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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
[X] Annual Report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the fiscal year ended June 30, 2000
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the transition period from _______________ to ________________
Commission File No. 000-22474
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AMERICAN BUSINESS FINANCIAL SERVICES, INC.
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(Name of registrant as specified in its charter)
Delaware 87-0418807
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
111 Presidential Boulevard, Bala Cynwyd, PA 19004
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(Address of Principal Executive Offices) (Zip Code)
(610) 668-2440
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(Registrant's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the
Exchange Act:
Common Stock, par value
$.001 per share
---------------
(Title of Class)
Indicate by check mark whether the Registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the 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. [X] YES [ ] NO
Indicate by check mark if disclosure of delinquent filers in response
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 the Form 10-K or
amendment to this Form 10-K. [ ] YES [X] NO
1
The aggregate market value of the 3,323,674 shares of common stock,
$.001 par value per share, held by non-affiliates of the Registrant as of
September 15, 2000 was $35.9 million.
The number of shares outstanding of the Registrant's sole class of
common stock as of September 15, 2000 was 3,323,674 shares.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III - Proxy Statement for 2000 Annual Meeting of Stockholders
2
Part I
Item 1. Business
Forward Looking Statements
Some of the information in this Annual Report on Form 10-K may contain
forward-looking statements. You can identify these statements by words or
phrases such as "will likely result," "may," "are expected to," "will continue
to," "is anticipated," "estimate," "projected," "intends to" or other similar
words. These forward-looking statements regarding our business and prospects are
based upon numerous assumptions about future conditions, which may ultimately
prove to be inaccurate. Actual events and results may materially differ from
anticipated results described in those statements. Forward-looking statements
involve risks and uncertainties described under "Risk Factors" as well as other
portions of this Annual report on Form 10-K, which could cause our actual
results to differ materially from historical earnings and those presently
anticipated. When considering forward-looking statements, you should keep these
risk factors in mind as well as the other cautionary statements in this Form
10-K. You should not place undue reliance on any forward-looking statement.
General
American Business Financial Services, Inc. is a diversified financial
services company operating throughout the United States. We originate loans
through a combination of channels including a national processing center located
at our centralized operating office in Bala Cynwyd, Pennsylvania, and a retail
branch network of offices. Through our principal direct and indirect
subsidiaries, we originate, service and sell:
o loans to businesses secured by real estate and other business
assets, which we refer to in this document as business purpose
loans;
o mortgage loans which are secured by first and second mortgages on
single-family residences and which do not satisfy the eligibility
requirements of Fannie Mae, Freddie Mac or similar buyers which we
refer to in this document as home equity loans; and
o mortgage loans which are secured by first mortgages on one-to
four-unit residential properties, most of which satisfy the
eligibility requirements of Fannie Mae and Freddie Mac, which are
referred to in this document as conventional first mortgage loans.
In addition, we have entered into business arrangements with several
financial institutions. According to these business arrangements, we purchase
home equity loans that meet our underwriting criteria but do not meet the
underwriting guidelines of the selling institution for loans it holds in its
portfolio. The loans are originated by the selling institution and immediately
sold to us. Following our purchase of the loans through this program, we hold
these
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loans as available for sale until they are sold in connection with a
future securitization. We refer to these business arrangements in this document
as the Bank Alliance Program.
Prior to December 31, 1999, we also originated equipment leases.
Effective December 31, 1999, we de-emphasized the leasing origination business
as a result of our strategy of focusing on our most profitable lines of
business. We are continuing to service the remaining leases in our managed
portfolio, which totaled $119.0 million in gross receivables at June 30, 2000.
We may from time to time consider originating or purchasing new leases.
Our loan customers fall primarily in two categories. The first category
of customers includes credit-impaired borrowers who are generally unable to
obtain financing from banks or savings and loan associations. These institutions
have historically provided loans only to individuals with the most favorable
credit characteristics. These borrowers generally have impaired or
unsubstantiated credit histories and/or unverifiable income. The second category
of customers includes borrowers who would qualify for loans from traditional
lending sources but who still prefer to use our products and services. Our
experience has indicated that these borrowers are attracted to our loan products
as a result of our marketing efforts, the personalized service provided by our
staff of highly trained lending officers and our timely response to loan
requests. Historically, both categories of customers have been willing to pay
our origination fees and interest rates even though they are generally higher
than those charged by traditional lending sources. Leases in our managed
portfolio were typically made to small businesses or proprietorships with less
than 100 employees and favorable credit histories.
We were incorporated in Delaware in 1985 and we began operations in
1988, initially offering business purpose loans secured by real estate through
our subsidiary, American Business Credit.
The ongoing securitization of our loans is a central part of our
current business strategy. A securitization is a financing technique often used
by originators of financial assets to raise capital. A securitization involves
the transfer of a pool of financial assets, in our case, loans, to a trust in
exchange for certificates, notes or other securities issued by the trust and
representing an undivided interest in the trust assets. The transfer to the
trust could involve a sale or pledge of the financial assets depending on the
particular transaction. Next, we sell a portion of the certificates, notes or
other securities to investors for cash. Often the originator of the loans
retains servicing rights, which is the right to service the loans for a fee. The
originator may also retain an interest in the cash flows generated by the
securitized loans, which is subordinate to the regular interest sold to
investors. This interest in the cash flows generated by the securitization is
called an interest-only strip. Through June 30, 2000, we had securitized an
aggregate of $2.3 billion of loans and leases, consisting of $305.7 million of
business purpose loans, $1.8 billion of home equity loans, and $161.6 million of
equipment leases. We retain the servicing rights on all securitized loans and
leases. See "Business-- Securitizations."
In addition to securitizations, we fund our operations with
subordinated debt that we offer from our principal operating office located in
Pennsylvania and branch offices located in Florida and Arizona. We offer this
debt without the assistance of an underwriter or dealer. At June 30, 2000, we
had $390.7 million in subordinated debt outstanding. This debt had a weighted
average
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interest rate of 10.7% and a weighted average maturity of 23 months as of June
30, 2000. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
We continue to explore a variety of strategic options to broaden our
product offerings and reduce our cost of funds. To achieve these goals, we may
consider various electronic commerce initiatives, the acquisition of other
finance companies or related companies, the purchase of portfolios of loans, the
issuance of secured credit cards, the origination and servicing of loans insured
by the Small Business Administration and the engagement of independent NASD
registered brokers to assist in the sale of the subordinated debt securities. We
cannot assure you that we will engage in any of the activities listed above or
the impact of those activities on our financial condition or results of
operations.
Our principal executive office is located at 103 Springer Building,
3411 Silverside Road, Wilmington, Delaware 19810. The telephone number at that
address is (302) 478-6160. Our principal operating office is located at
Balapointe Office Centre, 111 Presidential Boulevard, Bala Cynwyd, Pennsylvania
19004. The telephone number at the Balapointe Office Centre is (610) 668-2440.
We maintain a site on the World Wide Web at www.abfsonline.com. The information
on our web site is not and should not be considered part of this document.
Subsidiaries
As a holding company, our activities have been limited to:
o holding the shares of our operating subsidiaries, and
o raising capital for use in the subsidiaries' lending operations.
ABFS is the parent holding company of American Business Credit, Inc.
and its primary subsidiaries, HomeAmerican Credit, Inc. (doing business as
Upland Mortgage), Processing Service Center, Inc., American Business Leasing,
Inc., Tiger Relocation Company (formerly ABC Holdings Corporation), and New
Jersey Mortgage and Investment Corp. and its subsidiary, Federal Leasing Corp.
American Business Credit, a Pennsylvania corporation incorporated in
1988 and acquired by us in 1993, originates, services and sells business purpose
loans. HomeAmerican Credit, a Pennsylvania corporation incorporated in 1991,
originates and sells home equity loans. HomeAmerican Credit acquired Upland
Mortgage Corp. in 1996 and since that time has conducted business as "Upland
Mortgage." Upland Mortgage also purchases home equity loans through the Bank
Alliance Program. Processing Service Center processes home equity loan
applications for financial institutions as part of the Bank Alliance Program.
Incorporated in 1994, American Business Leasing commenced operations in 1995 and
currently services equipment leases held in our managed portfolio.
New Jersey Mortgage and Investment Corp., a New Jersey corporation
organized in 1938 and acquired by us in October 1997, is currently engaged in
the origination and sale of home
5
equity loans, as well as conventional first mortgage loans. New Jersey Mortgage
originates loans secured by real estate. These loans are originated through New
Jersey Mortgage's network of six branch sales offices and three satellite
offices. New Jersey Mortgage has been offering mortgage loans since 1939. We
currently sell conventional first mortgage loans originated by American
Household Mortgage, a division of New Jersey Mortgage, in the secondary market
with servicing released. We also securitize home equity loans originated by New
Jersey Mortgage pursuant to our current securitization program.
New Jersey Mortgage's wholly-owned subsidiary, Federal Leasing Corp.,
is a Delaware corporation which was organized in 1974. Federal Leasing Corp.
currently services leases previously originated and sold through securitization.
Tiger Relocation Company, formerly ABC Holdings Corporation, a
Pennsylvania corporation, was incorporated in 1992 to hold properties acquired
through foreclosure.
We also have numerous special purpose subsidiaries that were
incorporated solely to facilitate our securitizations. Some of those companies
are Delaware investment holding companies. None of these corporations engage in
any business activity other than holding the subordinated certificate, if any,
and the interest-only strips created in connection with securitizations
completed. See "-- Securitizations."
Our newly formed subsidiary, Upland Corporation, has filed an
application with the Federal Deposit Insurance Corporation, and the Utah
Department of Financial Institutions, for a Utah Industrial Loan Corporation
charter. If regulatory approval is obtained, the industrial loan charter would
allow us to originate residential mortgage loan products under one centralized
jurisdiction. The industrial loan subsidiary would also provide us with the
ability to offer home equity lines of credit with card access, Small Business
Administration guaranteed business loans, and FDIC-insured certificates of
deposit. No assurance can be given as to whether or during what time period the
necessary regulatory approvals will be obtained or the conditions that would be
imposed in connection with these approvals.
6
The following chart sets forth our basic organizational structure and
our primary subsidiaries(a).
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ABFS
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(Holding Company)
(Issues subordinated debt securities)
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AMERICAN BUSINESS CREDIT, INC.
------------------------------------------------------------------
(Originates and services business purpose loans)
------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
HOMEAMERICAN
CREDIT, INC.
NEW JERSEY d/b/a PROCESSING AMERICAN TIGER
MORTGAGE AND UPLAND SERVICE BUSINESS RELOCATION
INVESTMENT CORP. MORTGAGE CENTER, INC. LEASING, INC. COMPANY
- ------------------------------------------------------------------------------------------------------
(Originates and (Originates, (Processes Bank (Services (Holds foreclosed
services purchases and Alliance equipment real estate)
conventional services home Program leases)
first mortgage equity loans) (b) home equity
and home equity loans)
loans)
- -----------------------
- -----------------------
FEDERAL
LEASING CORP.
- -----------------------
(Services
equipment leases)
- -----------------------
- ---------------------
(a) In addition to the corporation pictured above, we organized at least one
special purpose corporation for each securitization.
(b) Loans purchased by Upland Mortgage represents loans acquired through the
Bank Alliance Program.
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Lending and Leasing Activities
General. The following table sets forth information concerning our loan
and lease origination, purchase and sale activities for the periods indicated.
Year Ended June 30,
---------------------------------------------
2000 1999 1998
--------------- -------------- --------------
(dollars in thousands)
Loans/Leases Originated/Purchased
Business purpose loans.......................... $ 106,187 $ 64,818 $ 52,335
Home equity loans............................... 949,014 634,820 328,089
Conventional first mortgage loans............... 42,607 66,519 33,671
Equipment leases................................ 19,631 96,289 70,480
Number of Loans/Leases
Business purpose loans.......................... 1,198 806 632
Home equity loans............................... 13,544 8,629 5,292
Conventional first mortgage loans............... 267 403 218
Equipment leases................................ 1,020 4,138 3,350
Average Loan/Lease Size
Business purpose loans.......................... $ 89 $ 80 $ 83
Home equity loans............................... 70 74 62
Conventional first mortgage loans............... 160 165 154
Equipment leases................................ 19 23 21
Weighted Average Interest Rate
Business purpose loans.......................... 15.99% 15.91% 15.96%
Home equity loans............................... 11.28% 11.05% 11.95%
Conventional first mortgage loans............... 8.75% 7.67% 8.22%
Equipment leases................................ 11.25% 11.40% 12.19%
Weighted Average Term (in months)
Business purpose loans.......................... 171 169 172
Home equity loans............................... 259 261 244
Conventional first mortgage loans............... 345 322 340
Equipment leases................................ 50 50 49
Loans/Leases Sold
Business purpose loans.......................... $ 104,503 $ 71,931 $ 54,135
Home equity and conventional first
mortgage loans............................... 990,606 613,069 322,459
Equipment leases................................ 9,263 92,597 59,700
Number of Loans/Leases Sold
Business purpose loans.......................... 1,163 911 629
Home equity and conventional first mortgage
loans........................................ 13,190 8,074 4,753
Equipment leases................................ 459 4,363 3,707
Weighted Average Rate on Loans/Leases................. 11.63% 11.30% 11.63%
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The following table sets forth information regarding the average
loan-to-value ratios for loans we originated during the periods indicated.
Years Ending June 30,
----------------------------------
Loan Type 2000 1999 1998
------ ------ ------
Business purpose loans.................................. 60.9% 61.5% 60.5%
Home equity loans....................................... 78.9 78.0 76.6
Conventional first mortgage loans....................... 83.7 78.0 79.9
The following table shows the geographic distribution of our loan and
lease originations and purchases during the periods indicated.
Year Ended June 30,
----------------------------------------------------------------------------
2000 % 1999 % 1998 %
---------- ------ -------- ------ --------- ------
New York............. $300,380 26.88% $163,580 18.97% $ 54,907 11.31%
New Jersey........... 184,123 16.48 236,976 27.48 128,025 26.38
Pennsylvania......... 130,928 11.72 139,992 16.23 150,048 31.06
Florida.............. 87,872 7.86 61,312 7.11 23,905 4.93
Illinois............. 43,181 3.86 27,663 3.21 -- --
Ohio................. 42,561 3.81 17,155 1.99 -- --
Georgia.............. 40,230 3.60 59,395 6.89 23,084 4.76
Virginia............. 27,722 2.48 17,126 1.99 13,138 2.71
Massachusetts........ 27,138 2.43 -- -- -- --
Maryland............. 24,582 2.21 19,625 2.28 11,748 2.42
North Carolina....... 23,826 2.13 13,648 1.58 5,144 1.06
Connecticut.......... 18,769 1.68 14,052 1.63 5,964 1.23
Delaware............. 13,012 1.16 14,254 1.65 10,823 2.23
Other................ 153,115 13.70 77,668 9.01 57,789 11.93
---------- ------ -------- ------ --------- ------
Total........... $1,117,439 100.00% $862,446 100.00% $ 484,575 100.00%
========== ====== ======== ====== ========= ======
Business Purpose Loans. Through our subsidiary, American Business
Credit, we currently originate business purpose loans on a regular basis in
Connecticut, Delaware, Florida, Georgia, Illinois, Indiana, Maryland, New
Jersey, New York, North Carolina, Ohio, Pennsylvania, South Carolina and
Virginia through a network of salespeople and through our business loan web
site, www.abceasyloan.com. We focus our marketing efforts on small businesses
who do not meet all of the credit criteria of commercial banks and small
businesses that our research indicates may be predisposed to using our products
and services.
We originate business purpose loans to corporations, partnerships, sole
proprietors and other business entities for various business purposes including,
but not limited to, working capital, business expansion, equipment acquisition
and debt-consolidation. We do not target any particular industries or trade
groups and, in fact, take precautions against concentration of loans.
9
in any one industry group. All business purpose loans generally are
collateralized by a first or second mortgage lien on a principal residence of
the borrower or a guarantor of the borrower or some other parcel of real
property, such as office buildings, apartment buildings, or mixed use buildings
owned by the borrower. In addition, in most cases, these loans are further
collateralized by personal guarantees, pledges of securities, assignments of
contract rights, life insurance and lease payments and liens on business
equipment and other business
Our business purpose loans generally ranged from $15,000 to $500,000
and had an average loan size of approximately $89,000 for the loans originated
during fiscal 2000. Generally, our business purpose loans are made at fixed
rates and for terms ranging from five to 15 years. We generally charge
origination fees for these loans of 5.0% to 6.0% of the original principal
balance. The weighted average interest rate charged on the business purpose
loans originated by us was 15.99% for fiscal 2000. The business purpose loans we
originated during the past fiscal year had a weighted average loan-to-value
ratio, based solely upon the real estate collateral securing the loans, of
60.9%. We originated $106.2 million of business purpose loans during fiscal
2000.
Generally, we compute interest due on our outstanding loans using the
simple interest method. Where permitted by applicable law, we generally impose a
prepayment fee. Although prepayment fees imposed vary based upon applicable
state law, the prepayment fees on our business purpose loan documents generally
amount to a significant portion of the outstanding loan balance. We believe that
such prepayment terms tend to extend the average life of our loans by
discouraging prepayment which makes these loans more attractive for
securitization. Whether a prepayment fee is imposed and the amount of such fee,
if any, is negotiated between the individual borrower and American Business
Credit prior to closing of the loan.
During fiscal 2000, we launched an Internet loan distribution channel
under the name www.abceasyloan.com. The www.abceasyloan.com web site provides
borrowers with convenient access to the business loan application process, 7
days a week, 24 hours a day. We believe that the addition of this distribution
channel maximizes the efficiency of the application process and could reduce our
transaction costs in the future to the extent the volume of loan applications
received via the web page increases. Throughout the loan processing period,
borrowers who submit applications online are supported by our staff of highly
trained loan officers.
Home Equity Loans. We originate home equity loans through our Consumer
Mortgage Group which includes Upland Mortgage and New Jersey Mortgage. We also
purchase loans through Processing Service Center, Inc. We originate home equity
loans primarily to credit-impaired borrowers through various channels including
retail marketing which includes telemarketing operations, direct mail, radio and
television advertisements as well as through our interactive web site,
www.UplandMortgage.com. We entered the home equity loan market in 1991.
Currently, we are licensed to originate home equity loans in 47 states
throughout the United States.
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Home equity loans originated and funded by our subsidiaries are
generally securitized. In addition, we may sell home equity loans to one of
several third party lenders, at a premium and with servicing released.
Home equity loan applications are obtained from potential borrowers
over the phone, in writing, in person or over the Internet through our
interactive web site. The loan request is then processed and closed. The loan
processing staff generally provides its home equity borrowers with a loan
approval within 24 hours and closes its home equity loans within approximately
ten to fifteen days of obtaining a loan approval.
Home equity loans generally range from $10,000 to $250,000 and had an
average loan size of approximately $70,000 for the loans originated during
fiscal 2000. During fiscal 2000, we originated $949.0 million of home equity
loans. Generally, home equity loans are made at fixed rates of interest and for
terms ranging from five to 30 years. Such loans generally have origination fees
of approximately 2.0% of the aggregate loan amount. For fiscal 2000, the
weighted average interest rate received on such loans was 11.28% and the
weighted average loan-to-value ratio was 78.9% for loans originated during this
period. We attempt to maintain our interest and other charges on home equity
loans competitive with the lending rates of other finance companies and banks.
Where permitted by applicable law, a prepayment fee may be negotiated with the
borrower and is generally charged to the borrower on the prepayment of a home
equity loan except in the event the borrower refinances a home equity loan with
us.
Beginning in fiscal 1996, through Upland Mortgage and in conjunction
with Processing Service Center, Inc., we entered into exclusive business
arrangements with financial institutions which provide for Upland Mortgage's
purchase of home equity loans that meet our underwriting criteria but do not
meet the underlying guidelines of the selling institutions for loans held in
portfolio. This program is called the Bank Alliance Program. The Bank Alliance
Program is designed to provide an additional source of home equity loans. This
program targets traditional financial institutions, such as banks, which because
of their strict underwriting and credit guidelines have generally provided
mortgage financing only to the most credit-worthy borrowers. This program allows
these financial institutions to originate loans to credit-impaired borrowers in
order to achieve community reinvestment goals and to generate fee income and
subsequently sell such loans to Upland Mortgage. Following our purchase of the
loans through this program, we hold these loans as available for sale until they
are sold in connection with a future securitization. We believe that the Bank
Alliance Program is a unique method of increasing our production of home equity
loans.
Under this program, a borrower who fails to meet a financial
institution's underwriting guidelines for portfolio loans will be referred to
Processing Service Center, Inc. which will process the loan application and
underwrite the loan pursuant to Upland Mortgage's underwriting guidelines. If
the borrower qualifies under Upland Mortgage's underwriting standards, the loan
will be originated by the financial institution and subsequently sold to Upland
Mortgage.
Since the introduction of this program, we have entered into agreements
with 31 financial institutions to provide us with the opportunity to underwrite,
process and purchase loans
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generated by the branch networks of such institutions which consist of over
1,500 branches located in various states throughout the country. During fiscal
2000, Upland Mortgage purchased approximately $53.4 million of loans pursuant to
this program. We intend to continue to expand the Bank Alliance Program with
financial institutions across the United States.
During fiscal 1999, we launched an Internet loan distribution channel
under the name www.UplandMortgage.com. Through this interactive web site,
borrowers can examine available loan options, calculate interest payments, and
submit an application via the Internet. The Upland Mortgage Internet platform
provides borrowers with convenient access to the mortgage loan application
process, 7 days a week, 24 hours a day. Throughout the loan processing period,
borrowers who submit applications online are supported by our staff of highly
trained loan officers. During fiscal 2000, we continued to phase in advanced
Internet technology through our web site, www.UplandMortgage.com. In addition to
the ability to take online loan applications and utilize an automated rapid
credit approval process, both of which reduce time and manual effort required
for loan approval, the site features our proprietary software, Easy Loan Wizard,
which provides personalized services and solutions to retail customers through
interactive web dialog. We have applied to the U.S. Patent and Trademark Office
to patent this product.
Conventional First Mortgage Loans. We began offering conventional first
mortgage loans in October 1997 in connection with our acquisition of New Jersey
Mortgage. New Jersey Mortgage has been originating mortgage loans since 1939. We
originate conventional first mortgage loans and sell them in the secondary
market with servicing released. Our conventional first mortgage lending market
area is primarily the eastern region of the United States. We originated $42.6
million of conventional first mortgage loans during fiscal 2000.
The conventional first mortgage loans are secured by one-to four-unit
residential properties located primarily in the eastern region of the United
States. These properties are generally owner-occupied single family residences
but may also include second homes and investment properties. These loans are
generally made through American Household Mortgage, a division of New Jersey
Mortgage, to borrowers with favorable credit histories and are underwritten
pursuant to Freddie Mac or Fannie Mae standards to permit their sale in the
secondary market; however, we also originate first mortgage loans which do not
meet the Freddie Mac or Fannie Mae standards for sale in the secondary market.
Some of these first mortgage loans have balances in excess of $252,700 and are
commonly referred to as jumbo loans.
New Jersey Mortgage typically sells such loans to third parties with
servicing released. New Jersey Mortgage also originates Federal Housing
Authority, the FHA, and Veterans Administration, the VA, loans which are
subsequently sold to third parties with servicing released. This means that we
do not generally retain the right to collect and service these loans after they
are sold. New Jersey Mortgage originates such loans for sale in the secondary
market.
Equipment Leases. Prior to December 31, 1999, we also originated
equipment leases. Effective December 31, 1999, we de-emphasized the leasing
origination business as a result of our strategy of focusing on our most
profitable lines of business. We are continuing to service the remaining leases
in our managed portfolio, which totaled $119.0 million in gross receivables
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at June 30, 2000 and we may from time to time consider originating or purchasing
new leases. Equipment leases held in our portfolio included leases to
corporations, partnerships, other entities and sole proprietors on various types
of business equipment including, but not limited to, computer equipment,
automotive repair equipment, construction equipment, commercial equipment,
medical equipment and industrial equipment.
Generally, our equipment leases consist of two types: (i) finance
leases which have a term of 12 to 60 months and provide a purchase option
exercisable by the lessee at $1.00 or 10% of the original equipment cost at the
termination of the lease, and (ii) fair market value or true leases which have a
similar term, but provide a purchase option exercisable by the lessee at the
fair market value of the equipment at the termination of the lease. Our
equipment leases generally range in size from $2,000 to $250,000, with an
average lease size of approximately $19,000 for the leases originated during
fiscal 2000. Our leases generally had maximum terms of seven years. The weighted
average interest rates received on leases for fiscal 2000 was 11.25%. During
fiscal 2000, we originated $19.6 million of equipment leases. Generally, the
interest rates and other terms and conditions of our equipment leases are
competitive with the leasing terms of other leasing companies in our market
area.
There are risks inherent in holding a portfolio of leases which are
different than those risks inherent in our mortgage lending activities. See "--
Risk Factors -- If we experience losses in the value of our leased equipment
securing the leases we hold, our profitability may be reduced."
Prepayment Fees. Historically, we charged prepayment fees on a
significant percentage of our business purpose loans and on less than 50% of our
home equity loans. We currently charge prepayment fees on substantially all of
our business purpose loans, and have increased the percentage of home equity
loans originated with prepayment fees to approximately 85%. Home equity loans
comprise approximately 90% of all loans we originate and the remaining 10% are
business purpose loans. The type of prepayment fee we obtain on a home equity
loan is generally a certain percentage of the outstanding principal balance of
the loan. One typical prepayment fee provides for a fee of 5% of the outstanding
principal loan balance if paid within the first three years after the loan's
origination and 2% of the outstanding principal loan balance if prepaid between
three and five years after the loan's origination and no prepayment fee if the
loan is prepaid after five years from the date of origination. In the case of
business purpose loans, the prepayment fee generally amounts to a significant
portion of the outstanding principal loan balance and is most often calculated
on the basis of the Rule of 78s formula, also known as the "sum of the digits"
method.
Our ability to charge a prepayment fee is sometimes impacted by state
law, with respect to both home equity loans and business purpose loans. In the
case of home equity loans which have a "balloon" payment feature, whenever
possible, we use the Federal Alternative Mortgage Transactions Parity Act of
1982 referred to as the Parity Act to preempt state laws which limit or restrict
prepayment fees. In states which have overridden the Parity Act and in the case
of some fully amortizing home equity loans, state laws may restrict prepayment
fees either by the amount of the prepayment fee or the time period during which
it can be imposed. Similarly, in the case of
13
business purpose loans, some states prohibit or limit prepayment fees where the
loan is below a specific dollar threshold or is secured by residential real
property.
Marketing Strategy
We concentrate our marketing efforts primarily on two potential
customer groups. One group, based on historical profiles, has a tendency to
select our loan products because of our personalized service and timely response
to loan requests. The other group is comprised of credit-impaired borrowers who
satisfy our underwriting guidelines. We also market conventional first mortgage
loans to borrowers with favorable credit histories. See "-- Risk Factors -
Lending to credit-impaired borrowers may result in higher delinquencies in our
managed portfolio which could result in a reduction in profits."
Our marketing efforts for business purpose loans focus on our niche
market of selected small businesses located in our market area which generally
includes the eastern half of the United States. We target businesses which we
believe would qualify for loans from traditional lending sources but would elect
to use our products and services. Our experience has indicated that these
borrowers are attracted to us as a result of our marketing efforts, the
personalized service provided by our staff of highly trained lending officers
and our timely response to loan applications. Historically, such customers have
been willing to pay our origination fees and interest rates which are generally
higher than those charged by traditional lending sources.
We market business purpose loans through various forms of advertising,
our business loan web site, www.abceasyloan.com and a direct sales force.
Advertising media used includes large direct mail campaigns and newspaper and
radio advertising. Our commissioned sales staff, which consists of full-time
highly trained salespersons, is responsible for converting advertising leads
into loan applications. We use a proprietary training program involving
extensive and on-going training of our lending officers. Our sales staff uses
significant person-to-person contact to convert advertising leads into loan
applications and maintains contact with the borrower throughout the application
process. See "-- Lending and Leasing Activities - Business Purpose Loans."
We market home equity loans through telemarketing, radio and television
advertising, direct mail campaigns and through our web site,
www.UplandMortgage.com. During fiscal 2000, the Consumer Mortgage Group
redirected its marketing mix to focus on targeted direct mail, which we believe
delivers more leads at a lower cost than broadcast marketing channels. Our
integrated approach to media advertising which utilizes a combination of direct
mail and Internet advertising is intended to maximize the effect of our
advertising campaigns. We also use a network of loan brokers, the Bank Alliance
Program and our website as additional sources of loans.
Our marketing efforts for home equity loans are strategically located
throughout the eastern region of the United States. We currently utilize branch
offices in various eastern states to market our loans. We intend to open
additional sales offices in the future. Loan processing, underwriting, servicing
and collection procedures are performed at our centralized operating
14
office located in Bala Cynwyd, Pennsylvania. See "--Lending and Leasing
Activities-Home Equity Loans."
We market conventional first mortgage loans through our network of loan
brokers. Our marketing efforts for conventional first mortgage loans are
concentrated in the mid-Atlantic region of the United States. In addition, we
market conventional first mortgage loans under the name American Household
Mortgage. See "--Lending and Leasing Activities - Conventional First Mortgage
Loans."
Loan and Lease Servicing
Generally, we service the loans and leases we hold as available for
sale or which we securitize in accordance with our established servicing
procedures. Servicing includes collecting and transmitting payments to
investors, accounting for principal and interest, collections and foreclosure
activities, and selling the real estate or other collateral that is acquired. At
June 30, 2000, our total managed portfolio included approximately 32,000 loans
and leases with an aggregate outstanding balance of $1.9 billion. We generally
receive contractual servicing fees for our servicing responsibilities. In
addition, we receive other ancillary fees related to the loans and leases
serviced. Our servicing and collections activities are centralized at the
processing center located at our operating office in Bala Cynwyd, Pennsylvania.
In servicing loans and leases, we typically send an invoice to obligors
on a monthly basis advising them of the required payment and its due date. We
begin the collection process immediately after a borrower fails to make a
monthly payment. When a loan or lease becomes 45 to 60 days delinquent, it is
referred to our legal collection group for the initiation of foreclosure
proceedings or other legal remedies. In addition, after a loan or lease becomes
61 days delinquent, our loss mitigation unit becomes involved. Our loss
mitigation unit tries to reinstate a delinquent loan or lease, seek a payoff, or
occasionally enter into a modification agreement with the borrower to avoid
foreclosure. All proposed work-out arrangements are evaluated on a case-by-case
basis, based upon the borrower's past credit history, current financial status,
cooperativeness, future prospects and the reasons for the delinquency. If the
loan or lease becomes delinquent 61 days or more and a satisfactory work-out
arrangement with the borrower is not achieved or the borrower declares
bankruptcy, the foreclosure, replevin or other legal action is initiated. Legal
action may be initiated prior to a loan or lease becoming delinquent over 60
days if management determines that the circumstances warrant such action.
Real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure is classified as real estate owned until it is sold. When property
is acquired or expected to be acquired by foreclosure or deed in lieu of
foreclosure, we record it at the lower of cost or estimated fair value, less
estimated cost of disposition. After acquisition, all costs incurred in
maintaining the property are accounted for as expenses.
Our ability to foreclose on some properties may be affected by state
and federal environmental laws. The costs of investigation, remediation or
removal of hazardous substances may be substantial and can easily exceed the
value of the property. The presence of hazardous substances, or the failure to
properly eliminate the substances from the property, can hurt the
15
owner's ability to sell or rent the property and prevent the owner from using
the property as collateral for a loan. Even people who arrange for the disposal
or treatment of hazardous or toxic substances also may be liable for the costs
of removal or remediation of the substances at the disposal or treatment
facility, whether or not the facility is owned or operated by the person who
arranged for the disposal or treatment. See "-- Risk Factors - Environmental
laws and regulations may restrict our ability to foreclose on loans secured by
real estate or increase costs associated with those loans which could reduce our
profitability."
As the servicer of securitized loans and leases, we are obligated to
advance funds for scheduled payments that have not been received from the
borrower unless we determine that our advances will not be recoverable from
subsequent collections in respect to the related loans or leases. See
"--Securitizations."
Underwriting Procedures and Practices
Summarized below are some of the policies and practices which are
followed in connection with the origination of business purpose loans, home
equity loans and conventional first mortgage loans. These policies and practices
may be altered, amended and supplemented as conditions warrant. We reserve the
right to make changes in our day-to-day practices and policies.
Our loan underwriting standards are applied to evaluate prospective
borrowers' credit standing and repayment ability as well as the value and
adequacy of the mortgaged property as collateral. Initially, the prospective
borrower is required to fill out a detailed application providing pertinent
credit information. As part of the description of the prospective borrower's
financial condition, the borrower is required to provide information concerning
assets, liabilities, income, credit, employment history and other demographic
and personal information. If the application demonstrates the prospective
borrower's ability to repay the debt as well as sufficient income and equity,
loan processing personnel generally obtain and review an independent credit
bureau report on the credit history of the borrower and verification of the
borrower's income. Once all applicable employment, credit and property
information is obtained, a determination is made as to whether sufficient
unencumbered equity in the property exists and whether the prospective borrower
has sufficient monthly income available to meet the prospective borrower's
monthly obligations.
16
The following table outlines the key parameters of the primary credit grades
contained in our current underwriting guidelines.
- ----------------------------------------------------------------------------------------------------
"A" Credit Grade "B" Credit Grade
- ---------------------------------- ------------------------------- --------------------------------
General Repayment Has good credit but might Pays the majority of accounts
have some minor delinquency. on time but has some 30-
and/or 60-day delinquency.
- ----------------------------------------------------------------------------------------------------
Existing Mortgage Loans Current at application time Current at application time
and a maximum of two 30-day and a maximum of 4 x 30-day
delinquencies in the past 12 delinquencies in the past 12
months. months.
- ----------------------------------------------------------------------------------------------------
Non-Mortgage Credit Major credit and installment Major credit and installment
debt should be current but debt can exhibit some minor 30
may exhibit some minor 30-day and/or 60 day delinquency.
delinquency. Minor credit Minor credit may exhibit up to
may exhibit some minor 90-day delinquency.
delinquency.
- ----------------------------------------------------------------------------------------------------
Bankruptcy Filings Discharged more than 2 years Discharged more than 2 years
with reestablished credit. with reestablished credit.
- ----------------------------------------------------------------------------------------------------
Debt Service-to-Income Generally not to exceed 50%. Generally not to exceed 50%.
- ----------------------------------------------------------------------------------------------------
Owner Occupied: Generally 80% (or 90%) for a Generally 80% (or 85%) for a 1
Loan-to-value ratio 1-4 family dwelling to 4 family dwelling
residence; 80% for a residence; 75% for a
condominium. condominium.
- ----------------------------------------------------------------------------------------------------
Non-Owner Occupied: Generally 80% for a 1 to 2 Generally 70% for a 1 to 2
Loan-to-value ratio family dwelling or family dwelling or condominium;
condominium; 90% for a 3 to 4 70% for a 3 to 4 family.
family.
- ----------------------------------------------------------------------------------------------------
[RESTUBBED]
- -------------------------------------------------------------------------------------------------------
"C" Credit Grade "D" Credit Grade
- ---------------------------------- --------------------------------- ---------------------------------
General Repayment Marginal credit history which Designed to provide a borrower
is offset by other positive with poor credit history an
attributes. opportunity to correct past
credit problems through lower
monthly payments.
- -------------------------------------------------------------------------------------------------------
Existing Mortgage Loans Cannot exceed four 30-day Must be paid in full from loan
delinquencies or 2 60-day proceeds and no more than 120
delinquencies in the past 12 days delinquent.
months.
- -------------------------------------------------------------------------------------------------------
Non-Mortgage Credit Major credit and installment Major and minor credit
debt can exhibit some minor 30- delinquency is acceptable, but
and/or 90-day delinquency. must demonstrate some payment
Minor credit may exhibit more regularity.
serious delinquency.
- -------------------------------------------------------------------------------------------------------
Bankruptcy Filings Discharged more than 2 years Discharged prior to closing.
with reestablished credit.
- -------------------------------------------------------------------------------------------------------
Debt Service-to-Income Generally not to exceed 55%. Generally not to exceed 55%.
- -------------------------------------------------------------------------------------------------------
Owner Occupied: Generally 70% (or 85%) for a 1 Generally 60% (or 70%) for a 1
Loan-to-value ratio to 4 family dwelling residence; to 4 family dwelling residence.
65% for a condominium.
- -------------------------------------------------------------------------------------------------------
Non-Owner Occupied: Generally 60% for a 1 to 2 N/A
Loan-to-value ratio family dwelling or condominium;
60% for a 3 to 4 family.
- -------------------------------------------------------------------------------------------------------
17
Generally, business purpose loans collateralized by residential real
estate must have an overall loan-to-value ratio (based solely on the independent
appraised fair market value of the real estate collateral securing the loan) on
the properties collateralizing the loans of no greater than 75%. Business
purpose loans collateralized by commercial real estate must generally have an
overall loan-to-value ratio (based solely on the independent appraised fair
market value of the real estate collateral securing the loan) of no greater than
60%. In addition, in substantially all instances, we also receive additional
collateral in the form of, among other things, personal guarantees, pledges of
securities, assignments of contract rights, life insurance and lease payments
and liens on business equipment and other business assets, as available. The
business purpose loans we originated had an average loan-to-value ratio of 60.9%
based solely on the real estate collateral securing the loan for fiscal 2000.
The maximum acceptable loan-to-value ratio for home equity loans held
as available for sale or securitized is generally 90%. The home equity loans we
originated had an average loan-to-value ratio of 78.9% for fiscal 2000.
Occasionally, exceptions to these maximum loan-to-value ratios are made if other
collateral is available or if there are other compensating factors. From time to
time, we make loans with loan-to-value ratios in excess of 90% which may be sold
with servicing released. Title insurance is generally obtained in connection
with all real estate secured loans.
We generally do not lend more than 95% of the appraised value in the
case of conventional first mortgage loans, other than Federal Housing Authority
and Veterans Administration Loans. The conventional first mortgage loans we
originated had an average loan-to-value ratio of 83.7% for fiscal 2000. We
generally require private mortgage insurance on all conventional first mortgage
loans with loan-to-value ratios in excess of 80% at the time of origination in
order to reduce our exposure. We obtain mortgage insurance certificates from the
FHA on all FHA loans and loan guaranty certificates from the VA on all VA loans
regardless of the loan-to-value ratio on the underlying loan amount.
We believe that the consistent application of the criteria described
above may mitigate some of the risks associated with lending to non-conforming
borrowers.
In determining whether the mortgaged property is adequate as
collateral, we have each property considered for financing appraised. The
appraisal is completed by an independent qualified appraiser and generally
includes pictures of comparable properties and pictures of the property securing
the loan. With respect to business purpose loans, home equity loans and
conventional first mortgage loans, the appraisal is completed by an independent
qualified appraiser on a Fannie Mae form.
Any material decline in real estate values reduces the ability of
borrowers to use home equity to support borrowings and increases the
loan-to-value ratios of loans previously made by us, thereby weakening
collateral coverage and increasing the possibility of a loss in the event of
borrower default. Further, delinquencies, foreclosures and losses generally
increase during economic slowdowns or recessions. As a result, we cannot assure
that the market value of the real estate underlying the loans will at any time
be equal to or in excess of the outstanding principal amount of those loans.
Although we have expanded the geographic area in which we
18
originate loans, a downturn in the economy generally or in a specific region of
the country may have an effect on our originations. See "-- Risk Factors - A
decline in value of the collateral securing our loans could result in an
increase in losses on foreclosure which could reduce our profitability."
Loan Administration Procedures
We employ a large staff of experienced collectors and supervisors
working in shifts to manage non-performing loans. In addition, several in-house
collection attorneys and paralegals work closely with these collectors and their
managers to optimize collection efforts. The goal of our labor-intensive
collections program is to emphasize delinquency prevention.
In servicing business purpose loans and home equity loans, we typically
send an invoice to borrowers on a monthly basis advising them of the required
payment and its due date. We begin the collection process immediately after a
borrower fails to make a monthly payment. We believe we begin the collection
process earlier than lenders who provide financing to credit worthy borrowers.
When a loan becomes 45 to 60 days delinquent, it is transferred to a workout
specialist in the collections department. The workout specialist tries to
reinstate a delinquent loan, seek a payoff, or occasionally enter into a
modification agreement with the borrower to avoid foreclosure. All proposed
workout arrangements are evaluated on a case-by-case basis, based upon the
borrower's past credit history, current financial status, cooperativeness,
future prospects and the reasons for the delinquency. If the loan becomes
delinquent 61 days or more and a satisfactory workout arrangement with the
borrower is not achieved or the borrower declares bankruptcy, the matter is
immediately referred to our attorneys for collection. Due to this timing, the
foreclosure process on most delinquent loans is commenced before the loan is 100
days past due.
To our knowledge, we are one of very few lenders that has an in-house
legal staff dedicated to the collection of delinquent loans and the handling of
bankruptcy cases. As a result, we believe our delinquent loans are reviewed from
a legal perspective earlier in the collection process than is the case with
loans made by traditional lenders so that troublesome legal issues can be noted
and, if possible, resolved earlier. Our in-house legal staff also attempts to
find solutions for delinquent loans, other than foreclosure. Every loan is
analyzed to compare the property value against the loan balance and solutions
are presented to the borrower based on the results of that analysis.
In those situations where foreclosures are handled by outside counsel,
the in-house legal staff manages outside counsel to ensure that the time period
for handling foreclosures meets or exceeds established industry standards.
Frequent contact between in-house and outside counsel insures that the process
moves quickly and efficiently in an attempt to achieve a timely and economical
resolution to contested matters.
19
Securitizations
Since 1995, we have completed 19 securitization transactions. The 19
pools of loans and leases securitized were comprised of approximately $305.7
million of business purpose loans, approximately $1.8 billion of home equity
loans and approximately $161.6 million of equipment leases. During fiscal 2000,
we securitized $104.5 million of business purpose loans, $887.9 million of home
equity loans and $9.3 million of equipment leases.
Securitization is a financing technique often used by originators of
financial assets to raise capital. A securitization involves the transfer of a
pool of financial assets, in our case loans or leases, to a trust in exchange
for cash and a retained interest in the securitized loans and leases which is
called an interest-only strip. The trust issues multi class securities which
derive their cash flows from a pool of securitized loans and leases. These
securities, which are senior to our interest-only strips in the trust, are sold
to public investors. We also retain servicing on securitized loans and leases.
See "--Loan and Lease Servicing."
As the holder of the interest-only strip received in a securitization,
we are entitled to receive excess (or residual) cash flows. These cash flows are
the difference between the payments made by the borrowers on the loans and
leases and the sum of the scheduled and prepaid principal and pass-through
interest paid to the investors in the trust, servicing fees, trustee fees and,
if applicable, surety fees. Surety fees are paid to an unrelated insurance
entity to provide protection for the trust investors. Overcollateralization is
the excess of the aggregate principal balances of loans and leases in a
securitized pool over investor interests. Overcollateralization requirements are
established to provide additional protection for the trust investors.
We may be required either to repurchase or to replace loans or leases
which do not conform to the representations and warranties we made in the
pooling and servicing agreements entered into when the loans or leases are
pooled and sold through securitizations. As of June 30, 2000, we had not been
required to repurchase or replace any such loans or leases.
When borrowers are delinquent in making scheduled payments on loans or
leases included in a securitization trust, we are required to advance interest
payments with respect to such delinquent loans or leases to the extent that we
determine that such advances will be ultimately recoverable. These advances
require funding from our capital resources but have priority of repayment from
the succeeding month's collection.
While we are under no obligation to do so, at times we elect to
repurchase some foreclosed and delinquent loans from the securitization trusts.
Under the terms of the securitization agreements, repurchases are permitted only
for foreclosed and delinquent loans and the purchase prices are at the loans'
outstanding contractual balance. We elect to repurchase loans in situations
requiring more flexibility for the administration and collection of these loans
in order to maximize their economic recovery and to avoid temporary
discontinuations of residual or stepdown overcollateralization cash flows from
securitization trusts.
20
Our securitizations often include a prefunding option where a portion
of the cash received from investors is withheld until additional loans or leases
are transferred to the trust. The loans or leases to be transferred to the trust
to satisfy the prefund option must be substantially similar in terms of
collateral, size, term, interest rate, geographic distribution and loan-to-value
ratio as the loans or leases initially transferred to the trust. To the extent
we fail to originate a sufficient number of qualifying loans or leases for the
prefunded account within the specified time period, our earnings during the
quarter in which the funding was to occur would be reduced.
The securitization of loans and leases generated gains on sale of loans
and leases for fiscal 2000 of $90.4 million. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Securitization
Accounting Considerations."
Subject to market conditions, we anticipate that we will continue to
securitize business purpose loans and home equity loans. We believe that a
securitization program provides a number of benefits by allowing us to diversify
our funding base, provide liquidity and lower our cost of funds.
Competition
We compete for business purpose loans against many other finance
companies and financial institutions. Although many other entities originate
business purpose loans, we have focused our lending efforts on our niche market
of businesses which may qualify for loans from traditional lending sources but
who we believe are attracted to our products as a result of our marketing
efforts, responsive customer service and rapid processing and closing periods.
We have significant competition for home equity loans. Through Upland
Mortgage and New Jersey Mortgage, we compete with banks, thrift institutions,
mortgage bankers and other finance companies, which may have greater resources
and name recognition. We attempt to mitigate these factors through a highly
trained staff of professionals, rapid response to prospective borrowers'
requests and by maintaining a relatively short average loan processing time. In
addition, we implemented our Bank Alliance Program in order to generate
additional loan volume.
The various segments of our lending businesses are highly competitive.
See "-- Risk Factors - Competition from other lenders could adversely affect our
profitability."
Regulation
General. Our business is regulated by both federal and state laws. All
home equity and conventional first mortgage loans must meet the requirements of,
among other statutes and regulations, the Truth in Lending Act, the Real Estate
Settlement Procedures Act, the Equal Credit Opportunity Act of 1974, Federal
Reserve Board Regulations Z and B and Department of Housing and Urban
Development Regulation X.
Truth in Lending. The Truth in Lending Act and Regulation Z contain
disclosure requirements designed to provide consumers with uniform,
understandable information about the
21
terms and conditions of loans and credit transactions so that consumers may
compare credit terms. The Truth in Lending Act also guarantees consumers a
three-day right to cancel some transactions described in the Act and imposes
specific loan feature restrictions on some loans including the same type
originated by us. We believe that we are in compliance with the Truth in Lending
Act in all material respects. If we were found not to be in compliance with the
Truth in Lending Act, some aggrieved borrowers could have the right to rescind
their loans and/or to demand, among other things, the return of finance charges
and fees paid to us. Other fines and penalties can also be imposed under the
Truth in Lending Act and Regulation Z.
Equal Credit Opportunity and Other Laws. We are also required to comply
with the Equal Credit Opportunity Act and Regulation B, which prohibit creditors
from discriminating against applicants on the basis of race, color, religion,
national origin, sex, age or marital status. Regulation B also restricts
creditors from obtaining specific types of information from loan applicants.
Among other things, it also requires certain disclosures by the lender regarding
consumer rights and requires lenders to advise applicants of the reasons for any
credit denial. We are also required to report statistical information on loan
applicants to the Department of Housing and Urban Development which monitors
compliance with fair lending laws.
In instances where the applicant is denied credit or the rate of
interest for a loan increases as a result of information obtained from a
consumer credit reporting agency, the Fair Credit Reporting Act of 1970, as
amended, requires lenders to supply the applicant with the name and address of
the reporting agency whose credit report was used in determining to reject a
loan application. It also requires that lenders provide other information and
disclosures about the loan application rejection. In addition, we are subject to
the Fair Housing Act and regulations under the Fair Housing Act, which broadly
prohibit specific discriminatory practices in connection with our home equity
lending business.
We are also subject to the Real Estate Settlement Procedures Act and
Regulation X. These laws and regulations impose limits on the amount of funds a
borrower can be required to deposit with us in any escrow account for the
payment of taxes, insurance premiums or other charges; limits the fees which may
be paid to third parties; and imposes various disclosure requirements.
We are subject to various other federal and state laws, rules and
regulations governing the licensing of mortgage lenders and servicers,
procedures that must be followed by mortgage lenders and servicers, and
disclosures that must be made to consumer borrowers. Failure to comply with
these laws, as well as with the laws described above, may result in civil and
criminal liability.
Several of our subsidiaries are licensed and regulated by the
departments of banking or similar entities in the various states in which they
are licensed. The rules and regulations of the various states impose licensing
and other restrictions on lending activities such as prohibiting discrimination
and regulating collection, foreclosure procedures and claims handling, payment
features, and, in some cases, these laws fix maximum interest rates and fees.
Failure to comply with these requirements can lead to termination or suspension
of licenses, rights of rescission for mortgage loans, individual and class
action lawsuits and administrative enforcement actions.
22
Upland Mortgage and New Jersey Mortgage maintain compliance with the various
federal and state laws through its in-house counsel and outside counsel which
review their documentation and procedures and monitor and inform them of various
changes in the laws.
The previously described laws and regulations are subject to
legislative, administrative and judicial interpretation. Some of these laws and
regulations have recently been enacted. Some of these laws and regulations are
rarely challenged in or interpreted by the courts. Infrequent interpretations of
these laws and regulations or an insignificant number of interpretations of
recently enacted regulations can make it difficult for us to know what is
permitted conduct under these laws and regulations. Any ambiguity under the laws
and regulations to which we are subject may lead to regulatory investigations or
enforcement actions and private causes of action, such as class action lawsuits,
with respect to our compliance with the applicable laws and regulations. See "--
Risk Factors - Our residential lending business is subject to government
regulation and licensing requirements which may hinder our ability to operate
profitably."
Federal and state government agencies have recently begun to consider,
and in some instances have adopted, legislation to restrict lenders' ability to
charge rates and fees in connection with subprime residential mortgage loans and
loans to borrowers with problem credit. This legislation also imposes various
loan term restrictions, e.g., limits on balloon loan features. Frequently
referred to generally as "predatory lending" legislation, the legislation may
limit our ability to impose fees, charge interest rates on consumer loans to
those borrowers with problem credit and may impose additional regulatory
restrictions on our business.
The Gramm-Leach-Bliley Act, which was signed into law at the end of
1999, contains comprehensive consumer financial privacy restrictions. The
various federal enforcement agencies, including the Federal Trade Commission,
have issued final regulations to implement this act; however, compliance with
the new regulations is voluntary until July 1, 2001. These restrictions fall
into two basic categories. First, a financial institution must provide various
notices to consumers about an institution's privacy policies and practices.
Second, this act gives consumers the right to prevent the financial institution
from disclosing non-public personal information about the consumer to
non-affiliated third parties, with exceptions. As with any new regulations, we
intend to prepare the appropriate disclosures and internal procedures to assure
compliance with these new requirements.
Although we believe that we have implemented systems and procedures to
make sure that we comply with regulatory requirements, if more restrictive laws,
rules and regulations are enacted or more restrictive judicial and
administrative interpretations of those laws are issued, compliance with the
laws could become more expensive or difficult.
Truth in Savings. If we receive the regulatory approval to operate an
industrial loan company, we will offer certificates of deposit through our
industrial loan company and will be subject to the disclosure requirements
contained in the Truth in Savings Act and Regulation DD which require depository
institutions to provide uniform disclosures to consumers about the rates and
terms of certificates of deposit and other retail deposit accounts. These
disclosures enable consumers to make meaningful comparisons among depository
institutions. Failure to comply
23
with these disclosure requirements would subject the depository institution to
claims for damages from account holders, as well as, other fines and penalties
imposed by the regulatory agencies.
Federal Deposit Insurance Corporation. If we receive the regulatory
approval to operate an industrial loan company, the deposits of our industrial
loan company will be insured by the Federal Deposit Insurance Corporation up to
limits permitted by applicable law. As such, the Federal Deposit Insurance
Corporation will exercise primary regulatory supervision over our industrial
loan company. The Federal Deposit Insurance Corporation will also oversee the
compliance of our industrial loan company with consumer protection laws and
regulations applicable to lending and deposit products, as set forth above. In
addition, if we receive regulatory approval to operate an industrial loan
company, the Federal Deposit Insurance Corporation will establish the reporting,
capital and reserve requirements of our industrial loan company in accordance
with the Federal Deposit Insurance Act. Currently, we are unable to predict what
capital requirements will be imposed on our industrial loan company. If our
industrial loan company fails to comply with the applicable regulatory
requirements, the industrial loan company would be subject to enforcement
actions by the Federal Deposit Insurance Corporation.
There are risks inherent in our leasing activities which are different
than those risks inherent in our mortgage lending activities. See "--Risk
Factors--If we experience losses in the value of our leased equipment securing
the leases we hold, our profits may be reduced."
Risk Factors
Since we have historically experienced negative cash flows from our operations
and expect to do so in the foreseeable future, our ability to repay the
investment notes could be impaired.
We have historically experienced negative cash flow from operations
since 1996 primarily because our strategy of selling loans through
securitization requires us to build an inventory of loans over time. During the
period we are building this inventory of loans, we incur costs and expenses. We
do not recognize a gain on the sale of loans until we complete a securitization,
which may not occur until a subsequent period. In addition, our gain on a
securitization results from our retained interests in the securitized loans,
consisting primarily of interest-only strips, which do not generate cash flow
immediately. We expect this negative cash flow from operations to continue in
the foreseeable future. Should we continue to experience negative cash flows
from operations, it could impair our ability to make principal and interest
payments due under the terms of the investor notes. At June 30, 2000, there was
$177.7 million of investment notes which will mature through June 30, 2001.
We obtain the funds to repay the investment notes at their maturities
by securitizing our loans, selling whole loans and selling additional investment
notes. We may in the future generate cash flows by securitizing or selling
interest-only strips and selling servicing rights generated in past
securitizations. If we are unable in the future to securitize our loans, to sell
whole loans, or to realize cash flows from interest-only strips and servicing
rights generated in past securitizations,
24
our ability to repay the investment notes could be impaired. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Our estimates of the value of interest-only strips and servicing rights we
retain when we securitize loans could be inaccurate and could result in reduced
profits.
We generally retain interest-only strips and servicing rights in the
securitization transactions we complete. We estimate the fair value of the
interest-only strips and servicing rights based upon discount rates established
by management of our company and prepayment and default assumptions. Together,
these two assets represent 59.5% of our total assets at June 30, 2000. The value
of our interest-only strips totaled $277.9 million and the value of our
servicing rights totaled $74.9 million at June 30, 2000. Although we believe
that these amounts represent the fair value of these assets, the amounts were
estimated based on discounting the expected cash flows to be received in
connection with our securitizations using discount rates, established by us,
prepayment rates and default rate assumptions. Changes in market interest rates
may impact our discount rate assumptions and our actual prepayment and default
experience may vary materially from these estimates. Even a small unfavorable
change in these assumptions utilized could have a significant adverse impact on
the value of these assets. In the event of an unfavorable change in these
assumptions, the fair value of these assets would be overstated, requiring an
adjustment which would adversely affect our income in the period of adjustment.
During the year ended June 30, 2000, a write down of $12.6 million was
recorded on our interest-only strips. The write down included a charge of $11.2
million related to an increase from 11% to 13% in the discount rate used to
value our interest-only strips. This change in the discount rate was considered
a permanent fair value adjustment and was recorded as expense in fiscal 2000.
The write down also included a charge of $1.9 million for the impact of changes
in the one-month LIBOR which was deemed to be permanent. As a result of these
changes, we had a loss of $5.0 million for the fourth quarter of fiscal 2000 and
reported net income of $6.4 million for the year ended June 30, 2000 as compared
to net income of $14.1 million for the year ended June 30, 1999. In addition, we
changed the prepayment assumptions used to value our interest-only strips and
servicing rights to reflect actual experience. The effect of these changes was a
$0.5 million increase in our interest-only strips which is netted in the $12.6
million write down above, and a $0.7 million write down on the value of our
servicing rights. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Since we depend upon the availability of financing to fund our continuing
operations, any failure to obtain adequate funding could hurt our profitability.
For our ongoing operations, we depend upon frequent financings,
including the sale of unsecured subordinated debt securities and warehouse
credit facilities or lines of credit. If we are unable to renew or obtain
adequate funding under a warehouse credit facility, or other borrowings, the
lack of adequate funds would reduce our profitability. To the extent that we are
not successful in maintaining or replacing existing subordinated debt securities
upon maturity, we may have to limit our loan originations or sell loans earlier
than intended and restructure our operations. Limiting our originations or
earlier sales of loans could reduce our profitability. See
25
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Lending to credit-impaired borrowers may result in higher delinquencies in our
managed portfolio which could result in a reduction in profits.
We market a significant portion of our loans to borrowers who are
either unable or unwilling to obtain financing from traditional sources, such as
commercial banks. Loans made to these borrowers may entail a higher risk of
delinquency and loss than loans made to borrowers who use traditional financing
sources. Historically, we have experienced a higher rate of delinquencies on
loans made to these credit-impaired borrowers as compared to delinquency rates
experienced by banks on loans to conforming borrowers. While we use underwriting
standards and collection procedures designed to mitigate the higher credit risk
associated with lending to these borrowers, our standards and procedures may not
offer adequate protection against risks of default. Higher than anticipated
delinquencies, foreclosures or losses in our sold and serviced loans would
reduce our profits. See "-- Lending and Leasing Activities" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Our reliance upon the sale of our loans through securitization may result in
fluctuating operating results.
In recent periods, a significant portion of our revenue and net income
represented gain on the sale of loans and leases in securitization transactions.
Operating results for a given period can fluctuate significantly as a result of
the timing and size of securitizations. If we do not close securitizations when
expected, we could experience a loss for a period. In addition, we rely
primarily on securitizations to generate cash proceeds for the repayment of our
warehouse credit facilities and origination of additional loans.
Our ability to complete securitizations depends on several factors,
including:
o conditions in the securities markets generally including
market interest rates;
o conditions in the asset-backed securities markets
specifically; and
o the credit quality of our managed portfolios.
Any substantial impairment in the size or availability of the market for our
loans could result in our inability to continue to originate loans and repay the
investment notes upon maturity. See "--Securitizations" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Securitizations."
A change in market interest rates may result in a reduction in our profits.
Rapid changes, either upward or downward, in interest rates may
adversely affect our profits. Any future rise in interest rates may:
o reduce customer demand for our products;
o widen investor spread requirements and increase
overcollateralization
26
requirements in future securitizations;
o increase our cost of funds;
o reduce the spread between the rate of interest we receive on loans
and interest rates we must pay under our outstanding credit
facilities and debt securities;
o reduce the profit we will realize in securitizations or other sales
of loans; and
o limit our access to borrowings in the capital market.
Gain on sale of loans may be unfavorably impacted to the extent that we
hold fixed rate mortgages prior to securitization and a change in rates reduces
the spread between the average coupon rate on fixed rate loans and the weighted
average pass-through rate to investors for interests issued in connection with
the securitization. Although the average loan coupon rate is fixed at the time
the loan is originated, the pass-through rate to investors is not fixed until
the pricing of the securitization which occurs just prior to the sale of the
loans. Therefore, if market rates required by investors increase prior to
securitization of the loans, the spread between the average coupon rate on the
loans and the pass-through rate to investors may be reduced or eliminated which
would reduce or eliminate our profit on the sale of the loans. In addition, an
increase in interest rates could increase interest costs on all sources of
borrowed funds and reduce spreads on securitized loans which could negatively
impact our liquidity and capital resources by reducing cash flows which would
decrease our profitability.
Since a portion of the certificates issued to investors by
securitization trusts are floating rate certificates, the interest rates on
these certificates adjust based on an established index plus a spread. The fair
value of the excess cash flow we will receive from these trusts would be reduced
as a result of any increases in rates paid on the floating certificates. At June
30, 2000, $253.9 million of debt issued by securitization was floating rate debt
representing 13.8% of total debt issued by securitization trusts.
If we are not able to sustain the levels of growth in revenues and earnings that
we experienced in the past our future profits may be reduced.
During fiscal 2000, we experienced record levels of total revenue and
net income as a result of increases in loan originations and the securitization
of loans. Our ability to sustain the level of growth in total revenue and net
income experienced in the past depends upon a variety of factors outside our
control, including:
o interest rates,
o conditions in the asset-backed securities markets,
o economic conditions in our primary market area,
o competition, and
o regulatory restrictions.
Our ability to sustain the levels of growth experienced in the past will become
increasingly difficult in light of rising interest rates experienced during
fiscal 2000 as compared to a falling or stable interest rate environment. If we
are unable to sustain our levels of growth, our profits may
27
be reduced. See "A change in market interest rates may result in a reduction in
our profits" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Decreasing market interest rates could reduce our profitability due to the
length of maturities of our outstanding subordinated debt.
We are subject to risks associated with changes in interest rates to
the extent that we have issued fixed rate subordinated debt securities with
scheduled maturities of one to ten years. At June 30, 2000, we had $212.9
million of subordinated debt securities with scheduled maturities greater than
one year, which is not subject to early redemption at our option. If market
interest rates decrease in the future, the rates paid on our long term
subordinated debt could exceed the current market rate paid for similar
instruments which could result in a reduction in our profitability. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Interest Rate Risk Management."
If we are unable to continue to successfully implement our business strategy,
our revenues may decrease.
Our business strategy seeks to increase our loan volume through further
development of existing markets while maintaining our customary origination
fees, the spread between loan interest rates and the interest rates we pay for
capital and underwriting criteria. Implementation of this strategy will depend
in large part on our ability to:
o open or expand offices in markets with a sufficient concentration
of borrowers who meet our underwriting criteria;
o obtain adequate financing on favorable terms;
o profitably securitize our loans in the secondary market on a
regular basis;
o hire, train and retain skilled employees;
o successfully implement our marketing campaigns; and
o continue to expand in the face of increasing competition from other
lenders.
Our inability to achieve any or all of these factors could impair our ability to
implement our business strategy and successfully leverage our fixed costs which
could result in a reduction in our revenues. See "--Lending and Leasing
Activities."
If loan prepayment rates are higher than anticipated, our profits could be
reduced.
A significant decline in market interest rates could increase the level
of loan prepayments, which would decrease the size of the total managed loan
portfolio and the related projected cash flows. Higher than anticipated rates of
loan prepayments could require a write down of the fair value of the related
interest-only strips and servicing rights, adversely impacting earnings during
the period of adjustment which would result in a reduction in our profitability.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
28
A decline in real estate values could result in a reduction in originations
which could reduce our revenues.
Our business may be adversely affected by declining real estate values.
Any significant decline in real estate values reduces the ability of borrowers
to use home equity as collateral for borrowings. This reduction in real estate
values may reduce the number of loans we are able to make, which will reduce the
gain on sale of loans and servicing and origination fees we will collect which
could reduce our revenues. See "-- Lending and Leasing Activities" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
A decline in value of the collateral securing our loans could result in an
increase in losses on foreclosure which could reduce our profitability.
Declining real estate values will also increase the loan-to-value
ratios of loans we previously made, which in turn, increases the probability of
a loss in the event the borrower defaults and we have to sell the mortgaged
property. In addition, delinquencies and foreclosures generally increase during
economic slowdowns or recessions. As a result, the market value of the real
estate or other collateral underlying our loans may not, at any given time, be
sufficient to satisfy the outstanding principal amount of the loans. See
"--Lending and Leasing Activities" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
If we experience losses in the value of our leased equipment securing the leases
we hold, our profitability may be reduced.
The equipment which secures the leases we hold is subject to the risk
of damage, destruction or obsolescence prior to the termination of the lease. In
the case of our fair market value leases, lessees may choose not to exercise
their option to purchase the equipment for its fair market value at the
termination of the lease. When this happens, we may have to sell the equipment
to third party buyers at a discount which may result in reduced profitability.
See "--Lending and Leasing Activities."
If we are unable to implement an effective hedging strategy, our net income may
be reduced.
We have implemented a hedging strategy in an attempt to mitigate the
effect of changes in interest rates on our fixed rate mortgage loans prior to
securitization that involves the use of derivative financial instruments such as
futures, interest rate swaps and forward pricing of securitizations. An
effective hedging strategy is complex and no strategy can completely insulate us
from interest rate risk. In fact, poorly designed strategies or improperly
executed transactions may increase rather than mitigate interest rate risk.
Hedging involves transaction and other costs, and these costs could increase as
the period covered by the hedging protection increases or in periods of rising
and fluctuating interest rates. In addition, this interest rate hedging strategy
may not be effective against the risk that the difference between the treasury
rate and the rate needed to attract potential buyers of asset backed securities
may widen. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Interest Rate Risk Management."
29
Competition from other lenders could adversely affect our profitability.
The lending markets that we compete in are highly competitive. Some
competing lenders have substantially greater resources, greater experience,
lower cost of funds, and a more established market presence than we have. If our
competitors increase their marketing efforts to include our market niche of
borrowers, we may be forced to reduce the rates and fees we currently charge in
order to maintain and expand our market share. Any reduction in our rates or
fees could have an adverse impact on our profitability. Our profitability and
the profitability of other similar lenders may attract additional competitors
into this market. See "Competition."
An economic downturn in the eastern half of the United States could result in
reduced profitability.
We currently originate loans primarily in the eastern half of the
United States. The concentration of loans in a specific geographic region
subjects us to the risk that a downturn in the economy in the eastern half of
the country would more greatly affect us than if our lending business were more
geographically diversified. As a result, an economic downturn in this region
could result in reduced profitability. See "-- Lending and Leasing Activities"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Our securitization agreements require us to retain some risk on loans that do
not meet the requirements in these agreements which could result in a reduction
in profitability.
Although we sell substantially all of the loans we originate through
securitizations, all of the securitization agreements require that we replace or
repurchase loans which do not conform to the representations and warranties made
by us at the time of sale. Additionally, when borrowers are delinquent in making
monthly payments on loans included in a securitization trust, we are required to
advance interest payments for the delinquent loans if we deem that the advances
will be ultimately recoverable. These advances require funding from our capital
resources but have priority of repayment from the succeeding month's
collections. See "-- Securitizations."
Our residential lending business is subject to government regulation and
licensing requirements which may hinder our ability to operate profitably.
Our residential lending business is subject to extensive regulation,
supervision and licensing by various state departments of banking or financial
services. Our lending business is also subject to various laws and judicial and
administrative decisions imposing requirements and restrictions on all or part
of our home equity and conventional first mortgage lending activities. We are
also subject to examinations by state departments of banking or financial
services in the 47 states where we are licensed with respect to originating,
processing, underwriting, selling and servicing home equity loans and
conventional first mortgage loans. We are also subject to Federal Reserve Board
regulations related to residential mortgage lending and servicing and the
Department of Housing and Urban Development regulation and reporting
requirements. Failure to comply with these requirements can lead to, among other
remedies, termination or suspension
30
of licenses, rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement actions.
Federal and state government agencies have recently begun to consider,
and in some instances have adopted, legislation to restrict lenders' ability to
charge rates and fees in connection with subprime residential mortgage loans and
loans to borrowers with problem credit. This legislation also imposes various
loan term restrictions, e.g., limits on balloon loan features. Frequently
referred to generally as "predatory lending" legislation, such legislation may
limit our ability to impose certain fees, charge certain interest rates on
certain consumer loans and may impose additional regulatory restrictions on our
business.
Although we believe that we have implemented systems and procedures to
facilitate compliance with these requirements, more restrictive laws, rules and
regulations may be adopted in the future that could make compliance more
difficult or expensive and hinder our ability to operate profitably. See "--
Regulation."
Claims by borrowers or investors could result in reduced profitability.
In the ordinary course of our business, we are subject to claims made
against us by borrowers and private investors arising from, among other things:
o losses that are claimed to have been incurred as a result of
alleged breaches of fiduciary obligations, misrepresentation, error
and omission by our employees, officers and agents (including our
appraisers);
o incomplete documentation; and
o failure to comply with various laws and regulations applicable to
our business.
Although no material claims or legal actions are currently assessed
against us, any claims asserted in the future may result in legal expenses,
liability and reduced profitability. See "--Legal Proceedings."
We depend on the services of key people, and the loss of any of these people
could disrupt our operations and result in reduced profitability.
The success of our operations depends on the continued employment of
our senior level management. If key members of the senior level management were
for some reason unable to perform their duties or were to leave us for any
reason, we may not be able to find capable replacements which could disrupt
operations and result in reduced profitability.
Environmental laws and regulations may restrict our ability to foreclose on
loans secured by real estate or increase costs associated with those loans which
could reduce our profitability.
Our ability to foreclose on the real estate collateralizing our loans
may be limited by environmental laws which pertain primarily to commercial
properties that require a current or previous owner or operator of real property
to investigate and clean up hazardous or toxic
31
substances or chemical releases on the property. In addition, the owner or
operator may be held liable to a governmental entity or to third parties for
property damage, personal injury, investigation and cleanup costs relating to
the contaminated property. While we would not knowingly make a loan
collateralized by real property that was contaminated, it is possible that the
environmental contamination would not be discovered until after we had made the
loan.
To date there have been three instances where we have determined not to
foreclose on the real estate collateralizing a delinquent loan because of
environmental considerations. Any losses we may sustain on these three loans
will not have a material adverse effect on our profitability.
In addition to federal or state regulations, 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 the property. See "--Loan and Lease Servicing."
Employees
At June 30, 2000, we employed 911 people on a full-time basis and 43
people on a part-time basis. None of our employees are covered by a collective
bargaining agreement. We consider our employee relations to be good.
Executive Officers Who Are Not Also Directors
The following is a description of the business experience of each
executive officer who is not also a director.
Beverly Santilli, age 41, is First Executive Vice President, a position
she has held since September 1998 and Secretary, a position she has held since
our inception. Mrs. Santilli has held a variety of positions including Executive
Vice President and Vice President. Mrs. Santilli is also the President of
American Business Credit. Mrs. Santilli is responsible for all sales, marketing
and day-to-day operation of American Business Credit. Mrs. Santilli is also
responsible for human resources of ABFS. Prior to joining American Business
Credit and from September 1984 to November 1987, Mrs. Santilli was affiliated
with PSFS initially as an Account Executive and later as a Commercial Lending
Officer with that bank's Private Banking Group. Mrs. Santilli is the wife of
Anthony J. Santilli.
Jeffrey M. Ruben, age 37, is Executive Vice President and General
Counsel, positions he has held since September 1998. He is also Executive Vice
President and General Counsel of some of our subsidiaries, positions he has held
since April 1992. Mr. Ruben is responsible for the loan and the lease
collections departments, the asset allocation unit and the legal department. Mr.
Ruben served as Senior Vice President from April 1992 to September 1998. From
June 1990 until he joined us in April 1992, Mr. Ruben was an attorney with the
law firm of Klehr, Harrison, Harvey, Branzburg & Ellers in Philadelphia,
Pennsylvania. From December 1987 until June 1990, Mr. Ruben was employed as a
credit analyst with the CIT Group Equipment Financing, Inc. Mr. Ruben is a
member of the Pennsylvania and New Jersey Bar Associations.
32
Mr. Ruben holds both a New Jersey Mortgage Banker License and a New Jersey
Secondary Mortgage Banker License.
Albert W. Mandia, age 53, is our Executive Vice President and Chief
Financial Officer of ABFS, positions he has held since June 1998 and October
1998, respectively. Mr. Mandia is responsible for all financial, information
systems and investor relations functions. From 1974 to 1998, Mr. Mandia was
associated with CoreStates Financial Corp. where he last held the position of
Chief Financial Officer from February 1997 to April 1998.
Milt Riseman, age 63, is Chairman of the Consumer Mortgage Group, a
position he has held since June 1999. Mr. Riseman is responsible for the sales,
marketing and day-to-day operation of Upland Mortgage, including the Upland
Mortgage retail operation at the Bala Cynwyd, Pennsylvania headquarters, and the
Upland branch operation, which includes 12 offices throughout the United States.
He is also responsible for the consumer mortgage web site,
www.UplandMortgage.com. Mr. Riseman was President of Advanta Mortgage from
February 1994 until 1999. He joined Advanta in 1992 as Senior Vice President,
Administration. From 1986 until 1992, Mr. Riseman was President of Citicorp
Acceptance Corp. He joined Citicorp in 1965, and in 1978, he moved into general
management positions in the bank's New York region.
Ralph J. Hall, age 51, is Chairman of the Business Alliance Group, a
position he held since joining the Company in May 2000. Mr. Hall is responsible
for leading the Company's New Jersey Mortgage and Processing Service Center
subsidiaries in their business development efforts. He will also lead the
growing business opportunities presented by business-to-business commerce. Mr.
Hall was President and Chief Executive Officer of GreenPoint Mortgage Corp.,
North Carolina and Executive Vice President of GreenPoint Bank, New York, from
July 1995 to April 2000. From 1992 to 1994, Mr. Hall was General Manager and
Chief Operating Officer of GMAC Mortgage Corp., Philadelphia, Pennsylvania.
Before joining GMAC Mortgage, he was President and Chief Executive Officer of
GMAC Capital Corp. in Utah. Mr. Hall has also held positions with Citicorp,
Arthur Anderson & Co., and Shell Oil Company.
Item 2. Properties
Except for real estate acquired in foreclosure in the normal course of
our business, we do not presently hold title to any real estate for operating
purposes. The interests which we presently hold in real estate are in the form
of mortgages against parcels of real estate owned by our borrowers or their
affiliates and real estate acquired through foreclosure.
We presently lease office space at 111 Presidential Boulevard, Bala
Cynwyd, Pennsylvania, just outside the city limits of Philadelphia. We are
currently leasing this office space under lease with an annual rental cost of
approximately $2.2 million. The current lease term expires on July 31, 2003. We
also lease the Roseland, New Jersey office which functions as the headquarters
for New Jersey Mortgage and its subsidiary. The Roseland office lease term
expires in July 2003 and contains a renewal option for an additional term of
five years. The Roseland office facility has a current annual rental cost of
approximately $766,000. In addition, we lease branch offices on a short term
basis in various cities throughout the United States. We do not believe that the
leases for the branch offices are material to our operations.
33
Item 3. Legal Proceedings
From time to time, we are involved as plaintiff or defendant in various
other legal proceedings arising in the normal course of our business. While we
cannot predict the ultimate outcome of these various legal proceedings, it is
management's opinion that the resolution of these legal actions should not have
a material effect on our financial position, results of operations or liquidity.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended June 30, 2000.
34
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
Our common stock is currently traded on the NASDAQ National Market
System under the symbol "ABFI." Our common stock began trading on the NASDAQ
National Market System on February 14, 1997. Prior to February 14, 1997, our
common stock had been traded on the Philadelphia Stock Exchange under the symbol
"AFX" since May 13, 1996. Prior to the commencement of trading on the PHLX,
there was no active trading market for our common stock.
The following table sets forth the high and low sales prices of our
common stock for the periods indicated. The stock price information for June 30,
1999 and prior appearing below has been retroactively adjusted to reflect the
effect of a 5% stock dividend declared subsequent to June 30, 1999. On September
15, 2000, the closing price of the common stock on the NASDAQ National Market
System was $10.81.
Quarter Ended High Low
----------------------------------------- ------ ------
June 30, 1998........................... $24.29 $20.95
September 30, 1998...................... 20.71 11.19
December 31, 1998....................... 13.70 5.48
March 31, 1999.......................... 14.29 11.67
June 30, 1999........................... 18.93 10.23
March 31, 2000.......................... 26.00 11.63
June 30, 2000........................... 18.38 9.88
As of June 30, 2000, there were approximately 130 record holders and
approximately 1,400 beneficial holders of our common stock.
During fiscal 2000, we paid dividends of $ 0.30 per share on our common
stock for an aggregate dividend payment of $1.0 million. During fiscal 1999, we
paid $0.165 per share in dividends on our common stock, for an aggregate
dividend payment of $0.5 million. During fiscal 1998, we paid dividends of $0.2
million. The payment of dividends in the future is in the sole discretion of our
Board of Directors and will depend, among other things, upon earnings, capital
requirements and financial condition, as well as other relevant factors.
On August 18, 1999, our Board of Directors declared a 5% stock dividend
paid on September 27, 1999, to stockholders of record as of September 3, 1999.
The stock price information in the table above has been adjusted to reflect this
stock dividend.
As a Delaware corporation, we may not declare and pay dividends on
capital stock if the amount paid exceeds an amount equal to the excess of our
net assets over paid-in-capital or, if there is no excess, our net profits for
the current and/or immediately preceding fiscal year.
On October 27, 1997, we issued 20,240 shares of common stock to Stanley
L. Furst and Joel E. Furst as partial consideration for their 100% interest in
New Jersey Mortgage.
35
This issuance was exempt from registration in accordance with Section
4(2) of the Securities Act of 1933, as amended, because the issuance did not
involve a public offering. Therefore, the shares issued are subject to certain
transfer restrictions.
Item 6. Selected Consolidated Financial Data
You should consider our selected consolidated financial information set
forth below together with the more detailed consolidated financial statements,
the notes to the consolidated financial statements and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this document:
Year Ended June 30,
--------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- ------- ------- ------
Statement of Income Data: (Dollars in thousands, except per share data)
Revenues:
Gain on sale of loans and leases.......... $ 90,380 $64,490 $40,778 $19,942 $ 8,721
Interest and fees......................... 19,400 16,553 17,386 5,584 3,245
Interest accretion on interest-only strips 16,616 2,021 538 101 --
Other..................................... 4,250 3,360 633 335 129
-------- ------- ------- ------- -------
Total revenues.............................. 130,646 86,424 59,335 25,962 12,095
Total expenses(a)........................... 120,284 64,573 41,445 16,960 8,974
-------- ------- ------- ------- -------
Operating income before income taxes.. ..... 10,362 21,851 17,890 9,002 3,121
Income taxes................................ 3,938 7,763 6,435 3,062 802
-------- ------- ------- ------- -------
Net income.................................. $ 6,424 $14,088 $11,455 $ 5,940 $ 2,319
======== ======= ======= ======= =======
Per Common Share Data:
Basic earnings per common share(b) ......... $ 1.88 $ 3.83 $ 3.10 $ 2.03 $ 0.96
Diluted earnings per common share(b)........ 1.83 3.72 2.98 1.95 0.96
Cash dividends declared per common share ... 0.30 0.165 0.06 0.06 0.03
- ----------------------
(a) Includes an interest-only strip fair value adjustment of $12.6 million in
the year ended June 30, 2000.
(b) Amounts for the years ended June 30, 1999, 1998, 1997 and 1996 have been
retroactively adjusted to reflect the effect of a 5% stock dividend declared
August 18, 1999 as if the additional shares had been outstanding for each
period presented.
36
June 30,
--------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- ------- ------- ------
(In thousands)
Balance Sheet Data:
Cash and cash equivalents................... $ 69,751 $ 22,395 $ 4,486 $ 5,014 $ 5,345
Loan and lease receivables, net
Available for sale........................ 44,132 33,776 62,382 35,712 18,003
Other..................................... 13,002 6,863 4,096 1,144 534
Interest-only strips........................ 277,872 178,218 95,913 37,507 32,639
Receivable for sold loans and leases........ 51,283 66,086 2,377 960 26
Servicing rights............................ 74,919 43,210 18,472 8,083 5,907
Total assets................................ 592,668 396,301 226,551 103,989 46,894
Subordinated debt........................... 390,676 211,652 115,182 56,486 33,620
Total liabilities........................... 530,553 338,055 183,809 73,077 42,503
Stockholders' equity........................ 62,115 58,246 42,742 30,912 4,392
Year Ended June 30,
--------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- ------- ------- ------
Other Data: (Dollars in thousands, except per share data)
Originations:
Business purpose loans ................... $ 106,187 $ 64,818 $52,335 $38,721 $28,872
Home equity loans ........................ 949,014 634,820 328,089 91,819 36,479
Conventional first mortgage loans......... 42,607 66,519 33,671 -- --
Equipment leases.......................... 19,631 96,289 70,480 8,004 5,967
Loans and Leases Sold:
Securitizations........................... 1,001,702 777,598 384,700 115,000 36,506
Other..................................... 102,670 105,751 51,594 3,817 19,438
Total managed loan and lease
portfolio............................... 1,918,540 1,176,918 559,398 176,651 59,891
Average loan/lease size:
Business purpose loans.................... 89 80 83 78 78
Home equity loans......................... 70 74 62 51 47
Conventional first mortgage loans......... 160 165 154 -- --
Equipment leases.......................... 19 23 21 11 11
Weighted average interest rate on
Loans and leases originated:
Business purpose loans.................... 15.99% 15.91% 15.96% 15.91% 15.83%
Home equity loans......................... 11.28 11.05 11.95 11.69 9.94
Conventional first mortgage loans......... 8.75 7.67 8.22 -- --
Equipment leases.......................... 11.25 11.40 12.19 15.48 17.22
37
Year Ended June 30,
--------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- ------- ------- ------
Financial Ratios:
Return on average assets.................... 1.31% 4.56% 6.93% 7.87% 6.71%
Return on average equity.................... 10.29 28.10 31.10 33.65 70.96
Total delinquencies as a
percentage of total managed portfolio,
at end of period.......................... 2.91 3.19 3.01 2.15 2.30
Real estate owned as a percentage
of total managed portfolio,
at end of period.......................... 0.68 0.85 0.16 0.34 1.01
Loan and lease losses as a
percentage of the average
total managed portfolio
during the period......................... 0.31 0.12 0.12 0.07 0.33
Pre-tax income as a percentage of
total revenues............................ 7.93 25.28 30.15 33.99 25.81
Ratio of earnings to fixed charges.......... 1.26x 1.92x 2.23x 2.56x 1.97x
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following financial review and analysis of the financial condition
and results of operations, for the years ended June 30, 2000, 1999 and 1998
should be read in conjunction with the consolidated financial statements and the
accompanying notes to the consolidated financial statements, and other detailed
information appearing in this document.
General
We are a diversified financial services company operating throughout
the United States. We originate, sell and service business purpose loans, home
equity loans and conventional first mortgage loans through our principal direct
and indirect subsidiaries. We also underwrite, process and purchase home equity
loans through the Bank Alliance Program whereby we purchase home equity loans
from financial institutions that meet our underwriting criteria but do not meet
the underlying guidelines of the selling institutions for loans to be held in
the portfolio of the selling institutions. Following our purchase of the loans
through this program, we hold these loans as available for sale until they are
sold in connection with a future securitization. Loans originated primarily
consist of fixed rate loans secured by first or second mortgages on single
family residences. Our customers include credit impaired borrowers and other
borrowers who would qualify for loans from traditional sources but who are
attracted to our loan products due to our personalized service, and timely
response to loan applications. We originate loans through a combination of
channels including a centralized processing center located in Bala Cynwyd,
Pennsylvania and a retail branch network of 18 offices. In addition, we offer
subordinated debt securities to the public, the proceeds of which are used to
repay existing debt, fund loan originations, our operations and for general
corporate purposes.
38
Due to increases in market interest rates, we expect our ability to
originate loans at rates that will maintain our current level of profitability
will become more difficult than during a stable or falling interest rate
environment. We are addressing this challenge by carefully monitoring our
product pricing, the actions of our competition and market trends in order to
continue to originate loans in as profitable a manner as possible. The higher
interest rate environment could also unfavorably impact our liquidity and
capital resources. Higher interest rates could impact our short-term liquidity
by widening investor spread requirements in pricing future securitizations,
increasing the levels of overcollateralization in future securitizations,
limiting our access to borrowings in the capital markets and limiting our
ability to sell our subordinated debt securities at favorable interest rates. In
a rising interest rate environment, short-term and long-term liquidity could
also be impacted by increased interest costs on all sources of borrowed funds,
including the subordinated debt, and by reducing spreads on our securitized
loans which would reduce our cash flows. See "Liquidity and Capital Resources"
for a discussion of both long and short term liquidity and "Risk Factors -- If
we are not able to sustain the levels of growth in revenues and earnings that we
experienced in the past our future profits may be reduced."
Prior to December 31, 1999 we also originated equipment leases.
Effective December 31, 1999, we de-emphasized the leasing origination business
in keeping with our strategy of focusing on our most profitable lines of
business. We are continuing to service the remaining leases in our managed
portfolio, which totaled $119.0 million in gross receivables at June 30, 2000.
We may from time to time consider originating or purchasing new leases.
A recent focus by state and federal banking regulatory agencies, state
attorneys general offices, the Federal Trade Commission, the U.S. Department of
Justice and the U.S. Department of Housing and Urban Development relates to
predatory lending practices by companies in our industry. Sanctions have been
imposed on selected industry competitors for practices including, but not
limited to, charging borrowers excess fees, imposing higher interest rates than
the borrower's credit risk warrants and failing to disclose the material terms
of loans to the borrowers. We have reviewed our lending policies in light of
these actions against other lenders and we believe we are in compliance with all
lending related guidelines. To date, no sanctions or recommendations from
governmental regulatory agencies regarding our practices related to predatory
lending have been imposed. We are unable to predict whether state or federal
regulatory authorities will require changes in our lending practices in the
future or the impact of those changes on our profitability. See "Risk Factors -
Our residential lending business is subject to government regulation and
licensing requirements which may hinder our ability to operate profitably."
Securitizations
In fiscal 2000, a write down of $12.6 million was recorded on our
interest-only strips. The write down included a charge of $11.2 million related
to an increase from 11% to 13% in the discount rate used to value our
interest-only strips. This change in the discount rate was considered a
permanent fair value adjustment and was recorded as expense in fiscal 2000. The
write down also included a charge of $1.9 million for the impact of changes in
one-month LIBOR deemed to be permanent. A portion of the certificates issued to
investors by our securitization trusts have floating interest rates based on the
value of an adjustable market interest rate index, one-month LIBOR, plus a
spread. The fair value of the excess cash flow we
39
will receive from these trusts would be affected by any changes in rates paid on
the floating rate certificates. Additionally, the write down included a credit
of $0.5 million for the net impact of adjustments made to the prepayment
assumptions on mortgage loan securitizations at June 30, 2000. The fair value of
our interest-only strips at June 30, 2000 was $277.9 million. See
"Securitization Accounting Considerations" for a discussion of the discount rate
and prepayment assumptions. See "Interest Rate Risk Management - Interest-only
Strips and Servicing Rights" for a discussion of the impact of one-month LIBOR.
The ongoing securitization of loans is a central part of our current
business strategy. We sell loans and have in the past sold leases through
securitizations with servicing retained. This strategy generates the cash
proceeds to repay warehouse and line of credit facilities, to fund additional
loan originations and to provide additional sources of revenue through retained
mortgage and lease servicing rights. The following table summarizes the volume
of loans and leases securitized and whole loan sales for the years ended June
30, 2000, 1999 and 1998 (dollars in millions):
Year Ended June 30,
-------------------------------
2000 1999 1998
-------- ------ ------
Securitizations:
- ---------------
Business loans........................... $ 104.5 $ 71.9 $ 54.1
Home equity loans........................ 887.9 613.0 270.9
Equipment leases......................... 9.3 92.6 59.7
-------- ------ ------
Total.................................. $1,001.7 $777.5 $384.7
======== ====== ======
Whole loan sales......................... $ 102.7 $105.8 $ 51.6
======== ====== ======
Gain on sale of loans and
leases through securitizations......... $ 90.4 $ 64.5 $ 40.8
Securitization gains as a
percentage of total revenues........... 69.2% 74.6% 68.7%
Gains on whole loan sales................ $ 1.7 $ 2.3 $ 2.7
Our quarterly revenues and net income have fluctuated in the past and
may fluctuate in the future principally as a result of the timing, size and
profitability of securitizations. The strategy of selling loans through
securitizations requires building an inventory of loans and leases over time,
during which time we incur costs and expenses. Since a gain on sale is not
recognized until a securitization is closed, which may not occur until a
subsequent quarter, operating results for a given quarter can fluctuate
significantly. If securitizations do not close when expected, we could
experience a materially adverse effect on our results of operations for a
quarter. In addition, due to the timing difference between the period when costs
are incurred in connection with the origination of loans and their subsequent
sale through the securitization process, we have operated on a negative cash
flow basis in the past and anticipate that we will continue to do so in the
foreseeable future, which could adversely impact our results of operations and
financial condition. See "Liquidity and Capital Resources" for a discussion of
our liquidity and cash flows and "Risk Factors -- Since we have historically
experienced
40
negative cash flows from our operations and expect to do so in the foreseeable
future, our ability to repay the investment notes could be impaired."
Several factors affect our ability to complete securitizations on a
profitable basis, including conditions in the securities markets generally, such
as, fluctuations in interest rates described below, conditions in the
asset-backed securities markets relating to the types of financial assets we
originate and credit quality of the managed portfolio of loans. Any substantial
reduction in the size or availability of the securitization market for loans
could have a material adverse effect on our results of operations and financial
condition.
Recent movements in market interest rates will negatively impact the
profitability of our future securitizations. The profitability of our
securitizations may be unfavorably impacted to the extent we hold fixed rate
mortgage loans pending securitization and market interest rates increase prior
to the securitization of those fixed rate loans. Although the loan coupon rate
is fixed at the time the loan is originated, the interest rate paid to investors
in the securitization, called the pass-through rate, is not fixed until the
pricing of the securitization which occurs just prior to the sale of the loans.
Our gain on sale of loans in a securitization will be reduced if the spread
between the average coupon rate on our fixed rate loans, and the weighted
average pass-through rate paid to investors for interests issued in connection
with a securitization declines. Since our September 1998 mortgage loan
securitization, the pass-through rates on the asset-backed securities issued in
our securitizations have increased by approximately 1.5%. During this period,
the average coupon on our loans securitized has increased 0.7%. The spread
between the average coupon rate on the loans and the pass-through rate to
investors could be reduced further if, for example, market interest rates
continue to increase. Because the coupon on our loans securitized has been
relatively high, we have been able to absorb this net reduction in spread and
have continued to access the asset-backed securities markets. We estimate that
each 0.1% reduction in the spread reduces the gain on sale of loans as a
percentage of loans securitized by approximately 0.25%. See "Interest Rate Risk
Management" for further detail. We are continuously monitoring market rate
fluctuations, our loan pricing and our hedging strategy in order to attempt to
manage these changes and maintain our current level of profitability in
connection with the securitization of loans. See "Risk Factors - A change in
market interest rates may result in a reduction in our profits."
In addition, as the spread is reduced, we are required to increase the
level of overcollateralization which is required to provide additional
protection to trust investors. Decreased spread has contributed to an increase
in the required final overcollateralization amount by approximately 1.0% of the
initial balance of loans securitized since September 1999. The increase in the
overcollateralization amount negatively impacts the timing of the cash flows
from the interest-only strips. See "Securitization Accounting Considerations"
for a discussion of overcollateralization amounts.
Our strategy of securitizing loans could also impact our future
profitability to the extent that the carrying value of our interest-only strips
may require negative adjustments. We generally retain interest-only strips and
servicing rights in the securitization transactions we complete. We estimate the
fair value of the interest-only strips and servicing rights based upon estimated
discount rates and prepayment and default assumptions. Together, these two
assets
41
represent 59.5% of our total assets at June 30, 2000. The value of our
interest-only strips totaled $277.9 million and the value of our servicing
rights totaled $74.9 million at June 30, 2000. Although we believe that these
amounts represent the fair value of these assets, the amounts were estimated
based on discounting the expected cash flows to be received in connection with
our securitizations using estimated discount rates, prepayment rates and default
rate assumptions. Changes in market interest rates may impact our discount rate
assumptions and our actual prepayment and default experience may vary materially
from these estimates. Even a small unfavorable change in these assumptions
utilized could have a significant adverse impact on the value of these assets.
In the event of an unfavorable change in these assumptions, the fair value of
these assets would be overstated, requiring an adjustment which would adversely
affect our income in the period of adjustment.
Our business strategy is dependent upon our ability to identify and
emphasize lending related activities that will provide us with the most economic
value. The implementation of this strategy will depend in large part on a
variety of factors outside of our control, including, but not limited to, our
ability to obtain adequate financing on favorable terms, profitably securitize
our loans on a regular basis and continue to expand in the face of increasing
competition. Our failure with respect to any of these factors could impair our
ability to successfully implement our strategy, which would adversely affect our
results of operations and financial condition.
Whole Loan Sales
We also sell loans with servicing released referred to as whole loan
sales. Gains on whole loan sales equal the difference between the net proceeds
from such sales and the loans' net carrying value. The net carrying value of
loans is equal to their principal balance plus unamortized origination costs and
fees. Gains from these sales are recorded as fee income.
Subordinated Debt and Other Borrowings
We also rely upon funds generated by the sale of subordinated debt and
other borrowings to fund our operations and to repay subordinated debt. At June
30, 2000, $390.7 million of subordinated debt was outstanding and credit
facilities and lines of credit totaling $346.1 million were available, of which
$131.8 million was drawn upon on that date. We expect to continue to rely on the
borrowings to fund loans prior to securitization.
Securitization Accounting Considerations
When we securitize our loans and leases by selling them to trusts we
receive cash and an interest-only strip, which represents our retained interest
in the securitized loans and leases. The trust issues multi-class securities,
which derive their cash flows from the pool of securitized loans and leases.
These securities, which are senior to our interest-only strips in the trusts,
are sold to public investors. In addition, when we securitize our loans and
leases we retain the right, for a fee paid to us, to service the loans and
leases which creates an asset that we refer to as our servicing rights.
Servicing includes billing and collecting payments from borrowers, transmitting
payments to investors, accounting for principal and interest, collections and
foreclosure activities and disposing of real estate owned.
42
As the holder of the interest-only strips received in a securitization,
we are entitled to receive excess (or residual) cash flows. These cash flows are
the difference between the payments made by the borrowers on securitized loans
and leases and the sum of the scheduled and prepaid principal and pass-through
interest paid to the investors in the trust, servicing fees, trustee fees and,
if applicable, surety fees. Surety fees are paid to an unrelated insurance
entity to provide protection for the trust investors. Overcollateralization is
the excess of the aggregate principal balances of loans and leases in a
securitized pool over investor interests. Overcollateralization requirements are
established to provide additional protection for the trust investors.
The overcollateralization requirements for a mortgage loan
securitization, which are different for each securitization, include:
(1) The initial requirement, which is a percentage of the
original balance of loans securitized and is paid in cash at
the time of sale;
(2) The final target, which is a percentage of the original
balance of loans securitized and is funded from the monthly
excess cash flow; and
(3) The stepdown overcollateralization requirement, which is a
percentage of the remaining balance of loans securitized.
During the stepdown period, the overcollateralization amount
is gradually reduced through cash payments to us. The
stepdown period begins at the later of 30 months or when the
remaining balance of loans securitized is less than 50% of
the original balance of securitized loans.
At June 30, 2000, investments in interest-only strips in
securitizations totaled $277.9 million including investments in
overcollateralization of $82.0 million.
In March 2000, we amended our arrangements with a warehouse lender to
include an off-balance sheet mortgage loan conduit facility. The sale into the
off-balance sheet conduit facility involves a two-step transfer that qualifies
for sale accounting under SFAS No. 125. First we sell the loans to a special
purpose entity which has been established for the limited purpose of buying and
reselling the loans. Next the special purpose entity sells the loans to a
qualified special purpose entity ("the facility") for cash proceeds generated by
its sale of notes to a third party purchaser. We have no obligation to
repurchase the loans and neither the third party note purchaser nor the facility
has a right to require such repurchase. The facility has the option to
re-securitize the loans, ordinarily using longer-term certificates. If the loans
are not re-securitized by the facility, the third party note purchaser has the
right to securitize or sell the loans. Under this arrangement, the loans have
been isolated from us and our subsidiaries; and, as a result, the transfer to
the conduit facility is treated as a sale for financial reporting purposes.
During fiscal 2000, we sold approximately $97.7 million in principal amount of
loans to the conduit facility and recognized gains on those sales totaling
approximately $9.6 million. In June 2000, $19.4 million of loans in the conduit
facility were re-securitized by the facility. At June 30, 2000 there were $78.3
million in principal amount of loans in the conduit facility and an additional
$0.2 million in the on balance sheet facility.
43
The following table provides information regarding the nature and
principal balances of mortgage loans securitized in each trust, the securities
issued by each trust, and the overcollateralization requirements of each trust.
Summary of Selected Mortgage Loan Securitization Trust Information
Current Balances as of June 30, 2000
(dollars in millions)
2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998-4 1998-3
------ ------ ------ ------ ------ ------ ------ ------
Original balance of loans securitized:
Business loans $ 22 $ 25 $ 25 $ 28 $ 30 $ 16 $ 9 $ 17
Home equity loans 213 212 197 194 190 169 71 183
Total 235 237 222 222 220 185 80 200
Current balance of loans securitized:
Business loans $ 22 $ 25 $ 25 $ 26 $ 28 $ 15 $ 7 $ 14
Home equity loans 213 211 194 188 178 148 59 147
Total 235 236 219 214 206 163 66 161
Weighted average coupon on loans securitized:
Business loans 15.99% 16.10% 16.04% 15.78% 15.78% 15.99% 16.04% 15.96%
Home equity loans 11.52% 11.37% 11.10% 10.94% 10.50% 10.68% 10.83% 10.76%
Total 11.65% 11.88% 11.69% 11.53% 11.23% 11.16% 11.39% 11.21%
Percentage of first mortgage loans 78% 77% 79% 82% 88% 89% 89% 89%
Weighted average loan-to-value 75% 78% 76% 77% 76% 77% 77% 78%
Weighted average remaining term(months)
on loans securitized 243 245 239 242 244 243 243 240
Original balance of Trust Certificates $ 300* $ 235 $ 220 $ 219 $ 219 $ 184 $ 79 $ 198
Current balance of Trust Certificates $ 299 $ 229 $ 207 $ 199 $ 188 $ 147 $ 59 $ 143
Weighted average pass-through interest
rate to Trust Certificate holders 7.88% 7.71% 7.32% 7.34% 7.05% 6.56% 6.61% 6.26%
Highest Trust Certificate
pass-through rate 8.04% 7.93% 7.68% 7.49% 7.13% 6.58% 7.08% 6.43%
Overcollateralization requirements:
Required Percentages:
Initial 0.90% 0.75% 1.00% 1.00% 0.50% 0.50% 1.00% 1.00%
Final target 5.95% 5.95% 5.50% 5.00% 5.00% 5.00% 5.00% 5.00%
Stepdown overcollateralization 11.90% 11.90% 11.00% 10.00% 10.00% 10.00% 10.00% 10.00%
Required Amounts:
Initial $ 3 $ 2 $ 2 $ 2 $ 1 $ 1 $ 1 $ 2
Final target 18 14 12 11 11 9 4 10
Current Status:
Overcollateralization amount $ 2 $ 4 $ 6 $ 7 $ 9 $ 9 $ 4 $ 10
Final target reached or
anticipated date to reach 1/2002 1/2002 5/2001 2/2001 12/2000 Yes Yes Yes
Stepdown reached or anticipated
date to reach 3/2004 1/2004 9/2003 7/2003 12/2002 7/2002 2/2001 2/2001
Annual surety wrap fee 0.21% 0.19% 0.21% 0.21% 0.19% 0.19% 0.20% 0.20%
Servicing rights:
Original Balance $ 10 $ 10 $ 10 $ 10 $ 10 $ 8 $ 3 $ 7
Current Balance 10 10 9 9 9 6 2 5
na = not applicable
44
1998-2 1998-1 1997-2 1997-1 1996-2 1996-1
------ ------ ------ ------ ------ ---------
Original balance of loans securitized:
Business loans $ 15 $ 16 $ 23 $ 22 $ 16 $ 13
Home equity loans 105 89 77 53 24 9
Total 120 105 100 75 40 22
Current balance of loans securitized:
Business loans $ 12 $ 10 $ 15 $ 10 $ 7 $ 5
Home equity loans 69 53 36 21 7 4
Total 81 63 51 31 14 9
Weighted average coupon on loans securitized:
Business loans 15.92% 15.95% 15.90% 15.90% 15.98% 15.83%
Home equity loans 10.76% 11.09% 11.59% 11.44% 11.30% 10.61%
Total 11.46% 11.90% 12.85% 12.94% 13.42% 13.55%
Percentage of first mortgage loans 86% 79% 72% 70% 69% 69%
Weighted average loan-to-value 77% 74% 72% 70% 67% 66%
Weighted average remaining term(months)
on loans securitized 213 202 195 171 142 139
Original balance of Trust Certificates $ 118 $ 103 $ 98 $ 73 $ 39 $ 22
Current balance of Trust Certificates $ 69 $ 53 $ 40 $ 25 $ 10 $ 6
Weighted average pass-through interest
rate to Trust Certificate holders 6.47% 6.68% 6.74% 7.37% 7.53% 7.95%
Highest Trust Certificate
pass-through rate 6.85% 7.15% 7.13% 7.53% 7.53% 7.95%
Overcollateralization requirements:
Required Percentages:
Initial 1.50% 1.50% 2.00% 3.00% 3.00% -
Final target 5.00% 5.50% 7.00% 8.00% 10.00% 7.00%
Stepdown overcollateralization 10.00% 11.00% 14.00% 16.00% 20.00% na
Required Amounts:
Initial $ 2 $ 2 $ 2 $ 2 $ 1 -
Final target 6 6 7 6 4 2
Current Status:
Overcollateralization amount $ 6 $ 6 $ 6 $ 5 $ 2 $ 2
Final target reached or
anticipated date to reach Yes Yes Yes Yes Yes Yes
Stepdown reached or anticipated
date to reach 4/2001 11/2000 Yes Yes Yes na
Annual surety wrap fee 0.22% 0.23% 0.26% 0.26% 0.28% na
Servicing rights:
Original Balance $ 4 $ 4 $ 4 $ 3 $ 2 $ 2
Current Balance 3 3 2 2 1 1
na = not applicable
*In July 2000 we satisfied a mortgage securitization prefund requirement of
$67.9 million.
45
Gains on sale of loans and leases through securitizations represent the
difference between our net proceeds and the allocated cost of loans and leases
securitized. The allocated cost of the loans and leases securitized is
determined by allocating their net carrying value between the loans and leases
securitized, the interest-only strips and the servicing rights retained, based
upon their relative fair values.
The calculation of the fair value of interest-only strips is based upon
a discounted cash flow analysis which estimates the present value of the future
expected excess cash flows utilizing assumptions made by management at the time
loans are sold. These original assumptions include the rate used to calculate
the present value of expected future cash flows, referred to as the discount
rate, the rates of prepayment and credit loss rates on the pool of loans. The
prepayment rate of loans may be affected by a variety of economic and other
factors, including prevailing interest rates and the availability of alternative
financing to borrowers. The effect of those factors on loan prepayment rates may
vary depending on the type of loan. Estimates of prepayment rates and credit
loss rates are made based on management's expectation of future experience,
which are based, in part, on the historical experience and in the case of
prepayment rate assumptions, consideration of the impact of changes in market
interest rates. Our interest-only strips and servicing rights are periodically
evaluated based upon the present value of the expected future cash flows from
our interest-only strips and servicing rights related to the loans remaining in
the trusts. The current assumptions for prepayment and credit loss rates are
monitored against actual experience and would be adjusted if necessary.
In fiscal 2000, a write down of $12.6 million was recorded on our
interest-only strips. The write down included a charge of $11.2 million related
to an increase from 11% to 13% in the discount rate used to value our
interest-only strips. This change in the discount rate was considered a
permanent fair value adjustment and was recorded as expense in fiscal 2000. The
write down also included a charge of $1.9 million for the impact of changes in
one-month LIBOR deemed to be permanent. A portion of the certificates issued to
investors by securitization trusts have floating interest rates based on
one-month LIBOR plus a spread. The fair value of the excess cash flow we will
receive from these trusts would be affected by any changes in rates paid on the
floating rate certificates. See "Interest Rate Risk Management - Interest-only
Strips and Servicing Rights" for a discussion of the impact of one-month LIBOR.
Additionally, the write down included a credit of $0.5 million for the net
favorable impact of adjustments made to the prepayment assumptions on mortgage
loan securitizations to reflect actual experience at June 30, 2000.
We use a discount rate which we believe is commensurate with the risks
involved in our securitization assets. While quoted market prices on comparable
interest-only strips are not available, we have performed comparisons of our
valuation assumptions and performance experience to others in the
non-conventional mortgage industry. We quantify the risks in our securitization
assets by comparing the asset quality and performance experience of the
underlying securitized mortgage pools to comparable industry performance. We
believe that the practice of many companies in the non-conventional mortgage
industry has been to add a spread for risk to the all-in cost of securitizations
to determine their discount rate. From these experience comparisons, we have
determined a spread, which is added to the all-in cost of our mortgage loan
securitization trusts' investor certificates. The 13% discount rate considers
our
46
higher asset quality and performance of our securitized assets compared to
industry asset quality and performance and the other characteristics of our
securitized loans described below:
o Underlying loan collateral with fixed yields, which are higher than
others in the non-conventional mortgage industry. The average
coupons of our securitized loans exceed the industry average by 100
basis points or more. All of our loans have fixed interest rates,
which are more predictable than adjustable rate loans.
o Most of our loans include prepayment fees. Approximately 90% to 95%
of our business purpose loans have prepayment fees. Approximately
85% to 90% of our home equity loans have prepayment fees. Our
experience indicates that prepayment fees increase the prepayment
ramp periods and slow annual prepayment speeds, which have the
effect of increasing the life of the loans securitized.
o A portfolio mix of 80-85% first mortgage loans and 15-20% second
mortgage loans. The high proportion of first mortgages results in
lower delinquencies and losses.
o A portfolio credit grade mix comprised of 62% A credits, 22% B
credits, 13% C credits, and 3% D credits. In addition, our loss
experience is below what is experienced by others in the
non-conventional mortgage industry.
The increase in the discount rate reflects the overall sustained
increase in market interest rates experienced in fiscal 2000 including increases
in the all-in cost of the mortgage loan securitization trusts' investor
certificates, and increases in the costs of our funding.
The all-in cost of the trusts' investor certificates includes the
highest trust certificate pass through interest rate in each mortgage
securitization, trustee fees, and surety fees. Trustee fees and surety fees are
deal specific and generally range from 19 to 22 basis points combined.
Prior to fiscal year 2000, our actual prepayment experience both
quantitatively and qualitatively was not sufficient to conclude that the final
actual experience expected would be materially different than the original
prepayment assumptions used. For each of the first three-quarters of fiscal year
2000, the net effect of the differences between the prepayment assumptions and
the actual experience was not material. Because we were continuing to accumulate
more complete and accurate statistics, and the impact of differences between the
assumptions and actual experience was not material, no adjustments were made to
the prepayment assumptions used in periodic evaluations of interest-only strips
through March 31, 2000. At June 30, 2000, assumptions for prepayments were
adjusted based on actual historical experience. The total effect of the changes
in prepayment assumptions resulted in a favorable adjustment in the fair value
of interest-only strips of $0.5 million.
The initial prepayment rate assumptions beginning with the 1999-1
mortgage loan securitization were changed to reflect a reduction in the annual
prepayment rate assumption on business loans and an increase in the length of
the prepayment ramp period for home equity loans. The length of time before a
pool of mortgage loans reaches its expected annual prepayment rate is referred
to as the "prepayment ramp period." See "Year Ended June 30, 2000 Compared to
Year
47
Ended June 30, 1999 - Gain on Sale of Loans and Leases" for more information
regarding the reasons for the change in initial prepayment assumptions.
The initial credit loss assumptions beginning with the 1999-4 mortgage
loan securitization were increased as a result of an increase in the percentage
of second mortgage loans included in current year securitizations and our
concerns regarding the current high levels of real estate values. As shown on
the table above, "Summary of Selected Mortgage Loan Securitization Trust
Information," the average percentage of first mortgage loans securitized
declined approximately 10% from fiscal 1999 to fiscal 2000 securitizations. The
current high real estate values affected our loss assumptions on recent
securitizations because in the event of an economic downturn, the loan-to-value
ratios of the recently originated loans could be understated. Both of these
factors increase the potential that the underlying real estate collateral would
not be sufficient to satisfy the loan if a foreclosure was required. We believe
these factors may limit our ability in recent securitizations to maintain the
credit loss experience realized in prior securitizations. Actual credit loss
experience for securitizations prior to the 1999-4 mortgage loan securitization
continues to support the initial credit loss assumptions for those
securitizations.
The following table provides information regarding the initial and
current assumptions applied in determining the fair values of mortgage loan
related interest-only strips and servicing rights. The assumptions for
prepayment rates and credit loss rates are compared to actual experience on the
table. At the time of the sales, the initial assumptions for prepayment rates
and credit loss rates were representative of expectations for the securitized
portfolios' performance.
48
Summary of Material Mortgage Loan Securitization Asset Valuation Assumptions and
Actual Experience
2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998-4 1998-3 1998-2
------------------------------------------------------------------------------
Residual interests discount rate:
Initial valuation 13.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation 13.0% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0%
Servicing rights discount rate:
Initial valuation 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%
Prepayment rates:
Initial assumption:
Expected Constant Prepayment Rate(CPR):
Business loans 10% 10% 10% 10% 10% 10% 13% 13% 13%
Home equity loans 24% 24% 24% 24% 24% 24% 24% 24% 24%
Ramp period (months) (a):
Business loans 24 24 24 24 24 24 24 24 24
Home equity loans 24 18 18 18 18 18 12 12 12
Current assumption:
Expected Constant Prepayment Rate(CPR):
Business loans 10% 10% 10% 10% 13% 10% 15% 13% 13%
Home equity loans 24% 24% 24% 24% 24% 24% 24% 24% 24%
Ramp period (months):
Business loans 24 24 24 24 12 12 12 24 24
Home equity loans 24 24 24 24 24 24 24 24 12
CPR adjusted to reflect ramp:
Business loans 3.00% 3.61% 4.52% 5.43% 13.00% 10.00% 15.00% 11.70% 13.00%
Home equity loans 2.00% 3.91% 6.78% 9.65% 12.52% 15.39% 18.26% 21.13% 24.00%
Blended rate 2.10% 3.88% 6.51% 9.13% 12.59% 14.91% 17.91% 20.33% 22.43%
Actual CPR experience:
Business loans - 4.20% 1.18% 4.65% 12.87% 10.37% 14.82% 10.33% 12.85%
Home equity loans - 3.95% 10.66% 9.65% 10.56% 11.32% 12.09% 13.00% 20.46%
Blended rate - 4.16% 9.57% 9.09% 10.81% 11.24% 12.21% 12.78% 18.50%
Credit loss rates:
Annual credit loss rate:
Initial assumption 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Current assumption 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Actual experience - - - 0.01% - 0.03% 0.17% 0.05% 0.18%
Cumulative credit loss rate:
Initial assumption 1.85% 1.85% 1.35% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20%
Current assumption 1.85% 1.85% 1.35% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20%
Cumulative experience to date - - - 0.02% - 0.09% 0.26% 0.06% 0.61%
Servicing fees:
Contractual fees 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Ancillary fees 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 0.75%
1998-1 1997-2 1997-1 1996-2 1996-1
---------------------------------------------
Residual interests discount rate:
Initial valuation 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation 13.0% 13.0% 13.0% 13.0% 13.0%
Servicing rights discount rate:
Initial valuation 11.0% 11.0% 11.0% 11.0% 11.0%
Current valuation 11.0% 11.0% 11.0% 11.0% 11.0%
Prepayment rates:
Initial assumption:
Expected Constant Prepayment Rate(CPR):
Business loans 13% 13% 13% 13% 13%
Home equity loans 24% 24% 24% 24% 24%
Ramp period (months) (a):
Business loans 24 24 24 24 24
Home equity loans 12 12 12 12 12
Current assumption:
Expected Constant Prepayment Rate(CPR):
Business loans 17% 16% 20% 22% 21%
Home equity loans 24% 25% 25% 26% 20%
Ramp period (months):
Business loans 24 24 24 24 24
Home equity loans 12 12 12 12 12
CPR adjusted to reflect ramp:
Business loans 17.00% 16.00% 20.00% 22.00% 21.00%
Home equity loans 24.00% 25.00% 25.00% 26.00% 20.00%
Blended rate 22.84% 22.36% 23.32% 24.19% 20.56%
Actual CPR experience:
Business loans 16.33% 15.80% 19.98% 22.44% 20.75%
Home equity loans 21.77% 24.84% 24.83% 26.34% 19.73%
Blended rate 20.95% 22.57% 23.34% 24.70% 20.31%
Credit loss rates:
Annual credit loss rate:
Initial assumption 0.25% 0.25% 0.25% 0.25% 0.25%
Current assumption 0.25% 0.25% 0.25% 0.25% 0.25%
Actual experience 0.25% 0.13% 0.18% 0.24% 0.09%
Cumulative credit loss rate:
Initial assumption 1.20% 1.20% 1.20% 1.20% 1.20%
Current assumption 1.20% 1.20% 1.20% 1.20% 1.20%
Cumulative experience to date 0.66% 0.44% 1.11% 0.77% 0.62%
Servicing fees:
Contractual fees 0.50% 0.50% 0.50% 0.50% 0.50%
Ancillary fees 0.75% 0.75% 0.75% 0.75% 0.75%
(a) The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected Constant Prepayment Rate. The business loan prepayment
ramp begins at 3% in month one. The home equity loan prepayment ramp begins
at 2% in month one.
49
Although we believe we have made reasonable estimates of prepayment
rates and credit loss assumptions, the actual prepayment and credit loss
experience may materially vary from our estimates. To the extent that
prepayments or credit losses differ materially from the estimates made,
adjustments of our interest-only strips and servicing rights may be required in
accordance with Statement of Financial Accounting Standards No. 115. Levels of
future prepayments and credit loss assumptions higher than those initially
estimated could result in a reduction in the value of interest-only strips and
servicing rights which would adversely affect income in the period of
adjustment. Additionally, some of our securitization trusts have issued floating
rate certificates supported by fixed rate mortgages. The fair value of the
excess cash flow we will receive may be affected by any changes in the rates
paid on the floating rate certificates.
Lease Securitizations. Information related to our two lease
securitizations is presented in the table below. As of December 31, 1999, we
de-emphasized the lease origination business but continue to service the
remaining leases in our managed portfolio.
Summary of Selected Lease Securitization Information
Current Balances as of June 30, 2000
(dollars in millions)
1999-a 1998-a
-------- --------
Original balance of leases securitized.......................... $ 82 $ 80
Current balance of leases securitized........................... $ 57 $ 31
Weighted average yield on leases securitized.................... 11.17% 12.09%
Weighted average remaining term (months) on
on leases securitized...................................... 33 19
Original balance of Trust Certificates.......................... $ 78 $ 76
Current balance of Trust Certificates........................... $ 54 $ 28
Weighted average pass-through interest rate
to Trust Certificate holders............................... 6.55% 6.15%
Overcollateralization requirements.............................. 3% 3%
Annual surety wrap fee.......................................... 0.29% 0.29%
Valuation Assumptions
Residual interests discount rate:
Initial valuation............................................ 11.0% 11.0%
Current valuation............................................ 13.0% 13.0%
Servicing rights discount rate:
Initial valuation............................................ 11.0% 11.0%
Current valuation............................................ 11.0% 11.0%
Prepayment rates............................................. (a) (a)
Credit loss rates:
Annual credit loss rate:
Initial assumption......................................... 0.50% 0.50%
Current assumption......................................... 0.50% 0.50%
Actual experience.......................................... 0.45% 0.63%
Servicing Fees:
Contractual fees............................................. 0.50% 0.50%
Ancillary fees .............................................. 0.30% 0.30%
(a) The equipment leasing portfolio has experienced insignificant prepayments,
less than 1.5% annualized. Should a lease terminate early, any impact on the
valuation of lease securitization assets would be recorded upon termination
of the lease.
50
Servicing Rights. When loans or leases are sold through a
securitization, the servicing on the loans or leases is retained and we
capitalize the benefit associated with the rights to service securitized loans
and leases based on those servicing rights relative fair value to other
consideration received in the securitization. We receive annual contractual
servicing fees of 50 basis points which is paid out of accumulated mortgage loan
payments before payments of principal and interest are made to trust certificate
holders, prepayment fees, late charges, non-sufficient funds fees and other fees
which are retained directly by us as servicer as payments are collected from the
borrowers.
Fair value of servicing rights is determined by computing the present
value of projected net cash flows from contractual servicing fees and ancillary
servicing fees as described above, net of costs to service expected to be
received over the life of the loans or leases securitized. These projections
incorporate assumptions, including prepayment rates, credit loss rates and
discount rates. These assumptions are similar to those used to value the
interest-only strips retained in a securitization. Periodically, capitalized
servicing rights are evaluated for impairment, which is measured as the excess
of unamortized cost over fair value. Interest rates are not considered as a
predominant risk characteristic for purposes of evaluating impairment. We have
generally found that the non-conforming mortgage market is less sensitive to
changes in interest rates than the conventional mortgage market where borrowers
have more favorable credit history for the following reasons. First, there are
relatively few lenders willing to supply credit to non-conforming borrowers
which limits those borrowers' opportunity to refinance. Second, interest rates
available to non-conforming borrowers tend to adjust much slower than
conventional mortgage rates which reduces the non-conforming borrowers'
opportunity to capture economic value from refinancing. Also, a majority of
loans to our borrowers require prepayment fees. As a result, the prepayment
experience on our managed portfolio is more stable than the mortgage market in
general. This stability favorably impacts our ability to value the future cash
flows from our servicing rights and interest-only strips because it increases
the predictability of future cash flows.
As a result of adjustments to prepayment assumptions to reflect actual
experience on earlier mortgage loan securitizations, a servicing rights write
down of $0.7 million was recorded in fiscal 2000. At June 30, 2000, servicing
rights totaled $74.9 million, compared to $43.2 million at June 30, 1999.
51
Results of Operations
Summary Financial Results
(Dollars in thousands, except per share data)
Year Ended June 30, Percentage Change
---------------------------- ------------------
2000 1999 1998 '00/'99 '99/'98
-------- ------- ------- ------- -------
Total revenues......................... $130,646 $86,424 $59,335 51.2% 45.7%
Total expenses......................... $120,284 $64,573 $41,445 86.3% 55.8%
Net income............................. $6,424 $14,088 $11,455 (54.4)% 23.0%
Return on average equity............... 10.29% 28.10% 31.10%
Return on average assets............... 1.31% 4.56% 6.93%
Earnings per share:
Basic................................ $ 1.88 $ 3.83 $3.10 (50.9)% 23.5%
Diluted.............................. $ 1.83 $ 3.72 $2.98 (50.8)% 24.8%
Dividends declared per share........... $ 0.30 $ 0.165 $0.06
Overview
For fiscal 2000, net income decreased $7.7 million, or 54.4%, to $6.4
million from $14.1 million for 1999. Basic earnings per share decreased $1.95,
to $1.88 for year ended June 30, 2000, on average common shares of 3,424,000,
compared to $3.83 on average common shares of 3,682,000 for fiscal 1999. Diluted
earnings per share decreased $1.89, to $1.83 for year ended June 30, 2000, on
average common shares of 3,509,000 compared to $3.72 on average common shares of
3,791,000 for fiscal 1999.
Increases in gain on sale of loans and leases, interest accretion on
interest-only strips and servicing income were offset by increases in expenses
including a $12.6 million write down of our interest-only strips primarily due
to an increase in the discount rate used to value the interest-only strips from
11% to 13%. This change in the discount rate was considered a permanent fair
value adjustment and was recorded as expense in fiscal 2000. The write down also
included a charge of $1.9 million for the impact of changes in one-month LIBOR
deemed to be permanent. A portion of the certificates issued to investors by
securitization trusts have floating interest rates based on one-month LIBOR plus
a spread. The fair value of the excess cash flow we will receive from these
trusts would be affected by any changes in rates paid on the floating rate
certificates. The write down included a credit of $0.5 million for the net
impact of adjustments made to the prepayment assumptions on mortgage loan
securitizations at June 30, 2000. See "Securitization Accounting Considerations"
for a discussion of the discount rate and prepayment assumptions. See "Interest
Rate Risk Management - Interest-only Strips and Servicing Rights" for a
discussion of the impact of one-month LIBOR. See "Year Ended June 30, 2000
Compared to Year Ended June 30, 1999" for a more detailed discussion of results
of operations.
52
Average common share and earnings per common share amounts for fiscal
1999 and prior have been retroactively adjusted to reflect the effect of a 5%
stock dividend declared August 18, 1999. See note 10 in the consolidated
financial statements for further description.
Dividends of $0.30 per share were paid for year ended June 30, 2000
compared to dividends of $0.165 per share for year ended June 30, 1999. In the
first quarter of fiscal year 2000, we increased our quarterly dividend by 40.0%
to $0.07 per share and by an additional 14.3% to $0.08 per share in January
2000. The common dividend payout ratio based on diluted earnings per share was
16.4% for year ended June 30, 2000 compared to 4.2% for fiscal 1999.
As previously reported, our Board of Directors authorized the
repurchase of up to 10% of the outstanding shares of our common stock. On
January 24, 2000, the Board of Directors authorized the repurchase of an
additional 338,000 shares, representing 10.0% of the then outstanding shares.
Our Board of Directors initiated the stock repurchase program in view of the
price level of our common stock which was trading at that time at below book
value and its consistent earnings growth over fiscal 1998 and 1999, which did
not result in a corresponding increase in the market value of our common stock.
In fiscal 2000, 328,000 shares were repurchased representing 9% of the
outstanding shares. The impact of the share repurchase program was an increase
of diluted earnings per share by approximately $0.06 for the year ended June 30,
2000.
Our business strategy is dependent upon our ability to increase loan
origination volume through both geographic expansion and growth in current
markets to realize efficiencies in the infrastructure and loan production
channels we have been building. The implementation of this strategy will depend
in large part on a variety of factors outside of our control, including, but not
limited to, the ability to obtain adequate financing on favorable terms and
profitably securitize loans on a regular basis and continue to expand in the
face of increasing competition. Our failure with respect to any of these factors
could impair our ability to successfully implement our growth strategy, which
could adversely affect our results of operations and financial condition. See
"Risk Factors - If we are unable to continue to successfully implement our
growth strategy, our revenues may decrease."
Year Ended June 30, 2000 Compared to Year Ended June 30, 1999
Total Revenues. Total revenues increased $44.2 million, or 51.2%, to
$130.6 million for fiscal 2000 from $86.4 million for fiscal 1999. Growth in
total revenues was the result of increases in gains on securitizations of
mortgage loans, increases in interest accretion earned on our interest-only
strips, increases in interest and fees on loans originated, and increases in
servicing income due to the growth of the total managed portfolio.
Gain on Sale of Loans and Leases. Gains of $90.4 million were recorded
on the securitization of $1.0 billion of loans for fiscal 2000. This represented
an increase of $25.9 million, or 40.1%, over gains of $64.5 million recorded on
securitizations of $777.5 million of loans and leases for fiscal 1999.
53
The following schedule details the volume of loan and lease
securitizations during the fiscal years ended June 30, 2000, 1999 and 1998 (in
millions):
Year Ended June 30,
-----------------------------------
2000 1999 1998
--------- ------- -------
Securitizations:
Business loans................ $ 104.5 $ 71.9 $ 54.1
Home equity loans............. 887.9 613.0 270.9
Equipment leases.............. 9.3 92.6 59.7
--------- ------- -------
Total...................... $ 1,001.7 $ 777.5 $ 384.7
========= ======= =======
The increase in securitization gains for the year ended June 30, 2000
was primarily due to the higher volume of loans securitized as reflected in the
table above. The securitization gain as a percentage of mortgage loans
securitized, 9.0% for fiscal 2000, was down slightly from 9.1% on mortgage loans
securitized for fiscal 1999. Including less profitable lease securitizations in
fiscal 1999, the securitization gain percentage was 8.3% for that year. The
decrease in the mortgage loan securitization gain percentage for fiscal 2000 was
due to a reduction in the spread between the average pass-through rate paid to
investors, increases in the credit loss assumptions beginning with the 1999-4
mortgage loan securitization, an increase in the discount rate used in the
2000-2 mortgage loan securitization and the impact of the January 1, 1999
adoption of the Statement of Financial Accounting Standards No. 134,
"Accounting for Mortgage Backed Securities Retained After the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise" ("SFAS No. 134").
See "Securitization Accounting Considerations" for more information on the
calculation of securitization gains, the average coupons on loans securitized,
pass-through rates paid to investors and credit loss assumptions. The impact of
SFAS No. 134 is discussed below. These decreases in the gain percentage for
fiscal 2000 were partially offset by a higher percentage of business loans
securitized and a reduction in prepayment rate assumptions as discussed below.
The increase in the initial credit loss assumptions beginning with the
1999-4 mortgage loan securitization resulted from an increase in the percentage
of second mortgage loans included in current year securitizations and our
concerns regarding the current high levels of real estate values. As shown on
the table "Summary of Selected Mortgage Loan Securitization Trust Information"
in "Securitization Accounting Considerations" the average percentage of first
mortgage loans securitized declined approximately 10% from fiscal 1999 to fiscal
2000 securitizations. The current high real estate values affected our loss
assumptions on recent securitizations because in the event of an economic
downturn, the loan-to-value ratios of the recently originated loans could be
understated. Both of these factors increase the potential that the underlying
real estate collateral would not be sufficient to satisfy the loan if a
foreclosure was required. We believe these factors may limit our ability in
recent securitizations to maintain the credit loss experience realized in prior
securitizations. Actual credit loss experience for securitizations prior to the
1999-4 mortgage loan securitization continues to support the initial credit loss
assumptions for those securitizations.
54
The unfavorable impacts of the reduction in spread for fiscal 2000,
increases in credit loss assumptions beginning with the 1999-4 mortgage loan
securitization, and the impact SFAS No. 134 were partially offset by the
following factors:
o A higher percentage of business loans securitized. For fiscal 2000,
business loans securitized, which have a higher coupon than home
equity loans, represented 10.4% of total loans and leases
securitized, compared to 9.2% of total loans and leases securitized
for fiscal 1999. The higher percentage of business loans resulted in
an increased value of the interest-only strips generated from the
pool of securitized loans.
o A reduction in the annual prepayment rate assumption on business
loans and an increase in the length of the prepayment ramp period
for home equity loans. Due to increases in the volume of loans
originated with prepayment fees, we have reduced the annual
prepayment rate assumption on business loans and lengthened the
prepayment ramp period for home equity loans for mortgage loan
securitizations beginning with the 1999-1 securitization. Reducing
the annual prepayment assumption and lengthening the prepayment ramp
period is supported by our experience with loans having prepayment
fees, as discussed below, that fewer borrowers will prepay, and
those prepaying will do so more slowly. The percentage of home
equity loans containing prepayment fees increased from less than 50%
of loans originated to over 85% over the nine-month period ending
October 31, 1998. As a result of this increase in the percentage of
loans originated having prepayment fees, we had lengthened the
initial assumptions used for the prepayment ramp period on home
equity loans from 12 to 18 months beginning with the 1999-1 mortgage
loan securitization through the 2000-1 mortgage loan securitization
and to 24 months for the 2000-2 mortgage loan securitization. This
increase in the length of the prepayment ramp period for home equity
loans was supported by actual cumulative prepayment experience
through June 30, 2000, which demonstrated that only 25% of home
equity loans having prepayment fees were actually prepaid by the
borrowers, while 47% of home equity loans without prepayment fees
were prepaid. This cumulative historical performance demonstrates
that it is nearly twice as likely that a loan without a prepayment
fee will be prepaid. See "Securitization Accounting Considerations"
for a comparison of the prepayment assumptions used in our valuation
of interest-only strips and servicing rights to actual historical
experience.
SFAS No. 134 requires that, after the securitization of a mortgage loan
held for sale, an entity classify the resulting mortgage-backed security or
other retained interests based on its ability and intent to hold or sell those
investments. In accordance with the provisions of SFAS No. 134, as of January 1,
1999, we reclassified our interest-only strips from trading securities to
available for sale securities. As available for sale securities, the difference
on the date of securitization between the fair value of an interest-only strip
and its allocated cost is recorded in stockholders' equity and reported as a
component of comprehensive income. Fair value adjustments of $3.5 million
pre-tax were recorded as a component of comprehensive income for fiscal 2000. In
the first six months of fiscal 1999, which was prior to the adoption of SFAS No.
134 and the resulting reclassification from trading securities to available for
sale securities, all differences on the date of securitization between
55
fair value and allocated cost of interest-only strips were recognized in
securitization gains. In the third and fourth quarters of fiscal 1999 and 2000,
fair value differences were recognized as a component of comprehensive income.
The adoption of SFAS No. 134 did not have a material effect on our financial
condition.
The following schedule details loan and lease originations during the
fiscal years ended June 30, 2000, 1999 and 1998 (in thousands):
Year Ended June 30,
------------------------------------
2000 1999 1998
---------- --------- ---------
Business Purpose Loans ....... $ 106,187 $ 64,818 $ 52,335
Home Equity Loans ............ 991,621 701,339 361,760
Equipment Leases.............. 19,631 96,289 70,480
---------- --------- ---------
$1,117,439 $ 862,446 $ 484,575
========== ========= =========
Loan originations for our subsidiary, American Business Credit, Inc.,
which offers business purpose loans secured by real estate, increased $41.4
million, or 63.8%, to $106.2 million for fiscal 2000 from $64.8 million for
fiscal 1999. This increase was attributable to geographic expansion of American
Business Credit's lending program as well as refocused marketing efforts. In the
third quarter of fiscal 2000, American Business Credit launched a web site,
www.abceasyloan.com in order to increase its distribution channels for business
purpose loans.
Home equity loans originated by our Consumer Mortgage Group, which
includes Upland Mortgage, New Jersey Mortgage and Investment Corp. and
Processing Service Center, Inc., increased $290.3 million, or 41.4%, to $991.6
million for fiscal 2000 from $701.3 million for fiscal 1999. The Consumer
Mortgage Group has redirected its marketing mix to focus on targeted direct
mail, which delivers more leads at a lower cost than broadcast marketing
channels. The Consumer Mortgage Group has continued to phase in advanced
Internet technology through its web site www.UplandMortgage.com. In addition to
the ability to take online loan applications and utilize an automated rapid
credit approval process, both of which reduce time and manual effort required
for loan approval, the site features our proprietary patent-pending Easy Loan
Advisor, which provides personalized services and solutions to retail customers
through interactive web dialog.
Interest and Fee Income. Interest and fee income for fiscal 2000
increased $2.8 million, or 17.2%, to $19.4 million from $16.6 million for fiscal
1999. Interest and fee income consists primarily of interest income earned on
available for sale loans and leases, premiums earned on whole loan sales and
other ancillary fees collected in connection with loan and lease originations.
Interest income remained relatively consistent at $7.2 million for
fiscal 2000 from $7.3 million for fiscal 1999.
Fee income increased $2.9 million, or 31.9%, to $12.2 million from $9.2
million for fiscal 1999. The increase in fee income for fiscal 2000 was the
result of increases in the volume of loans originated during the period. Loan
origination related fees which are mainly comprised of application fees and
other fees collected in connection with the loan approval and closing process
56
increased $3.3 million or 57.0%, for fiscal 2000 from fiscal 1999 mainly due to
a 29.6% increase in loan originations in fiscal 2000 from fiscal 1999.
Included in fee income are premiums earned on whole loan sales.
Premiums on whole loan sales decreased 24.4% to $1.7 million for fiscal 2000,
from $2.3 million for fiscal 1999. The decrease in premium income was due to a
decline in the average premium earned on whole loan sales from 2.2% in fiscal
1999 to 1.4% in the current year, and a decrease in the volume of whole loan
sales from $105.8 million for fiscal 1999, to $102.7 million for fiscal 2000.
Interest Accretion on Interest-Only Strips. Interest accretion
represents the yield component of cash flows received on interest-only strips.
Interest accretion of $16.6 million was recorded for fiscal 2000 and $2.0
million was recorded for fiscal 1999.
We currently use a prospective approach to estimate interest accretion.
Periodically we update estimates of residual cash flow from our securitizations.
When it is probable that there is a favorable change in estimated residual cash
flow from the cash flow previously projected, we recognize a greater percentage
of estimated interest accretion earned by the securitization. Any probable
unfavorable change in estimated residual cash flow would likewise decrease the
percentage of estimated interest accretion earned by the securitization. Any
change in value of the underlying interest-only strip could impact our current
estimate of residual cash flow earned from the securitizations. For example, a
significant change in market interest rates could increase or decrease the level
of prepayments, thereby changing the size of the total managed loan portfolio
and related projected cash flows. See "Securitization Accounting Considerations"
for additional discussion.
Our methodology and assumptions for each period since March 31, 1999
are further described below.
The increase in interest accretion was affected by two factors. First,
the increase reflects growth of $94.4 million or 69.6% in the average balance of
interest-only strips from $135.5 million for fiscal 1999 to $229.9 million for
fiscal 2000 and growth in cash flow received from interest-only strips. Second,
cash flows received on interest-only strips were $49.5 million for fiscal 2000
compared to $32.9 million for fiscal 1999. As of June 30, 1998, only one of our
existing securitizations had satisfied its final target overcollateralization
requirement and was generating residual cash flow. As of June 30 1999, five
securitizations had met final overcollateralization requirements and as of June
30, 2000 nine securitizations had met final overcollateralization requirements.
Meeting these final targets as well as the fact that our more recent
securitizations were much larger resulted in a significant increase in cash flow
to us from fiscal 1998 to the present.
Prior to the fourth quarter of fiscal 1999, residual cash flows to us
were limited due to the lack of maturity of the securitizations underlying our
interest-only strips. As described above, as the securitizations matured,
meaning that the final overcollateralization requirements were met, we received
cash flow from a greater number of securitizations. During the period prior to
receiving significant cash flow from the securitizations, we recognized only a
portion of the estimated interest accretion earned on our interest-only strips.
This methodology reflected our uncertainty as to the timing and quantity of
future residual cash flow. Our estimate of the
57
amount of interest accretion to be recognized did not change until we received
expected cash flow for a sustained period of time. By the last quarter of fiscal
1999, more experience with the securitization pools was acquired and on a
gradual basis more securitizations were performing as expected in meeting their
final targets. At that time, we were realizing consistent cash flow and based on
this historical experience, we recognized a greater percentage of the estimated
interest accretion earned by the securitizations. By the end of the first
quarter of fiscal 2000, as an even greater number of securitizations were
meeting final targets, again, based on the sustained performance of the
securitizations, we increased the percentage of estimated interest accretion
recognized. These increases reflected our increased certainty as to the amount
of ongoing residual cash flow to be received from the securitization trusts.
Throughout fiscal 2000, the interest accretion recognized by quarter as a
percentage of cash flow from the securitization trusts has remained stable.
Servicing Income. Servicing income is comprised of contractual and
ancillary fees collected on securitized loans and leases less amortization of
the servicing rights that are recorded at the time loans and leases are
securitized. Ancillary fees include prepayment fees, late fees and other
servicing compensation. For fiscal 2000, servicing income increased $0.9
million, or 27.6%, to $4.2 million, from $3.3 million for fiscal 1999. A
servicing rights write down of $0.7 million was recorded in fiscal 2000 to
reflect the impact of adjustments to prepayment assumptions on earlier mortgage
loan securitizations to reflect actual prepayment experience.
The following table summarizes the components of servicing income for
the years ended June 30, 2000 and 1999 (in millions):
Year Ended June 30,
---------------------
2000 1999
-------- --------
Contractual and ancillary fees.......... $ 17.1 $ 8.8
Amortization of servicing rights........ (12.2) (5.5)
Servicing rights write down ........... (0.7) -
------- -------
Net servicing income.................... $ 4.2 $ 3.3
======= =======
As an annualized percentage of the average managed portfolio, servicing
income before the fiscal 2000 servicing rights write down was 0.33% compared to
0.39% for 1999. The decrease resulted from a lower percentage of loans prepaying
in fiscal 2000. In fiscal 2000, prepayment fees collected as a percentage of the
average managed portfolio were 0.26% compared to 0.39% for fiscal 1999.
The origination of loans with prepayment fees impacts our servicing
income in two ways. Prepayment fees reduce the likelihood of a borrower
prepaying their loan. This results in prolonging the length of time a loan is
outstanding which increases the contractual servicing fees to be collected over
the life of the loan. Additionally, the terms of our servicing agreements with
the securitization trusts allow us to retain prepayment fees collected from
borrowers as part of our compensation for servicing loans.
Amortization of the servicing rights asset for securitized loans and
leases is calculated individually for each securitization pool and is recognized
in proportion to, and over the period of, estimated future servicing income on
that particular pool of loans or leases. We perform a valuation
58
analysis of servicing rights on a quarterly basis to determine the fair value of
our servicing rights. If our valuation analysis indicates the carrying value of
servicing rights are not recoverable through future cash flows from contractual
servicing and other ancillary fees, a valuation allowance or write down would be
recorded. To date, our valuation analysis has not indicated any impairment other
than the $0.7 million write down recorded in fiscal 2000 and no valuation
allowance has been required. Impairment is measured as the excess of carrying
value over fair value.
Total Expenses. For fiscal 2000, total expenses increased $55.7
million, or 86.3%, to $120.3 million from $64.6 million for fiscal 1999. As
described in more detail below, this increase was a result of increased interest
expense attributable to the sale of subordinated debt and borrowings used to
fund loan and lease originations and increases in employee related costs, sales
and marketing, and general and administrative expenses related to growth in loan
originations, the growth of the total managed portfolio and the continued
building of support area infrastructure and Internet capabilities. In addition a
write down of our interest-only strips of $12.6 million was recorded primarily
as a result of an increase from 11% to 13% in the discount rate used to value
our interest-only strips.
Interest Expense. For the year ended June 30, 2000, interest expense
increased $15.7 million, or 70.0%, to $38.1 million from $22.4 million for
fiscal 1999. The increase was attributable to an increase in the amount of
subordinated debt outstanding during fiscal 2000, the proceeds of which were
used to fund loan originations, operating activities, repayments of maturing
subordinated debt and investments in systems technology and Internet
capabilities required to position us for future growth. Average subordinated
debt outstanding during fiscal 2000 was $286.6 million compared to $156.6
million during fiscal 1999. Average interest rates paid on subordinated debt
outstanding increased to 10.14% during fiscal 2000 from 9.32% during fiscal
1999. Rates offered on subordinated debt increased in response to general
increases in market rates and to attract funds with a longer average maturity.
The average outstanding balances under warehouse and other lines of
credit were $102.7 million during fiscal 2000, compared to $102.6 million during
fiscal 1999. In fiscal 2000, we increased the utilization of proceeds from the
sale of subordinated debt to fund loan originations thereby maintaining a
comparable average warehouse line of credit balance while increasing loan
originations. Borrowings under warehouse lines of credit are secured by mortgage
loans and represent advances of cash to us, usually at 98% of the principal
amount of the mortgage loan used as collateral. These borrowings are for a
limited duration, generally no more than 270 days, pending the ultimate sale of
the mortgage loans through securitization or whole loan sale, either of which
will generate the proceeds necessary to retire the borrowing.
Provision for Credit Losses. An allowance for credit losses for
available for sale loans and leases is maintained primarily to account for loans
and leases that are delinquent and are expected to be ineligible for sale into a
future securitization. The allowance is calculated based upon management's
estimate of the expected collectibility of loans and leases outstanding based
upon a variety of factors, including but not limited to, periodic analysis of
available for sale loans and leases, economic conditions and trends, historical
credit loss experience, borrowers' ability to repay, and collateral
considerations. Although we maintain an allowance for credit losses at the level
we
59
consider adequate to provide for potential losses, there can be no assurances
that actual losses will not exceed the estimated amounts or that an additional
provision will not be required.
The following table summarizes changes in the allowance for credit
losses for the fiscal years ended June 30, 2000, 1999 and 1998 (in thousands):
Year Ended June 30,
--------------------------------
2000 1999 1998
-------- -------- ------
Balance at beginning of period................ $ 702 $ 881 $ 338
Acquired through acquisition................... -- -- 719
Provision for credit losses.................... 2,045 928 491
Charge-offs, net of recoveries................. (1,458) (1,107) (667)
------- ------- -----
Balance at end of period....................... $ 1,289 $ 702 $ 881
======= ======= =====
The following table summarizes net charge-off experience by loan type
for the fiscal years ended June 30, 2000, 1999 and 1998 (in thousands):
Years Ended June 30,
--------------------------------
2000 1999 1998
-------- -------- ------
Business purpose loans.................................. $ 225 $ 301 $ 138
Home equity loans....................................... 85 486 --
Equipment Leases........................................ 1,148 320 529
------- ------ -----
Total................................................... $ 1,458 $1,107 $ 667
======= ======= =====
The increase in charge-offs for fiscal 2000 related to deterioration in
our lease portfolio.
The increase in charge-offs for fiscal 1999 related to the growth in
the total managed portfolio, which increased 110.4% from $559.4 million as of
June 30, 1998 to $1.2 billion as of June 30, 1999, and to loans repurchased from
our securitization trusts. While we are under no obligation to do so, at times
we elect to repurchase some foreclosed and delinquent loans from the
securitization trusts. Under the terms of the securitization agreements,
repurchases are permitted only for foreclosed and delinquent loans and the
purchase prices are at the loans' outstanding contractual balance. Under the
terms of the trust agreements, a foreclosed loan is one where we as servicer
have initiated formal foreclosure proceedings against the borrower and a
delinquent loan is one that is 30 days or more past due. The foreclosed and
delinquent loans we typically elect to repurchase must be 90 days or more
delinquent and are the subject of completed foreclosure proceedings, or where a
completed foreclosure action is imminent. We elect to repurchase loans in
situations requiring more flexibility for the administration and collection of
these loans in order to maximize their economic recovery and to avoid temporary
discontinuations of residual or stepdown overcollateralization cash flows from
securitization trusts. The related charge-offs on these repurchased loans are
included in our provision for credit losses in the period of charge-off. Our
ability to repurchase these loans does not disqualify us for sales accounting
under SFAS No. 125 and other relevant accounting literature because we are not
required to repurchase any loan and our ability to repurchase a loan is limited.
60
The following table summarizes the principal balances of loans we have
repurchased from the mortgage loan securitization trusts for the three years
ended June 30, 2000, 1999 and 1998. All loans were repurchased at the
contractual outstanding balances at the time of repurchase. Mortgage loan
securitization trusts are listed only if loan repurchases were made.
61
Summary of Loans Repurchased from Mortgage Loan Securitization Trusts
(Dollars in thousands)
2000-1 1999-3 1999-1 1998-4 1998-3 1998-2
---------------------------------------------------
Year ended June 30, 2000
Business loans $ - $ 101 $ - $ - $ - $ 827
Home equity loans 167 - - 363 106 2,588
----- ----- ---- ----- ----- -------
Total $ 167 $ 101 $ - $ 363 $ 106 $ 3,415
===== ===== ==== ===== ===== =======
Number of loans repurchased 3 1 - 3 1 24
Year ended June 30, 1999
Business loans $ - $ - $ - $ - $ - $ -
Home equity loans - - 35 15 311 -
----- ----- ---- ----- ----- -------
Total $ - $ - $ 35 $ 15 $ 311 $ -
===== ===== ==== ===== ===== =======
Number of loans repurchased - - 1 1 2 -
Year ended June 30, 1998
Business loans $ - $ - $ - $ - -
Home equity loans - - - - - -
----- ----- ---- ----- ------- -------
Total $ - $ - $ - $ - $ - $ -
===== ===== ==== ===== ===== =======
Number of loans repurchased - - - - - -
1998-1 1997-2 1997-1 1996-2 1996-1 Total
-------------------------------------------------
Year ended June 30, 2000
Business loans $ - $ 153 $ 2,441 $ 337 $ 259 $ 4,118
Home equity loans 165 84 1,123 114 - 4,710
----- ----- ------- ----- ----- -------
Total $ 165 $ 237 $ 3,564 $ 451 $ 259 $ 8,828
===== ===== ======= ===== ===== =======
Number of loans repurchased 1 6 35 6 1 81
Year ended June 30, 1999
Business loans $ 23 $ - $ 51 $ - $ - $ 74
Home equity loans 277 265 344 - 25 1,272
----- ----- ------- ----- ----- -------
Total $ 300 $ 265 $ 395 $ - $ 25 $ 1,346
===== ===== ======= ===== ===== =======
Number of loans repurchased 4 4 6 - 1 19
Year ended June 30, 1998
Business loans $ - $ - $ 33 $ 264 $ - $ 297
Home equity loans - - 57 144 - 201
----- ----- ------- ----- ----- -------
Total $ - $ - $ 90 $ 408 $ - $ 498
===== ===== ======= ===== ===== =======
Number of loans repurchased - - 2 2 - 4
62
The following table summarizes the changes in the allowance for credit losses by
loan and lease type for the fiscal year ended June 30, 2000 (in thousands):
Business Home Equity Equipment
Purpose Loans Loans Leases Total
------------- ----------- --------- --------
Balance at beginning of period........... $ 27 $ 243 $ 432 $ 702
Provision for credit losses.............. 660 350 1,035 2,045
Charge-offs, net of recoveries........... (225) (85) (1,148) (1,458)
----- ----- ------- -------
Balance at end of period................. $ 462 $ 508 $ 319 $ 1,289
===== ===== ======= =======
Employee Related Costs. For fiscal 2000, employee related costs
increased $7.5 million, to $12.8 million, from $5.3 million for fiscal 1999. The
increase was primarily attributable to an increase in the number of staff in the
marketing, loan servicing and other business support areas to support the growth
in loan originations and total managed portfolio. The number of employees was
954 at June 30, 2000 and 894 at June 30, 1999.
Sales and Marketing Expenses. For fiscal 2000, sales and marketing
expenses increased $3.5 million, or 15.9%, to $25.3 million from $21.9 million
for fiscal 1999. Expenses for direct mail advertising increased $6.1 million, or
81.1%, for fiscal 2000 compared to the prior year due to increased use of
targeted direct mail programs for our loan products. These targeted programs are
considered to be more cost effective than the television and radio advertising
campaigns utilized into the second quarter of fiscal 2000. Television and radio
advertising costs decreased by $5.5 million, or 59.9%, for fiscal 2000 compared
to the prior year. In addition, we increased the use of newspaper and periodical
advertising by $1.2 million to generate additional sales of our loan products
and subordinated debt securities. The remaining increase in sales and marketing
expense was due to increased expenditures on various Internet and short-term
telemarketing programs undertaken by the loan origination operations and
expenditures for various corporate communications and initiatives. Subject to
market conditions, we plan to selectively increase the funding for advertising
in markets where we believe we can generate significant additional increases in
loan originations and sales of subordinated debt securities.
General and Administrative Expenses. For fiscal 2000, general and
administrative expenses increased $15.3 million, or 108.9%, to $29.3 million
from $14.0 million for fiscal 1999. The increase was primarily attributable to
increases in rent, telephone, office supplies and equipment, expenses associated
with real estate owned, professional fees, investments in systems and technology
and other expenses incurred as a result of the previously discussed growth in
loan originations, the volume of total loans and leases managed during fiscal
2000 and the continued building of support area infrastructure and Internet
capabilities.
Interest-Only Strips Fair Value Adjustment. In fiscal 2000, a write
down of $12.6 million was recorded on our interest-only strips. The write down
included a charge of $11.2 million related to an increase from 11% to 13% in the
discount rate used to value our interest-only strips. This change in the
discount rate was considered a permanent fair value adjustment and was recorded
as expense in fiscal 2000. The write down also included a charge of $1.9
63
million for the impact of changes in one-month LIBOR deemed to be permanent. A
portion of the certificates issued to investors by securitization trusts have
floating interest rates based on one-month LIBOR plus a spread. The fair value
of the excess cash flow we will receive from these trusts would be affected by
any changes in rates paid on the floating rate certificates. The write down
included a credit of $0.5 million for the net impact of adjustments made to the
prepayment assumptions on mortgage loan securitizations at June 30, 2000. The
fair value of our interest-only strips at June 30, 2000 was $277.9 million. See
"Securitization Accounting Considerations" for a discussion of the discount rate
and prepayment assumptions. See "Interest Rate Risk Management - Interest-only
Strips and Servicing Rights" for a discussion of the impact of one-month LIBOR.
Provision for Income Taxes. In fiscal 2000, our effective tax rate
increased to 38.0% from 35.5% in fiscal 1999 due to increased state tax
liabilities. As a result of our geographic expansion, we have increased the
number of states we are now doing significant business in and have increased our
tax provision for additional tax liabilities in certain states.
Year Ended June 30, 1999 Compared to Year Ended June 30, 1998
Total Revenues. Total revenues increased $27.1 million, or 45.7%, to
$86.4 million for fiscal 1999 from $59.3 million for fiscal 1998. The increase
was primarily attributable to increases in gains on sale of loans and leases
through securitizations, increases in interest accretion on interest-only strips
and servicing income.
Gain on Sale of Loans and Leases. For fiscal 1999, gains of $64.5
million were recorded on the securitization of $777.5 million of loans and
leases. This is an increase of $23.7 million, or 58.1%, over gains of $40.8
million recorded on securitizations of $384.7 million of loans and leases for
fiscal 1998.
The increase in securitization gains for fiscal 1999 was primarily due
to the higher volume of loans securitized. The securitization gain as a
percentage of mortgage loans securitized, 9.1% for fiscal 1999, was down from
12.3% on mortgage loans securitized for fiscal 1998. Including leases
securitized, the gain percentages on loans and leases securitized for the fiscal
years ended June 30, 1999 and 1998 were 8.3% and 10.6%, respectively. The
decrease in the gain percentage on mortgage loans securitized for fiscal 1999
was primarily due to a reduction in the spread between the average coupon on
loans securitized and the pass-through rate paid to investors, a lower
percentage of business loans securitized for fiscal 1999, and the impact of the
January 1, 1999 adoption of SFAS No. 134. For fiscal 1999, business loans
securitized, which have a higher coupon than home equity loans, represented
10.5% of total loans securitized, compared to 16.6% of total loans securitized
for fiscal 1998. The lower percentage of business loans securitized resulted in
a reduced value of the interest-only strips generated from the pool of
securitized loans. See "Securitization Accounting Considerations" for more
detail on average coupons on loans securitized and pass-through rates paid to
investors. The impact of SFAS No. 134 is discussed below.
The unfavorable impacts of the reduction in spread for fiscal 1999, a
lower percentage of business loans securitized for fiscal 1999, and the impact
of SFAS No. 134 were partially offset
64
by a reduction in the annual prepayment rate assumption on business loans and an
increase in the length of the prepayment ramp period for home equity loans. Due
to increases in the volume of loans originated with prepayment fees, we have
reduced the annual prepayment rate assumption on business loans and lengthened
the prepayment ramp period for home equity loans for mortgage loan
securitizations beginning with the 1999-1 securitization. See "Year Ended June
30, 2000 Compared to Year Ended June 30, 1999" for further explanation of the
reduction in the annual prepayment rate assumption on business loans and the
increase in the length of the prepayment ramp period for home equity loans.
SFAS No. 134 requires that, after the securitization of a mortgage loan
held for sale, an entity classify the resulting mortgage-backed security or
other retained interests based on its ability and intent to hold or sell those
investments. In accordance with the provisions of SFAS No. 134, as of January 1,
1999, we reclassified our interest-only strips from trading securities to
available for sale securities. As available for sale securities, the difference
on the date of securitization between the fair value of an interest-only strip
and its allocated cost is recorded in stockholders' equity and reported as a
component of comprehensive income. Fair value adjustments of $5.8 million
pre-tax were recorded as a component of comprehensive income in the third and
fourth quarters of fiscal 1999. In fiscal 1998, which was prior to the adoption
of SFAS No. 134 and the resulting reclassification from trading securities to
available for sale securities, all differences on the date of securitization
between fair value and allocated cost of interest-only strips were recognized in
securitization gains.
Interest and Fee Income. Interest and fee income was $16.6 million for
fiscal 1999, a decrease of $0.8 million, or 4.8% from fiscal 1998. Interest and
fee income consists primarily of income earned on available for sale loans and
leases, premiums earned on whole loan sales and other ancillary fees collected
in connection with loan and lease originations.
Interest income decreased $3.1 million, or 29.5%, to $7.4 million for
fiscal 1999 as compared to $10.5 million for fiscal 1998. This decrease was
primarily attributable to a reduction in the duration of time available for sale
loans accrued interest income prior to securitization and a reduction in the
average coupon earned on loans and leases originated, from 11.63% in fiscal 1998
to 11.30% in fiscal 1999. The decline in the average coupon in fiscal 1999
primarily resulted from competitive pricing in the home equity lending market.
Fee income increased $2.3 million, or 34.2%, to $9.2 million for fiscal
1999 from $6.9 million for fiscal 1998. The increase in fee income was due to an
increase in ancillary fees earned in connection with increased originations. An
increase in loan and lease origination related fees, which are primarily
comprised of application fees and other fees collected in connection with the
loan and lease approval and closing process, of $2.8 million was partially
offset by a decrease in premiums on whole loan sales.
Premiums on whole loan sales decreased 15.7% to $2.3 million for the
fiscal year ended June 30, 1999 from $2.7 million for fiscal year ended June 30,
1998. The decrease in premiums on whole loan sales for fiscal 1999 was due to a
decrease in the average premium earned on whole loan sales. For fiscal 1998, the
average premium earned on whole loan sales was 5.2% compared to 2.2% in fiscal
1999. The decrease was due to general market corrections in the
65
whole loan sale market where purchasers of whole loans were no longer willing to
pay the level of premiums previously earned. The decrease in the average premium
earned was partially offset by a 105.0% increase in the volume of whole loan
sales in fiscal 1999 to $105.8 million from $51.6 million during fiscal 1998.
Interest Accretion on Interest-Only Strips. Interest accretion
represents the interest component of cash flows received on interest-only
strips. Interest accretion of $2.0 million was recorded for fiscal 1999 compared
to $0.5 for fiscal 1998. The increase in interest accretion reflects the growth
in the average balance of interest-only strips of 111.4%, or $135.5 million for
the year ending June 30, 1999 from $64.1 million for the year ending June 30,
1998 and growth in cash flow received on interest-only strips. Cash flows
received on interest-only strips were $32.9 million for fiscal 1999, compared to
$13.4 million for fiscal 1998. Because of the cash flow performance of the
interest-only strips, we began to recognize greater amounts of accretion in the
fourth quarter of fiscal 1999. See "Year Ended June 30, 2000 Compared to Year
Ended June 30, 1999" for further explanation of the increase in the amounts of
accretion recognized in fiscal 1999.
Servicing Income. Servicing income is comprised of contractual and
ancillary fees collected on securitized loans and leases, less amortization of
the servicing rights recorded at the time the loans and leases are securitized.
Servicing income increased $2.8 million, or 597.7%, to $3.3 million for fiscal
1999, from $0.5 million for fiscal 1998. This increase resulted from the higher
average total managed portfolio, which was $915.8 million during fiscal 1999
compared to $368.0 million during fiscal 1998, an increase of 148.9%. As a
percentage of the average managed portfolio, servicing income increased to 0.36%
for fiscal 1999, from 0.13% for fiscal 1998, as a result of the increase in the
origination of loans with prepayment fees and the collection of other ancillary
fees. The origination of loans with prepayment fees increases our servicing
income in two ways. Prepayment fees reduce the likelihood of borrowers prepaying
their loans. This results in prolonging the period these loans are outstanding
which increases the contractual servicing fees collected over the life of the
loans. Additionally, the terms of our servicing agreements with securitization
trusts allow us to retain prepayment fees collected from borrowers as part of
our compensation for servicing loans. As a result, if a borrower does prepay a
loan, we are compensated for the loss of the remaining contractual servicing
fees that would have been collected over the remaining term of the loan by
receiving a lump sum fee at the time the prepayment occurs.
Total Expenses. Total expenses increased $23.1 million, or 55.8%, to
$64.6 million for fiscal 1999, from $41.4 million for fiscal 1998. As described
in more detail below, this increase was primarily a result of higher interest
expense attributable to sales of subordinated debt securities and borrowings
used to fund loan and lease originations and increases in sales and marketing,
and general and administrative expenses. These increases related to the growth
in loan and lease originations, the growth in the total managed portfolio and
the continued building of support area infrastructure to support the increases
in originated and managed portfolios.
66
Interest Expense. Interest expense increased $9.2 million, or 70.0%, to
$22.4 million for fiscal 1999 from $13.2 million for fiscal 1998. The increase
was attributable to an increase in the amount of subordinated debt outstanding
during fiscal 1999, the proceeds of which were used to fund operating
activities, repayments of maturing subordinated debt and investments in
operations required to position us for future growth, and the interest costs
related to greater utilization of warehouse and credit line facilities to fund
loan and lease originations. Average subordinated debt outstanding during fiscal
1999 was $156.6 million compared to $85.8 million during fiscal 1998. Average
interest rates paid on outstanding subordinated debt increased to 9.32% for
fiscal 1999 from 9.23% for fiscal 1998 due to increases in the rates offered on
subordinated debt in order to respond to general increases in market rates and
to attract additional funds. The average outstanding balances under warehouse
and other credit lines were $102.6 million during fiscal 1999, compared to $57.6
million during fiscal 1998.
Provision for Credit Losses. The provision for credit losses for fiscal
1999 was $0.9 million, compared to $0.5 million for fiscal 1998. An allowance
for credit losses for available for sale loans and leases is maintained
primarily to account for loans and leases that are delinquent and are expected
to be ineligible for sale into a future securitization. The allowance for credit
losses was $0.7 million at June 30, 1999 as compared to $0.9 million at June 30,
1998.
The following table summarizes the changes in the allowance for credit
losses by loan and lease type for the fiscal year ended June 30, 1999 (in
thousands):
Home
Business Equity Equipment
Purpose Loans Loans Leases Total
-------------- ------ --------- --------
Balance at beginning of period................ $ 49 $ 433 $ 399 $ 881
Provision for credit losses.................... 278 296 354 928
Charge-offs, net of recoveries................. (301) (486) (320) (1,107)
------- ------ ------ --------
Balance at end of period....................... $ 26 $ 243 $ 433 $ 702
======= ====== ====== ========
Net charge-offs increased $0.4 million to $1.1 million in fiscal 1999
primarily due to the growth in the total managed portfolio, which increased
110.4% from $559.4 million as of June 30, 1998 to $1.2 billion as of June 30,
1999, and to loans repurchased from our securitization trusts. While we are
under no obligation to do so, at times we elect to repurchase some foreclosed
and delinquent loans from the securitization trusts. Under the terms of the
securitization agreements, repurchases are permitted only for foreclosed and
delinquent loans and the purchase prices are at the loans' outstanding
contractual balance. We elect to repurchase loans in situations requiring more
flexibility for the administration and collection of these loans in order to
maximize their economic recovery and to avoid temporary discontinuations of
residual or stepdown overcollateralization cash flows from securitization
trusts. The related charge-offs on these repurchased loans are included in our
provision for credit losses in the period of charge-off.
Employee Related Costs. Employee related costs increased $0.3 million,
or 5.7% to $5.3 million for fiscal 1999 from $5.0 million for fiscal 1998. The
increase was primarily the result of additions to staff in support of the
increased marketing efforts, loan and lease originations and servicing
activities. The number of employees at June 30, 1999 and 1998 were 894 and 638
67
respectively. Management anticipates that these expenses will continue to
increase in the future as our expansion continues and loan and lease
originations continue to increase.
Sales and Marketing Expenses. Sales and marketing expenses increased
$7.7 million, or 54.2%, to $21.9 million for fiscal 1999 from $14.2 million for
fiscal 1998. The increases were primarily attributable to targeted television
and radio advertising related to home equity loans and advertising costs
resulting from increased newspaper and direct mail advertising related to sales
of subordinated debt and loan products. During fiscal 1999, targeted television
advertising was intensified in Chicago, Florida and Georgia. Subject to market
conditions, we plan to continue to expand our service area throughout the United
States. As a result, it is anticipated that sales and marketing expenses will
continue to increase in the future.
General and Administrative Expenses. General and administrative
expenses increased $5.5 million, or 64.7%, to $14.0 million for fiscal 1999 from
$8.5 million for fiscal 1998. The increase was primarily attributable to
increases in rent, telephone, office expenses, professional fees and other
expenses incurred as a result of previously discussed increases in loan and
lease originations and in the volume of total loans and leases managed during
fiscal 1999 and the continued building of support area infrastructure to support
the increases in originations and the total managed portfolio.
Income Taxes. Income taxes increased $1.4 million, or 20.6%, to $7.8
million for fiscal 1999 from $6.4 million for fiscal 1998 due to an increase in
income before income taxes. The effective tax rate for fiscal 1999 was 35.5%,
compared to 36% for fiscal 1998.
68
Financial Condition
Balance Sheet Information
(in thousands, except per share data)
June 30,
---------------------------------------------
2000 1999 1998
--------- --------- --------
Cash and cash equivalents................................. $ 69,751 $ 22,395 $ 4,486
Loan and lease receivables, net:
Available for sale..................................... 44,132 33,776 62,382
Other.................................................. 13,002 6,863 4,096
Interest-only strips...................................... 277,872 178,218 95,913
Servicing rights.......................................... 74,919 43,210 18,472
Receivable for sold loans and leases...................... 51,283 66,086 2,377
Total assets.............................................. 592,668 396,301 226,551
Subordinated debt......................................... 390,676 211,652 112,182
Warehouse lines and other notes payable................... 50,842 58,691 32,403
Total liabilities......................................... 530,553 338,055 183,809
Total stockholders' equity................................ 62,115 58,246 42,742
Book value per common share............................... 18.69 16.24 11.55
Debt to tangible equity(a)(d)............................. 11.64x 7.83x 6.94x
Adjusted debt to tangible equity(b)(d).................... 8.27x 7.01x 5.32x
Subordinated debt to tangible equity(d)................... 8.6x 4.9x 4.2x
Interest-only strips to adjusted
tangible equity(c)(d).................................. 2.6x 2.5x 2.2x
- --------------
(a) Total liabilities to tangible equity.
(b) Total liabilities less cash and secured borrowings to tangible equity.
(c) Interest-only strips less overcollateralization interests to tangible equity
plus subordinated debt with a remaining maturity greater than five years.
(d) Tangible equity is calculated as total stockholders' equity less goodwill.
June 30, 2000 Compared to June 30, 1999
Total assets increased $196.4 million, or 49.6%, to $592.7 million at
June 30, 2000 from $396.3 million at June 30, 1999 due primarily to increases in
interest-only strips, cash and cash equivalents and servicing rights.
Cash and cash equivalents increased $47.4 million, or 211.5% to $69.8
million at June 30, 2000 from $22.4 million at June 30, 1999 primarily due to
receipts from sales of subordinated debt securities.
69
Interest-only strips increased $99.7 million, or 55.9%, to $277.9
million at June 30, 2000 from $178.2 million at June 30, 1999. During fiscal
2000, $1.0 billion in loan and lease securitizations were completed resulting in
the recognition of $111.7 million of interest-only strips. Activity of our
interest-only strips for fiscal 2000 and 1999 were as follows (dollars in
thousands):
2000 1999
---------- ---------
Balance at beginning of year $ 178,218 $ 95,913
Initial recognition of
Interest-only strips, including initial
overcollateralization of $11,232 and $4,825,
respectively 111,714 93,175
Required purchases of additional overcollateralization 29,925 16,682
Interest accretion and other 16,616 2,021
Cash flow from interest-only strips (49,508) (32,927)
Net temporary adjustments to fair value 3,510 3,354
Permanent fair value adjustment (12,603) --
--------- ---------
Balance at end of year $ 277,872 $ 178,218
========= =========
In fiscal 2000, a write down of $12.6 million was recorded on our
interest-only strips. The write down included a charge of $11.2 million related
to an increase from 11% to 13% in the discount rate used to value our
interest-only strips. This change in the discount rate was considered a
permanent fair value adjustment and was recorded as expense in fiscal 2000. The
write down also included a charge of $1.9 million for the impact of changes in
one-month LIBOR deemed to be permanent. A portion of the certificates issued to
investors by securitization trusts are floating interest rate certificates based
on one-month LIBOR plus a spread. The fair value of the excess cash flow we will
receive from these trusts would be affected by any changes in rates paid on the
floating rate certificates. See "Interest Rate Risk Management - Interest-only
Strips and Servicing Rights" for a discussion of the impact of one-month LIBOR.
The write down included a credit of $0.5 million for the net favorable impact of
adjustments made to the prepayment assumptions on mortgage loan securitizations
to reflect actual experience at June 30, 2000. See "Securitization Accounting
Considerations" for a discussion of the discount rate and prepayment
assumptions.
The following table summarizes the purchases of overcollateralization
by trust for the three years ending June 30, 2000, 1999 and 1998. See
"Securitization Accounting Considerations" for a discussion of
overcollateralization requirements.
70
Summary of Mortgage Loan Securitization Overcollateralization Purchases
(Dollars in thousands)
Off-
Balance
Sheet
Facility 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1
-----------------------------------------------------------------------------------
Year ended June 30, 2000
Initial overcollateralization $2,909 $ 2,114 $ 1,776 $ 2,222 $ 2,211 $ - $ -
Required purchases of
additional overcollateralization - - 2,303 4,040 5,125 7,585 6,601
------ ------- ------- ------- ------- ------- -------
Total $2,909 $ 2,114 $ 4,079 $ 6,262 $ 7,336 $ 7,585 $ 6,601
====== ======= ======= ======= ======= ======= =======
Year ended June 30, 1999
Initial overcollateralization $ 1,100 $ 925
Required purchases of
additional overcollateralization - 1,724
------ ------- ------- ------- ------- ------- -------
Total - - - - - $ 1,100 $ 2,649
====== ======= ======= ======= ======= ======= =======
Year ended June 30, 1998
Initial overcollateralization
Required purchases of
additional overcollateralization
------ ------- ------- ------- ------- ------- -------
Total - - - - - - -
====== ======= ======= ======= ======= ======= =======
1998-4 1998-3 1998-2 1998-1 1997-2 1997-1
-------------------------------------------------------------------
Year ended June 30, 2000
Initial overcollateralization $ - $ -
Required purchases of
additional overcollateralization 1,348 2,923
------- ------- ------- ------- ------- -------
Total $ 1,348 $ 2,923 - - - -
======= ======= ======= ======= ======= =======
Year ended June 30, 1999
Initial overcollateralization $ 800 $ 2,000 $ - $ - $ -
Required purchases of
additional overcollateralization 1,852 5,076 4,307 2,267 1,456
------- ------- ------- ------- ------- -------
Total $ 2,652 $ 7,076 $ 4,307 $ 2,267 $ 1,456 -
======= ======= ======= ======= ======= =======
Year ended June 30, 1998
Initial overcollateralization $ 1,801 $ 1,575 $ 2,000 $ -
Required purchases of
additional overcollateralization 3 1,938 3,544 2,972
------- ------- ------- ------- ------- -------
Total - - $ 1,804 $ 3,513 $ 5,544 $ 2,972
======= ======= ======= ======= ======= =======
1996-2 1996-1 Total
-------------------------------
Year ended June 30, 2000
Initial overcollateralization $ 11,232
Required purchases of
additional overcollateralization 29,925
------- ----- --------
Total - - $ 41,157
======= ===== ========
Year ended June 30, 1999
Initial overcollateralization $ 4,825
Required purchases of
additional overcollateralization $ 16,682
------- ----- --------
Total - - $ 21,507
======= ===== ========
Year ended June 30, 1998
Initial overcollateralization $ - $ - $ 5,376
Required purchases of
additional overcollateralization 1,334 170 9,961
------- ----- --------
Total $ 1,334 $ 170 $ 15,337
======= ===== ========
71
Servicing rights increased $31.7 million, or 73.4%, to $74.9 million at
June 30, 2000 from $43.2 million at June 30, 1999 due primarily to the recording
of $44.6 million of servicing rights obtained in connection with loan and lease
securitizations, partially offset by amortization of servicing rights.
Total liabilities increased $192.5 million, or 56.9%, to $530.6 million
at June 30, 2000 from $338.1 million at June 30, 1999 due primarily to increases
in subordinated debt, deferred income taxes and other liabilities. Subordinated
debt increased $179.0 million, or 84.6%, to $390.7 million at June 30, 2000 due
to net sales of subordinated debt securities. See "Liquidity and Capital
Resources" for further detail. Deferred income taxes increased $6.2 million, or
37.2%, to $22.8 million at June 30, 2000 due to the structuring of
securitization transactions as debt for tax transactions. As debt for tax
transactions, the tax liability on securitization gains is deferred and becomes
payable in future periods as cash is received from securitization trusts.
Accounts payable and accrued expenses increased $4.7 million, or 17.4%, to $31.5
million at June 30, 2000 primarily due to an increase in accrued interest
payable on subordinated debt.
June 30, 1999 Compared to June 30, 1998
Total assets increased $169.7 million, or 74.9%, to $396.3 million at
June 30, 1999 from $226.6 million at June 30, 1998 due primarily to increases in
interest-only strips and other receivables, cash and cash equivalents and
servicing rights.
Cash and cash equivalents increased $17.9 million, or 399.2% to $22.4
million at June 30, 1999 from $4.5 million at June 30, 1998 primarily due to
receipts from sales of subordinated debt securities.
Interest-only strips increased $82.3 million, or 85.8%, to $178.2
million at June 30, 1999 from $95.9 million at June 30, 1998. During fiscal
1999, $777.5 million in loan and lease securitizations were completed. A
detailed analysis of the account activity for fiscal 1999 is presented above.
Servicing rights increased $24.7 million, or 133.9%, to $43.2 million
at June 30, 1999 from $18.5 million at June 30, 1998 due primarily to the
recording of $30.3 million of servicing rights obtained in connection with loan
and lease securitizations, partially offset by amortization of servicing rights.
Loan and lease receivables - available for sale decreased $28.6
million, or 45.9%, at June 30, 1999, primarily due to the timing and size of
fourth quarter fiscal 1999 securitizations. Mortgage loans securitized in the
fourth quarter of fiscal 1999 were $220.0 million compared to $120.0 million in
the fourth quarter of fiscal 1998.
Total liabilities increased $154.3 million, or 83.9%, to $338.1 million
at June 30, 1999 from $183.8 million at June 30, 1998 due primarily to increases
in subordinated debt and warehouse lines and other notes payable. The increase
in subordinated debt of $99.5 million, or 87.0%, was primarily attributable to
net sales of subordinated debt securities. Additional borrowings
72
of $26.3 million, net of repayments, were obtained under warehouse and line of
credit facilities to fund lending and leasing activities. See "Liquidity and
Capital Resources" for further detail.
Accounts payable and accrued expenses increased $11.3 million, or
72.4%, to $26.8 million at June 30, 1999 from $15.6 million at June 30, 1998 due
to growth in lending and leasing activities resulting in larger accruals for
interest expense and other operating expenses. Deferred income taxes increased
$5.7 million, or 52.8%, to $16.6 million at June 30, 1999 from $10.9 million at
June 30, 1998 due to timing differences in recognition of income from
securitizations.
73
Managed Portfolio Quality
The following table provides data concerning delinquency experience,
real estate owned and loss experience for the loan and lease portfolio serviced
(dollars in thousands):
June 30,
------------------------------------------------------------------------------------------
2000 1999 1998
------------------------ ----------------------- -----------------------
Delinquency by Type Amount % Amount % Amount %
- --------------------------------- ----------- ----- ----------- ----- ----------- -----
Business Purpose Loans
Total managed portfolio.......... $ 221,546 $ 148,932 $ 101,250
=========== =========== =========
Period of delinquency:
31-60 days..................... $ 908 .41% $ 1,506 1.01% $ 1,236 1.22%
61-90 days..................... $ 1,757 .79 475 .32 928 .92
Over 90 days................... 11,362 5.13 8,612 5.78 3,562 3.52
----------- ----- ----------- ----- --------- -----
Total delinquencies............ $ 14,027 6.33% $ 10,593 7.11% $ 5,726 5.66%
=========== ===== =========== ===== ========= =====
REO.............................. $ 1,299 $ 2,881 $ 611
=========== =========== =========
Home Equity Loans
Total managed portfolio.......... $ 1,578,038 $ 858,806 $ 349,685
=========== =========== =========
Period of delinquency:
31-60 days..................... $ 6,596 .42% $ 4,836 .56% $ 3,726 1.08%
61-90 days..................... 5,659 .36 4,149 .48 1,022 .30
Over 90 days................... 27,600 1.75 15,346 1.79 3,541 1.02
----------- ----- ----------- ----- --------- -----
Total delinquencies............ $ 39,855 2.53% $ 24,331 2.83% $ 8,289 2.40%
=========== ===== =========== ===== ========= =====
REO.............................. $ 11,823 $ 7,067 $ 311
=========== =========== =========
Equipment Leases
Total managed portfolio.......... $ 118,956 $ 169,180 $ 108,463
=========== =========== =========
Period of delinquency:
31-60 days..................... $ 475 .40% $ 389 .23% $ 1,000 .92%
61-90 days..................... 478 .40 425 .25 320 .30
Over 90 days................... 992 .83 1,826 1.08 1,478 1.36
----------- ----- ----------- ----- --------- -----
Total delinquencies............ $ 1,945 1.63% $ 2,640 1.56% $ 2,798 2.58%
=========== ===== =========== ===== ========= =====
Combined
- ---------------------------------
Total managed portfolio.......... $ 1,918,540 $ 1,176,918 $ 559,398
=========== =========== =========
Period of delinquency:
31-60 days..................... $ 7,979 .42% $ 6,731 .57% $ 5,962 1.07%
61-90 days..................... 7,894 .41 5,049 .43 2,270 .41
Over 90 days................... 39,954 2.08 25,784 2.19 8,581 1.53
----------- ----- ----------- ----- --------- -----
Total delinquencies............ $ 55,827 2.91% $ 37,564 3.19 $ 16,813 3.01%
=========== ===== =========== ===== ========= =====
REO.............................. $ 13,122 .68% $ 9,948 .85% $ 922 .16%
=========== ===== =========== ===== ========= =====
Losses experienced during the period
(a)(b)
Loans.......................... $ 3,319 .25% $ 817 .11% $ 138 .05%
Leases......................... 1,339 1.04% 320 .27% 529 .90%
----------- ----- ----------- ----- --------- -----
Total losses................... $ 4,658 .31% $ 1,137 .12% $ 667 .12%
=========== ===== =========== ===== ========= =====
- ------------------------------
(a) Percentage based on average total managed portfolio.
(b) Losses recorded on our books for loans owned by us including loans
repurchased from securitization trusts were $2.1 million ($1.5 million from
charge-offs through the provision for credit losses and $0.6 million for
write downs of real estate owned) for the year ended June 30, 2000. Losses
absorbed by loan securitization trusts were $2.6 million for fiscal 2000.
Losses recorded on our books for loans owned by us including loans
repurchased from securitization trusts were $1.1 million and losses absorbed
by securitization trusts were $30,000 for the year ended June 30, 1999. All
losses recorded for the year ended June 30, 1998 related to loans owned by
us including loans repurchased from securitization trusts.
74
Delinquent Loans and Leases
Total delinquencies (loans and leases with payments past due greater
than 30 days) in the total managed portfolio were $55.8 million at June 30, 2000
compared to $37.6 million and $16.8 million at June 30, 1999 and 1998,
respectively. Total delinquencies as a percentage of the total managed portfolio
(the "delinquency rate") were 2.91% at June 30, 2000 compared to 3.19% and 3.01%
at June 30, 1999 and 1998, respectively, on a total managed portfolio of $1.9
billion at June 30, 2000 and $1.2 billion and $559.4 million at June 30, 1999
and 1998, respectively.
Delinquent loans and leases in the available for sale portfolio (which
are included in total delinquencies) at June 30, 2000 were $3.0 million, or
5.29%. At June 30, 2000, $4.3 million of portfolio loans were on non-accrual
status. See "--Risk Factors -- Lending to credit-impaired borrowers may result
in higher delinquencies in our managed portfolio which could result in a
reduction in profits" for a discussion of risks associated with increases in
delinquencies.
Real Estate Owned
Total real estate owned, comprised of foreclosed properties and deeds
acquired in lieu of foreclosure, increased to $13.1 million, or 0.68% of the
total managed portfolio at June 30, 2000 compared to $9.9 million, or 0.85% and
$0.9 million, or 0.16% at June 30, 1999 and 1998, respectively. The increase in
the volume of real estate owned reflects the seasoning of the managed portfolio
and the results of loss mitigation initiatives of quick repossession of
collateral through accelerated foreclosure processes and "Cash For Keys"
programs. Cash for Keys is a program utilized in select situations. When
collateral values of loans support the action, a delinquent borrower may be
offered a monetary payment in exchange for the deed to a property held as
collateral for a loan. This process eliminates the need to initiate a formal
foreclosure process, which could take many months.
Included in total real estate owned at June 30, 2000 was $1.7 million
recorded in our financial statements, and $11.4 million in loan securitization
trusts. Property acquired by foreclosure or in settlement of loan and lease
receivables is recorded in our financial statements at the lower of the cost
basis in the loan or fair value of the property less estimated costs to sell.
Loss Experience
During fiscal 2000, we experienced net loan and lease charge-offs in
our total managed portfolio of $4.7 million. Net loan charge-offs for fiscal
2000 represent 0.31% of the average total managed portfolio. Loss severity
experience on delinquent loans generally has ranged from 5% to 15% of principal
and loss severity experience on real estate owned generally has ranged from 25%
to 30% of principal. The business purpose loans we originate have average
loan-to-value ratios of 61.0%. The home equity loans we originate have average
loan-to-value ratios of 78.9% and the predominant share of our home mortgage
products are first liens as opposed to junior lien loans. We believe these
factors may mitigate some potential losses on our managed portfolio.
75
Interest Rate Risk Management
A primary market risk exposure that we face is interest rate risk.
Profitability and financial performance is sensitive to changes in U.S. Treasury
yields, LIBOR yields and the spread between the effective rate of interest
received on loans and leases available for sale or securitized (generally fixed
interest rates) and the interest rates paid pursuant to credit facilities or the
pass-through rate to investors for interests issued in connection with
securitizations. A substantial and sustained increase in market interest rates
could adversely affect our ability to originate and purchase loans. The overall
objective of our interest rate risk management strategy is to mitigate the
effects of changing interest rates on profitability and the fair value of
interest rate sensitive balances (primarily loans and leases available for sale,
interest-only strips, servicing rights and subordinated debt).
Due to increases in market interest rates, we expect our ability to
originate loans at rates that will maintain our current level of profitability
will become more difficult than during a stable or falling interest rate
environment. We are addressing this challenge by carefully monitoring our
product pricing, the actions of our competition and market trends in order to
continue to originate loans in as profitable a manner as possible. The higher
rate environment could also unfavorably impact our liquidity and capital
resources. Higher interest rates could impact our short-term liquidity by
widening investor spread requirements in pricing future securitizations,
increasing the levels of overcollateralization in future securitizations,
limiting our access to borrowings in the capital markets and limiting our
ability to sell our subordinated debt securities at favorable interest rates. In
a rising interest rate environment, short-term and long-term liquidity could
also be impacted by increased interest costs on all sources of borrowed funds,
including the subordinated debt, and by reducing spreads on our securitized
loans, which would reduce our cash flows. See "Liquidity and Capital Resources"
for a discussion of both long and short term liquidity and "Risk Factors -- If
we are not able to sustain the levels of growth in revenues and earnings that we
experienced in the past, our future profits may be reduced."
Interest Rate Sensitivity. The following table provides information
about financial instruments that are sensitive to changes in interest rates. For
interest-only strips and servicing rights, the table presents projected
principal cash flows utilizing certain assumptions including prepayment and
default rates. See "Securitization Accounting Considerations" for more
information on these assumptions. For debt obligations, the table presents
principal cash flows and related average interest rates by expected maturity
dates (dollars in thousands):
76
Amount Maturing After June 30, 2000
-------------------------------------------------------------------------------------
There- Fair
2001 2002 2003 2004 2005 after Total Value
---------- --------- --------- --------- --------- ---------- ---------- ---------
Rate Sensitive Assets:
Loans and leases available for
sale (a)........................ $ 41,543 $ 30 $ 34 $ 38 $ 43 $ 2,444 $ 44,132 $ 45,330
Interest-only strips.............. 38,818 54,406 57,417 52,763 47,116 167,116 417,636 277,872
Servicing rights.................. 23,677 18,984 14,689 11,340 8,771 36,253 113,714 75,400
Investments- held to maturity..... 60 59 73 93 129 569 983 859
Investments- available for sale... 713 - - - - - 713 713
Rate Sensitive Liabilities:
Fixed interest rate borrowings.... $ 178,192 $ 97,407 $ 46,715 $ 20,787 $ 19,677 $ 28,455 $ 391,233 $ 388,148
Average interest rate............. 9.85% 11.12% 11.47% 11.42% 11.92% 12.08% 10.71%
Variable interest rate borrowings. $ 41,136 $ 1,625 $ 1,625 $ 785 $ 4,976 $ 698 $ 50,285 $ 50,285
Average interest rate............. 8.28% 8.44% 8.44% 8.44% 8.44% 8.44% 8.31%
- ------------------------
(a) For purposes of this table, all loans and leases which qualify for
securitization are reflected as maturing within twelve months because all
loans and leases available for sale are generally held for less than three
months prior to securitization.
Loans and Leases Available for Sale. Gain on sale of loans may be
unfavorably impacted to the extent fixed rate available for sale mortgage loans
are held prior to securitization. A significant variable affecting the gain on
sale of loans in a securitization is the spread between the average coupon rate
on fixed rate loans and the weighted average pass-through rate to investors for
interests issued in connection with the securitization. Although the average
loan coupon rate is fixed at the time the loan is originated, the pass-through
rate to investors is not fixed until the pricing of the securitization which
occurs just prior to the sale of the loans. Therefore, if market rates required
by investors increase prior to securitization of the loans, the spread between
the average coupon rate on the loans and the pass-through rate to investors may
be reduced or eliminated, which could have a material adverse effect on our
results of operations and financial condition. We estimate that each 0.1%
reduction in the spread reduces the gain on sale of loans as a percentage of
loans securitized by approximately 0.25%.
Hedging strategies may be utilized in an attempt to mitigate the effect
of changes in interest rates between the date rate commitments on loans are made
and the date the fixed rate pass-through certificates to be issued by a
securitization trust are priced, a period typically less than 90 days. These
strategies include the utilization of derivative financial instruments such as
futures and forward pricing on securitizations. The nature and quality of
hedging transactions are determined based on various factors, including market
conditions and the expected volume of mortgage loan and lease originations and
purchases. At the time the contract is executed, derivative contracts are
specifically designated as hedges of mortgage loans, loan commitments or of our
residual interests in mortgage loans in our conduit facility to be included in
the next subsequent securitization. The mortgage loans, loan commitments and the
mortgage loans underlying our residual interests in the conduit facility consist
of essentially similar pools of fixed rate loans and loan commitments,
collateralized by real estate (primarily residential real estate) with similar
maturities and similar credit characteristics. Fixed rate pass-through
certificates issued by securitization trusts are generally priced to yield a
spread above a benchmark rate based on U.S. Treasury securities with a
three-year maturity. The U.S. Treasury
77
Department has embarked on a repurchase program as a result of budget surpluses
resulting in less liquidity in the Treasury market. As a result the asset-backed
security market is moving toward pricing that is based on the Eurodollar and the
interest rate swap markets. Therefore, we have incorporated Eurodollar futures
into our hedging program. We hedge potential rate changes in Treasury securities
and Eurodollars with futures contracts on similar underlying securities. This
has provided strong correlation between our hedge contracts and the ultimate
pricing we have received on the subsequent securitization. The gain or loss
derived from these hedging transactions is deferred, reported in other assets or
other liabilities and recognized as an adjustment to the gains on sale of loans
when the loans are securitized. Cash flow related to hedging activities is
reported as it occurs. Gains or losses on terminated contracts are recognized in
the period the termination occurs. The effectiveness of our hedges are
continuously monitored. If correlation did not exist, the related gain or loss
on the contract would be recognized as an adjustment to income in the period
incurred.
During fiscal 2000, net cash losses of $2.1 million were realized on
hedging transactions (futures contracts) and were recognized as a component of
gains on sale recorded on securitizations during the year. During fiscal 1999,
net losses of approximately $2.0 million were realized on hedging transactions
(futures contracts) and were recognized as reductions to the gains on sale for
the securitizations during the year.
The following schedule details outstanding hedge positions at June 30,
2000. There were no outstanding hedge positions at June 30, 1999. (in thousands)
Eurodollar Forward
Futures Treasury
Contracts Sales Total
------------- -------- ----------
Loans Available for Sale
Notional Amount........................... $ 20,000 $ - $ 20,000
Unrealized Losses.......................... (54) - (54)
Mortgage Conduit Facility Assets
Notional Amount........................... 25,000 35,000 60,000
Unrealized Losses.......................... (19) (114) (133)
Loan Commitments
Notional Amount........................... 20,000 10,000 30,000
Unrealized Losses.......................... (25) (23) (48)
-------- -------- ---------
Total
Notional Amount........................... $ 65,000 $ 45,000 $ 110,000
Unrealized Losses.......................... (98) (137) (235)
======== ======== =========
If market interest rates decreased by 100 basis points, the above hedge
positions would result in a loss of approximately $3.3 million. While Treasury
rates, Eurodollar rates and the pass-through rate of securitizations are
generally strongly correlated, this correlation has not held in periods of
financial market disruptions (e.g. the so-called Russian Crisis in the later
part of 1998).
In addition to the above open hedge positions at June 30, 2000, we were
obligated to satisfy a mortgage securitization prefund requirement of $67.9
million which was satisfied in
78
July 2000. In the future, we may expand the types of derivative financial
instruments we use to hedge interest rate risk to include interest rate swaps or
other types of futures contracts.
We may use hedging in an attempt to mitigate the effect of changes in
market value of fixed rate mortgage loans held for sale. However, an effective
interest rate risk management strategy is complex and no such strategy can
completely insulate us from interest rate changes. Poorly designed strategies or
improperly executed transactions may increase rather than mitigate risk. In
addition, hedging involves transaction and other costs. Such costs could
increase as the period covered by the hedging protection increases. It is
expected that such loss would be offset by income realized from securitizations
in that period or in future periods. As a result, we may be prevented from
effectively hedging fixed rate loans held for sale, without reducing income in
current or future periods due to the costs associated with hedging activities.
Interest-Only Strips and Servicing Rights. A portion of the
certificates issued to investors by securitization trusts are floating interest
rate certificates based on one-month LIBOR plus a spread. The fair value of the
excess cash flow we will receive from these trusts would be affected by any
changes in rates paid on the floating rate certificates. At June 30, 2000,
$253.9 million of debt issued by loan securitization trusts was floating rate
debt based on LIBOR, representing 13.8% of total debt issued by mortgage loan
securitization trusts. For fiscal 2000 increases in one-month LIBOR resulted in
a decrease in the fair value of our interest-only strips of $6.4 million. In
accordance with generally accepted accounting principles, the temporary changes
in fair value were recognized as part of net adjustments to other comprehensive
income, which is a component of retained earnings. Of the total $6.4 million
impact of the change in LIBOR, $1.9 million was deemed to be a permanent change
in fair value and has been recognized as a write down through the Statement of
Income during fiscal 2000. It is estimated that a 1.0% increase in one-month
LIBOR would decrease the fair value of interest-only strips by approximately
$6.0 million.
A significant change in market interest rates could increase or
decrease the level of loan prepayments, thereby changing the size of the total
managed loan portfolio and the related projected cash flows. Higher than
anticipated rates of loan prepayments could require a write down of the fair
value of related interest-only strips and servicing rights, adversely impacting
earnings during the period of adjustment. Revaluations of our interest-only
strips and servicing rights are periodically performed. As part of the
revaluation process, assumptions used for prepayment rates are monitored against
actual experience and adjusted if warranted. It is estimated that a 100 basis
point increase in prepayment rates (for example, from 24% to 25% on home equity
loans and from 10% to 11% on business loans) would decrease the fair value of
interest-only strips by approximately $7.3 million and the fair value of
servicing rights by approximately $1.8 million. See "Securitization Accounting
Considerations" for further information regarding these assumptions.
We attempt to minimize prepayment risk on interest-only strips and
servicing rights by requiring prepayment fees on business purpose loans and home
equity loans, where permitted by law. Currently, approximately 95% of business
purpose loans and 80% of home equity loans in the managed portfolio are subject
to prepayment fees.
79
Subordinated Debt. We also experience interest rate risk to the extent
that as of June 30, 2000 approximately $212.9 million of our liabilities were
comprised of fixed rate subordinated debt with scheduled maturities of greater
than one year. To the extent that market interest rates demanded for
subordinated debt increase in the future, the rates paid on replacement debt
could exceed rates currently paid thereby increasing interest expense and
reducing net income.
Liquidity and Capital Resources
Because we have historically experienced negative cash flows from
operations, our business requires continual access to short and long-term
sources of debt to generate the cash required to fund our operations. Our cash
requirements include funding loan originations and capital expenditures,
repaying existing subordinated debt, paying interest expense and operating
expenses, and, in connection with our securitizations, funding
overcollateralization requirements and servicer obligations. At times, we have
used cash to repurchase our common stock and could in the future use cash for
unspecified acquisitions of related businesses or assets.
Borrowings against warehouse and credit facilities provide the primary
funding source for loan originations. These borrowings represent cash advanced
to us for a limited duration, generally no more than 270 days, and are secured
by the loans. The ultimate sale of the loans through securitization or whole
loan sale generates the cash proceeds necessary to repay the borrowings under
these facilities. See "Credit Facilities" below for a more detailed description
on these facilities.
Cash flow from operations and the issuance of subordinated debt fund
our remaining cash requirements discussed above. We rely significantly on our
ability to issue subordinated debt to meet these requirements since our cash
flow from operations is not sufficient to meet these requirements. Our cash
requirements include the obligation to repay maturing subordinated debt. In the
process of growing our businesses over the last three years, we have issued
subordinated debt to partially fund that growth and to partially fund maturities
of subordinated debt. We expect that our historical levels of negative cash flow
from operations will decline in the future and then become positive as the rate
of increase in our operating cash expenditures begins to level, then decline due
to an expected decrease in the rate of growth in loan production and as we
realize efficiencies in the infrastructure and loan production channels we have
been building and as the cash flows from our interest-only strips increase. The
cash balances that we have built over the last two years are sufficient to cover
approximately 39.2% of the $177.7 million of subordinated debt maturities due
within one year. Cash balances have increased from $4.5 million at June 30,
1998, to $22.4 million at June 30, 1999 and $69.8 million at June 30, 2000.
We continue to significantly rely on access to the asset-backed
securities market through securitizations to generate cash proceeds for the
repayment of borrowings under warehouse and credit facilities and to create our
interest-only strips and servicing rights which will provide future cash flows.
It is our expectation that future cash flows from our interest-only strips and
servicing rights will generate more of the cash flows required to meet
maturities of our subordinated debt.
80
A significant portion of our loan originations are non-conforming
mortgages to subprime borrowers. Some participants in the non-conforming
mortgage industry have experienced greater than anticipated losses on their
securitization interest-only strips and servicing rights due to the effects of
increased delinquencies, increased credit losses and increased prepayment rates,
resulting in some competitors exiting the business or recording valuation
allowances or write-downs for these conditions. As a result, some participants
experienced restricted access to capital required to fund loan originations, and
have been precluded from participation in the asset-backed securitization
market. However, we have maintained our ability to obtain funding and to
securitize loans. Factors that have minimized the effect of adverse market
conditions on our business include our ability to originate loans through
established retail channels, focus on credit underwriting, assess prepayment
fees on loans, diversify lending in the home equity and business loan markets
and raise capital through sales of subordinated debt securities pursuant to a
registered public offering. Subject to economic, market and interest rate
conditions, we intend to continue to transact additional securitizations for
future loan originations. Any delay or impairment in our ability to securitize
loans, as a result of market conditions or otherwise, could adversely affect our
liquidity and results of operations.
Additionally, we act as the servicer of the loans and leases
securitized and in that capacity will be obligated to advance funds in some
circumstances which may create greater demands on our cash flow than either
selling loans with servicing released or maintaining a portfolio of loans and
leases. When borrowers are delinquent in making monthly payments on mortgage
loans included in a securitization trust, we are required to advance interest
for the delinquent loans if we deem that the advances will be ultimately
recoverable. These advances require funding from our capital resources, but have
priority of repayment from the succeeding month's mortgage loan payments.
To a limited extent, we intend to continue to augment the interest and
fee income earned on loans and leases by selling loans and leases in whole loan
sales to unrelated third parties. These transactions also create additional
liquid funds available for lending activities.
Subordinated Debt Securities. During fiscal 2000, we sold $179.0
million in principal amount of subordinated debt securities, net of redemptions,
with maturities ranging between one day and ten years. As of June 30, 2000,
$390.7 million of subordinated debt was outstanding. Under a shelf registration
statement declared effective by the Securities and Exchange Commission on
October 15, 1999, we registered $300.0 million of subordinated debt, of which
$98.2 million was available for future issuance at June 30, 2000. The proceeds
from sales of subordinated debt securities will be used to fund general
operating and lending activities and maturities of subordinated debt. We intend
to meet our obligation to repay such debt as it matures with cash flow from
operations, cash flows from interest-only strips, and cash generated from
additional debt financing. The utilization of funds for the repayment of such
obligations should not adversely affect operations.
Credit Facilities. The following is a description of the warehouse and
line of credit facilities that are utilized to fund origination of loans and our
operations. All of our balance sheet facilities are senior in right of payment
to the subordinated debt. The warehouse revolving lines of credit are secured by
loan and lease receivables. The other credit facilities are secured with
interest-
81
only strips or other assets. The warehouse credit agreements require
that we maintain specific covenants regarding net worth, leverage and other
standards. At June 30, 2000, we were in compliance with the terms of all loan
covenants.
Amount Amount
Amount Utilized-on Utilized-off
Committed Balance Sheet Balance Sheet
-------------- ---------------- ------------------
Warehouse revolving line of credit, expiring August 2000...... $ 150,000 $ 249 78,334
Warehouse revolving line of credit, expiring October 2000..... 150,000 28,229 -
Warehouse revolving line of credit, December 2000............. 25,000 3,861 -
-------------- ---------------- ------------------
Total warehouse facilities.................................... 325,000 32,339 78,334
Revolving line of credit, expiring December 2000.............. 5,000 5,000 -
Repurchase agreement.......................................... 3,606 3,606 -
-------------- ---------------- ------------------
Total revolving credit facilities............................. 333,606 40,945 78,334
Other credit facilities and notes payable:
Commercial paper conduit for lease production, maturity
matches underlying leases................................... 11,963 9,339 2,624
Other debt.................................................... 558 558 -
-------------- ---------------- ------------------
Total credit facilities....................................... $ 346,127 $ 50,842 80,958
============== ================ ==================
At June 30, 2000, our subsidiaries had an aggregate $150.0 million
available under Interim Warehouse and Security Agreements with Prudential
Securities Credit Corporation expiring August 31, 2000. In September 2000, the
Agreement with Prudential was increased to $250.0 million and its expiration
date was extended to September 2001. The obligations described in these
agreements are guaranteed by us. Under these agreements, the subsidiaries may
fund loan originations by obtaining advances subject to specific conditions,
which bear interest at a specified margin over the LIBOR rate. The obligations
described in these agreements are collateralized by pledged loans. In March of
2000, these agreements were amended to provide for the sale of loans into an off
balance sheet conduit facility. The combination of on-balance sheet borrowings
against the warehouse facility to fund loan originations and the amount of loans
sold into the off-balance sheet conduit facility at any point in time was
limited to $150 million at June 30, 2000, $250 million beginning September 2000.
The sale into the off-balance sheet conduit facility involves a
two-step transfer that qualifies for sale accounting under SFAS No. 125. First
we sell the loans to a special purpose entity which has been established for the
limited purpose of buying and reselling the loans. Next the special purpose
entity sells the loans to a qualified special purpose entity ("the facility")
for cash proceeds generated by its sale of notes to a third party purchaser. We
have no obligation to repurchase the loans and neither the third party note
purchaser nor the facility has a right to require such repurchase. The facility
has the option to re-securitize the loans, ordinarily using longer-term
certificates. If the loans are not re-securitized by the facility, the third
party note purchaser has the right to securitize or sell the loans. Under this
arrangement, the loans have been isolated from us and our subsidiaries; and, as
a result, the transfer to the conduit facility is treated as a sale for
financial reporting purposes. During fiscal 2000, we sold approximately $97.7
million in principal amount of loans to the conduit facility and recognized
gains on those sales totaling approximately $9.6 million. In June 2000, $19.4
million of loans in the conduit facility were re-securitized by the facility. At
June 30, 2000 there were $78.3 million in principal amount of loans in the
conduit facility and an additional $0.2 million in the on balance sheet
facility.
82
Subsequent to June 30, 2000, we and our subsidiaries, American Business
Credit, HomeAmerican Credit and New Jersey Mortgage, established a $200.0
million facility which provides for the sale of loans into an off balance sheet
funding facility with UBS Principal Finance, LLC, an affiliate of UBS Warburg.
The sale into the off-balance sheet conduit facility involves a two-step
transfer that qualifies for sale accounting under SFAS No. 125. First, we sell
the loans to a special purpose entity which has been established for the limited
purpose of buying and reselling the loans. Next, the special purpose entity
sells the loans to a qualified special purpose entity ("the facility") for cash
proceeds generated by its sale of notes to a third party purchaser. We have no
obligation to repurchase the loans, except under certain conditions where loans
do not conform to representations and warranties made by us at the time of sale,
and neither the third party note purchaser nor the sponsor has a right to
require such repurchase. The facility has the option to re-securitize the loans,
ordinarily using longer-term certificates. If the facility fails to
re-securitize the loans within a specified period, the third party note
purchaser has the right to securitize or sell the loans. Under this arrangement,
the loans have been isolated from us and our subsidiaries; and, as a result,
transfers to the conduit facility will be treated as sales for financial
reporting purposes.
Along with certain of our subsidiaries, we obtained a $150.0 million
warehouse credit facility from a syndicate of banks led by Chase Bank of Texas
N.A., expiring October 1, 2000. Under this warehouse facility, advances may be
obtained, subject to specific conditions described in the agreement, including
sublimits based upon the type of collateral securing the advance. Interest rates
on the advances are based upon 30-day LIBOR plus a margin. Obligations under the
facility are collateralized by specified pledged loans and other related
collateral. The facility also requires us to meet specified financial ratios and
contains restrictive covenants, including covenants limiting loans to and
transaction with affiliates, the issuance of additional debt, and the types of
investments that can be purchased. At June 30, 2000, $28.2 million of this
facility was drawn upon. Given the increase in the Prudential facility from
$150.0 million to $250.0 million and the new $200.0 million facility from UBS
Warburg, we intend to allow the Chase facility to expire or be renewed at a
reduced amount.
Our subsidiaries, American Business Credit, HomeAmerican Credit and
New Jersey Mortgage obtained a $25.0 million warehouse line of credit facility
from Residential Funding Corporation which expires December 31, 2000. Under this
warehouse facility, advances may be obtained, subject to specific conditions
described in the agreement. Interest rates on the advances are based on LIBOR
plus a margin. The obligations under this agreement are collateralized by
pledged loans. At June 30, 2000, $3.9 million of this facility was drawn upon.
Along with our subsidiaries, American Business Credit, HomeAmerican
Credit and New Jersey Mortgage, we obtained a $5.0 million line of credit from
Chase Bank expiring December 2000. Interest rates on advances under the line are
at LIBOR plus a margin. At June 30, 2000, $5.0 million of this line of credit
was being utilized.
The commercial paper conduit for lease production provided for sale of
equipment leases using a pooled securitization. After January 2000, the facility
was no longer available for sales of equipment leases. The facility permitted us
to sell leases in a two-step transfer that qualified for sale accounting under
SFAS No. 125. First, we sold the leases to a special purpose entity
83
which has been established for the limited purpose of buying and reselling the
leases. Next, the special purpose entity sold the leases to a qualified special
purpose entity ("the facility") for cash. The facility is sponsored by a major
financial institution which has the option to re-securitize the leases,
ordinarily using longer-term certificates. Should a longer-term securitization
not occur, the leases would remain in the commercial paper conduit until their
contractual termination. We have no obligation to repurchase the leases and
neither the facility nor the sponsor has a right to require such repurchase. At
June 30, 2000, there was $2.6 million of equipment leases in the commercial
paper conduit facility representing the remaining balance of leases sold into
the facility and accounted for as sales prior to the time we ceased originating
equipment leases. The Company ceased originating equipment leases as of December
31, 1999 and no longer sells leases into this facility. The final two transfers
of leases into this facility with a remaining amount of $9.3 million were
accounted for as financing transactions. The leases transferred in those final
transfers were retained on our balance sheet and the financing raised by the
commercial paper conduit facility was recorded as debt on the balance sheet.
As of June 30, 2000, $228.6 million of debt was scheduled to mature
during the next twelve months which was mainly comprised of maturing
subordinated debt and warehouse lines of credit. We currently expect to
refinance the maturing debt through extensions of maturing debt or new debt
financing and, if necessary, may retire the debt through cash flow from
operations and loan sales or securitizations. Despite the current use of
securitizations to fund loan growth, we are also dependent upon other borrowings
to fund a portion of our operations. We intend to continue to utilize debt
financing to fund operations in the future.
A failure to renew or obtain adequate funding under a warehouse credit
facility, or other borrowings, or any substantial reduction in the size or
pricing in the markets for loans, could have a material adverse effect on our
results of operations and financial condition. To the extent we are not
successful in maintaining or replacing existing financing, we may have to
curtail loan production activities or sell loans rather than securitize them,
thereby having a material adverse effect on our results of operations and
financial condition.
We lease our corporate headquarters facilities under a five-year
operating lease expiring in July 2003 at a minimum annual base rent of
approximately $2.2 million. We also lease a facility in Roseland, New Jersey
under two operating leases, with the primary lease expiring in July 2003 and a
sub-lease expiring in January 2003, at an annual base rent of $0.8 million. The
primary Roseland lease has a renewal provision at an increased annual rental. In
addition, branch offices are leased on a short-term basis in various cities
throughout the United States. The leases for the branch offices are not material
to operations. See note 14 of the notes to consolidated financial statements for
information regarding lease payments.
Recent Accounting Pronouncements
Set forth below are recent accounting pronouncements which may have a
future effect on operations. These pronouncements should be read in conjunction
with the significant accounting policies, which have been adopted, that are set
forth in Note 1 of the notes to the consolidated financial statements.
84
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities"
("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards
for derivative instruments, including derivative instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If specific conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment (fair value
hedge), (b) a hedge of the exposure to variable cash flows of a forecasted
transaction (cash flow hedge), or (c) a hedge of the foreign currency exposure
of a net investment in a foreign operation, an unrecognized firm commitment, an
available for sale security, or a foreign-currency-denominated forecasted
transaction. At the time of issuance SFAS No. 133 was to be effective on a
prospective basis for all fiscal quarters of fiscal years beginning after June
15, 1999. Subsequently, the effective date of the standard was delayed until
years beginning after June 15, 2000. The adoption of this standard is not
expected to have a material effect on our financial condition or results of
operations.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The information required to be included in this Item 7A regarding
Quantitative and Qualitative Disclosures about Market Risk is incorporated by
reference from "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Interest Rate Risk Management."
Item 8. Financial Statements
Page
----
Report of Independent Certified Public Accountants........................................................ 82
Consolidated Balance Sheets as of June 30, 2000 and 1999.................................................. 83
Consolidated Statements of Income for the years ended
June 30, 2000, 1999 and 1998..................................................................... 84
Consolidated Statements of Stockholders' Equity for the years ended
June 30, 2000, 1999 and 1998..................................................................... 85
Consolidated Statements of Cash Flow for the years ended
June 30, 2000, 1999 and 1998..................................................................... 86
Notes to Consolidated Financial Statements................................................................ 88
85
American Business Financial
Services, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
Report of Independent Certified Public Accountants
American Business Financial Services, Inc.
Bala Cynwyd, Pennsylvania
We have audited the accompanying consolidated balance sheets of American
Business Financial Services, Inc. and subsidiaries as of June 30, 2000 and 1999,
and the related consolidated statements of income and stockholders' equity, and
cash flow for each of the years in the three-year period ended June 30, 2000.
These 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 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of American Business
Financial Services, Inc. and subsidiaries as of June 30, 2000 and 1999, and the
consolidated results of their operations and their cash flow for each of the
years in the three-year period ended June 30, 2000 in conformity with generally
accepted accounting principles.
/s/ BDO Seidman LLP
BDO Seidman LLP
Philadelphia, Pennsylvania
September 29, 2000
86
American Business Financial
Services, Inc. and Subsidiaries
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
June 30, 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
(dollar amounts in thousands)
Assets
Cash and cash equivalents $ 69,751 $ 22,395
Loan and lease receivables, net
Available for sale 44,132 33,776
Other 13,002 6,863
Interest-only strips 277,872 178,218
Servicing rights 74,919 43,210
Receivable for sold loans and leases 51,283 66,086
Prepaid expenses 2,209 1,671
Property and equipment, net 17,756 10,671
Other assets 41,744 33,411
- -----------------------------------------------------------------------------------------------------------------------
Total assets $ 592,668 $ 396,301
=======================================================================================================================
Liabilities and Stockholders' Equity
Liabilities
Subordinated debt $ 390,676 $ 211,652
Warehouse lines and other notes payable 50,842 58,691
Accounts payable and accrued expenses 31,496 26,826
Deferred income taxes 22,773 16,604
Other liabilities 34,766 24,282
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities 530,553 338,055
- -------------------------------------------------------------------------------------------------------------------------
Stockholders' equity
Preferred stock, par value $.001
Authorized, 1,000,000 shares; Issued and outstanding, none -- --
Common stock, par value $.001
Authorized, 9,000,000 shares
Issued: 3,642,592 shares in 2000 and 3,703,514 shares in 1999
(including Treasury shares of 318,918 in 2000 and 116,550 in 1999) 4 3
Additional paid-in capital 24,291 23,339
Accumulated other comprehensive income 5,458 3,354
Retained earnings 36,850 33,596
Treasury stock at cost, 318,918 shares in 2000 and 116,550 shares in
1999 (3,888) (1,446)
- -------------------------------------------------------------------------------------------------------------------------
62,715 58,846
Note receivable (600) (600)
- -------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 62,115 58,246
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 592,668 $ 396,301
=======================================================================================================================
See accompanying notes to consolidated financial statements
87
American Business Financial
Services, Inc. and Subsidiaries
Consolidated Statements of Income
- --------------------------------------------------------------------------------
Year ended June 30, 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------
(dollar amounts in thousands, except per share data)
Revenues
Gain on sale of loans and leases $ 90,380 $ 64,490 $ 40,778
Interest and fees 19,400 16,553 17,386
Interest accretion on interest-only strips 16,616 2,021 538
Servicing income 4,239 3,321 476
Other income 11 39 157
- --------------------------------------------------------------------------------------------------------------------
Total revenues 130,646 86,424 59,335
- --------------------------------------------------------------------------------------------------------------------
Expenses
Interest 38,122 22,427 13,190
Provision for credit losses 2,045 928 491
Employee related costs 12,847 5,318 5,030
Sales and marketing 25,336 21,859 14,237
General and administrative 29,331 14,041 8,497
Interest-only strips fair value adjustment 12,603 -- --
- --------------------------------------------------------------------------------------------------------------------
Total expenses 120,284 64,573 41,445
- --------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 10,362 21,851 17,890
Provision for income taxes 3,938 7,763 6,435
- --------------------------------------------------------------------------------------------------------------------
Net income $ 6,424 $ 14,088 $ 11,455
====================================================================================================================
Earnings per common share
Basic $ 1.88 $ 3.83 $ 3.10
Diluted $ 1.83 $ 3.72 $ 2.98
====================================================================================================================
Average common shares (in thousands)
Basic 3,424 3,682 3,692
Diluted 3,509 3,791 3,847
====================================================================================================================
See accompanying notes to consolidated financial statements
88
American Business Financial
Services, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
- --------------------------------------------------------------------------------
Year ended June 30, 2000, 1999 and 1998
- ----------------------------------------------------------------------------------------------------------------------------
Common Stock
--------------------------- Accumulated
Number Additional Other
Of Shares Paid-In Comprehensive Retained
Outstanding Amount Capital Income Earnings
- ----------------------------------------------------------------------------------------------------------------------------
(dollar amounts in thousands)
Balance, June 30, 1997 3,679 $ 3 $ 22,669 $ -- $ 8,839
Common stock issued for acquisition 21 -- 500 -- --
Issuance of non-employee stock options -- -- 87 -- --
Cash dividends ($.06 per share) -- -- -- -- (211)
Net income -- -- -- -- 11,455
- ----------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1998 3,700 3 23,256 -- 20,083
Comprehensive income:
Net income -- -- -- -- 14,088
Unrealized gains on interest-only strips -- -- -- 3,354 --
- ----------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- 3,354 14,088
Issuance of non-employee stock options -- -- 73 -- --
Exercise of stock options 4 -- 10 -- --
Cash dividends ($0.165 per share) -- -- -- -- (575)
Repurchase of treasury shares (117) -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1999 3,587 3 23,339 3,354 33,596
Comprehensive income:
Net income -- -- -- -- 6,424
Unrealized gains on interest-only strips -- -- -- 2,104 --
- ----------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- 2,104 6,424
Issuance of non-employee stock options -- -- 130 --
Exercise of stock options 64 1 218 --
Cash dividends ($0.30 per share) -- -- -- -- (1,014)
Repurchase of treasury shares (327) -- -- --
Stock dividend (5% of outstanding shares)
Issuance of treasury shares -- -- --
Issuance of new shares -- -- 604 -- (2,156)
- ----------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 2000 3,324 $ 4 $ 24,291 $ 5,458 $ 36,850
============================================================================================================================
American Business Financial
Services, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
- --------------------------------------------------------------------------------
Total
Treasury Note Stockholders'
Stock Receivable Equity
-------------------------------------------------
Balance, June 30, 1997 $ -- $ (600) $ 30,911
Common stock issued for acquisition -- -- 500
Issuance of non-employee stock options -- -- 87
Cash dividends ($.06 per share) -- -- (211)
Net income -- -- 11,455
- ----------------------------------------------------------------------------------------------------
Balance, June 30, 1998 -- (600) 42,742
Comprehensive income:
Net income -- -- 14,088
Unrealized gains on interest-only strips -- -- 3,354
- ----------------------------------------------------------------------------------------------------
Total comprehensive income -- -- 17,442
Issuance of non-employee stock options -- -- 73
Exercise of stock options -- -- 10
Cash dividends ($0.165 per share) -- -- (575)
Repurchase of treasury shares (1,446) -- (1,446)
- ----------------------------------------------------------------------------------------------------
Balance, June 30, 1999 (1,446) (600) 58,246
Comprehensive income:
Net income -- -- 6,424
Unrealized gains on interest-only strips -- -- 2,104
- ----------------------------------------------------------------------------------------------------
Total comprehensive income -- -- 8,528
Issuance of non-employee stock options -- -- 130
Exercise of stock options -- -- 219
Cash dividends ($0.30 per share) -- -- (1,014)
Repurchase of treasury shares (3,994) -- (3,994)
Stock dividend (5% of outstanding shares)
Issuance of treasury shares 1,552 -- 1,552
Issuance of new shares -- -- (1,552)
- ----------------------------------------------------------------------------------------------------
Balance, June 30, 2000 $ (3,888) $ (600) $ 62,115
====================================================================================================
See accompanying notes to consolidated financial statements
89
American Business Financial
Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow
- --------------------------------------------------------------------------------
Year ended June 30, 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
(dollar amounts in thousands)
Cash flows from operating activities
Net income $ 6,424 $ 14,088 $ 11,455
Adjustments to reconcile net income to
net cash used in operating activities
Gain on sales of loans and leases (90,380) (64,490) (40,778)
Depreciation and amortization 21,452 10,826 5,340
Interest accretion on interest-only strips (16,616) (2,021) (538)
Interest-only strips fair value adjustment 12,603 -- --
Provision for credit losses 2,045 928 491
Net charge-offs (1,458) (1,107) (667)
Loans and leases originated for sale (1,174,518) (918,477) (510,783)
Proceeds from sale of loans and leases 1,104,372 883,349 436,294
Principal payments on loans and leases 9,686 9,200 19,003
(Increase) decrease in accrued interest
and fees on loan and lease receivables (6,139) (2,767) 6,164
Required purchases of initial overcollateralization
on securitized loans and leases (11,232) (4,825) (5,376)
Required purchase of additional
overcollateralization for securitized
loans and leases (29,925) (16,682) (9,961)
Cash flow from interest-only strips 49,508 32,927 13,382
Decrease (increase) in receivable for loans and
leases sold 8,314 (70,895) (2,687)
(Increase) decrease in prepaid expenses (538) 901 (1,391)
Increase in accounts payable and
accrued expenses 4,670 11,465 9,199
Increase in deferred income taxes 6,169 5,539 5,333
Increase in loans in process 10,484 11,484 6,455
Other, net (6,874) (976) 3,393
- ------------------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (101,953) (101,533) (55,672)
- ------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of property and equipment (11,523) (5,819) (4,085)
Proceeds from sale of property and equipment -- 684 --
Purchase of investments (713) -- (2,986)
Principal receipts and maturity of investments 32 3,428 5,101
Purchase of subsidiary, net -- -- (8,866)
- -------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (12,204) (1,707) (10,836)
- -------------------------------------------------------------------------------------------------------------------------------
90
American Business Financial
Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow
- --------------------------------------------------------------------------------
Year ended June 30, 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------------
(dollar amounts in thousands)
Cash flows from financing activities
Proceeds from issuance of subordinated
debentures $ 265,590 $ 168,357 $ 73,884
Principal payments on subordinated
debentures (86,567) (70,636) (25,044)
Net borrowings on revolving lines of credit (14,153) 25,241 19,750
Borrowings, lease funding facility 12,294 -- --
Principal payments, lease funding facility (2,955) -- --
(Principal payments on) proceeds from repurchase
agreement (1,072) 4,677 --
Principal payments on notes payable, other (1,963) (1,566) (445)
Financing costs incurred (5,002) (2,986) (2,041)
Exercise of employee stock options 219 10 --
Issuance of non-employee stock options 130 73 87
Cash dividends paid (1,014) (575) (211)
Purchase of treasury stock (3,994) (1,446) --
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 161,513 121,149 65,980
- -------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in
cash and cash equivalents $ 47,356 $ 17,909 $ (528)
Cash and cash equivalents at beginning of year 22,395 4,486 5,014
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 69,751 $ 22,395 $ 4,486
=========================================================================================================================
Supplemental disclosures of cash flow information
Cash paid (net refunds received) during the year for:
Interest $ 29,076 $ 18,900 $ 10,647
=========================================================================================================================
Income taxes $ (469) $ 3,750 $ 50
=========================================================================================================================
Supplemental disclosure of noncash financing activity
Noncash transaction recorded in connection with
acquisition of subsidiary
Decrease in acquisition debt $ (457) $ (1,001) $ (3,418)
Decrease in loan and lease receivables 457 1,001 3,418
See accompanying notes to consolidated financial statements.
91
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Business
Significant
Accounting American Business Financial Services, Inc. ("ABFS"),
Policies together with its subsidiaries (the "Company"), is a
diversified financial service organization operating
throughout the United States. The Company originates loans
through a combination of channels including a national
processing center located in the Company's centralized
operating office in Bala Cynwyd, Pennsylvania, and a retail
branch network of offices. The Company, through its
principal direct and indirect subsidiaries, originates,
sells and services loans to businesses secured by real
estate and other business assets, mortgage and home equity
loans, typically to credit impaired borrowers secured by
first and second mortgages. In addition the Company offers
subordinated debt securities to the public, the proceeds of
which are used to fund loan and lease originations and the
Company's operations.
Prior to December 31, 1999 the Company also originated
equipment leases. Effective December 31, 1999 the Company
de-emphasized the leasing origination business as a result
of its strategy of focusing on its most profitable lines of
business. The Company is continuing to service the remaining
leases in its managed portfolio, which totaled $119.0
million at June 30, 2000.
Business Conditions
For its ongoing operations, the Company depends upon
frequent financings, including the sale of unsecured
subordinated debt securities and borrowings under warehouse
credit facilities or lines of credit. If it is unable to
renew or obtain adequate funding through its sale of
subordinated debt securities or under a warehouse credit
facility, or other borrowings, the lack of adequate funds
would reduce profitability. To the extent that the Company
is not successful in maintaining or replacing existing
subordinated debt securities upon maturity, it may have to
limit loan originations or sell loans earlier than intended
and restructure its operations. Limiting originations or
earlier sales of loans could reduce profitability.
The Company has historically experienced negative cash flow
from operations since 1996 primarily because its business
strategy of selling loans through securitization does not
generate cash flow immediately. The Company expects this
negative cash flow from operations to continue in the
foreseeable future. If the Company continues to experience
negative cash flows from operations, its ability to make
principal and interest payments due under the terms of the
subordinated debentures could be impaired. At June 30, 2000,
there were approximately $177.7 million of subordinated
debentures which will mature through June 30, 2001.
The Company obtains the funds to repay the subordinated
debentures at their maturities by securitizing loans,
selling whole loans and selling additional subordinated
debentures. The Company could, in the future, generate cash
92
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of flows by securitizing, selling, or borrowing against
Significant its interest-only strips and selling servicing
Accounting rights generated in past securitizations. If the
Policies (continued) Company is unable in the future to securitize loans,
to sell whole loans, or to realize cash flows from
interest-only strips and servicing rights generated
in past securitizations, its ability to repay the
subordinated debentures could be impaired.
Because the Company has only $98.2 million of
registered subordinated debt available for future
issuance at June 30, 2000, and a new subordinated
debenture registration is not effective, the Company
has developed a contingent financial restructuring
plan including cash flow projections for the twelve
months ending September 30, 2001. Based on the
Company's current cash flow projections, the Company
anticipates being able to make all scheduled
subordinated maturities and vendor payments.
The contingent financial restructuring plan is based
on actions that the Company would take to reduce its
operating expenses and conserve cash. These actions
would include reducing capital expenditures,
transitioning from securitizing the majority of
loans originated to selling those loans on a
whole-loan basis, eliminating or downsizing various
lending, overhead and support groups, and scaling
back the development of new business distribution
channels and less profitable businesses.
Basis of Financial Statement Presentation
The consolidated financial statements include the
accounts of ABFS and its subsidiaries (all of which
are wholly owned.) The consolidated financial
statements have been prepared in accordance with
generally accepted accounting principles. All
significant intercompany balances and transactions
have been eliminated. In preparing the consolidated
financial statements, management is required to make
estimates and assumptions which affect the reported
amounts of assets and liabilities as of the date of
the consolidated financial statements and the
reported amounts of revenues and expenses during the
reporting period. Actual results could differ from
those estimates. These estimates include, among
other things, estimated prepayment, credit loss and
discount rates on loans and leases sold with
servicing retained, estimated servicing revenues and
costs, valuation of collateral owned and
determination of the allowance for credit losses.
Certain prior period financial statement balances
have been reclassified to conform to current period
presentation. All outstanding share, average common
share, earnings per common share and stock option
amounts reported as of June 30, 1999 and prior have
been retroactively adjusted to reflect the effect of
a 5% stock dividend declared August 18, 1999. See
Note 10 for further description.
93
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Cash and Cash Equivalents
Significant
Accounting Cash equivalents consist of short-term investments
Policies (continued) with an initial maturity of three months or less.
Loan and Lease Receivables
Loan and lease receivables - available for sale are
loans and leases the Company plans to sell or
securitize and are carried at the lower of aggregate
cost (principal balance, including unamortized
origination costs and fees) or market value. Market
value is determined by quality of credit risk, types
of loans originated, current interest rates,
economic conditions, and other relevant factors.
Loan and lease receivables - other is comprised
mainly of accrued interest and fees on loans and
leases and lease equipment residuals receivable from
a third party. These amounts are carried at their
net recoverable value.
Allowance for Credit Losses
The Company's allowance for credit losses on
available for sale loans and leases is maintained to
account for loans and leases that are delinquent and
are expected to be ineligible for sale into a
securitization. The allowance is calculated based
upon management's estimate of the expected
collectibility of loans and leases outstanding based
upon a variety of factors, including but not limited
to, periodic analysis of the available for sale
loans and leases, economic conditions and trends,
historical credit loss experience, borrowers'
ability to repay, and collateral considerations.
Additions to the allowance arise from the provision
for credit losses charged to operations or from the
recovery of amounts previously charged-off. Loan and
lease charge-offs reduce the allowance.
Loan and Lease Origination Costs and Fees
Direct loan and lease origination costs and loan
fees such as points and other closing fees are
recorded as an adjustment to the cost basis of the
related loan and lease receivable and are recognized
in the Consolidated Statement of Income as an
adjustment to the gain on sale recorded at the time
the loans and leases are securitized.
94
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Interest-only Strips
Significant
Accounting The Company sells a majority of its originated loans
Policies (continued) and leases through securitizations. In connection
with these securitizations, the Company receives
cash and an interest-only strip which represents our
retained interest in the securitized loans and
leases. As a holder of the interest-only strips, the
Company is entitled to receive certain excess (or
residual) cash flows which are derived from payments
made to the trust from the securitized loans and
leases after deducting payments to investors in the
securitization trust and other miscellaneous fees.
These cash flows are projected over the life of the
loans and leases using certain prepayment and
default assumptions. Excess cash flows are retained
by the trust until certain overcollateralization
levels are established. The overcollateralization
causes the aggregate principal amount of the related
securitization pool to exceed the aggregate balance
of the investor notes. The overcollateralization
serves as credit enhancement for the investors. The
securitization trusts and its investors have no
recourse to other assets of the Company for failure
of the securitized loans and leases to pay when due.
The fair values of the excess cash flows are
estimated based on a discounted cash flow analysis,
and are recorded by the Company at the time loans
and leases are securitized. Cash flows are
discounted from the date the cash is expected to be
available to the Company (the "cash-out method").
Cash flows are discounted at a rate management
believes is commensurate with the risks involved in
the Company's securitization assets. See
"Management's Discussion and Analysis -
Securitization Accounting Considerations" for
further discussion of how the discount rate is
determined.
Interest-only strips are periodically revalued by
the Company based on a discounted cash flow analysis
of loans and leases remaining in the trusts. The
assumptions for prepayment and default rates are
monitored against actual experience and adjusted if
warranted. See "Management's Discussion and Analysis
- Securitization Accounting Considerations" for more
information regarding these assumptions and actual
experience.
Servicing Rights
Upon the securitization of loans and leases, the
Company retains servicing rights. Because the
benefits of servicing are expected to be more than
adequate compensation to the Company for performing
the servicing, the Company capitalizes the benefits
associated with the rights to service securitized
loans and leases based on the servicing rights'
relative fair value to other consideration received
in a securitization. The fair value of servicing
rights is estimated based on a discounted cash flow
analysis which considers contractual fees for
servicing (generally 0.5% of outstanding loans and
leases serviced) and the rights to collect ancillary
servicing related fees, which include prepayment
fees, late charges, nonsufficient fund fees and
other miscellaneous fees from the loans
95
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of and leases, net of costs to service the loans and
Significant leases. Assumptions for prepayments and credit
Accounting losses used to value servicing rights are consistent
Policies (continued) with assumptions used to value interest-only strips
in securitizations. Servicing rights are amortized
based on the ratio of net servicing income received
in the current period to total net servicing income
projected to be realized from the servicing rights.
Projected net servicing income is in turn determined
by the estimated future balance of the underlying
mortgage loan portfolio, which declines over time
from prepayments and scheduled loan amortization.
Capitalized servicing rights are evaluated for
impairment. The servicing rights are stratified by
loan type (business or home equity loan) which is
the predominant risk characteristic of the
underlying financial asset. Impairment, if any, is
measured (by strata) as the excess of unamortized
cost over fair value as measured by discounted cash
flows. See "Management's Discussion and Analysis -
Securitization Accounting Considerations" for more
information regarding these assumptions and actual
experience.
Property and Equipment
Property and equipment are stated at cost less
accumulated depreciation and amortization.
Depreciation and amortization is computed using the
straight-line method over the estimated useful life
of the assets ranging from 3 to 15 years.
Financing Costs and Amortization
Financing costs incurred in obtaining revolving
lines of credit are recorded in other assets and are
amortized using the straight-line method over the
terms of the agreements. Financing costs incurred in
connection with public offerings of subordinated
debt securities are also recorded in other assets
and are amortized over the term of the related debt.
Investments Held to Maturity
Investments classified as held to maturity recorded
in other assets consist of asset-backed securities
that the Company has the positive intent and ability
to hold to maturity. These investments are stated at
amortized cost.
Real Estate Owned
Property acquired by foreclosure or in settlement of
loan and lease receivables is recorded in other
assets, and is carried at the lower of the cost
basis in the loan or fair value of the property less
estimated costs to sell.
96
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Goodwill
Significant
Accounting Goodwill is recorded in other assets and represents
Policies (continued) the excess of cost over the fair value of the net
assets acquired from the Company's 1997 acquisition
of New Jersey Mortgage and Investment Corp. Goodwill
is amortized on a straightline basis over the
expected period of benefit, which approximates 15
years.
Revenue Recognition
The Company derives its revenue principally from
gain on sale of loans and leases, interest and fee
income on loans and leases, and servicing income.
Gains on sales of loans and leases through
securitizations represent the difference between the
net proceeds to the Company, including retained
interests in the securitization, and the allocated
cost of loans and leases securitized. The allocated
cost of loans and leases securitized is determined
by allocating their net carrying value between the
loans and leases, the interest-only strips and the
servicing rights retained by the Company based upon
their relative fair values.
Interest and fee income consists of interest earned
on loans and leases while held in the Company's
portfolio, premiums earned on loans sold with
servicing released and other ancillary fees
collected in connection with loan and lease
origination. Interest income is recognized based on
the interest method. Accrual of interest income is
suspended when the receivable is contractually
delinquent for 90 days or more. The accrual is
resumed when the receivable becomes contractually
current, and past-due interest income is recognized
at that time. In addition, a detailed review will
cause earlier suspension if collection is doubtful.
Premiums earned on loans sold with servicing
released, referred to as whole loan sales, are the
difference between the net proceeds from the sale
and the loans net carrying value. The net carrying
value of loans is equal to their principal balance
plus unamortized origination costs and fees.
Interest accretion on interest-only strips
represents the yield component of cash flows
received on interest-only strips. The basis for
recognizing interest accretion on interest-only
strips is the prospective approach. Periodically the
Company updates estimates of residual cash flow from
its securitizations. When it is probable that there
is a favorable change in estimated residual cash
flow from the cash flow previously projected, the
Company recognizes a greater percentage of estimated
interest accretion earned by the securitization. Any
probable unfavorable change in estimated residual
cash flow would likewise decrease the percentage of
estimated interest accretion earned by the
securitization. See "Management's Discussion and
Analysis -- Year Ended June 30, 2000 Compared to
Year Ended June 30, 1999" for additional discussion
of interest accretion.
97
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Servicing income is recognized as contractual fees
Significant and other fees for servicing loans and leases are
Accounting collected, net of amortization of servicing rights
Policies (continued) assets.
Derivative Financial Instruments
The primary market risk exposure that the Company
faces is interest rate risk. Interest rate risk
occurs due to potential changes in interest rates
between the date fixed rate loans are originated and
the date of securitization. The company utilizes
hedging strategies to mitigate the effect of changes
in interest between the date rate commitments on
loans are made and the date the fixed rate
pass-through certificates to be issued by a
securitization trust are priced, a period typically
less than 90 days.
These strategies include the utilization of
derivative financial instruments such as futures and
forward pricing on securitizations. The nature and
quality of hedging transactions are determined by
the Company's management based on various factors,
including market conditions and the expected volume
of mortgage loan originations and purchases. At the
time the contract is executed, derivative contracts
are specifically designated as hedges of mortgage
loans, loan commitments or of residual interests in
mortgage loans in the Company's conduit facility to
be included in the next subsequent securitization.
The mortgage loans, loan commitments and mortgage
loans underlying the residual interests in the
conduit facility consist of essentially similar
pools of fixed rate loans and loan commitments,
collateralized by real estate (primarily residential
real estate) with similar maturities and credit
characteristics. Fixed rate pass-through
certificates issued by securitization trusts are
generally priced to yield a spread above a benchmark
rate based on U.S. Treasury securities or Eurodollar
futures with a three-year maturity. The Company
hedges potential rate changes in the Treasury and
Eurodollar securities with futures contracts or
forward sales contracts on a similar underlying
security. This has provided strong correlation
between our hedge contracts and the ultimate pricing
we have received on the subsequent securitizations.
The gain or loss derived from these hedging
transactions is deferred, reported in other assets
or other liabilities and recognized as an adjustment
to the gains on sale of loans when the loans are
securitized. The cash flow related to hedging
activities is reported as it occurs. Gains and
losses on terminated contracts are recognized when
the termination occurs. The effectiveness of our
hedges are continuously monitored. If correlation
did not exist, the related gain or loss on the
contract would be recognized as an adjustment to
income in the period incurred. See "Management's
Discussion and Analysis -- Interest Rate Risk
Management" for further discussion of the Company's
use of derivative financial instruments.
98
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Income Taxes
Significant
Accounting The Company and its subsidiaries file a consolidated
Policies (continued) federal income tax return.
Under the asset and liability method used by the
Company to provide for income taxes, deferred tax
assets and liabilities are recognized for the
expected future tax consequences of temporary
differences between the financial statement and tax
basis carrying amounts of existing assets and
liabilities.
Acquisition
Effective October 1, 1997, the Company acquired all
of the issued and outstanding stock of New Jersey
Mortgage and Investment Corp. ("NJMIC"), a mortgage
and leasing company based in Roseland, New Jersey.
The purchase price for the stock consisted of $11.0
million in cash, a note payable of $5.0 million and
the issuance of 20,240 shares of the Company's
common stock. The purchase agreement included a
provision for a series of contingent payments to the
former stockholders of NJMIC totaling $4.0 million
based on NJMIC's attainment of certain performance
targets over a three year period. To date the
Company has paid $2.7 million of the total amount of
contingent payments and the remaining $1.3 million
has been recorded as a payable as of June 30, 2000.
The contingent payments were recorded as additional
goodwill. Pursuant to the terms of the acquisition
agreement, the Company is permitted to reduce the
amount payable to the former owners of NJMIC under
the $5.0 million note payable described above, in an
amount equal to the losses sustained from October
1997 to October 2000 on any loans or leases acquired
in the NJMIC transaction.
The transaction has been accounted for under the
purchase method and accordingly the results of NJMIC
have been included with the Company's since the date
of acquisition.
99
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Recent Accounting Pronouncements
Significant
Accounting In June 1998, the FASB issued SFAS No. 133
Policies (continued) "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133
establishes accounting and reporting standards for
derivative instruments, including certain derivative
instruments embedded in other contracts
(collectively referred to as derivatives), and for
hedging activities. It requires that an entity
recognize all derivatives as either assets or
liabilities in the statement of financial position
and measure those instruments at fair value. If
certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the
exposure to changes in the fair value of a
recognized asset or liability or an unrecognized
firm commitment (fair value hedge), (b) a hedge of
the exposure to variable cash flows of a forecasted
transaction (cash flow hedge), or (c) a hedge of the
foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment,
an available for sale security, or a
foreign-currency-denominated forecasted transaction.
At the time of issuance SFAS No. 133 was to be
effective on a prospective basis for all fiscal
quarters of fiscal years beginning after June 15,
1999. Subsequently the effective date of the
standard was delayed until years beginning after
June 15, 2000. The adoption of this standard is not
expected to have a material effect on the Company's
financial condition or results of operations.
2. Loan and Lease June 30, 2000 1999
Receivables --------------------------------------------------------------------------------
(in thousands)
Real estate secured loans $ 26,589 $ 21,027
Leases (net of unearned income
of $2,503 and $1,543) 18,832 13,451
--------------------------------------------------------------------------------
45,421 34,478
Less allowance for credit losses on
loan and lease receivables
available for sale 1,289 702
--------------------------------------------------------------------------------
$ 44,132 $ 33,776
================================================================================
Real estate secured loans have contractual
maturities of up to 30 years.
At June 30, 2000 and 1999, the accrual of interest
income was suspended on real estate secured loans of
$4.3 million and $85 thousand, respectively. Based
on its evaluation of the collateral related to these
loans, the Company expects to collect the
contractual principal.
Substantially all leases originated by the Company
are direct finance-type leases whereby the lessee
has the right to purchase the leased equipment at
the lease expiration for a nominal amount.
100
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. Allowance for
Credit Losses Year ended June 30, 2000 1999 1998
----------------------------------------------------------------------------------------
(in thousands)
Balance at beginning
of year $ 702 $ 881 $ 338
Provision for credit losses:
Business purpose loans 660 278 128
Home equity loans 350 296 --
Equipment leases 1,035 354 363
----------------------------------------------------------------------------------------
Total provision 2,045 928 491
----------------------------------------------------------------------------------------
Acquired through
acquisition -- -- 719
----------------------------------------------------------------------------------------
Charge-offs, net of
recoveries:
Business purpose loans (225) (301) (138)
Home equity loans (85) (486) --
Equipment leases (1,148) (320) (529)
----------------------------------------------------------------------------------------
Total charge-offs (1,458) (1,107) (667)
----------------------------------------------------------------------------------------
Balance at end of year $ 1,289 $ 702 $ 881
----------------------------------------------------------------------------------------
Ratio of net charge-offs
during the period to
average managed
portfolio 0.31% 0.12% 0.12%
Ratio of allowance to
gross receivables 2.84% 2.04% 1.39%
Recoveries of loans previously charged off were $40
thousand and $3 thousand during the years ended June
30, 2000 and 1999, respectively. No recoveries were
recorded in the year ended June 30, 1998.
101
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. Allowance for Credit While we are under no obligation to do so, at times
Losses (continued) we elect to repurchase some foreclosed and
delinquent loans from the securitization trusts.
Under the terms of the securitization agreements,
repurchases are permitted only for foreclosed and
delinquent loans and the purchase prices are at the
loans' outstanding contractual balance. We elect to
repurchase loans in situations requiring more
flexibility for the administration and collection of
these loans in order to maximize their economic
recovery and to avoid temporary discontinuations of
residual or stepdown overcollateralization cash
flows from securitization trusts. The related
charge-offs on these repurchased loans are included
in our provision for credit losses in the period of
charge-off.
The following table summarizes the principal
balances of loans repurchased from securitization
trusts (in thousands):
Year ended June 30, 2000 1999 1998
---------------------------------------------------------------------------------
Business loans $ 4,118 $ 74 $ 297
Home equity loans 4,710 1,272 201
---------------------------------------------------------------------------------
Total $ 8,828 $ 1,346 $ 498
=================================================================================
Number of loans repurchased 81 19 4
---------------------------------------------------------------------------------
4. Securitizations The following schedule details loan and lease
securitizations (in thousands):
Year ended June 30, 2000 1999 1998
----------------------------------------------------------------------------------
Loans and leases sold:
Business loans $ 104.5 $ 71.9 $ 54.1
Home equity loans 887.9 613.0 270.9
Equipment leases 9.3 92.6 59.7
----------------------------------------------------------------------------------
$1,001.7 $ 777.5 $ 384.7
----------------------------------------------------------------------------------
Number of securitizations:
Business and home equity
loans 4 4 3
Equipment leases 1 2 1
----------------------------------------------------------------------------------
Cash proceeds:
Business and home equity
loans $ 993.0 $ 685.0 $ 325.0
Equipment leases 10.0 91.1 13.7
----------------------------------------------------------------------------------
Gains:
Business and home equity
loans 90.2 61.9 40.5
Equipment leases 0.2 2.6 0.3
----------------------------------------------------------------------------------
$ 90.4 $ 64.5 $ 40.8
==================================================================================
102
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
4. Securitizations The Company's securitizations involve a two-step
(continued) transfer that meets the requirements of SFAS No.
125. First, the Company sells the loans and leases
to a special purpose entity ("SPE") which has been
established for the limited purpose of buying and
reselling the loans and leases. Next, the SPE then
sells the loans and leases to a qualified special
purpose entity ("the Trust"), transferring title to
the loans and leases and isolating those assets from
the Company. Finally, the Trust issues certificates
to investors to raise the cash purchase price,
collects proceeds on behalf of the certificate
holders, distributes proceeds and has a distinct
legal standing from the Company.
In March 2000, the Company amended its arrangements
with a warehouse lender to include an off-balance
sheet conduit facility. The sale into the
off-balance sheet conduit facility involves a
two-step transfer that qualifies for sale accounting
under SFAS No. 125. First we sell the loans to a
special purpose entity which has been established
for the limited purpose of buying and reselling the
loans. Next the special purpose entity sells the
loans to a qualified special purpose entity ("the
facility") for cash proceeds generated by its sale
of notes to a third party purchaser. We have no
obligation to repurchase the loans and neither the
third party note purchaser nor the facility has a
right to require such repurchase. The facility has
the option to re-securitize the loans, ordinarily
using longer-term certificates. If the loans are not
re-securitized by the facility, the third party note
purchaser has the right to securitize or sell the
loans. Under this arrangement, the loans have been
isolated from us and our subsidiaries; and, as a
result, the transfer to the conduit facility is
treated as a sale for financial reporting purposes.
During fiscal 2000, we sold approximately $97.7
million in principal amount of loans to the conduit
facility and recognized gains on those sales
totaling approximately $9.6 million. In June 2000,
$19.4 million of loans in the conduit facility were
re-securitized by the facility. At June 30, 2000
there were $78.3 million in principal amount of
loans in the conduit facility and an additional $0.2
million in the on balance sheet facility.
Subsequent to June 30, 2000, we and our
subsidiaries, American Business Credit, HomeAmerican
Credit and New Jersey Mortgage, established a $200.0
million facility which provides for the sale of
loans into an off balance sheet funding facility
with UBS Principal Finance, LLC, an affiliate of UBS
Warburg. The sale into the off-balance sheet conduit
facility involves a two-step transfer that qualifies
for sale accounting under SFAS No. 125. First we
sell the loans to a special purpose entity which has
been established for the limited purpose of buying
and reselling the loans. Next the special purpose
entity sells the loans to a qualified special
purpose entity ("the facility") for cash proceeds
generated by its sale of notes to third party
purchaser. We have no obligation to repurchase the
loans, except under certain conditions where loans
do not conform to representations and warranties
made by us at the time of sale, and neither the
third party note purchaser nor the sponsor has a
right to require such repurchase. The facility has
the option to re-securitize the loans, ordinarily
using longer-term certificates. If the facility
fails to re-securitize the loans within a specified
period, the third party note purchaser has the right
to securitize or sell the loans.
103
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
4. Securitizations Under this arrangement, the loans have been isolated
(continued) from us and our subsidiaries; and, as a result,
transfers to the conduit facility will be treated as
sales for financial reporting purposes.
During the year ended June 30, 1999, equipment
leases were also securitized in numerous sales to a
commercial paper conduit. The commercial paper
conduit arrangement provided for sale of the
equipment leases using a pooled securitization. The
facility is sponsored by a major financial
institution which has the option to re-securitize
the leases, ordinarily using longer-term
certificates. Should a longer-term securitization
not occur, the leases would remain in the commercial
paper conduit until their contractual termination.
The Company has no obligation to repurchase the
leases and neither the facility nor the sponsor has
a right to require such repurchase. Under this
arrangement the leases have been isolated from the
Company; and as a result, the transfer of these
leases to the conduit facility is treated as a sale
for financial reporting purposes. The Company ceased
originating equipment leases as of December 31, 1999
and no longer sells leases into this facility. The
final two transfers of leases into this facility
with a remaining balance of $9.3 million at June 30,
2000 were accounted for as financing transactions.
In Fiscal 2000, a write down of $12.6 million was
recorded on our interest-only strips. The write down
included a charge of $11.2 million related to an
increase from 11% to 13% in the discount rate used
to value our interest-only strips. This change in
the discount rate was considered a permanent fair
value adjustment and was recorded as expense in
fiscal 2000. The write down also included a charge
of $1.9 million for the impact of changes in
one-month LIBOR deemed to be permanent. A portion of
the certificates issued to investors by
securitization trusts have floating interest rates
based on one-month LIBOR plus a spread. The fair
value of the excess cash flow we will receive from
these trusts would be affected by any changes in
rates paid on the floating rate certificates. The
write down included a credit of $0.5 million for the
net impact of adjustments made to the prepayment
assumptions on mortgage loan securitizations at June
30, 2000. See "Management's Discussion and Analysis
- Securitization Accounting Considerations" for a
discussion of the discount rate and prepayment
assumptions. See "Interest Rate Risk Management -
Interest-only Strips and Servicing Rights" for a
discussion of the impact of one-month LIBOR. The
write down reduced net income by $7.8 million and
reduced diluted earnings per share by $2.23.
Information regarding the initial and current
assumptions applied in determining the fair values
of our mortgage and lease related interest-only
strips and servicing rights are detailed in
"Management's Discussion and Analysis -
Securitization Accounting Considerations."
104
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. Interest-Only Strips June 30, 2000 1999
--------------------------------------------------------------
(in thousands)
Interest-only strips-
Available for sale $ 273,629 $ 172,411
Trading assets 4,243 5,807
---------------------------------------------------------------
$ 277,872 $ 178,218
===============================================================
5. Interest-Only Strips SFAS No. 134, which became effective January 1,
(continued) 1999, requires that after the securitization of a
mortgage loan held for sale, the resulting
mortgage-backed security or other retained interests
be classified based on the Company's ability and
intent to hold or sell the investments. As a result,
retained interests previously classified as trading
assets, as required by prior accounting principles,
have been reclassified to available-for-sale. The
effect of SFAS No. 134 on net income and net income
per share in fiscal 1999 was $3.3 million and $0.88,
respectively.
Interest-only strips include overcollateralization
balances that represent undivided interests in
securitizations maintained to provide credit
enhancement to investors in securitization trusts.
At June 30, 2000 and 1999, the Company's investment
in overcollateralization was $82.0 million and $38.6
million, respectively.
The activity for interest-only strip receivables is
summarized as follows (in thousands):
Year ended June 30, 2000 1999
-----------------------------------------------------------------------------------
Balance at beginning of year $ 178,218 $ 95,913
Initial recognition of
Interest-only strips, including
initial overcollateralization of
$11,232 and $4,825, respectively 111,714 93,175
Required purchases of additional
overcollateralization 29,925 16,682
Interest accretion and other 16,616 2,021
Cash flow from interest-only strips (49,508) (32,927)
Net adjustments to fair value 3,510 3,354
Permanent fair value adjustment (12,603) --
-----------------------------------------------------------------------------------
Balance at end of year $ 277,872 $ 178,218
===================================================================================
In Fiscal 2000, a write down of $12.6 million was
recorded on the Company's interest-only strips. See
Note 4 - "Securitizations" for further description
of the write down.
105
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. Servicing Rights The total managed loan and lease portfolio, which
includes loans and leases sold to investors and
those retained by the Company, is as follows (in
thousands):
June 30, 2000 1999
--------------------------------------------------------------------------------
Home equity loans $ 1,578,038 $ 858,806
Business purpose loans 221,546 148,932
Equipment leases 118,956 169,180
--------------------------------------------------------------------------------
$ 1,918,540 $ 1,176,918
================================================================================
The activity for the loan and lease servicing rights
asset is summarized as follows (in thousands):
Year ended June 30, 2000 1999
--------------------------------------------------------------------------------
Balance at beginning of year $ 43,210 $ 18,472
Initial recognition of
Servicing rights 44,574 30,289
Amortization (12,181) (5,551)
Write down (684) --
--------------------------------------------------------------------------------
Balance at end of year $ 74,919 $ 43,210
================================================================================
Servicing rights are periodically valued by the
Company based on the current estimated fair value of
the mortgage servicing asset. A review for
impairment is performed by stratifying the serviced
loans and leases based on the predominant risk
characteristic, which consists of loan type. Key
assumptions used in the periodic valuation of the
servicing rights are described in "Management's
Discussion and Analysis - Securitization Accounting
Considerations." Impairments, if they occurred,
would be recognized in a valuation allowance for
each impaired stratum in the period of impairment.
To date, our valuation analysis has not indicated
any impairment other than the $0.7 million write
down recorded in fiscal 2000 and no valuation
allowance has been required. At June 30, 2000 and
1999, the periodic valuations supported the carrying
value of servicing rights.
106
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. Property and
Equipment June 30, 2000 1999
--------------------------------------------------------------------------------
(in thousands)
Computer equipment and software $ 16,809 $ 7,548
Office furniture and equipment 10,119 8,531
Leasehold improvements 2,481 1,756
-----------------------------------------------------------------------------------
29,409 17,835
Less accumulated depreciation
and amortization 11,653 7,164
-----------------------------------------------------------------------------------
$ 17,756 $ 10,671
====================================================================================
Depreciation and amortization expense was $4.4
million, $2.9 million and $1.7 million for the years
ended June 30, 2000, 1999 and 1998, respectively.
8. Other Assets June 30, 2000 1999
---------------------------------------------------------------------------------
(in thousands)
Goodwill, net of accumulated
amortization of $3,132 and $1,913 $ 16,465 $ 15,018
Due from securitization trusts for
servicing related activities 10,075 7,131
Financing costs, debt offerings, net of
accumulated amortization of $5,467
and $3,903 6,244 4,487
Other 5,605 4,918
Real estate owned 1,659 843
Investments held to maturity 983 1,014
Investments available for sale (U.S.
Treasury Securities) 713 --
-----------------------------------------------------------------------------------
$ 41,744 $ 33,411
===================================================================================
107
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. Subordinated Debt Subordinated debt was comprised of the following (in
and Warehouse Lines thousands):
and Other Notes
Payable
June 30, 2000 1999
--------------------------------------------------------------------------------
Subordinated debentures (a) $ 389,477 $ 206,918
Subsidiary subordinated debentures (b) 1,199 4,734
--------------------------------------------------------------------------------
Total subordinated debentures $ 390,676 $ 211,652
================================================================================
Warehouse lines and other notes payable were
comprised of the following (in thousands):
June 30, 2000 1999
------------------------------------------------------------------------------
Warehouse revolving line of credit (c) $ 28,229 $ 42,627
Warehouse revolving line of credit (d) 3,861 --
Warehouse revolving line of credit (e) 250 102
Warehouse revolving line of credit (f) -- 3,764
Lease funding facility (g) 9,339 --
Revolving line of credit (h) 5,000 5,000
Repurchase agreement (i) 3,606 4,677
Other debt 557 1,271
Senior subordinated debt (j) -- 1,250
--------------------------------------------------------------------------------
Total warehouse lines and other notes
payable $ 50,842 $ 58,691
================================================================================
(a) Subordinated debentures due July 2000 through
June 2010, interest rates ranging from 6.15% to
12.25%; subordinated to all of the Company's
indebtedness.
(b) Subsidiary subordinated debentures due July 2000
through December 2002, interest rates ranging
from 9.00% to 10.45%; subordinated to all of the
Company's indebtedness.
(c) $150 million warehouse revolving line of credit
expiring October 2000, interest rates ranging
from LIBOR plus 1.375% to LIBOR plus 2.0%,
collateralized by certain loan receivables.
(d) $25 million warehouse revolving line of credit
expiring December 2000, interest rate of LIBOR
plus 1.75%, collaterized by certain loan
receivables.
(e) $150 million warehouse line of credit expiring
August 2000, interest rate of LIBOR plus 1.0%,
collateralized by certain loan receivables.
108
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. Subordinated Debt (f) $20 million warehouse revolving line of credit,
and Warehouse Lines expired January 2000, interest rates at prime
and Other Notes less 1.0% or LIBOR at the Company's option,
Payable (continued) collateralized by lease receivables.
(g) Lease funding facility due April 2000 through
December 2004, interest rate of LIBOR plus
1.775%, collateralized by certain lease
receivables.
(h) $5 million revolving line of credit expiring
December 2000, interest rate of LIBOR plus 2.0%,
collateralized by certain residual interests in
securitization trusts.
(i) Repurchase agreement due July 2000, interest
rate of LIBOR plus 0.5%, collateralized by
certain lease backed securities.
(j) Senior subordinated debt due July 2000, interest
rate of 12.0%, subordinated to certain
subsidiary's senior indebtedness.
Principal payments on debt for the next five years
are as follows: year ending June 30, 2001 - $219.3
million; 2002 - $98.5 million; 2003 - $48.3 million;
2004 - $21.6 million; and 2005 - $24.7 million.
The Company's subordinated debt securities are
subordinated in right of payment to, or subordinate
to, the prior payment in full of all senior debt as
defined in the indentures related to such debt,
whether outstanding on the date of the applicable
indenture or incurred following the date of the
indenture. There is no limit on the amount of senior
debt the Company may incur. The Company's assets,
including the stock it holds in its subsidiaries,
are available to repay the subordinated debt in the
event of default following payment to holders of the
senior debt. In the event of the Company's default
and liquidation of its subsidiaries to repay the
debt holders, creditors of the subsidiaries must be
paid or provision made for their payment from the
assets of the subsidiaries before the remaining
assets of the subsidiaries can be used to repay the
holders of the subordinated debt securities.
The loan agreements provide for certain covenants
regarding net worth and financial matters. At June
30, 2000, the Company is in compliance with the
terms of the loan covenants.
Subsequent to June 30, 2000, the Company and its
subsidiaries, American Business Credit, HomeAmerican
Credit and New Jersey Mortgage established a $200.0
million facility which provides for the sale of
loans into an off balance sheet funding facility
with UBS Principal Finance, LLC an affiliate of UBS
Warburg.
10. Stockholders' Equity On August 18, 1999, the Company's Board of Directors
declared a 5% stock dividend to be paid on September
27, 1999 to shareholders of record on September 3,
1999. In addition the Board resolved that all
outstanding stock options would be adjusted for the
dividend. Accordingly, all outstanding shares,
earnings per common share, average common share and
stock option amounts have been retroactively
adjusted to reflect the effect of the stock
dividend.
109
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. Stockholders' Equity As previously reported, the Company's Board of
(continued) Directors authorized the repurchase of up to 10% of
the outstanding shares of our common stock. On
January 24, 2000, the Board of Directors authorized
the repurchase of an additional 338,000 shares,
representing 10.0% of the then outstanding shares.
The Company's Board of Directors initiated the stock
repurchase program in view of the price level of our
common stock which was trading at that time at below
book value and the Company's consistent earnings
growth over fiscal 1998 and 1999, which did not
result in a corresponding increase in the market
value of our common stock. In fiscal 2000, 328,000
shares were repurchased representing 9% of the
outstanding shares. The impact of the share
repurchase program was an increase of diluted
earnings per share by approximately $0.06 for the
year ended June 30, 2000.
The Company increased its quarterly dividend to
$0.08 per share in fiscal 2000. Dividends of $0.30
were paid in the year ended June 30, 2000 compared
to $0.165 and $0.06 in each of the years ended June
30, 1999 and 1998, respectively.
The Company has a loan receivable from an officer of
the Company for $600 thousand, which was an advance
for the exercise of stock options to purchase
225,012 shares of the Company's common stock. The
loan is due in September 2005 (earlier if the stock
is disposed of). Interest at 6.46% is payable
annually. The loan is secured by 225,012 shares of
the Company's stock, and is shown as a reduction of
stockholders' equity on the accompanying balance
sheet.
11. Employee The Company has a 401(k) defined contribution plan,
Benefit Plan which was established in 1995, available to all
employees who have been with the Company for one
year and have reached the age of 21. Employees may
generally contribute up to 15% of their salary each
year, subject to IRS imposed limitations. The
Company, at its discretion, may match up to 25% of
the first 5% of salary contributed by the employee,
and may match an additional 25% of the first 5% of
salary contributed by the employee in Company stock.
The Company's contribution was $304 thousand and
$263 thousand for the years ended June 30, 2000 and
1999, respectively.
110
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. Stock Option Plans The Company has a stock option plan that provides
for the periodic granting of options to key
employees ("the Employee Plan"). The options are
generally granted at the market price of the
Company's stock on the date of grant and expire five
to ten years from date of grant. Options either
fully vest when granted or over periods of up to
five years. At June 30, 2000, 261,000 shares were
available for future grant under this plan.
A summary of stock option activity under the
Employee Plan for the years ended June 30, 2000,
1999 and 1998 follows. Stock option activity for the
years ended June 30, 1999 and 1998 has been
retroactively adjusted for the effect of the 5%
stock dividend described in Note 10.
Number Weighted-Average
of Shares Exercise Price
-----------------------------------------------------------------------------------
Options outstanding, June 30, 1997 238,875 $ 14.43
Options granted 106,575 22.95
Options canceled (9,450) 19.51
-----------------------------------------------------------------------------------
Options outstanding, June 30, 1998 336,000 18.10
Options granted 14,175 17.86
Options exercised (3,937) 2.54
Options canceled (41,475) 20.48
-----------------------------------------------------------------------------------
Options outstanding, June 30, 1999 304,763 16.74
Options granted 225,650 13.00
Options exercised (41,738) 2.58
Options canceled (22,575) 20.79
-----------------------------------------------------------------------------------
Options outstanding, June 30, 2000 466,100 $ 16.00
===================================================================================
111
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. Stock Option Plans The following tables summarize information about
(continued) stock options outstanding under the Employee Plan at
June 30, 2000:
Options Outstanding
Weighted
Range of Remaining Weighted
Exercise Prices Number Contractual Average
Of Options of Shares Life in Years Exercise Price
------------------------------------------------------------------------------------
$ 4.76 23,625 0.2 $4.76
13.00 225,650 9.4 13.00
14.29 to 19.05 133,350 6.5 18.76
19.52 to 24.76 83,475 7.4 22.88
------------------------------------------------------------------------------------
466,100 7.8 $16.00
====================================================================================
Options Exercisable
Weighted
Range of Remaining Weighted
Exercise Prices Number Contractual Average
Of Options of Shares Life in Years Exercise Price
------------------------------------------------------------------------------------
$ 4.76 23,625 0.2 $4.76
13.00 10,000 9.3 13.00
14.29 to 19.05 83,685 6.4 18.61
19.52 to 24.76 36,960 7.4 22.86
------------------------------------------------------------------------------------
154,270 5.9 $17.15
====================================================================================
112
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. Stock Option Plans The Company accounts for stock options issued under
(continued) the Employee Plan using the intrinsic value method,
and, accordingly, no expense is recognized where the
exercise price equals or exceeds the fair value of
the shares at the date of grant. Had the Company
accounted for stock options granted under the
Employee Plan using the fair value method, pro forma
net income and earnings per share would have been as
follows (in thousands except per share amounts):
June 30, 2000 1999 1998
-------------------------------------------------------------------------------------
Net income
As reported $ 6,424 $ 14,088 $ 11,455
Pro forma 6,161 13,811 10,956
Earnings per share -basic
As reported $ 1.88 $ 3.83 $ 3.10
Pro forma 1.80 3.75 2.97
Earnings per share -diluted
As reported $ 1.83 $ 3.72 $ 2.98
Pro forma 1.75 3.64 2.85
=====================================================================================
The fair value of options granted was estimated on
the date of grant using the Black-Scholes
option-pricing model with the following assumptions:
June 30, 2000 1999 1998
-----------------------------------------------------------------------------------
Expected volatility 30% 30% 30%
Expected life 8 yrs. 5-10 yrs. 5-10 yrs.
Risk-free interest rate 6.12% - 6.70% 4.50%-5.68% 5.39%-6.17%
The Company also has a non-employee director stock
option plan ("the Director Plan") that provides for
the granting of options to non-employee directors.
Options generally are granted at or above the market
price of the stock on the date of grant, fully vest
when granted and expire three to ten years after the
date of grant.
113
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
12. Stock Option Plans A summary of activity under the Director Plan for
(continued) the three years ended June 30, 2000, 1999 and 1998
follows. Stock option activity for the years ended
June 30, 1999 and 1998 have been retroactively
adjusted for the effect of the 5% stock dividend
described in Note 10.
Weighted-
Number Average
of Shares Exercise Price
-------------------------------------------------------------------------------------
Options outstanding, June 30, 1997 115,500 $ 6.97
Options granted 21,000 22.14
-------------------------------------------------------------------------------------
Options outstanding, June 30, 1998 136,500 9.30
Options granted 21,000 14.29
-------------------------------------------------------------------------------------
Options outstanding, June 30, 1999 157,500 9.97
Options granted 40,000 13.00
Options exercised (22,500) 5.00
Options outstanding, June 30, 2000 175,000 $ 11.43
=====================================================================================
The fair value of options granted under the Director
Plan is expensed on the date of grant. The Company
recognized expense of $130 thousand, $73 thousand,
and $87 thousand for the years ended June 30, 2000,
1999, and 1998, respectively.
13. Income Taxes The provision for income taxes consists of the
following (in thousands):
Year ended June 30, 2000 1999 1998
--------------------------------------------------------------------------------
Current
Federal $ 935 $ 1,268 $ 1,087
--------------------------------------------------------------------------------
Deferred
Federal 3,003 6,495 5,348
State -- -- --
--------------------------------------------------------------------------------
3,003 6,495 5,348
--------------------------------------------------------------------------------
Total provision for
income taxes $ 3,938 $ 7,763 $ 6,435
================================================================================
There were no tax benefits from the utilization of
net operating loss carryforwards in the years ended
June 30, 2000 or 1999.
114
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
13. Income Taxes The cumulative temporary differences resulted in net
(continued) deferred income tax assets or liabilities consisting
primarily of the following (in thousands):
Year ended June 30, 2000 1999
-------------------------------------------------------------------------------
Deferred income tax assets
Allowance for credit losses $ 1,575 $ 704
Net operating loss carryforwards 33,657 11,262
Other 125 --
-------------------------------------------------------------------------------
35,357 11,966
Less valuation allowance 12,121 6,845
-------------------------------------------------------------------------------
$ 23,236 $ 5,121
-------------------------------------------------------------------------------
Deferred income tax liabilities
Loan and lease origination
costs/fees, net $ 1,301 $ 1,123
Book over tax basis of property
and equipment -- 47
Interest-only strips and other
receivables 41,585 16,551
Servicing rights 3,123 4,004
-------------------------------------------------------------------------------
46,009 21,725
-------------------------------------------------------------------------------
Net deferred income tax liability $ 22,773 $ 16,604
===============================================================================
The valuation allowance represents the income tax
effect of state net operating loss carryforwards of
the Company, which are not presently expected to be
utilized.
A reconciliation of income taxes at federal
statutory rates to the Company's tax provision is as
follows (in thousands):
Year ended June 30, 2000 1999 1998
--------------------------------------------------------------------------------
Federal income tax at
statutory rates $ 3,627 $ 7,429 $ 6,083
Nondeductible items 623 528 349
Other, net (312) (194) 3
--------------------------------------------------------------------------------
$ 3,938 $ 7,763 $ 6,435
================================================================================
115
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
13. Income Taxes For income tax reporting, the Company has net
(continued) operating loss carryforwards aggregating
approximately $151.5 million available to reduce
future state income taxes for various states as of
June 30, 2000. If not used, substantially all of the
carryforwards will expire at various dates from June
30, 2001 to June 30, 2003.
14. Commitments and As of June 30, 2000, the Company leases property
Contingencies under noncancelable operating leases requiring
minimum annual rentals as follows (in thousands):
Year ending June 30, Amount
----------------------------------------------------
2001 $ 4,233
2002 3,954
2003 3,559
2004 82
2005 31
----------------------------------------------------
$ 11,859
----------------------------------------------------
Rent expense for leased property was $3.6 million,
$2.9 million and $1.7 million, respectively, for the
years ended June 30, 2000, 1999 and 1998.
Employment Agreements
The Company entered into employment agreements, as
amended, with three executives under which they are
entitled to annual base compensation of $625
thousand, collectively, adjusted for increases in
the Consumer Price Index and merit increases for one
executive. The agreements also provide for bonus
payments under a cash bonus plan established by the
Company's Board of Directors. The agreements
terminate upon: (a) the earlier of the executive's
death, permanent disability, termination of
employment for cause, voluntary resignation or 70th
birthday; or (b) the later of the third anniversary
for one executive and fifth anniversary of the
agreement for the other two executives, or from
three to five years from the date of notice to the
executive of the Company's intention to terminate
the agreement.
In addition, the three executives are entitled to a
cash payment equal to 299% of the last five years
average annual compensation in the event of a
"change in control," as defined in the agreement.
The Company has also entered into an employment
agreement with another executive under which he is
entitled to receive annual base compensation of $335
thousand which shall be reviewed annually and may be
adjusted for merit increases. The executive is also
entitled to participate in the Company's cash
116
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
14. Commitments and bonus plan based upon performance and achievement of
Contingencies specific goals. This agreement terminates upon: (a)
(continued) the earlier of the executive's death, permanent
disability, termination of employment for cause,
voluntary resignation (except that no voluntary
resignation may occur prior to June 2001) or 70th
birthday; or (b) upon notice to the executive of the
Company's intention to terminate the agreement
without cause in which case the executive will
receive a cash payment equal to his annual base
salary. This agreement is binding upon any successor
of the Company by merger, consolidation, purchase or
otherwise.
The Company has also entered into employment
arrangements with two additional executives under
which they are entitled to receive annual base
compensation of $645 thousand, collectively. The
arrangements also provide for cash bonus payments
based upon the executives achieving specific goals
and objectives. One of these executives is entitled
to one year's base salary if the Company terminates
his employment for any reason except cause. This
same executive is entitled to a maximum cash payment
of two times annual compensation in the event of a
"change of control" as defined in the agreement.
15. Legal Proceedings From time to time, the Company is involved as
plaintiff or defendant in various legal proceedings
arising in the normal course of our business. While
the Company cannot predict the ultimate outcome of
these various legal proceedings, it is management's
opinion that the resolution of these legal actions
should not have a material effect on the Company's
financial position, results of operations or
liquidity.
16. Fair Value of No active market exists for certain of the Company's
Financial Instruments assets and liabilities. Therefore, fair value
estimates are based on judgments regarding credit
risk, investor expectation of future economic
conditions, normal cost of administration and other
risk characteristics, including interest rates and
prepayment risk. These estimates are subjective in
nature and involve uncertainties and matters of
judgment and, therefore, cannot be determined with
precision. Changes in assumptions could
significantly affect the estimates.
117
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
16. Fair Value of The following table summarizes the carrying amounts
Financial Instruments and fair value estimates of financial instruments
(continued) recorded on the Company's financial statements at
June 30, 2000 and 1999 (in thousands):
June 30, 2000
-------------------------------------------------------------------------------
Carrying Fair
Value Value
-------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 69,751 $ 69,751
Loans and leases available
for sale 44,132 45,330
Interest-only strips 277,872 277,872
Servicing rights 74,919 75,400
Investments available for sale 713 713
Investments held to maturity 983 859
Liabilities
Subordinated debt and warehouse
lines and notes payable $ 441,518 $ 438,433
===============================================================================
June 30, 1999
-------------------------------------------------------------------------------
Carrying Fair
Value Value
-------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 22,395 $ 22,395
Loans and leases available
for sale 33,776 35,152
Interest-only strips 178,218 178,218
Servicing rights 43,210 43,210
Investments held to maturity 1,014 911
Liabilities
Subordinated debt and warehouse
lines and notes payable $ 270,343 $ 270,915
===============================================================================
The methodology and assumptions utilized to estimate
the fair value of the Company's financial
instruments are as follows:
Cash and cash equivalents - For these short-term
instruments, the carrying amount approximates
fair value.
Loans and leases available for sale - Fair value
is determined by recent sales and
securitizations.
Interest-only strips - Fair value is determined
using estimated discounted future cash flows
taking into consideration anticipated prepayment
rates and credit loss rates of the underlying
loans and leases.
118
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
16. Fair Value of Servicing rights - Fair value is determined
Financial Instruments using estimated discounted future cash flows
(continued) taking into consideration anticipated prepayment
rates and credit loss rates of the underlying
loans and leases.
Investments available for sale (U.S. Treasury
Securities) - Fair value is determined using
current market rates.
Investments held to maturity - Represent
mortgage loan backed securities retained in
securitizations. Fair value is determined using
estimated discounted future cash flows taking
into consideration anticipated prepayment rates
and credit loss rates of the underlying loans.
Subordinated debt and notes payable - The fair
value of fixed debt is estimated using the rates
currently available to the Company for debt of
similar terms.
The carrying value of investment securities at June
30, 2000 was as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------------------------
Held-to-Maturity:
Mortgage backed
securities retained in
securitizations (mature July
2000 through April 2011) $ 983 $ -- $ (124) $ 859
Available for sale:
U.S. Treasury securities
(mature March 2001
through April 2001) 713 -- -- 713
---------------------------------------------------------------------------------
Total $ 1,696 $ -- $ (124) $1,572
=================================================================================
119
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
16. Fair Value of The carrying value of investment securities at June
Financial Instruments 30, 1999 was as follows (in thousands):
(continued)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------------------------
Held-to-Maturity:
Mortgage backed
securities retained in
securitizations $ 1,014 $ -- $ (103) $ 911
--------------------------------------------------------------------------------
Total $ 1,014 $ -- $ (103) $ 911
================================================================================
17. Derivative Outstanding derivative contracts by items hedged and
Financial associated unrealized losses as of June 30, 2000 are
Instruments as follows. There were no outstanding hedge
positions at June 30, 1999. (in thousands):
Eurodollar Forward
Futures Treasury
Contracts Sales Total
----------------------------------------------------------------------------------
Loans available for sale:
Notional amount $ 20,000 $ -- $ 20,000
Unrealized losses (54) -- (54)
Mortgage conduit facility:
Notional amount 25,000 35,000 60,000
Unrealized losses (19) (114) (133)
Loan commitments:
Notional amount 20,000 10,000 30,000
Unrealized losses (25) (23) (48)
----------------------------------------------------------------------------------
Total:
Notional amount $ 65,000 $ 45,000 $ 110,000
Unrealized losses (98) (137) (235)
==================================================================================
During fiscal 2000, net cash losses of $2.1 million
were realized on hedging transactions (futures
contracts), and were recognized as a component of
gains on sale recorded on securitizations during the
year. During fiscal 1999, net losses of
approximately $2.0 million were realized on hedging
transactions (futures contracts), and were
recognized as reductions to the gains on sale for
the securitizations during the year.
At June 30, 2000 the Company had an obligation to
satisfy a mortgage securitization prefund
requirement of $67.9 million which was satisfied in
July 2000.
120
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
18. Reconciliation of Year ended June 30, 2000 1999 1998
Basic and Diluted ------------------------------------------------------------------------------------
Earnings Per (in thousands except per share data)
Common Share (Numerator)
Net income $ 6,424 $ 14,088 $ 11,455
------------------------------------------------------------------------------------
(Denominator)
Average Common Shares
Average common
shares outstanding 3,424 3,682 3,692
Average potentially
dilutive shares 85 109 155
Average common and
potentially dilutive shares 3,509 3,791 3,847
--------------------------------------------------------------------------------------
Earnings per common
share
Basic $ 1.88 $ 3.83 $ 3.10
Diluted 1.83 3.72 2.98
======================================================================================
121
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
19. Segment Information The Company has three operating segments: Loan
Origination, Servicing, and Treasury and Funding.
The Loan Origination segment originates business
purpose loans secured by real estate and other
business assets, home equity loans typically to
credit-impaired borrowers, conventional first
mortgage loans secured by one to four family
residential real estate and prior to December 31,
1999, small ticket and middle market business
equipment leases.
The Servicing segment services the loans and leases
the Company originates both while held as available
for sale by the Company and subsequent to
securitization. Servicing activities include billing
and collecting payments from borrowers, transmitting
payments to investors, accounting for principal and
interest, collections and foreclosure activities and
disposing of real estate owned.
The Treasury and Funding segment offers the
Company's subordinated debt securities pursuant to a
registered public offering and obtains other sources
of funding for the Company's general operating and
lending activities.
All Other mainly represents segments that do not
meet the SFAS No. 131 defined thresholds for
determining reportable segments, financial assets
not related to operating segments, unallocated
overhead and other expenses of the Company unrelated
to the reportable segments identified.
The reporting segments follow the same accounting
policies used for the Company's consolidated
financial statements as described in the summary of
significant accounting policies. Management
evaluates a segment's performance based upon profit
or loss from operations before income taxes.
Reconciling items represent elimination of
inter-segment income and expense items, and are
included to reconcile segment data to the
consolidated financial statements.
122
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
19. Segment Information (continued)
Year ended June 30, 2000 Loan Treasury and Reconciling
(in thousands) Origination Funding Servicing All Other Items Consolidated
- --------------------------------------------------------------------------------------------------------------------------
External revenues:
Gain on sale of loans and
leases $ 90,380 $ -- $ -- $ -- $ -- $ 90,380
Interest income 5,179 848 1,218 16,615 -- 23,860
Non-interest income 1,468 -- 14,938 -- -- 16,406
Inter-segment revenues -- 43,909 -- 21,070 (64,979) --
Operating expenses:
Interest expense 22,892 29,471 385 29,283 (43,909) 38,122
Non-interest expense 34,866 10,918 11,238 6,739 -- 63,761
Depreciation and amortization 2,089 42 260 3,407 -- 5,798
Interest-only strips fair value
adjustment -- -- -- 12,603 -- 12,603
Inter-segment expense 21,070 -- -- -- (21,070) --
Income tax expense 6,122 1,644 1,624 (5,452) -- 3,938
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 9,988 $ 2,682 $ 2,649 $ (8,895) $ -- $ 6,424
===========================================================================================================================
Segment assets $ 118,949 $ 128,402 $ 77,499 $ 267,818 $ -- $ 592,668
===========================================================================================================================
123
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
19. Segment Information (continued)
Year ended June 30, 1999 Loan Treasury and Reconciling
(in thousands) Origination Funding Servicing All Other Items Consolidated
- --------------------------------------------------------------------------------------------------------------------------
External revenues:
Gain on sale of loans and
Leases $ 64,490 $ -- $ -- $ -- $ -- $ 64,490
Interest income 5,883 321 1,000 2,120 -- 9,324
Non-interest income 5,225 88 7,265 32 -- 12,610
Inter-segment revenues -- 24,716 -- 25,080 (49,796) --
Operating expenses:
Interest expense 14,313 14,995 415 17,419 (24,716) 22,426
Non-interest expense 21,885 6,242 2,274 7,574 -- 37,975
Depreciation and amortization 1,385 1,653 300 834 -- 4,172
Inter-segment expense 24,490 590 -- -- (25,080) --
Income tax expense 4,805 584 1,875 499 -- 7,763
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 8,720 $ 1,061 $ 3,401 $ 906 $ -- $ 14,088
===========================================================================================================================
Segment assets $ 66,969 $ 86,442 $ 44,921 $ 197,969 $ -- $ 396,301
===========================================================================================================================
124
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
20. Quarterly Data The following tables summarize financial data by
Statement (Unaudited) quarters for the years ended June 30, 2000 and 1999
(in thousands):
Quarterly data for the
year ended 2000 June 30, March 31, December 31, September 30,
---------------------------------------------------------------------------------------------
Revenues
Gain on sale of loans and leases $27,355 $23,412 $20,492 $19,121
Interest and fees 5,181 4,723 4,737 4,759
Interest accretion on interest-only
strips 4,714 4,836 4,316 2,750
Servicing income 827 1,173 1,050 1,189
Other income 6 2 2 1
---------------------------------------------------------------------------------------------
Total revenues 38,083 34,146 30,597 27,820
Total expenses 46,826(a) 27,621 24,334 21,503
---------------------------------------------------------------------------------------------
Income (loss) before provision
for income taxes (8,743) 6,525 6,263 6,317
Provision for income taxes (3,704) 2,610 2,505 2,527
---------------------------------------------------------------------------------------------
Net income (loss) $(5,039) $ 3,915 $ 3,758 $ 3,790
---------------------------------------------------------------------------------------------
Earnings per common share
Basic $ (1.44) $ 1.16 $ 1.10 $ 1.06
Diluted $ (1.40) $ 1.12 $ 1.08 $ 1.03
---------------------------------------------------------------------------------------------
(a) Includes an interest-only strips fair value
adjustment of $12.6 million.
125
American Business Financial
Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
20. Quarterly Data Statement (Unaudited)(continued)
Quarterly data for the
year ended 1999 June 30, March 31, December 31, September 30,
---------------------------------------------------------------------------------------------
Revenues
Gain on sale of loans and leases $18,701 $17,417 $14,775 $13,597
Interest and fees 3,836 4,271 3,907 4,539
Interest accretion on interest-only
strips 1,322 307 208 184
Servicing income 1,354 952 525 490
Other income 2 22 1 14
--------------------------------------------------------------------------------------------
Total revenues 25,215 22,969 19,416 18,824
Total expenses 19,495 17,487 13,949 13,642
--------------------------------------------------------------------------------------------
Income before provision for
income taxes 5,720 5,482 5,467 5,182
Provision for income taxes 2,059 1,973 1,969 1,762
--------------------------------------------------------------------------------------------
Net income $ 3,661 $ 3,509 $ 3,498 $ 3,420
--------------------------------------------------------------------------------------------
Earnings per common share
Basic $ 1.01 $ 0.95 $ 0.95 $ 0.92
Diluted $ 0.98 $ 0.92 $ 0.92 $ 0.90
--------------------------------------------------------------------------------------------
126
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
127
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required to be included in Item 10 of Part III of this
Form 10-K incorporates by reference certain information from our definitive
proxy statement, for our 2000 annual meeting of stockholders to be filed with
the SEC not later than 120 days after the end of our fiscal year covered by this
report.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act ("Section 16(a)") requires our
directors, executive officers, and persons who own more than 10% of a registered
class of our equity securities, to file with the SEC initial reports of
ownership and reports of changes in ownership of our common stock and other
equity securities. Officers, directors and greater than 10% stockholders are
required by SEC regulation to furnish us with copies of all Section 16(a) forms
they file.
Our knowledge, based solely on a review of the copies of such reports
furnished to us and written representations that no other reports were required,
during the fiscal year ended June 30, 2000, was that its officers, directors and
greater than 10% beneficial owners had complied with all Section 16(a) filing
requirements except for the late filing of a Form 4 by Leonard Becker.
Item 11. Executive Compensation
The information required to be included in Item 11 of Part II of this
Form 10-K incorporates by reference certain information from our definitive
proxy statement, for our 2000 annual meeting of stockholders to be filed with
the SEC not later than 120 days after the end of our fiscal year covered by this
report.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required to be included in Item 12 of Part II of this
Form 10-K incorporates by reference certain information from our definitive
proxy statement, for our 2000 annual meeting of stockholders to be filed with
the SEC not later than 120 days after the end of our fiscal year covered by this
report.
Item 13. Certain Relationships and Related Transactions
The information required to be included in Item 13 of Part III of this
Form 10-K incorporates by reference certain information from our definitive
proxy statement, for our 2000 annual meeting of stockholders to be filed with
the SEC not later than 120 days after the end of our fiscal year covered by this
report.
128
PART IV
Item 14. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits:
Exhibit Number Description
-------------- -----------
3.1 Amended and Restated Certificate of Incorporation
(Incorporated by reference from Exhibit 3.1 of the
ABFS Annual Report on Form 10-KSB for the fiscal
year ended June 30, 1996 filed on September 27,
1996, File No. 0-22472 (the "1996 Form 10-KSB")).
3.2 Bylaws of ABFS (Incorporated by reference from
Exhibit 3.2 of the Registration Statement on Form
SB-2 filed December 27, 1996, Registration Number
333-18919 (the "1996 Form SB-2")).
4.1 Form of unsecured Investment Note (Incorporated by
reference from Exhibit 4.1 of Amendment No. 1 to the
Registration Statement on Form SB-2 filed April 29,
1994, Registration Number 33-76390)).
4.2 Form of unsecured Investment Note issued pursuant to
Indenture with First Trust, National Association, a
national banking association (Incorporated by
reference from Exhibit 4.5 of Amendment No. One to
the Registration Statement on Form SB-2 filed on
December 14, 1995, Registration Number 33-98636 (the
"1995 Form SB-2").
4.3 Form of Indenture by and between ABFS and First
Trust, National Association, a national banking
association (Incorporated by reference from Exhibit
4.6 of the Registration Statement on Form SB-2 filed
on October 26, 1995, Registration Number 33-98636).
4.4 Form of Indenture by and between ABFS and First
Trust, National Association, a national banking
association (Incorporated by reference from Exhibit
4.4 of the Registration Statement on Form SB-2 filed
March 28, 1997, Registration Number 333-24115 (the
"1997 Form SB-2")).
129
Exhibit Number Description
-------------- -----------
4.5 Form of unsecured Investment Note (Incorporated by
reference from Exhibit 4.5 of the 1997 Form SB-2).
4.6 Form of Indenture by and between ABFS and First
Trust National Association, a national banking
association (Incorporated by reference from Exhibit
4.4 of the Registration Statement on Form SB-2 filed
May 23, 1997, Registration Number 333-24115).
4.7 Form of Unsecured Investment Note (Incorporated by
reference from Exhibit 4.5 of the Registration
Statement on Form SB-2 filed May 23, 1997,
Registration Number 333-24115).
4.8 Form of Indenture by and between ABFS and U.S. Bank
Trust, National Association, a national banking
association (Incorporated by reference from Exhibit
4.8 of the Registration Statement on Form S-2 filed
on September 21, 1998 (the "Form S-2")).
4.9 Form of Unsecured Investment Note (Incorporated by
reference from Exhibit 4.9 of the Form S-2).
4.10 Form of Indenture by and between ABFS and U.S. Bank
Trust National Association (Incorporated by
reference from Exhibit 4.10 of Registrant's
Registration Statement on Form S-2, No. 333-87333,
filed September 17, 1999).
4.11 Form of Indenture by and between ABFS and U.S. Bank
Trust National Association.
4.12 Form of Investment Note.
10.1 Loan and Security Agreement between Upland Mortgage
and BankAmerica Business Credit, Inc. dated May 23,
1996 (Incorporated by reference from the 1996 Form
10-KSB).
10.2 Amended and Restated Stock Option Plan (Incorporated
by reference from Exhibit 10.2 of the ABFS Quarterly
Report on Form 10-QSB from the quarter ended
September 30, 1997, File No. 0-22474).*
10.3 Stock Option Award Agreement (Incorporated by
reference from Exhibit 10.1 of the Registration
130
Exhibit Number Description
-------------- -----------
Statement on Form S-11 filed on February 26, 1993,
Registration No. 33-59042 (the "Form S-11")).*
10.4 Line of Credit Agreement by and between American
Business Credit, Inc. and Eagle National Bank
(Incorporated by reference from Exhibit 10.4 of
Amendment No. 1 to the Registration Statement on
Form SB-2 filed on April 29, 1993, Registration No.
33-59042 (the "1993 Form SB-2")).
10.5 Agreement dated April 12, 1993 between American
Business Credit, Inc. and Eagle National Bank
(Incorporated by reference from Exhibit 10.5 of the
1993 Form SB-2).
10.6 1995 Stock Option Plan for Non-Employee Directors
(Incorporated by reference from Exhibit 10.6 of the
Amendment No. 1 to the 1996 Form SB-2 filed on
February 4, 1996 Registration No. 333-18919 (the
"Amendment No. 1 to the 1997 Form SB-2")).*
10.7 Form of Option Award Agreement for Non-Employee
Directors Plan for Formula Awards (Incorporated by
reference from Exhibit 10.13 of the 1996 Form
10-KSB).*
10.8 1997 Non-Employee Director Stock Option Plan
(including form of Option Agreement) (Incorporated
by reference from Exhibit 10.1 of the September 30,
1997 Form 10-QSB).*
10.9 Interim Warehouse and Security Agreement between
Upland Mortgage and Prudential Securities Realty
Funding Corporation dated April 25, 1996
(Incorporated by reference from Exhibit 10.14 of the
1996 Form 10-KSB).
10.10 Lease dated January 7, 1994 by and between TCW
Realty Fund IV Pennsylvania Trust and ABFS
(Incorporated by reference from Exhibit 10.9 of the
Registration Statement on Form SB-2 filed March 15,
1994, File No. 33-76390).
10.11 First Amendment to Agreement of Lease by and between
TCW Realty Fund IV Pennsylvania Trust and ABFS dated
October 24, 1994. (Incorporated by reference from
Exhibit 10.9 of ABFS' Annual Report on Form 10-KSB
for the fiscal year ended June 30, 1995 (the "1995
Form 10-KSB")).
131
Exhibit Number Description
-------------- -----------
10.12 Second Amendment to Agreement of Lease by and
between TCW Realty Fund IV Pennsylvania Trust and
ABFS dated December 23, 1994 (Incorporated by
reference from Exhibit 10.10 of the 1995 Form
10-KSB).
10.13 Third Amendment to Lease between TCW Realty Fund IV
Pennsylvania Trust and ABFS dated July 25, 1995
(Incorporated by reference from Exhibit 10.11 of the
1995 Form 10-KSB).
10.14 Promissory Note of Anthony J. Santilli and Stock
Pledge Agreement dated September 29, 1995
(Incorporated by reference from Exhibit 10.14 of the
1995 Form SB-2).
10.15 Form of Employment Agreement with Anthony J.
Santilli, Beverly Santilli and Jeffrey M. Ruben
(Incorporated by reference from Exhibit 10.15 of the
Amendment No. 1 to the 1996 Form SB-2).*
10.16 Amendment One to Anthony J. Santilli's Employment
Agreement (Incorporated by reference from Exhibit
10.3 of the September 30, 1997 Form 10-QSB).*
10.17 Amendment One to Beverly Santilli's Employment
Agreement (Incorporated by reference from Exhibit
10.4 of the September 30, 1997 Form 10-QSB).*
10.18 Management Incentive Plan (Incorporated by reference
from Exhibit 10.16 of the 1996 Form SB-2).*
10.19 Loan and Security Agreement dated December 12, 1996
between American Business Credit, Inc. and Finova
Capital Corporation (Incorporated by reference from
Exhibit 10.17 of the 1996 Form SB-2).
10.20 Form of Option Award Agreement for Non-Employee
Directors Plan for Non-Formula Awards (Incorporated
by reference from Exhibit 10.18 of the Amendment No.
1 to the 1996 Form SB-2).*
10.21 Form of Pooling and Servicing Agreement related to
ABFS loan securitizations dated March 31, 1995,
October 1, 1995, May 1, 1996, August 31, 1996,
132
Exhibit Number Description
-------------- -----------
February 28, 1997, September 1, 1997, February 1,
1998 and June 1, 1998 (Incorporated by reference
from Exhibit 4.1 of the ABFS Quarterly Report on
Form 10-QSB for the quarter ended March 31, 1995
(the "March 31, 1995 Form 10-QSB")).
10.22 Form of Sales and Contribution Agreement related to
ABFS loan securitizations dated March 31, 1995,
October 1, 1995, May 1, 1996 and September 27, 1996
(Incorporated by reference from Exhibit 4.1 of the
March 31, 1995 Form 10-QSB).
10.23 Amendments to the Interim Warehouse and Security
Agreement between Upland Mortgage and Prudential
Securities Realty Funding Corporation. (Incorporated
by reference from Exhibit 10.21 of the Amendment No.
1 to the 1997 Form SB-2 filed on May 23, 1997
Registration No. 333-24115(the Amendment No. 1 to
the 1997 SB-2)).
10.24 Fourth Amendment to Lease between TCW Realty Fund IV
Pennsylvania Trust and ABFS dated April 9, 1996
(Incorporated by reference from Exhibit 10.22 to the
Amendment No. 1 to the 1997 SB-2).
10.25 Fifth Amendment to Lease between TCW Realty Fund IV
Pennsylvania Trust and ABFS dated October 8, 1996
(Incorporated by reference from Exhibit 10.23 to the
Amendment No. 1 to the 1997 SB-2).
10.26 Sixth Amendment to Lease between TCW Realty Fund IV
Pennsylvania Trust and ABFS dated March 31, 1997
(Incorporated by reference from Exhibit 10.24 to the
Amendment No. 1 to the 1997 SB-2).
10.27 Agreement for Purchase and Sale of Stock between
Stanley L. Furst, Joel E. Furst and ABFS dated
October 27, 1997 (Incorporated by reference from the
ABFS Current Report on Form 8-K dated October 27,
1997, File No. 0-22474).
10.28 Credit Agreement between American Business Credit,
Inc., HomeAmerican Credit, 10.28 Inc., and American
Business Leasing, Inc., as co-borrowers, ABFS as
parent, Chase Bank of Texas, NA, as administrative
133
Exhibit Number Description
-------------- -----------
agent and certain lenders (Incorporated by reference
from Exhibit 10.24 of ABFS' Annual Report on Form
10-KSB for the fiscal year ended June 30, 1997 filed
on September 29, 1997, File No. 0-22474).
10.29 Standard Form of Office Lease and Rider to Lease
dated April 2, 1993 by and between 5 Becker
Associates and New Jersey Mortgage (Incorporated by
reference from Exhibit 10.29 of Post-Effective
Amendment No. 1 to the Registration Statement on
Form SB-2 filed on January 22, 1998, Registration
No. 333-2445).
10.30 First Amendment of Lease by and between 5 Becker
Associates and New Jersey Mortgage dated July 27,
1994 (Incorporated by reference from Exhibit 10.30
of Post-Effective Amendment No. 1 to the
Registration Statement on Form SB-2 filed on January
22, 1998, Registration No. 333-2445).
10.31 Form of Debenture Note related to NJMIC's
subordinated debt (Incorporated by reference from
Exhibit 10.31 of Post-Effective Amendment No. 1 to
the Registration Statement on Form SB-2 filed on
January 22, 1998, Registration No. 333-2445).
10.32 Note Agreement and Promissory Note dated July 15,
1997 issued by New Jersey Mortgage to N.M.
Rothschild & Sons (Incorporated by reference from
Exhibit 10.32 of Post-Effective Amendment No. 1 to
the Registration Statement on Form SB-2 filed on
January 22, 1998, Registration No. 333-2445).
10.33 Form of Standard Terms and Conditions of Servicing
Agreement related to NJMIC's lease securitizations
dated May 1, 1995 and March 1, 1996. (Incorporated
by reference from Exhibit 10.33 of Post-Effective
Amendment No. 1 to the Registration Statement on
Form SB-2 filed on January 22, 1998, Registration
No. 333-2445).
10.34 Form of Standard Terms and Conditions of Lease
Acquisition Agreement related to New Jersey
Mortgage's lease securitizations dated May 1, 1995
and March 1, 1996 (Incorporated by reference from
Exhibit 10.34 of Post-Effective Amendment No. 1 to
the Registration Statement on Form SB-2 filed on
January 22, 1998, Registration No. 333-2445).
134
Exhibit Number Description
-------------- -----------
10.35 Amended and Restated Specific Terms and Conditions
of Servicing Agreement related to New Jersey
Mortgage's lease securitization dated May 1, 1995
(Incorporated by reference from Exhibit 10.35 of
Post-Effective Amendment No. 1 to the Registration
Statement on Form SB-2 filed on January 22, 1998,
Registration No. 333-2445).
10.36 Amended and Restated Specific Terms and Conditions
of Lease Acquisition Agreement related to New Jersey
Mortgage's lease securitization dated May 1, 1995
(Incorporated by reference from Exhibit 10.36 of
Post-Effective Amendment No. 1 to the Registration
Statement on Form SB-2 filed on January 22, 1998,
Registration No. 333-2445).
10.37 Specific Terms and Conditions of Servicing Agreement
related to New Jersey Mortgage's lease
securitization dated March 1, 1996 (Incorporated by
reference from Exhibit 10.37 of Post-Effective
Amendment No. 1 to the Registration Statement on
Form SB-2 filed on January 22, 1998, Registration
No. 333-2445).
10.38 Specific Terms and Conditions of Lease Acquisition
Agreement related to New Jersey Mortgage's lease
securitization dated March 1, 1996 (Incorporated by
reference from Exhibit 10.38 of Post-Effective
Amendment No. 1 to the Registration Statement on
Form SB-2 filed on January 22, 1998, Registration
No. 333-2445).
10.39 Indenture by and among ABFS Equipment Contract Trust
1998-A, American Business Leasing, Inc. and The
Chase Manhattan Bank dated June 1, 1998
(Incorporated by reference from Exhibit 10.39 of the
Form S-2).
10.40 Form of Unaffiliated Seller's Agreement related to
ABFS' loan securitizations dated March 27, 1997,
September 29, 1997, February 1, 1998, and June 1,
1998 (Incorporated by reference from Exhibit 10.40
of the Form S-2).
10.41 First Amended and Restated Interim Warehouse and
Security Agreement among Prudential Securities
Credit Corporation, as lender, and HomeAmerican
Credit Inc. and American Business Credit, Inc., as
borrowers (Incorporated by reference from Exhibit
10.41 of the Form S-2).
135
Exhibit Number Description
-------------- -----------
10.42 Amendments to the First Amended and Restated Interim
Warehouse and Security Agreement among Prudential
Securities Credit Corporation, as lender, and
HomeAmerican Credit Inc. and American Business
Credit, Inc., as borrowers (Incorporated by
reference from Exhibit 10.42 of the Form S-2).
10.43 Amendments to the Credit Agreement between American
Business Credit, Inc., HomeAmerican Credit, Inc.,
American Business Leasing, Inc., New Jersey Mortgage
and Federal Leasing Corp. as co-borrowers, American
Business Financial Services, Inc., as parent, Chase
Bank of Texas, National Association, as
administrative agent for lenders (Incorporated by
reference from Exhibit 10.43 of the Form S-2).
10.44 $100.0 Million Receivables Purchase Agreement, dated
September 30, 1998 among American Business Lease
Funding Corporation, American Business Leasing, Inc.
and a syndicate of financial institutions led by
First Union Capital Markets and First Union National
Bank, as liquidity agent. (Incorporated by reference
from Exhibit 10.1 of the Registrant's September 30,
1998 Form 10-Q)
10.45 $20.0 Million Credit Agreement dated September 28,
1998 between American Business Leasing, Inc.,
Federal Leasing Corp. and First Union National Bank
(Incorporated by reference from Exhibit 10.2 of the
Registrant's September 30, 1998 From 10-Q).
10.46 Interim Warehouse and Security Agreement, dated
August 3, 1998, among Prudential Securities Credit
Corporation, as lender, and Federal Leasing, Inc.
and American Business Leasing, Inc., as borrowers,
and Amendments One and Two thereto. (Incorporated by
reference from Exhibit 10.3 of the Registrant's
September 30, 1998 Form 10-Q)
10.47 Amended and Restated Credit Agreement, dated October
1, 1998, between American Business Credit, Inc.,
HomeAmerican Credit, Inc., American Business
Leasing, Inc., New Jersey Mortgage, as co-borrowers,
American Business Financial Services, Inc., as
parent and Chase Bank of Texas. (Incorporated by
reference from Exhibit 10.4 of the Registrant's
September 30, 1998 Form 10-Q).
10.48 $5,000,000 Loan Agreement dated as of December 30,
1998, between American Business Credit, Inc.,
HomeAmerican Credit, Inc., New Jersey Mortgage as
136
Exhibit Number Description
-------------- -----------
co-borrowers, and Chase Bank of Texas as lender.
(Incorporated by reference from Exhibit 10.1 of the
Registrant's December 31, 1998 Form 10-Q).
10.49 Amendment to the First Amended and Restated Interim
Warehouse and Security Agreement dated June 9, 1997
among Prudential Securities Credit Corporation and
HomeAmerican Credit, Inc., New Jersey Mortgage and
American Business Credit, Inc. and ABFS as
Guarantor.
10.50 Lease Agreement dated August 30, 1999 related to One
Presidential Boulevard (Incorporated by reference to
Exhibit 10.1 of the Registrant's September 30, 1999
Form 10-Q).
10.51 Employment Agreement between American Business
Financial Services, Inc. and Albert Mandia
(Incorporated by reference to Exhibit 10.2 of the
Registrant's September 30, 1999 Form 10-Q).
10.52 Change in Control Agreement between American
Business Financial Services, Inc. and Albert Mandia
(Incorporated by reference to Exhibit 10.3 of the
Registrant's September 30, 1999 Form 10-Q).
10.53 12/99 Amendment dated effective as of December 30,
1999, to $5,000,000 Loan Agreement dated as of
December 30, 1998, between American Business Credit,
Inc., HomeAmerican Credit, Inc., and New Jersey
Mortgage and Investment Corp., as co-borrower and
Chase Bank of Texas, National Association as lender
(Incorporated by reference from Exhibit 10.1 of the
Registrant's December 31, 1999 Form 10-Q).
10.54 American Business Financial Services Inc. 1999 Stock
Option Plan (Incorporated by reference from Exhibit
10.2 of the Registrant's December 31, 1999 Form
10-Q).
10.55 Amendment No. 3 to Receivables Purchase Agreement,
dated as of October 13, 1999 among American Business
Lease Funding Corporation, American Business
Leasing, Inc. and a syndicate of financial
institutions led by First Union Securities, Inc. as
Deal Agent (Incorporated by reference from Exhibit
10.3 of the Registrant's December 31, 1999 Form
10-Q).
10.56 Amendment No. 4, dated as of November 12, 1999, to
the Receivables Purchase Agreement, dated as of
137
Exhibit Number Description
-------------- -----------
September 30, 1998, among American Business Lease
Funding Corporation, American Business Leasing, Inc.
and a syndicate of financial institutions led by
First Union Securities, Inc. as Deal Agent
(Incorporated by reference from Exhibit 10.4 of the
Registrant's December 31, 1999 Form 10-Q).
10.57 Amendment No. 5, dated as of November 29, 1999, to
the Receivables Purchase Agreement, dated as of
September 30, 1998, among American Business Lease
Funding Corporation, American Business Leasing, Inc.
and a syndicate of financial institutions led by
First Union Securities, Inc. as Deal Agent
(Incorporated by reference from Exhibit 10.5 of the
Registrant's December 31, 1999 Form 10-Q).
10.58 Amendment No. 6, dated as of December 14, 1999, to
the Receivables Purchase Agreement, dated as of
September 30, 1998, among American Business Lease
Funding Corporation, American Business Leasing, Inc.
and a syndicate of financial institutions led by
First Union Securities, Inc. as Deal Agent
(Incorporated by reference from Exhibit 10.6 of the
Registrant's December 31, 1999 Form 10-Q).
10.59 Seventh Amendment, dated as of December 31, 1999, to
the Receivables Purchase Agreement, dated as of
September 30, 1998, among American Business Lease
Funding Corporation, American Business Leasing, Inc.
and a syndicate of financial institutions led by
First Union Securities, Inc. as Deal Agent
(Incorporated by reference from Exhibit 10.7 of the
Registrant's December 31, 1999 Form 10-Q).
10.60 Eighth Amendment, dated as of January 10, 2000, to
the Receivables Purchase Agreement, dated as of
September 30, 1998, among American Business Lease
Funding Corporation, American Business Leasing, Inc.
and a syndicate of financial institutions led by
First Union Securities, Inc. as Deal Agent
(Incorporated by reference from Exhibit 10.8 of the
Registrant's December 31, 1999 Form 10-Q).
138
10.61 2000-1 Securitization Agreement - the Sale and
Servicing Agreement, dated as of March 1, 2000, by
and among Prudential Securities Secured Financing
Corporation, ABFS Mortgage Loan Trust 2000-1, Chase
Bank of Texas, N.A., as collateral agent, The Chase
Manhattan Bank, as indenture trustee and American
Business Credit, Inc., as Servicer (Incorporated by
reference from Exhibit 10.1 of the Registrant's
March 31, 2000 Form 10-Q).
10.62 The Sale and Servicing Agreement dated as of March
1, 2000 by and among ABFS Millennium, Inc., as
Depositor, American Business Credit, Inc.,
HomeAmerican Credit, Inc., d/b/a Upland Mortgage and
New Jersey Mortgage and Investment Corp., as
Originators, American Business Financial Services,
Inc., as Guarantor, ABFS Mortgage Loan Warehouse
Trust, as Issuer, American Business Credit, Inc., as
Servicer, and The Chase Manhattan Bank, as Indenture
Trustee and Collateral Agent (Incorporated by
reference from Exhibit 10.2 of the Registrant's
March 31, 2000 Form 10-Q).
10.63 Warehousing Credit and Security Agreement dated as
of May 5, 2000 between New Jersey Mortgage and
Investment Corp., American Business Credit, Inc.,
HomeAmerican Credit, Inc. d/b/a Upland Mortgage and
Residential Funding Corporation (Incorporated by
reference from Exhibit 10.63 of the Registration
Statement on Form S-2 filed on June 27, 2000,
Registration No. 333-40248).
10.64 Sale and Servicing Agreement dated as of July 6,
2000 by and among ABFS Greenmont, Inc., as
Depositor, HomeAmerican Credit, Inc., d/b/a Upland
Mortgage, and New Jersey Mortgage and Investment
Corp., as Originators and Subservicers, ABFS
Mortgage Loan Warehouse Trust 2000-2, as Trust,
American Business Credit, Inc., as an Originator and
Servicer, American Business Financial Services,
Inc., as Sponsor, and The Chase Manhattan Bank, as
Indenture Trustee and Collateral Agent.
10.65 Indenture dated as of July 6, 2000 between ABFS
Mortgage Loan Warehouse Trust 2000-2 and The Chase
Manhattan Bank.
10.66 Employment Agreement by and between American
Business Financial Services, Inc. and Milton
Riseman.
139
Exhibit Number Description
-------------- -----------
10.67 Letter Employment Agreement by and between American
Business Financial Services, Inc. and Ralph Hall.
10.68 Indenture dated as of March 1, 2000, by and between
ABFS Mortgage Loan Warehouse Trust 2000-1, as Issuer
and The Chase Manhattan Bank, as Indenture Trustee.
10.69 Credit Confirmation and Note Amendment No. 9 to the
First Amended and Restated Interim Warehouse and
Security Agreement and Secured Note dated as of
March 20, 2000.
11 Statement of Computation of Per Share Earnings
(Included in Note 18 of the Notes to Consolidated
Financial Statements).
12 Computation of Ratio of Earnings to Fixed Charges.
21 Subsidiaries of ABFS.
23 Consents of BDO Seidman LLP.
27 Financial Data Schedule.
- --------------------
* Denotes a management contract or compensatory plan or arrangement.
140
Exhibit Number Description
-------------- -----------
(b) Reports on Form 8-K:
There were no Current Reports on Form 8-K filed during the quarter ended
June 30, 2000.
141
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
AMERICAN BUSINESS FINANCIAL SERVICES, INC.
Date: October 9, 2000 By: /s/ Anthony J. Santilli
-------------------------------------------
Name: Anthony J. Santilli
Title: Chairman, President, Chief Executive
Officer, Chief Operating Officer and
Director (Duly Authorized Officer)
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
/s/ Anthony J. Santilli /s/ Michael DeLuca
- -------------------------------------------- --------------------------
Name: Anthony J. Santilli Name: Michael DeLuca
Title: Chairman, President, Chief Executive Title: Director
Officer, Chief Operating Officer and
Director (Principal Executive and
Operating Officer)
Date: October 9, 2000 Date: October 10, 2000
/s/ Harold Sussman _________________________
- --------------------- Name: Richard Kaufman
Name: Harold Sussman Title: Director
Title: Director
Date: October 10, 2000 Date:
_________________________
/s/ Albert W. Mandia Name: Leonard Becker
- ------------------------------- Title: Director
Name: Albert W. Mandia
Title: Executive Vice President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: October 10, 2000 Date:
EXHIBIT INDEX
-------------
10.64 Sale and Servicing Agreement dated as of July 6,
2000 by and among ABFS Greenmont, Inc., as
Depositor, HomeAmerican Credit, Inc., d/b/a Upland
Mortgage, and New Jersey Mortgage and Investment
Corp., as Originators and Subservicers, ABFS
Mortgage Loan Warehouse Trust 2000-2, as Trust,
American Business Credit, Inc., as an Originator and
Servicer, American Business Financial Services,
Inc., as Sponsor, and The Chase Manhattan Bank, as
Indenture Trustee and Collateral Agent.
10.65 Indenture dated as of July 6, 2000 between ABFS
Mortgage Loan Warehouse Trust 2000-2 and The Chase
Manhattan Bank.
10.66 Employment Agreement by and between American
Business Financial Services, Inc. and Milton
Riseman.
10.67 Letter Employment Agreement by and between American
Business Financial Services, Inc. and Ralph Hall.
10.68 Indenture dated as of March 1, 2000, by and between
ABFS Mortgage Loan Warehouse Trust 2000-1, as Issuer
and The Chase Manhattan Bank, as Indenture Trustee.
10.69 Credit Confirmation and Note Amendment No. 9 to the
First Amended and Restated Interim Warehouse and
Security Agreement and Secured Note dated as of
March 20, 2000.
12 Computation of Ratio of Earnings to Fixed Charges
21 Subsidiaries of ABFS.
23 Consents of BDO Seidman LLP
27 Financial Data Schedule.