with the Exchange, Delta Funding
Corporation's status as an S corporation was terminated and the Company became a
C corporation for federal and state income tax purposes and as such was subject
to federal and state income tax on its taxable income for the months of November
and December 1996. During 1996, the Company recorded a tax provision of $9.5
million. This includes a $4.2 million provision for November and December
earnings at the statutory rate of 42% and a deferred tax expense of $3.9 million
in connection with the change in tax status from an S corporation to a C
corporation.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994
Revenues
Total revenues increased $14.3 million, or 66%, to $36.1 million in 1995
from $21.8 million in 1994. The increase in revenues was primarily due to the
combined effect of increases in loan originations and purchases, the adoption of
SFAS No. 122 and higher gains realized on the sale of loans through
securitizations.
Net Gain on Sale of Mortgage Loans. Net gain on sale of mortgage loans
increased $8.7 million, or 131%, to $15.4 million in 1995 from $6.7 million in
1994. This increase was primarily due to the combined effect of increased loan
originations and purchases and subsequent sales of loans through securitizations
and the adoption of SFAS No. 122. Total loan originations and purchases
increased $168.1 million, or 140%, to $287.8 million in 1995 from $119.7 million
in 1994. The Company sold or securitized $247.6 million of loans in 1995
compared to $102.0 million in 1994, with a weighted average net gain on sale of
6.2% and 6.5%, respectively. Included in the gain on sale of loans in 1995 was
$2.1 million which represents the present value of mortgage servicing rights
that the Company receives over time, as it sells loans through securitization on
a servicing-retained basis. The Company implemented SFAS No. 122, effective as
of January 1, 1995.
Interest Income. Interest income increased $3.8 million, or 38%, to $13.6
million in 1995 from $9.8 million in 1994. The increase in interest income was
primarily due to a higher average balance of loans held for sale during 1995
resulting from the increases in loan originations and purchases and, to a lesser
extent, to unrealized gains, net of discount accretion and cash remittances, in
the amount of $1.0 million on interest-only and residual certificates held by
the Company, resulting from mark-to-market adjustment valuations to fair value
according to SFAS No. 115.
Servicing Income. Servicing income increased $0.7 million, or 31%, to $2.9
million in 1995 from $2.2 million in 1994. This increase was primarily the
result of higher loan servicing volume, which resulted in larger contractual and
ancillary service fees. During 1995, the average balance of mortgage loans
serviced by the Company increased 24% to $373.4 million from $300.7 million in
1994. During 1995, the Company also increased its ancillary servicing income by
charging prepayment penalties in states where such charges are allowed.
Other Income. Other income increased $1.2 million, or 38%, to $4.3 million
in 1995 from $3.1 million in 1994. This increase was primarily due to the
increase in loan origination fees, which is the largest component of other
income. During 1995, broker loan originations increased by $94.3 million, or
116%, to $175.7 million from $81.4 million in 1994.
19
Expenses
Total expenses increased $11.7 million, or 59%, to $31.5 million for 1995
from $19.8 million in 1994. The increase in expenses was primarily the result of
increased interest expense on loans held for sale, the increased expense
associated with additional personnel required to process the greater number of
loan originations and purchases, and higher operating expenses related to
increased loan volume during 1995 compared to 1994.
Payroll Expense. Payroll expense increased $4.1 million, or 46%, to $12.9
million for 1995, from $8.8 million for 1994. The increase was due primarily to
bonus increases granted to certain members of senior management and, to a lesser
extent, due to increased staffing in the Company's originations area. As of
December 31, 1995, the Company employed 255 persons as compared to 197 persons
as of December 31, 1994.
Interest Expense. Interest expense increased $4.3 million, or 113%, to
$8.0 million in 1995 from $3.7 million in 1994. The increase in interest expense
was attributable to the interest costs associated with a higher balance of loans
pending sale during 1995, resulting from increases in loan originations and
purchases during the period, and a higher balance of loans held for sale at the
beginning of the period ($48.8 million compared to $41.7 million for 1995 and
1994, respectively). The Company's cost of funds on its floating rate warehouse
facilities, where it holds mortgage loans until the time of sale, was on average
1.51% higher in 1995 compared to 1994.
General and Administrative Expenses. General and administrative expenses
increased $3.5 million, or 48%, to $10.7 million in 1995 from $7.2 million in
1994. The increase in general and administrative expenses was primarily due to
expenses incurred in connection with the increases in loan originations and
purchases and associated increases in personnel expenses and the direct costs
relating to the transfer of the Company's prior servicing system to its current
servicing system.
FINANCIAL CONDITION
DECEMBER 31, 1996 COMPARED TO DECEMBER 31, 1995
Cash and interest-bearing deposits increased $2.1 million, or 13%, to $18.7
million at December 31, 1996 from $16.6 million at December 31, 1995. The
increase was primarily due to additional moneys held in securitization trust
accounts related to the Company's ongoing securitization program.
Accounts receivable increased $1.8 million, or 26%, to $8.6 million at
December 31, 1996 from $6.8 million at December 31, 1995. This increase was
primarily due to higher average loan servicing volume, which resulted in
increased reimbursable servicing advances made by the Company, acting as
servicer on its securitizations.
Loans held for sale increased $19.9 million, or 31%, to $83.7 million at
December 31, 1996 from $63.8 million at December 31, 1995. This increase was a
result of increases in loan originations and purchases in the fourth quarter of
1996 versus the fourth quarter of 1995, and a corresponding increase in the
amount of loans remaining in inventory subsequent to the Company's fourth
quarter 1996 securitization. Loan originations and purchases increased $142.6
million, or 141%, to $243.7 million in the fourth quarter of 1996 from $101.1
million in the fourth quarter of 1995.
Accrued interest and late charges receivable increased $4.3 million, or
26%, to $20.2 million at December 31, 1996 from $15.9 million at December 31,
1995. This increase was primarily due to higher loan servicing volume during
1996. The Company's average servicing portfolio increased 79% to $667.4 million
in 1996 from $373.4 million in 1995.
Capitalized mortgage servicing rights increased $7.6 million, or 198%, to
$11.4 million at December 31, 1996 from $3.8 million at December 31, 1995. This
increase was directly attributable to the application of SFAS No. 122, which
allows the Company to capitalize the fair market value of the servicing retained
asset after it completes a securitization. The Company's securitization issuance
amount increased 167% to $615 million from $230 million in 1995. The Company
began to capitalize ancillary service fee income in 1996 according to SFAS No.
122 which was not previously recognized in prior periods.
Interest-only and residual certificates increased $57.8 million, or 228%,
to $83.1 million at December 31, 1996 from $25.3 million at December 31, 1995,
primarily due to interest-only and residual certificates acquired in connection
with securitizations during the year. The Company securitized $615 million in
1996 versus $230 million in 1995.
20
Warehouse financing and other borrowings increased $12.7 million, or 15%,
to $95.5 million at December 31, 1996 from $82.8 million at December 31, 1995,
primarily due to additional loans held for sale and additional financing secured
by interest-only and residual certificates. The Company initially used $38.0
million of net proceeds from its initial public stock offering to pay down
amounts outstanding on a warehouse facility.
Investor payable increased $8.3 million, or 58%, to $22.6 million at
December 31, 1996 from $14.3 million at December 31, 1995. The increase was
primarily due to the higher loan servicing volume which resulted in an increase
in the amount of principal collected by the Company acting as servicer, which
must be remitted to the various trusts for the following distribution period.
Investor payable is comprised of all principal collected on mortgage loans,
either due to principal amortization or principal repayment, and accrued
certificate interest. Variability in this account is primarily due to the
principal prepayments collected within a given collection period.
Stockholders' equity increased $63.7 million, or 213%, to $93.5 million at
December 31, 1996 from $29.8 million at December 31, 1995. This increase is
primarily due to the net proceeds of $69.7 million received in connection with
the Company's initial public stock offering at November 1, 1996, as well as net
income for the year of $27.2 million, offset by distributions of $33.2 million
made to the former shareholders of Delta Funding Corporation prior to and in
connection with the initial public offering.
LIQUIDITY AND CAPITAL RESOURCES
The Company has operated, and expects to continue to operate, on a negative
cash flow basis due to increases in the volume of loan purchases and
originations, to the growth of its securitization program, and potential
acquisitions. Currently, the Company's primary cash requirements include the
funding of (i) mortgage originations and purchases pending their pooling and
sale, (ii) the points and expenses paid in connection with the acquisition of
correspondent loans, (iii) fees, expenses and tax payments incurred in
connection with its securitization program, (iv) over-collateralization
requirements in connection with loans pooled and sold, and (v) ongoing
administrative and other operating expenses. The Company has relied upon a few
lenders to provide the primary credit facilities for its loan originations and
purchases.
The Company must be able to sell loans and obtain adequate credit
facilities and other sources of funding in order to continue to originate and
purchase loans. As a result of increased loan originations and purchases and the
increase in its securitization program, the Company, during 1994, 1995 and 1996,
used cash of approximately $10.2 million, $23.9 million, $42.0 million,
respectively.
To accumulate loans for securitization, the Company borrows money on a
short-term basis through warehouse lines of credit. The Company has two
warehouse credit facilities for this purpose. One warehouse facility is a $250
million committed revolving line with a variable rate of interest and a maturity
date of February 1998. This facility was converted from an uncommitted to a
committed line subsequent to December 31, 1996. The Company's second warehouse
facility is a $200 million committed revolving line with a variable rate of
interest and a maturity date of February 1998. This facility was obtained
subsequent to December 31, 1996 and replaced a $100 million uncommitted credit
facility previously maintained by the Company with the warehouse lender. The
outstanding balance on the $250 million facility and $200 million facility as of
December 31, 1996 was $45.8 million and $0, respectively.
In addition, the Company has a one-year renewable credit line to support
its daily operating requirements in the amount of $1.0 million with a variable
interest rate, renewable in September 1997. The outstanding balance on this
credit line was $5,000 as of December 31, 1996. The Company had a second credit
line in the amount of $2.5 million which expired prior to December 31, 1996, and
was not renewed at the Company's option.
The Company has obtained financing facilities on all of its interest-only
and residual certificates acquired as part of its securitizations. As of
December 31, 1996, the aggregate outstanding balance on these facilities was
$47.0 million. These facilities have variable interest rates and mature between
October 1997 and December 1999.
The Company is required to comply with various operating and financial
covenants as provided in the agreements described above which are customary for
agreements of their type. The Company does not believe that its existing
financial covenants will restrict its operations or growth. The continued
availability of funds provided to the Company under these agreements is subject
to the Company's compliance with these covenants. Management believes the
Company is in compliance with all such covenants under these agreements.
21
HEDGING
The Company originates and purchases mortgage loans and then sells them
primarily through securitizations. At the time of securitization and delivery of
the loans, the Company recognizes gain on sale based on a number of factors
including the difference, or 'spread' between the interest rate on the loans and
the interest rate on treasury securities with maturities corresponding to the
anticipated life of the loans. If interest rates rise between the time the
Company originates or purchases the loans and the time the loans are priced at
securitization, the excess spread narrows, resulting in a loss in value of the
loans. To protect against such losses, the Company currently hedges the value of
the loans through the use of treasury rate lock contracts which function similar
to the short sale of treasury securities. Prior to hedging, the Company performs
an analysis of its loans taking into account such factors as interest rates,
maturities, durations, inventory of loans and amount of loans in the pipeline to
determine the proportion of contracts to sell so that the risk to the value of
the loans is most effectively hedged. The Company will enter into treasury rate
lock contracts through one of its warehouse lenders and/or one of the investment
bankers which underwrite the Company's securitizations. These contracts are
designated as hedges in the Company's records and are closed out when the
associated loans are sold through securitization.
If the value of the hedges decrease, offsetting an increase in the value of
the loans, the Company, upon settlement with its counter-party, will pay the
hedge loss in cash and realize the corresponding increase in the value of the
loans as part of its interest-only and residual certificates. Conversely, if the
value of the hedges increase, offsetting a decrease in the value of the loans,
the Company, upon settlement with its counterparty, will receive the hedge gain
in cash and realize the corresponding decrease in the value of the loans through
a reduction in the value of the corresponding interest-only and residual
certificates.
The Company believes that its current hedging strategy of using treasury
rate lock contracts is the most effective way to manage its interest rate risk
on loans prior to securitization.
INFLATION AND INTEREST RATES
Inflation has had no material effect on the Company's results of
operations. Inflation affects the Company most significantly in the area of loan
originations and can have a substantial effect on interest rates. Interest rates
normally increase during periods of high inflation and decrease during periods
of low inflation. Profitability may be directly affected by the level and
fluctuation in interest rates which affect the Company's ability to earn a
spread between interest received on its loans and the costs of its borrowings.
The profitability of the Company is likely to be adversely affected during any
period of unexpected or rapid changes in interest rates. A substantial and
sustained increase in interest rates could adversely affect the ability of the
Company to purchase and originate loans and affect the mix of first and second
mortgage loan products. Generally, first mortgage production increases relative
to second mortgage production in response to low interest rates and second
mortgage production increases relative to first mortgage production during
periods of high interest rates. A significant decline in interest rates could
decrease the size of the Company's loan servicing portfolio by increasing the
level of loan prepayments. Additionally, to the extent servicing rights,
interest-only and residual classes of certificates have been capitalized on the
books of the Company, higher than anticipated rates of loan prepayments or
losses could require the Company to write down the value of such servicing
rights and interest-only and residual certificates, adversely impacting
earnings. Fluctuating interest rates also may affect the net interest income
earned by the Company resulting from the difference between the yield to the
Company on loans held pending sales and the interest paid by the Company for
funds borrowed under the Company's warehouse facilities.
CERTAIN OTHER ACCOUNTING PRONOUNCEMENTS
SFAS NO. 125
In June 1996, FASB issued SFAS No. 125 'Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities', which
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. SFAS No.
125 distinguishes transfers of financial assets that are sales from transfers
that are secured borrowings.
SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishments of liabilities occurring after December 31, 1996, and is to
be applied prospectively. A securitization of a financial asset, a portion of a
financial asset, or a pool of financial assets in which the transferor
surrenders control over the assets
22
transferred, is accounted for as a sale. The transferor is considered to have
surrendered control only if all three of the following conditions are met:
(1) The transferred assets have been isolated from the transferor; i.e.,
put beyond the reach of the transferor and its creditors, even in the
event of bankruptcy of the transferor;
(2) The transferee is a 'qualifying special-purpose entity,' such as a
trust, and the holders of debt and equity investors in that entity have
the right to pledge or exchange those interests;
(3) The transferor does not effectively maintain control over the
transferred assets by a concurrent agreement that entitles the
transferor to repurchase, prior to maturity, transferred assets that
are not readily obtainable.
If the transfer does not qualify as a sale, the transferred assets will
remain on the balance sheet and the proceeds raised will be accounted for as a
secured borrowing with no gain or loss recognition. Because Delta's transfers of
loans made in connection with its securitizations qualify as sales under this
pronouncement, the required accounting will be an allocation of basis approach.
After the securitization of mortgage loans held for sale, the
mortgage-backed security (or any retained interests in REMIC securitizations of
loans held for sale, whether they are subordinate classes, IOs or residuals)
shall be classified as a trading security and reported at fair value under SFAS
No. 115.
Servicing assets created in a securitization of those assets (from
contractually specified servicing fees which are due the servicer in exchange
for servicing those assets) shall initially be measured at their allocated
carrying amount, based upon the relative fair value at the date of
securitization. Rights to future interest income from the serviced assets in
amounts that exceed the contractually specified fees (i.e. late charges, and
other ancillary revenues) should be accounted for separately from the servicing
asset. Those amounts are IO strips and are recorded at their fair value in
accordance with SFAS No. 115. Servicing assets are to be amortized in proportion
to, and over the period of, estimated net servicing income (the excess of
servicing revenues over servicing costs).
The Company has completed its analysis of SFAS No. 125 and has concluded
that it should not have any material affect on revenues or earnings.
RISK FACTORS
Except for historical information contained herein, certain matters
discussed in this Form 10-K are 'forward looking statements' as defined in the
Private Securities Litigation Reform Act (PSLRA) of 1995, which involve risk and
uncertainties that exist in the Company's operations and business environment,
and are subject to change based on various important factors. The Company wishes
to take advantage of the 'safe harbor' provisions of the PSLRA by cautioning
readers that numerous important factors discussed below, among others, in some
cases have caused, and in the future could cause the Company's actual results to
differ materially from those expressed in any forward-looking statements made
by, or on behalf of, the Company. The following include some, but not all, of
the factors or uncertainties that could cause actual results to differ from
projections:
o A general economic slowdown.
o The unanticipated expenses of assimilating newly-acquired business
into the Company's business structure; as well as, the impact of
unusual expenses from ongoing evaluations of business strategies,
asset valuations, acquisitions, divestitures and organizational
structures.
o Unpredictable delays or difficulties in the development of new
product programs.
o Rapid or unforeseen escalation of the cost of regulatory compliance
and/or litigation, including but not limited to, environmental
compliance, licenses, adoption of new, or changes in accounting
policies and practices and the application of such policies and
practices.
o The effects of changes in monetary and fiscal policies, laws and
regulations, other activities of governments, agencies and similar
organizations, and social and economic conditions, unforeseen
inflationary pressures and monetary fluctuation; the ability or
inability of the Company to hedge against fluctuations in interest
rates.
o The ability or inability of the Company to continue its practice of
securitization of mortgage loans held for sale.
o Increased competition within the Company's markets.
The Company believes that it has the product offerings, facilities,
personnel and competitive and financial resources for continued business
success. However, future revenues, costs, margins and profits are all influenced
by a number of factors, as discussed above.
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Financial Statements
December 31, 1996 and 1995
(With Independent Auditors' Report Thereon)
24
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Delta Financial Corporation:
We have audited the accompanying consolidated balance sheets of Delta Financial
Corporation and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Delta Financial
Corporation and subsidiary as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996 in conformity with generally accepted accounting
principles.
New York, New York KPMG Peat Marwick LLP
February 19, 1997
25
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
1996 1995
------------ ------------
ASSETS
Cash and interest bearing deposits............................................... $ 18,741,182 $ 16,635,135
Accounts receivable.............................................................. 8,654,885 6,845,947
Loans held for sale.............................................................. 83,677,017 63,816,298
Accrued interest and late charges receivable..................................... 20,158,812 15,946,847
Capitalized mortgage servicing rights............................................ 11,411,634 3,830,996
Equipment, net................................................................... 2,836,360 1,550,099
Cash held for advance payments................................................... 2,488,218 3,119,558
Real estate owned................................................................ 134,750 250,908
Interest only and residual certificates.......................................... 83,072,777 25,309,548
Prepaid and other assets......................................................... 1,560,578 1,316,702
Due from stockholders............................................................ -- 990,000
------------ ------------
$232,736,213 $139,612,038
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Bank payable..................................................................... $ 2,294,742 $ 5,100,087
Warehouse financing and other borrowings......................................... 95,481,627 82,756,232
Accounts payable and accrued expenses............................................ 7,201,674 4,843,719
Investor payable................................................................. 22,568,730 14,271,967
Advance payment by borrowers for taxes and insurance............................. 2,255,045 2,806,818
Income taxes payable............................................................. 9,416,784 --
------------ ------------
139,218,602 109,778,823
------------ ------------
Stockholders' equity:
Capital stock, $.01 par value. Authorized 49,000,000 shares; issued and
outstanding 15,253,000 shares and 10,653,000 shares in 1996 and 1995,
respectively................................................................ 152,530 106,530
Additional paid-in capital..................................................... 90,952,737 3,225,615
Retained earnings.............................................................. 2,412,344 26,501,070
------------ ------------
Total stockholders' equity.................................................. 93,517,611 29,833,215
------------ ------------
$232,736,213 $139,612,038
------------ ------------
------------ ------------
See accompanying notes to consolidated financial statements.
26
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
----------- ----------- -----------
Revenues:
Net gain on sale of mortgage loans................................ $46,525,042 $15,382,960 $ 6,661,163
Interest.......................................................... 16,372,115 13,587,807 9,839,484
Servicing fees.................................................... 5,368,488 2,855,642 2,182,568
Other............................................................. 5,266,109 4,308,985 3,113,692
----------- ----------- -----------
73,531,754 36,135,394 21,796,907
----------- ----------- -----------
Expenses:
Payroll and related costs......................................... 16,508,756 12,875,714 8,815,355
Interest expense.................................................. 11,298,224 7,963,613 3,734,877
General and administrative........................................ 12,236,260 10,710,179 7,238,140
----------- ----------- -----------
40,043,240 31,549,506 19,788,372
----------- ----------- -----------
Income before income taxes and extraordinary item................... 33,488,514 4,585,888 2,008,535
Provision for income taxes.......................................... 9,466,381 -- --
----------- ----------- -----------
Income before extraordinary item.................................... 24,022,133 4,585,888 2,008,535
Extraordinary item:
Gain on extinguishment of debt.................................... 3,167,828 -- --
----------- ----------- -----------
Net income........................................................ $27,189,961 $ 4,585,888 $ 2,008,535
----------- ----------- -----------
----------- ----------- -----------
Unaudited pro forma information:
Provision for pro forma income taxes
before extraordinary item...................................... 14,400,061 1,971,932 863,670
----------- ----------- -----------
Pro forma earnings before extraordinary item...................... $19,088,453 $ 2,613,956 $ 1,144,865
----------- ----------- -----------
----------- ----------- -----------
See accompanying notes to consolidated financial statements.
27
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
ADDITIONAL
PAID-IN RETAINED
CAPITAL STOCK(1) CAPITAL(1) EARNINGS TOTAL
---------------- ----------- ------------ ------------
Balance at December 31, 1993..................... $106,530 $ 3,225,615 $ 25,018,190 $ 28,350,335
Net income..................................... -- -- 2,008,535 2,008,535
Distributions.................................. -- -- (2,195,056) (2,195,056)
---------------- ----------- ------------ ------------
Balance at December 31, 1994..................... 106,530 3,225,615 24,831,669 28,163,814
Net income..................................... -- -- 4,585,888 4,585,888
Distributions.................................. -- -- (2,916,487) (2,916,487)
---------------- ----------- ------------ ------------
Balance at December 31, 1995..................... 106,530 3,225,615 26,501,070 29,833,215
Proceeds from initial public offering of common
stock....................................... 46,000 69,655,435 -- 69,701,435
Net income..................................... -- -- 27,189,961 27,189,961
Distributions.................................. -- -- (33,207,000) (33,207,000)
Reclassification of undistributed S Corporation
earnings.................................... -- 18,071,687 (18,071,687) --
---------------- ----------- ------------ ------------
Balance at December 31, 1996..................... $152,530 $90,952,737 $ 2,412,344 $ 93,517,611
---------------- ----------- ------------ ------------
---------------- ----------- ------------ ------------
- ------------------
(1) Restated to reflect share exchange in connection with the October 1996
reorganization.
See accompanying notes to consolidated financial statements.
28
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
------------ ------------ ------------
Cash flows from operating activities:
Net income...................................................... $ 27,189,961 $ 4,585,888 $ 2,008,535
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan losses.................................... 101,158 99,761 169,867
Depreciation and amortization................................ 996,875 564,310 277,956
Capitalized mortgage servicing rights, net of amortization (7,580,638) (1,409,683) 1,069,652
Deferred origination fees.................................... (2,399,299) (61,239) 147,522
Interest only and residual certificates received in
securitization transactions, net........................... (57,763,229) (17,795,998) (5,309,550)
Changes in operating assets and liabilities:
Increase in accounts receivable, net......................... (1,808,938) (1,136,618) (2,365,992)
Increase in loans held for sale, net......................... (17,562,578) (15,021,532) (7,447,873)
Increase in accrued interest and late charges receivable .... (4,211,965) (3,225,276) (1,783,978)
Decrease in cash held for advance payments................... 631,340 166,924 141,478
Decrease in real estate owned................................ 116,158 448,839 650,121
Decrease (increase) in prepaid and other assets.............. (243,876) 1,753,633 183,781
Decrease in due from stockholders............................ 990,000 2,165,000 165,000
Increase (decrease) in accounts payable and accrued
expenses................................................... 2,357,955 1,901,895 (354,737)
Increase in investor payable................................. 8,296,763 3,181,005 2,403,676
Decrease in advance payment by borrowers for taxes and
insurance.................................................. (551,773) (119,683) (115,629)
Increase in income taxes payable............................. 9,416,784 -- --
------------ ------------ ------------
Net cash used in operating activities............................. (42,025,302) (23,902,774) (10,160,171)
------------ ------------ ------------
Cash flows used in investing activities:
Purchase of equipment........................................... (2,283,136) (1,207,560) (917,512)
------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from initial public offering....................... 69,701,435 -- --
Proceeds from warehouse financing and
other borrowings, net........................................ 12,725,395 30,265,588 15,710,632
Increase (decrease) in bank payable, net........................ (2,805,345) 4,125,325 (11,954)
Distributions................................................... (33,207,000) (2,916,487) (2,195,056)
Payments (made to) received from affiliates..................... -- 913,870 (43,366)
------------ ------------ ------------
Net cash provided by financing activities......................... 46,414,485 32,388,296 13,460,256
------------ ------------ ------------
Net increase in cash.............................................. 2,106,047 7,277,962 2,382,573
Cash at beginning of year......................................... 16,635,135 9,357,173 6,974,600
------------ ------------ ------------
Cash at end of year............................................... $ 18,741,182 $ 16,635,135 $ 9,357,173
------------ ------------ ------------
------------ ------------ ------------
See accompanying notes to consolidated financial statements.
29
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995, and 1994
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Organization
Delta Financial Corporation and Subsidiary (the 'Company') is a Delaware
corporation which was organized in August 1996. On October 31, 1996, the Company
acquired all of the outstanding common stock of Delta Funding Corporation
('Delta Funding'), a New York corporation which had been organized on January 8,
1982 for the purpose of originating, selling, servicing and investing in
residential first and second mortgages and completed an initial public offering
(see note 2).
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary. All significant intercompany accounts and
transactions have been eliminated.
(c) Origination Fees
The Company accounts for origination fee income on mortgages held for sale
in conformity with Statement of Financial Accounting Standards (SFAS) No. 9l.
This Statement requires that origination fees be offset by their direct loan
costs and the net deferred fees be recognized over the life of the loan or upon
sale of the loan, if earlier.
(d) Loans held for sale
Loans held for sale are carried at the lower of cost or market, determined
on a net aggregate basis. Adjustments to market are made by charges or credits
to income.
(e) Income Taxes
Through October 30, 1996, the Company elected for both Federal and State
income tax purposes to be treated as an S corporation (effective July 1, 1985).
As an S corporation, the net earnings of the Company were taxed directly to the
stockholders rather than the Company.
On October 31, 1996, the Company became a C corporation. All income earned
from that date is subject to corporate tax at statutory rates for both Federal
and State income tax purposes. The Company accounts for income taxes from that
date in conformity with SFAS No. 109, 'Accounting for Income Taxes', which
requires an asset and liability approach for accounting and reporting of income
taxes.
(f) Sale of Mortgage Loans
The Company sells whole loans with servicing retained. Gains or losses on
such sales are recognized at the time of sale and are determined by the
differences between net sales proceeds and the unpaid principal balance of the
loans sold adjusted for the present value of any yield differential.
(g) Securitization
The Company sells pools of loans on a servicing retained basis. Gains or
losses are determined at the time of sale by the differences between the net
sales proceeds and the present value of the future stream of servicing fees,
adjusted for estimated losses and prepayments. The Company continues to service
these loans for a normal servicing fee.
Included in the gain on sale of loans is gain on securitization
representing the fair value of the interest-only and residual certificates
received by the Company. Fair value of these certificates is determined based on
various
30
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
economic factors, including loan types, sizes, interest rates, dates of
origination, terms and geographic locations. The Company also uses other
available information such as reports on prepayment rates, collateral value,
discount rates, economic forecasts and historical default and prepayment rates
of the portfolio under review. The Company reviews these factors and, if
necessary, adjusts the remaining assets to the fair value of the interest-only
and residual certificates.
(h) Real Estate Acquired Through Foreclosure
Properties acquired through foreclosure or a deed in lieu of foreclosure
are recorded at the lower of the unpaid loan balance, or fair value, at the date
of acquisition. The carrying value of the individual properties is subsequently
adjusted to the extent it exceeds estimated fair value less costs to sell, at
which time a provision for losses on such real estate is charged to operations.
(i) Equipment
Equipment, including leasehold improvements, is stated at cost, less
accumulated depreciation and amortization. Depreciation of equipment is computed
using the straight-line or accelerated method over the estimated useful lives of
three to five years. Leasehold improvements are amortized over the lesser of the
terms of the lease or the estimated useful lives of the improvements.
Expenditures for betterments and major renewals are capitalized and ordinary
maintenance and repairs are charged to operations as incurred.
(j) Interest Only and Residual Certificates
Interest only and residual certificates are carried at fair value in
accordance with SFAS No. 115, 'Accounting for Certain Investments in Debt and
Equity Securities.' Unrealized gains and losses are included in the statement of
operations.
(k) Mortgage Servicing Rights
Effective January 1, 1995 the Company adopted SFAS No. 122 'Accounting for
Mortgage Servicing Rights'. The Statement amends SFAS No. 65 to require that a
mortgage banking enterprise recognize as separate assets the rights to service
mortgage loans for others, however those servicing rights are acquired. The
Statement requires the assessment of capitalized mortgage servicing rights for
impairment. Mortgage servicing rights are amortized in proportion to and over
the period of the estimated net servicing income.
(l) Fair Value of Financial Instruments
SFAS No. 107, 'Disclosure About Fair Value of Financial Instruments'
requires the Company to disclose the fair value of financial instruments for
which is practicable to estimate fair value. Fair value is defined as the amount
at which a financial instrument could be exchanged in a current transaction
between willing parties, other than in a forced sale or liquidation and is best
evidenced by a quoted market price. Other than interest-only and residual
certificates, substantially all the Company's assets and liabilities deemed to
be financial instruments are carried at cost, which approximates their fair
value.
(m) Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results could
differ from those estimates.
31
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
(n) Servicing Income
Servicing income includes servicing fees, prepayment penalties and late
payment charges earned for servicing mortgage loans owned by investors. All fees
and charges are recognized into income when earned.
(o) Earnings Per Share
Earnings per share data for periods prior to October 31, 1996 have not been
presented in the accompanying consolidated financial statements because the
Company was not a public company.
Earnings per share data for the period November 1, 1996 to December 31,
1996 have not been presented in the accompanying consolidated financial
statements because management believes that such data would not be meaningful
given the relatively short period and the impact of the recognition of a
deferred tax liability in connection with the change in tax status.
(p) Stock Option Plan
During 1996, the company adopted SFAS No. 123, 'Accounting for Stock-Based
Compensation', which permits entities to continue to apply to provisions of APB
Opinion No. 25, 'Accounting for Stock Issued to Employees', and provide pro
forma net income and pro forma earnings per share disclosures for employee stock
option grants as if the fair-value based method defined in SFAS No. 123 had been
applied. The Company elected to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure provisions of SFAS No. 123 (see note 15).
(q) Unaudited Pro Froma Information
The pro forma financial information has been presented to show what the
significant effects on the historical results of operations before extraordinary
item might have been had the Company been treated as a C corporation for income
tax purposes as of the beginning of the earliest period presented and assumes an
effective tax rate of 43%.
(2) REORGANIZATION AND INITIAL PUBLIC OFFERING
On October 31, 1996, the Company acquired all of the outstanding stock of
Delta Funding in exchange for 10,653,000 shares of common stock of the Company.
Prior to the exchange, Delta Funding was treated for federal income tax purposes
as an S corporation under Subchapter S of the Internal Revenue Code, and as
such, the historical earnings of Delta Funding through October 31, 1996 were
taxed directly to the stockholders of Delta Funding. As a result of the
exchange, the Company and Delta Funding, which became a wholly owned subsidiary
of the Company, became subject to federal and state income taxes and the Company
recorded a deferred tax liability on its balance sheet relating to the tax
effect of temporary differences between book and tax accounting, principally
relating to recognition of gain on sale of mortgage loans.
On November 1, 1996, the Company completed an initial public offering (IPO)
of 4,600,000 shares of common stock at an offering price of $16.50/share. The
net proceeds of the offering to the Company, exclusive of underwriting discounts
and commissions and other expenses, was $69,701,435. In November, 1996,
$32,607,000 of the proceeds raised in the offering was distributed to the former
S corporation shareholders with respect to declared distributions of
undistributed S corporation earnings. Remaining undistributed S corporation
earnings of $18,071,687 were reclassified to additional paid in capital.
32
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(3) LOANS HELD FOR SALE
The Company owns first and second mortgages which had a weighted average
interest rate of 11.2% at December 31, 1996. These mortgages are being held as
inventory for future sale at the lower of cost or market. Certain of these
mortgages are pledged as collateral for a portion of the warehouse financing and
other borrowings.
Included in loans held for sale are deferred origination fees and purchase
premiums in the amount of $3,412,957, and $1,013,658 and an allowance for loan
losses of $850,000 and $750,000 at December 31, 1996 and 1995, respectively.
Mortgages are payable in monthly installments of principal and interest and
have due dates varying from five to thirty years.
The changes in the allowance for loan losses are as follows:
1996 1995 1994
-------- -------- --------
Balance at beginning of year....................................... $750,000 $700,000 $650,000
Provisions......................................................... 101,158 99,761 169,867
Charge-offs........................................................ (1,158) (49,761) (119,867)
-------- -------- --------
Balance at end of year............................................. $850,000 $750,000 $700,000
-------- -------- --------
-------- -------- --------
(4) ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
1996 1995
---------- ----------
Securitization.......................................... $4,390,694 $3,168,100
Escrow receivable....................................... 764,381 662,572
Insurance premiums...................................... 1,244,130 1,003,285
Other................................................... 2,255,680 2,011,990
---------- ----------
$8,654,885 $6,845,947
---------- ----------
---------- ----------
(5) WAREHOUSE FINANCING AND OTHER BORROWINGS
The Company has two warehouse credit facilities for a combined amount of
$350,000,000. These lines are collateralized by specific mortgage receivables,
which are equal or greater than the outstanding balances under the line at any
point in time. Both of these lines expire in February 1998.
The first warehouse line of credit is in the aggregate amount of
$250,000,000. At December 31, 1996 the interest rate was .80% above LIBOR. At
December 31, 1996 and 1995, the Company had $45,813,382 and $0 outstanding under
this agreement respectively.
The second warehouse line of credit is in the aggregate amount of
$100,000,000. At December 31, 1996 the interest rate was 1% above LIBOR. At
December 31, 1996 and 1995, the Company had $0 and $30,132,844 outstanding under
this agreement respectively. On February 14, 1997 this warehouse line of credit
was increased to $200,000,000 and the interest rate was changed to .75% above
LIBOR.
The Company had a warehouse line of credit in the aggregate amount of
$45,000,000. The line was collateralized by specific mortgage receivables, which
were equal to or greater than the outstanding balances under the line at any
point in time. The interest rate was 2% above LIBOR. At December 31, 1995, the
Company had $30,498,168 outstanding. In May 1996 the Company extinguished this
line of credit at a discount. An extraordinary gain of $3,167,828 was recorded
in connection with this extinguishment of debt.
33
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(5) WAREHOUSE FINANCING AND OTHER BORROWINGS--(CONTINUED)
At December 31, 1995, the Company had lines of credit in the aggregate
amount of $3,500,000, with separate banks. The individual lines available, and
their interest rates, were as follows: $2,500,000 at 1/2% above prime and
$1,000,000 at 2.9% above the 30-day dealer commercial paper rate. At December
31, 1995, the Company had $2,500,000 and $981,843, drawn down from these
sources. During 1996, the $2,500,000 line of credit expired and, at the
Company's option, was not renewed. At December 31, 1996, the Company had $5,367
outstanding on the $1,000,000 line of credit.
At December 31, 1996 and 1995, the Company had a term loan with $486,710
and $879,710 outstanding, respectively. The interest rate is 1% above New York
Prime and the loan matures in April 1998.
At December 31, 1996 and 1995 the Company had $2,160,990 and $1,586,935,
respectively outstanding from two leasing companies for financing of capital
assets. These capital leases are amortized at fixed rates ranging from 7.11% to
10.41% and mature between September 1998 and August 2001.
The Company has obtained financing facilities for its interest-only and
residual certificates. As of December 31, 1996 and 1995, the aggregate
outstanding balance on these facilities was $47,015,178 and $16,176,732,
respectively. These facilities have variable interest rates which ranged from
6.44% to 7.75% at December 31, 1996 and mature between October 1997 and December
1999.
(6) BANK PAYABLE
In order to maximize its cash management practices, the Company has
instituted a procedure whereby checks written against its operating account are
covered as they are presented to the bank for payment, either by drawing down
its lines of credit or from subsequent deposits of operating cash.
(7) INVESTOR PAYABLE
Investor payable represent the collection of mortgage payments by the
Company, from mortgagors, which were remitted to investors subsequent to year
end.
(8) CAPITALIZED MORTGAGE SERVICING RIGHTS
The Company sells mortgage loans to generate servicing income and provide
funds for additional investment and lending activities. Prior to January 1,
1995, the Company accounted for the sale of mortgage loans in conformity with
SFAS No. 65, 'Accounting for Certain Mortgage Banking Activities.' Effective
January 1, 1995, the Company adopted SFAS No. 122, 'Accounting for Mortgage
Servicing Rights' which prospectively changed the methodology for capitalized
mortgage servicing rights and the methodology used to measure impairment of its
capitalized mortgage servicing rights asset. These Statements require that the
gain on sale be recognized at the time of sale, using the present value of the
future servicing cash flows. The cash flow has been computed over the average
estimated life of the mortgages, adjusted for prepayments and recorded as
capitalized mortgage servicing rights.
The Company measures impairment of its servicing rights on a disaggregate
basis based on the predominate risk characteristics of the portfolio and
discounts the asset's estimated future cash flow using a current market rate.
The Company has determined the predominant risk characteristics to be prepayment
risk and interest rate risk. The fair value of the existing mortgage servicing
rights as of December 31, 1996 and 1995 approximated its book value and did not
require a valuation allowance to be established. To determine the fair value of
mortgage servicing rights, the Company estimates the expected future net
servicing revenue based on common industry assumptions, as well as on the
Company's historical experience.
34
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(9) INTEREST-ONLY AND RESIDUAL CERTIFICATES
The interests that the Company receives upon the sales through
securitizations are in the form of interest-only and residual mortgage
securities which are classified as interest-only and residual certificates.
In accordance with SFAS No. 115, the Company classifies the interest-only
and residual certificates as 'trading securities' and, as such, they are
recorded at their fair value. Fair value of these certificates has been
determined by the Company based on various economic factors, including loan
type, sizes, interest rates, dates of origination, terms and geographic
locations. The Company also uses other available information such as reports on
prepayment rates, interest rates, collateral value, economic forecasts and
historical default and prepayment rates of the portfolio under review. If the
fair value of the interest-only and residual certificates is different from the
recorded value, the unrealized gain or loss will be reflected on the statement
of operations.
In connection with loans sold through these securitization vehicles, the
Company has recorded interest-only and residual certificates totaling $83.1
million and $25.3 million which represents their fair market value at December
31, 1996 and 1995, respectively.
Although the Company believes it has made reasonable estimates of the fair
value of the interest-only and residual certificates likely to be realized, the
rate of prepayments and the amount of defaults utilized by the Company are
estimates and actual experience may vary from its estimate. The gain on
securitization recognized by the Company upon the sale of loans through
securitizations will have been overstated if prepayments or losses are greater
than anticipated. Higher than anticipated rates of loan prepayments or losses
would require the Company to write down the fair value of the interest-only and
residual certificates, adversely impacting earnings. Similarly, if
delinquencies, liquidations or interest rates were to be greater than was
initially assumed, the fair value of the interest-only and residual certificates
would be negatively impacted which would have an adverse effect on income for
the period in which such events occurred. Should the estimated loan life assumed
for this purpose be shorter than the actual life, the amount of cash actually
received over the lives of the loans would exceed the gain previously recognized
at the time the loans were sold through securitizations and would result in
additional income.
The activity in the interest-only and residual certificates is summarized
as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
----------- ----------- ----------
Balance, beginning of year................................. $25,309,548 $ 7,513,550 $2,204,000
Additions.................................................. 57,456,342 16,750,157 4,159,550
Cash remittances, accretion of discount and fair value
adjustments, net......................................... 306,887 1,045,841 1,150,000
----------- ----------- ----------
Balance, end of year....................................... $83,072,777 $25,309,548 $7,513,550
----------- ----------- ----------
----------- ----------- ----------
(10) HEDGING TRANSACTIONS
The Company regularly securitizes and sells fixed rate mortgage loans. To
offset the effects of interest rate fluctuations on the value of its fixed-rate
loans held for sale, the Company in certain cases will hedge its interest rate
risk related to loans held for sale through the use of treasury rate lock
contracts, which function similar to a short sale of U.S. Treasury securities.
The Company accounts for these contracts as hedges of specific loans held for
sale. The gains or losses derived from these contracts are deferred and
recognized as an adjustment to gains on sales of loans when the loans are sold
or securitized.
As of December 31, 1996, 1995 and 1994, the Company had no open hedge
positions. The Company included gains (losses) of $(519,192), $(1,721,860), and
$137,871 on the short sale of U.S. Treasury securities as part of gains on sale
of loans in 1996, 1995, and 1994, respectively.
35
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. RELATED PARTY TRANSACTIONS
The Company had notes due from stockholders in the amount of $990,000 at
December 31, 1995. These notes were repaid during 1996.
12. EMPLOYEE BENEFIT PLANS
The Company has an employee profit sharing plan covering all eligible
employees, as defined, with at least 30 months of service. The Company
contributed $220,000, $120,000, and $90,000 to the plan for the years ended
December 31, 1996, 1995 and 1994, respectively.
The Company sponsors a 401(k) Retirement Savings Plan. Substantially all
employees of the Company are eligible to participate in the plan after
completing one year of service and who are at least 21 years old. Contributions
are made from employees' elected salary deferrals. The Company may elect to make
a discretionary contribution to the Plan each year. There were no contributions
to the plan by the Company in 1996, 1995 or 1994.
13. COMMITMENTS AND CONTINGENCIES
The Company has repurchase agreements with certain institutions that have
purchased mortgages. Currently, some of the agreements provide for the
repurchase by the Company of any of the mortgage loans that go to actual
foreclosure sale. At the foreclosure sale, the Company will repurchase the
mortgage, if necessary, and make the institution whole. The dollar amount of the
Company's exposure is approximately $20 million at December 31, 1996.
The Company previously subleased its Woodbury offices from an affiliated
company. In August 1996, the lease was assigned to the Company. This lease
provides for rent to be paid on a month-to-month basis. Rental expense, net of
sublease income, for the years ended December 31, 1996, 1995 and 1994 amounted
to $967,258, $476,674 and $382,702, respectively.
Minimum future rentals under non-cancelable operating leases as of December
31, 1996 are as follows:
YEAR
- ---------------------------------------------------------------- AMOUNT
------
(000'S)
1997............................................................ $1,138
1998............................................................ 1,151
1999............................................................ 1,179
2000............................................................ 1,219
2001............................................................ 1,224
Thereafter...................................................... 2,695
------
Total...................................................... $8,606
======
In the normal course of business, the Company is subject to various legal
proceedings and claims, the resolution of which, in management's opinion, will
not have a material adverse effect on the financial position or the results of
operations of the Company.
14. SUPPLEMENTAL CASH FLOW INFORMATION
The Company paid $10,452,616, $7,659,000 and $3,796,047 for interest during
the years ended December 31, 1996, 1995 and 1994, respectively.
36
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
15. STOCK OPTION PLAN
On October 4, 1996, the board of directors ratified the 1996 Stock Option
Plan and authorized the reserve of 2,200,000 shares of authorized but unissued
common stock for issuance pursuant to the plan. The majority of options issued
during 1996 in connection with the IPO vest over a five year period at 20% per
year and the expiration dates range from five to seven years from grant date.
As of December 31, 1996, there were 466,850 options granted at an exercise
price of $16.50. Of the options granted, 6,000 were exercisable at the end of
the year. No options were exercised, forfeited or expired during the year.
The Company applies APB Opinion No. 25, 'Accounting for Stock Issued to
Employees', and related Interpretations in accounting for its stock option plan.
There was no intrinsic value of the options granted as the exercise price was
equal to the quoted market price at grant date. Accordingly, no compensation
cost has been recognized for the year ended December 31, 1996.
Had compensation cost for the stock option plan been determined based on
the fair value at the grant dates for awards under that plan consistent with the
method of SFAS No. 123, 'Accounting for Stock-Based Compensation,' the Company's
net income for 1996 would have been $25,481,126.
The weighted-average fair value of options granted during 1996 was $6.31.
For purposes of the pro forma calculation under SFAS No. 123, the fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used for
the 1996 grant:
1996
-------------
Dividend yield................................................ 0%
Expected volatility........................................... 51%
Risk-free interest rate....................................... 6%
Expected life................................................. 5 years
(16) INCOME TAXES
The income tax provision for the year ended December 31, 1996 is comprised
of the following components:
CURRENT DEFERRED TOTAL
---------- ---------- ----------
Ordinary tax provision
Federal........................................... $3,305,242 $ 825,832 $4,131,074
State............................................. 1,150,463 284,348 1,434,811
---------- ---------- ----------
4,455,705 1,110,180 5,565,885
---------- ---------- ----------
Change in tax status
Federal........................................... -- 2,901,470 2,901,470
State............................................. -- 999,026 999,026
---------- ---------- ----------
-- 3,900,496 3,900,496
---------- ---------- ----------
Total tax provision............................ $4,455,705 $5,010,676 $9,466,381
---------- ---------- ----------
---------- ---------- ----------
37
DELTA FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As discussed in Note 1, the Company was an S corporation through October
30, 1996 pursuant to the Internal Revenue Code of 1986, as amended, and as such
did not incur any federal income tax expense. The Company was liable for New
York State minimum tax and that provision is included above under current state
provision.
On October 31, 1996, the Company became a C corporation for federal and
state income tax purposes and as such is subject to federal and state income tax
on its taxable income for the months of November and December 1996. In
connection with the change in tax status from an S corporation to a C
corporation, the Company incurred deferred income tax expense of $3,900,496 as
of October 31, 1996.
The liability for income taxes at December 31, 1996 reflected on the
consolidated balance sheet includes a deferred tax liability of $5,010,676. This
represents the tax effect of differences between the tax basis and financial
statement carrying amounts of assets and liabilities. The major sources of
temporary differences and their deferred tax effect at December 31, 1996 are as
follows:
Deferred tax liabilities:
Capitalized cost of future servicing income................................... $4,814,213
Book/tax difference in interest-only residual certificate valuation........... 966,481
----------
Total deferred tax liabilities.................................................. 5,780,694
----------
Deferred tax assets:
Book over tax depreciation.................................................... 86,291
Book over tax basis in mortgage servicing asset............................... 326,906
Loss reserves................................................................. 356,821
----------
Total deferred tax assets....................................................... 770,018
----------
Net deferred tax liability...................................................... $5,010,676
----------
----------
A reconciliation of the statutory income tax provision to the effective
income tax provision, as applied to income for the period November 1, 1996 to
December 31, 1996, is as follows:
AMOUNT
----------
Tax at statutory rate........................................................... $4,161,394
Change in tax status............................................................ 3,900,000
State and local taxes........................................................... 835,127
S corporation state and local tax............................................... 150,000
Non-deductible expenses and other............................................... 419,860
----------
Total provision............................................................... $9,466,381
----------
----------
38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
39
PART III
ITEMS 10-13
Registrant incorporates by reference herein information in its proxy
statement which complies with the information called for by Items 10-13 of Form
10-K. The proxy will be filed at a later date with the Commission.
40
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements PAGE(S)
--------
The following Consolidated Financial Statements of Delta Financial Corporation and Subsidiary
are included in Part II, Item 8 of this report
Independent Auditors' Report................................................................... 25
Consolidated Balance Sheets--December 31, 1996 and 1995........................................ 26
Consolidated Statements of Income--Years ended December 31, 1996, 1995 and 1994................ 27
Consolidated Statement of Changes in Stockholders' Equity--Years ended
December 31, 1996, 1995 and 1994............................................................. 28
Consolidated Statements of Cash Flows--Years ended December 31, 1996, 1995 and
1994......................................................................................... 29
Notes to Consolidated Financial Statements..................................................... 30
(a)(2) Financial Statement schedules
None required.
(a)(3) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
- ---------- --------------------------------------------------------------------------------------------------------
3.1 -- Certificate of Incorporation of the Registrant. (Incorporated by reference to Company's
Registration Statement on Form S-1; File No. 333-11289).
3.2 -- By-Laws of Registrant. (Incorporated by reference to Company's Registration Statement on Form S-1;
File No. 333-11289).
4.1 -- Specimen Common Stock Certificate of Registrant. (Incorporated by reference to Company's
Registration Statement on Form S-1; File No. 333-11289).
10.1 -- Employment Agreement dated as of October 1, 1996 between Registrant and Sidney A. Miller.
(Incorporated by reference to Company's Registration Statement on Form S-1; File No. 333-11289).
10.2 -- Employment Agreement dated as of October 1, 1996 between Registrant and Hugh I. Miller.
(Incorporated by reference to Company's Registration Statement on Form S-1; File No. 333-11289).
10.3 -- Employment Agreement dated as of October 1, 1996 between Registrant and Christopher Donnelly.
(Incorporated by reference to Company's Registration Statement on Form S-1; File No. 333-11289).
10.4 -- Employment Agreement dated as of October 1, 1996 between Registrant and Randall F. Michaels.
(Incorporated by reference to Company's Registration Statement on Form S-1; File No. 333-11289).
10.5 -- Lease Agreement between Delta Funding Corporation and the Tilles Investment Company. (Incorporated
by reference to Company's Registration Statement on Form S-1; File No. 333-11289).
10.6 -- 1996 Stock Option Plan of Delta Financial Corporation. (Incorporated by reference to Company's
Registration Statement on Form S-8; File No. 333-15835).
21.1 -- Subsidiaries of Registrant.
(b) Reports on Form 8-K
None
41
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, THERETO DULY AUTHORIZED.
DELTA FINANCIAL CORPORATION
(Registrant)
Dated: March 26, 1997 By: /s/ HUGH MILLER
----------------------------------
Hugh Miller
President and Chief Executive
Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
- ------------------------------------------ ----------------------------------------------- ---------------
/s/ SIDNEY A. MILLER Chairman of the Board of Directors March 26, 1997
- ------------------------------------------
Sidney A. Miller
/s/ HUGH MILLER Chief Executive Officer, President and Director March 26, 1997
- ------------------------------------------ (Principal Executive Officer)
Hugh Miller
/s/ RICHARD BLASS Senior Vice President, Chief Financial Officer March 26, 1997
- ------------------------------------------ and Director (Principal Financial Officer)
Richard Blass
/s/ MARTIN D. PAYSON Director March 26, 1997
- ------------------------------------------
Martin D. Payson
/s/ ARNOLD B. POLLARD Director March 17, 1997
- ------------------------------------------
Arnold B. Pollard
42