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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
[ X ] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the fiscal year ended June 30, 2003
[ ] 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
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 No.)
100 Penn Square East, Philadelphia, PA 19107
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(Address of principal executive offices) (zip code)
(215) 940-4000
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(Registrant's telephone number, including area code)
111 Presidential Boulevard, Bala Cynwyd, PA 19004
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(Former name or former address, if changed since last report)
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
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(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. [ X ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). [X] YES [ ] NO
The aggregate market value of the Registrant's common stock, $.001 par
value per share, held by non-affiliates of the Registrant based on the price at
which the common stock last sold as of June 30, 2003 was $8.4 million.
The number of shares outstanding of the Registrant's sole class of
common stock as of September 23, 2003 was 2,946,892 shares.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III - Proxy Statement for 2003 Annual Meeting of Stockholders
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," "believe," "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
We are a diversified financial services organization operating
predominantly in the eastern and central portions of the United States. Through
our principal direct and indirect subsidiaries, we originate, sell and service
fixed interest rate:
o mortgage loans, secured by first and second mortgages on
one-to-four family residences, which may not satisfy the
eligibility requirements of Fannie Mae, Freddie Mac or similar
buyers and which we refer to in this document as home equity
loans; and
o loans to businesses, secured by real estate and other business
assets, which we refer to in this document as business purpose
loans.
We also process and purchase home equity loans through our Bank
Alliance Services program. Through this program, we purchase home equity loans
from financial institutions and hold them as available for sale until they are
sold in connection with a future securitization or whole loan sale. See "Lending
Activities -- Home Equity Loans."
Our customers are primarily credit-impaired borrowers who are generally
unable to obtain financing from banks or savings and loan associations and who
are attracted to our products and services. We originate loans through a
combination of channels including a national processing center located at our
centralized operating office in Philadelphia, Pennsylvania and a regional
processing center in Roseland, New Jersey. Our centralized operating office was
located in Bala Cynwyd, Pennsylvania prior to July 7, 2003. Prior to June 30,
2003 we also originated home equity loans through several retail branch offices.
1
Effective June 30, 2003, we no longer originate loans through retail branch
offices. Our loan servicing and collection activities are performed at our Bala
Cynwyd, Pennsylvania office, but are expected to relocate to our Philadelphia,
Pennsylvania office.
We sell substantially all of the loans we originate on a quarterly
basis through a combination of securitizations and the sale of loans with
servicing released, which we refer to as whole loan sales. When we securitize
loans, we retain interests in the securitized loans in the form of interest-only
strips and servicing rights, which we refer to as our securitization assets. In
addition, we offer subordinated debt securities to the public, the proceeds of
which are used for repayment of existing debt, loan originations, our operations
(including repurchases of delinquent assets from securitization trusts),
investments in systems and technology and for general corporate purposes.
Recent Developments
Fiscal 2003 Loss of $29.9 Million. In fiscal 2003, we recorded a net
loss of $29.9 million. The loss was primarily due to our inability to complete
our typical quarterly securitization of loans during the fourth quarter of our
fiscal year and to $45.2 million of pre-tax charges for net valuation
adjustments on our securitization assets charged to the income statement,
compared to $22.1 million of net valuation adjustments in fiscal 2002. Our
business strategy requires the sale of substantially all of the loans we
originate at least on a quarterly basis through a combination of securitizations
and whole loan sales. From 1995 until the fourth quarter of fiscal 2003, we had
elected to utilize securitization transactions extensively due to the favorable
conditions we had experienced in the securitization markets and the higher gains
recorded on securitizations through the application of gain-on-sale accounting
versus the gain realized on whole loan sales.
During fiscal 2003, we charged to the income statement total pre-tax
valuation adjustments on our interest-only strips and servicing rights, which we
refer to as securitization assets, of $63.1 million, which primarily reflect the
impact of higher than anticipated prepayments on securitized loans experienced
in fiscal 2003 due to the low interest rate environment experienced during
fiscal 2003. The pre-tax valuation adjustments charged to the income statement
were partially offset by $17.9 million due to the impact of a decrease in the
discount rates used to value our securitization assets, resulting in the $45.2
million of pre-tax charges for net valuation adjustments charged to the income
statement. We reduced the discount rates on our interest-only strips and our
servicing rights primarily to reflect the impact of the sustained decline in
market interest rates. The discount rate on the projected residual cash flows
from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The
discount rate used to determine the fair value of the overcollateralization
portion of the cash flows from our interest-only strips was minimally impacted
by the decline in interest rates and remained at 7% on average. As a result, the
blended rate used to value our interest-only strips, including the
overcollateralization cash flows, was 9% at June 30, 2003. The discount rate on
our servicing rights was reduced from 11% to 9% at June 30, 2003.
Our inability to complete our typical publicly underwritten
securitization during the fourth quarter of fiscal 2003 was the result of our
investment bankers' decision in late June not to underwrite the contemplated
June 2003 securitization transaction. Management believes that a number of
factors contributed to this decision, including a highly-publicized lawsuit
finding liability of an underwriter in connection with the securitization of
loans for another unaffiliated subprime lender, an inquiry by the U.S.
Attorney's Office in Philadelphia regarding our forbearance practices, an
anonymous letter regarding the Company received by our investment bankers, the
SEC's recent enforcement action against another unaffiliated subprime lender
related to its loan restructuring practices and related disclosure, a federal
regulatory agency investigation of practices by another subprime servicer and
our investment bankers' prior experience with securitization transactions with
non-affiliated originators. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Short-Term Liquidity and Remedial Steps Taken. 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 short term liquidity was negatively
impacted by several recent events. Our inability to complete our typical
publicly underwritten securitization during the fourth quarter of fiscal 2003
contributed to our loss for fiscal 2003 and adversely impacted our short-term
liquidity position. In addition, further advances under a non-committed portion
of one of our credit facilities were subject to the discretion of the lender and
subsequent to June 30, 2003, there were no new advances under the non-committed
portion. Additionally, on August 20, 2003, this credit facility was amended and,
among other changes, the non-committed portion was eliminated. We also had a
2
$300.0 million mortgage conduit facility with a financial institution that
enabled us to sell our loans into an off-balance sheet facility, which expired
pursuant to its terms on July 5, 2003. At June 30, 2003, of the $516.1 million
in revolving credit and conduit facilities available to us, $453.4 million was
drawn upon. At September 19, 2003, of the $117.0 million in revolving credit
facilities available to us, $102.3 million was drawn upon. Our revolving credit
facilities and mortgage conduit facility had $62.7 million of unused capacity
available at June 30, 2003 (and $14.7 million of unused capacity at September
19, 2003), which significantly reduced our ability to fund future loan
originations until we sell existing loans, extend or expand existing credit
facilities, or add new credit facilities. In addition, we have temporarily
discontinued sales of new subordinated debt, which further impaired our
liquidity.
As a result of these liquidity issues, since June 30, 2003, we
substantially reduced our loan origination volume. From July 1, 2003 through
August 31, 2003, we originated $85.7 million of loans which represents a
significant reduction as compared to originations of $245.8 million of loans for
the same period in fiscal 2003. Our inability to originate loans at previous
levels may adversely impact the relationships our subsidiaries have or are
developing with their brokers and our ability to retain employees. As a result
of the decrease in loan originations and liquidity issues described above, we
anticipate incurring a loss for the first quarter of fiscal 2004. The amount of
the loss will depend, in part, upon our ability to complete a securitization
prior to September 30, 2003 and, if completed, the size and terms of the
securitization. Further, we can provide no assurances that we will be able to
sell our loans, extend existing facilities or expand or add new credit
facilities. If we are unable to obtain additional financing, we may not be able
to restructure our business to permit profitable operations or repay our
subordinated debt when due. Even if we are able to obtain adequate financing,
our inability to securitize our loans could hinder our ability to operate
profitably in the future and repay our subordinated debt when due.
We undertook specific remedial actions to address short-term liquidity
concerns including entering into an agreement on June 30, 2003 with an
investment bank to sell up to $700.0 million of mortgage loans, subject to the
satisfactory completion of the purchaser's due diligence review and other
conditions, and soliciting bids and commitments from other participants in the
whole loan sale market. In total, from June 30, 2003 through September 17, 2003,
we sold approximately $482.9 million (which includes $221.9 million of loans
sold by the expired mortgage conduit facility) of loans through whole loan
sales. We are continuing the process of selling our loans. We also suspended
paying quarterly cash dividends on our common stock.
On September 22, 2003, we entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding our loan originations. Pursuant to the terms of this facility, we are
required to, among other things: (i) obtain a written commitment for another
credit facility of at least $200.0 million and close that additional facility by
October 3, 2003 (which condition would be satisfied by the closing of the $225.0
million facility described below); (ii) have a net worth of at least $28.0
million by September 30, 2003; with quarterly increases of $2.0 million
thereafter; (iii) apply 60% of our net cash flow from operations each quarter to
reduce the outstanding amount of subordinated debt commencing with the quarter
ending March 31, 2004, and (iv) provide a parent company guaranty of 10% of the
outstanding principal amount of loans under the facility. Prior to the closing
of the second facility, our borrowing capacity on this $200.0 million credit
facility is limited to $80.0 million. This facility has a term of 12 months
expiring in September 2004 and is secured by the mortgage loans which are funded
by advances under the facility with interest equal to LIBOR plus a margin. This
facility is subject to representations and warranties and covenants, which are
customary for a facility of this type, as well as amortization events and events
of default related to our financial condition. These provisions require, among
other things, our maintenance of a delinquency ratio for the managed portfolio
(which represents the portfolio of securitized loans and leases we service for
others) at the end of each fiscal quarter of less than 12.0%, our subordinated
debt not to exceed $705.0 million at any time, our ownership of an amount of
repurchased loans not to exceed 1.5% of the managed portfolio and our
registration statement registering $295.0 million of subordinated debt be
declared effective by the SEC no later than October 31, 2003.
3
On September 22, 2003, we executed a commitment letter for a mortgage
warehouse credit facility with a warehouse lender, which consists of a senior
secured revolving credit facility of up to $225.0 million and a secured last out
revolver facility up to $25.0 million to fund loan originations. The commitment
letter is subject to certain conditions, including, among other things: (i)
entering into definitive agreements, except as provided in the commitment
letter; (ii) the absence of a material adverse change in the business,
operations, property, condition (financial or otherwise) or prospects of us or
our affiliates; and (iii) our receipt of another credit facility in an amount
not less than $200.0 million, subject to terms and conditions acceptable to this
lender (which condition is satisfied by the new $200.0 million facility
described above). The commitment letter provides that these facilities will have
a term of three years with an interest rate on amounts outstanding under the
$225.0 million portion of the credit facility equal to the greater of one-month
LIBOR plus a margin or the difference between the yield maintenance fee (as
defined in the commitment letter) and the one-month LIBOR plus a margin.
Advances under this facility would be collateralized by substantially all of our
present and future assets including pledged loans and a security interest in
substantially all of our interest-only strips and residual interests which will
be contributed to a special purpose entity organized by us to facilitate this
transaction. We also agreed to pay fees of approximately $14.6 million annually
plus a nonusage fee based on the difference between the average daily
outstanding balance for the current month and the maximum credit amount under
the facility and the lender's out-of-pocket expenses.
We anticipate that these facilities will be subject to representations
and warranties, events of default and covenants which are customary for
facilities of this type, as well as our agreement to: (i) maintain sales or
renewals of our subordinated debt securities of $10.0 million per month; (ii)
restrict total principal and interest outstanding on our subordinated debt to
$750.0 million or less; (iii) make quarterly reductions commencing in April 2004
of an amount of subordinated debt outstanding to be determined; (iv) maintain
maximum interest rates payable on subordinated debt securities not to exceed 10
percentage points above comparable rates for FDIC insured products; and (v) the
lender's receipt of our audited financial statements for the period ended June
30, 2003. The definitive agreements will grant the lender an option at any time
after the first anniversary of entering into definitive agreements to increase
the credit amount on the $250.0 million facility to $400.0 million with
additional fees payable by us plus additional interest as may be required by the
institutions or investors providing the lender with these additional funds. The
commitment letter requires that we enter into definitive agreements not later
than October 17, 2003. While we anticipate that we will close this transaction
prior to such date, we cannot assure you that these negotiations will result in
definitive agreements or that such agreements, as negotiated, will be on terms
and conditions acceptable to us. In the event we are unable to close these
facilities or another facility within the time frame provided under the new
$200.0 million credit facility described above, the lender on that facility
would be under no obligation to make further advances under the terms of that
facility and outstanding advances would have to be repaid over a period of time.
During the first quarter of fiscal 2004, we explored a number of
strategic alternatives to address these liquidity issues in the event we are
unable to borrow under the new $200.0 million credit facility, close the $250.0
million credit facilities or obtain alternative financing. In the event we were
unable to obtain the additional credit facilities necessary to operate our
business, we developed a contingent business plan (described more fully under
"Business Strategy Adjustments") which contemplates, among other things, the
sale of $100 million principal amount of additional subordinated debt through
March 2004 and the renewal of approximately 50% of outstanding subordinated debt
upon maturity. We believe that this contingent business plan addresses our
liquidity issues and may permit us to restructure our operations, if necessary,
without the receipt of an expanded or additional credit facility. There can be
no assurance that our contingent business plan will be successful or that it
will enable us to repay our subordinated debt when due.
4
To the extent that we are not successful in maintaining, replacing or
obtaining alternative financing sources on acceptable terms, we may have to
limit our loan originations, sell loans earlier than intended and further
restructure our operations. Limiting our originations or earlier than intended
sales of our loans could reduce our profitability or result in losses and
restrict our ability to repay our subordinated debt upon maturity. While we
currently believe that we would be able to restructure our operations, if
necessary, we cannot assure you that such restructuring will enable us to attain
profitable operations or repay the subordinated debt when due. See "Risk Factors
- -- We depend upon the availability of financing to fund our continuing
operations. Any failure to obtain adequate funding could hurt our ability to
operate profitably and restrict our ability to repay our subordinated debt and
negatively impact the value of our common stock," and "-- If we are unable to
obtain additional financing, we may be not able to restructure our business to
permit profitable operations or repay our subordinated debt when due, which
would negatively impact the value of our common stock."
Credit Facilities and Waivers Related to Financial Covenants. We borrow
against various warehouse credit facilities as the primary funding source for
our loan originations. The sale of our loans through a securitization or whole
loan sale generates the cash proceeds necessary to repay the borrowings under
the warehouse facilities. In addition, we have the availability of revolving
credit facilities, which we may use to fund our operations. Each credit
agreement requires that we comply with specific financial covenants and has
multiple individualized financial covenant thresholds and ratio limits that we
must meet as a condition to drawing on that particular facility. Pursuant to the
terms of these credit facilities, the failure to comply with the financial
covenants constitutes an event of default and the lender may, at its option,
take certain actions including: terminate commitments to make future advances to
us, declare all or a portion of the loan due and payable, foreclose on the
collateral securing the loan, require servicing payments be made to the lender,
or other third party, or assume the servicing of the loans securing the credit
facility. An event of default under these credit facilities could result in
defaults pursuant to cross-default provisions of our other agreements, including
our other loan agreements and lease agreements. The failure to comply with the
terms of these credit facilities or to obtain the necessary waivers from the
lenders related to any default would have a material adverse effect on our
liquidity and capital resources, could result in us not having sufficient cash
to repay our indebtedness, require us to restructure our operations and may
force us to sell assets on less than optimal terms and conditions.
As a result of the loss experienced during fiscal 2003, we were not in
compliance with the terms of certain of the financial covenants under two of our
principal credit facilities (one for $50.0 million and the other for $200.0
million, of which $100.0 million was non-committed) and we requested and
obtained waivers of these requirements from our lenders. The lender under the
$50.0 million warehouse credit facility has granted us a waiver for our
non-compliance with a financial covenant in that credit facility through
September 30, 2003. This facility was amended to reduce the available credit to
$8.0 million and the financial covenants were replaced with new covenants with
which we are currently in compliance.
We also entered into an amendment to the $200.0 million credit facility
which provides for the waiver of our non-compliance with the financial covenants
in that facility, the reduction of the committed portion of this facility from
$100.0 million to $50.0 million, the elimination of the $100.0 million
non-committed portion of this credit facility and the acceleration of the
termination date of this facility from November 2003 to September 30, 2003. Our
ability to repay this facility upon termination is dependent on our ability to
refinance the loans in one of our new facilities or our sale of loans currently
warehoused in the terminating facility by September 30, 2003.
In addition, if the anticipated loss for the first quarter of fiscal
2004 described above results in our non-compliance with any financial covenants,
we intend to seek the appropriate waivers. There can be no assurances that we
will obtain any of these waivers.
5
Business Strategy Adjustments. Our business strategy requires the sale
of substantially all of the loans we originate at least on a quarterly basis
through a combination of securitizations and the sale of loans with servicing
released, which we refer to as whole loan sales. Our determination as to whether
to dispose of loans through securitizations or whole loan sales depends on a
variety of factors including market conditions, profitability and cash flow
considerations. From 1995 until the fourth quarter of fiscal 2003, we had
elected to utilize securitization transactions extensively due to the favorable
conditions we had experienced in the securitization markets. During fiscal 2003,
2002, and 2001, we securitized $1.42 billion, $1.35 billion, and $1.1 billion of
loans, respectively. During the same periods, we sold $28.3 million, $57.7
million, and $76.3 million of loans, respectively, through whole loan sales.
Under generally accepted accounting principles, we are permitted to record the
gain on the sale of these securitized loans utilizing an accounting method
referred to as "gain-on-sale" accounting. This accounting method permits us to
record a non-cash gain based upon the estimated value of securitization assets
generated in connection with the securitization of our loans even though only a
small portion of the gain is received in cash during the period the gain is
recorded. We are then required to reevaluate these assets quarterly and make
adjustments based upon changes in the fair value of these assets.
After we recognized our inability to securitize our assets in the
fourth quarter of fiscal 2003, we adjusted our business strategy to emphasize
more whole loan sales. We intend to continue to evaluate both public and
privately placed securitization transactions, subject to market conditions. We
generally realized higher gain on sale in our securitization transactions than
on whole loan sales for cash. Although the gain on whole loan sales is generally
significantly lower than gains realized in securitization transactions, we
receive the gain in cash immediately and generally receive more cash immediately
in a whole loan sale transaction than from securitizations of an equal principal
amount of loans. As a result of the emphasis on whole loan sales in late June
and July 2003, at July 31, 2003, our cash position was consistent with our
projected cash position, which assumed the completion of a fourth quarter
securitization.
The use of whole loan sales will enable us to immediately generate cash
flow, protect against volatility in the securitization markets and reduce risks
inherent in retaining securitization assets. However, unlike securitizations,
where we retain the right to service the loans for a fee, which we refer to as
servicing rights, and receive securitization assets in the form of interest-only
strips which generate future cash flows, whole loan sales are typically
structured as a sale with servicing rights released and do not result in our
receipt of securitization assets. As a result, using whole loan sales more
extensively in the future will reduce our income from servicing activities and
limit the amount of securitization assets created.
We believe that our adjustments to our business strategy focus on a
more diversified strategy of selling our loans, while protecting revenues,
controlling costs and improving liquidity. However, if we are unable to generate
sufficient liquidity through the sales of our loans, the sale of our
subordinated debt, the receipt of new credit facilities or a combination of the
foregoing, we will be required to restrict loan originations and make additional
changes to our business strategy, including restricting or restructuring our
operations which could reduce our profitability or result in losses and impair
our ability to repay the subordinated debt.
We have historically experienced negative cash flow from operations. To
the extent we are unable to successfully implement our adjusted business
strategy, which requires access to capital to originate loans and our ability to
profitably sell these loans, we would continue to experience negative cash flows
from operations which would impair our ability to repay our subordinated debt.
See "Risk Factors -- If we are unable to successfully implement our adjusted
business strategy which focuses on whole loan sales, we may be unable to attain
profitable operations which could impair our ability to repay our subordinated
debt and negatively impact the value of our common stock."
6
In the event we are unable to maintain the new $200.0 million credit
facility described above, close the $250.0 million credit facilities described
above within the required timeframes or obtain other credit facilities, we have
developed a contingent business plan which management believes will enable us to
repay the subordinated debt when due and continue operations, although with a
materially reduced amount of loan originations as compared to historical levels.
The major assumptions of our contingent business plan include, but are not
limited to, the following: (i) the sale of $100.0 million of subordinated debt
over a five month period ending in March 2004; (ii) the renewal of approximately
50% of our outstanding subordinated debt upon maturity; (iii) the securitization
of approximately $40.0 million of business purpose loans which are less
attractive to purchasers in the secondary loan market; (iv) the sale of
substantially all of the home equity loans we originate in whole loan sales in
the secondary market with servicing released; and (v) substantial cost
reductions in our operations. If we utilize the contingent business plan, we
currently anticipate incurring losses through the second quarter of fiscal 2004.
Although management believes that the contingent business plan is feasible,
there can be no assurance that we will be able to successfully implement it.
Civil Subpoena from the U.S. Attorney's Office. We received a civil
subpoena, dated May 14, 2003, from the Civil Division of the U.S. Attorney for
the Eastern District of Pennsylvania. The subpoena requests that we provide
certain documents and information with respect to us and our lending
subsidiaries for the period from May 1, 2000 to May 1, 2003: (i) all loan files
in which we entered into a forbearance agreement with a borrower who is in
default; (ii) the servicing, processing, foreclosing, and handling of delinquent
loans and non-performing loans, the carrying, processing and sale of real estate
owned, and forbearance agreements; and (iii) agreements to sell or otherwise
transfer mortgage loans (including, but not limited to, any pooling or
securitization agreements) or to obtain funds to finance the underwriting,
origination or provision of mortgage loans, any transaction in which mortgage
loans were sold or transferred, any instance in which we were not to service or
not to act as custodian for a mortgage loan, representations and warranties made
in connection with mortgage loans, secondary market loan sale schedules, and
credit loss, delinquency, default, and foreclosure rates of mortgage loans. We
have directed our attorneys to cooperate fully with this inquiry. Currently,
this inquiry appears to be focused on our practices relating to obtaining
forbearance agreements from delinquent borrowers who would otherwise be subject
to foreclosure. Because the inquiry is at a preliminary stage, we cannot reach
any conclusions about the ultimate scope of the inquiry or the potential
liability or financial consequences to us at this time.
To the extent management is unsuccessful in resolving this matter, the
ongoing review by the U.S. Attorney's Office could limit our ability to engage
in publicly underwritten securitization transactions or otherwise sell or
service our loans. In addition, the U.S. Attorney's inquiry could reduce sales
of subordinated debt upon which we rely to fund our operations and limit our
ability to obtain additional credit facilities, which are necessary for the
implementation of our business strategy. Furthermore, the U.S. Attorney could
impose sanctions or otherwise restrict our ability to restructure loans, which
could negatively impact our profitability and our ability to repay the
subordinated debt. See "-- Regulation."
Delinquencies; Forbearance and Deferment Arrangements. During fiscal
2003, we experienced an increase in the total delinquencies in our total managed
portfolio to $229.1 million at June 30, 2003 from $170.8 million and $107.0
million at June 30, 2002 and 2001, respectively. Total delinquencies (loans and
leases, excluding real estate owned, with payments past due for more than 30
days) as a percentage of the total managed portfolio were 6.27% at June 30, 2003
compared to 5.57% and 4.13% at June 30, 2002 and 2001, respectively.
As the managed portfolio continues to season and if our economy
continues to lag or worsen, the delinquency rate may continue to increase, which
could negatively impact our ability to sell or securitize loans and reduce our
profitability and the funds available to repay our subordinated debt. Continuing
low market interest rates could continue to encourage borrowers to refinance
their loans and increase the levels of loan prepayments we experience which
would negatively impact our delinquency rate.
7
Delinquencies in our total managed portfolio do not include $197.7
million of previously delinquent loans at June 30, 2003, which are subject to
deferment and forbearance arrangements. Generally, a loan remains current after
we enter into a deferment or forbearance arrangement with the borrower only if
the borrower makes the principal and interest payments as required under the
terms of the original note (exclusive of the delinquent payments advanced or
fees paid by us on the borrower's behalf as part of the deferment or forbearance
arrangement) and we do not reflect it as a delinquent loan in our delinquency
statistics. However, if the borrower fails to make principal and interest
payments, the account will generally be declared in default and collection
actions resumed.
During the final six months of fiscal 2003, we experienced a pronounced
increase in the number of borrowers under deferment arrangements than in prior
periods. At June 30, 2003, there was approximately $197.7 million of cumulative
unpaid principal balance under deferment and forbearance arrangements as
compared to approximately $138.7 million of cumulative unpaid principal balance
at June 30, 2002. Total cumulative unpaid principal balances under deferment or
forbearance arrangements as a percentage of the total managed portfolio were
5.41% at June 30, 2003 compared to 4.52% at June 30, 2002. Additionally, there
are loans under deferment and forbearance arrangements which have returned to
delinquent status. At June 30, 2003 there was $28.7 million of cumulative unpaid
principal balance under deferment arrangements and $51.5 million of cumulative
unpaid principal balance under forbearance arrangements that are now reported as
delinquent 31 days or more. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Managed Portfolio Quality --
Deferment and Forbearance Arrangements."
8
Business Strategy
The business strategy that we are emphasizing beginning in fiscal 2004
focuses on a shift from gain-on-sale accounting and the use of securitization
transactions as our primary method of selling loans to a more diversified
strategy which utilizes a combination of whole loan sales and securitizations,
while protecting revenues, controlling costs and improving liquidity. Our
business strategy includes the following:
o Selling substantially all of the loans we originate on a
quarterly basis through a combination of securitizations and
whole loan sales. Whole loan sales may be completed on a more
frequent basis.
o Shifting from a predominantly publicly underwritten
securitization strategy and gain-on-sale business model to a
strategy focused on a combination of whole loan sales and
smaller securitization transactions. Quarterly loan
securitization levels will be reduced significantly from
previous levels. Securitizations for the foreseeable future
are expected to be executed as private placements to
institutional investors or publicly underwritten
securitizations, subject to market conditions. Historically,
the market for whole loan sales has provided reliable
liquidity for numerous originators as an alternative to
securitization. Whole loan sales provide immediate cash
premiums to us, while securitizations generate cash over time
but generally result in higher gains at the time of sale. We
intend to rely less on gain-on-sale accounting and loan
servicing activities for our revenue and earnings and will
rely more on cash premiums earned on whole loan sales. This
strategy is expected to result in relatively lower earnings
levels at current loan origination volumes, but will increase
cash flow, accelerate the timeframe for becoming cash flow
positive and improve our liquidity position. See
"Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources"
for more detail on cash flow.
9
o Broadening our mortgage loan product line and increasing loan
originations. We currently originate primarily fixed-rate
loans. Under our business strategy, we plan to originate
adjustable-rate and alt-A mortgage loans as well as a wide
array of fixed-rate mortgage loans in order to appeal to a
broader base of prospective customers and increase loan
originations.
o Offering competitive interest rates charged to borrowers on
new products. By offering competitive interest rates charged
on new products, we expect to originate loans with higher
credit quality. In addition, by reducing interest rates we
expect to appeal to a wider customer base and substantially
reduce our marketing costs, make more efficient use of
marketing leads and increase loan origination volume.
o Reducing origination of the types of loans that are not well
received in the whole loan sale and securitization markets.
We intend to reduce the level of business purpose loans that
we will originate, but we will continue to originate business
purpose loans to meet demand in the whole loan sale and
securitization markets.
o Reducing the cost of loan originations. We have implemented
plans to:
- Eliminate our high cost origination branches.
- Reduce the cost to originate in Upland Mortgage by
among other things: a) broadening the product line and
offering competitive interest rates in order to
increase origination volume, b) reducing marketing
costs, and c) developing broker relationships.
- Reduce the cost to originate in American Business
Mortgage Services by increasing volume through a
broadening of the mortgage loan product line.
- Reduce the cost to originate in the Bank Alliance
Services program by broadening our product line and
increasing the amount of fees we charge to
participating financial institutions.
o Reducing the amount of outstanding subordinated debt. The
increase in cash flow expected under our business strategy is
expected to accelerate a reduction in our reliance on issuing
subordinated debt to meet our liquidity needs and allow us to
begin to pay down existing subordinated debt.
o Reducing operating costs. Since June 30, 2003, we reduced our
workforce by 170 employees. With our shift in focus to whole
loan sales with servicing released and offering a broader
mortgage product line that we expect will appeal to a wider
array of customers, we currently require a smaller employee
base with fewer sales, servicing and support positions. These
workforce reductions represent more than a 15% decrease in
staffing levels.
Our business strategy is expected to leverage our demonstrated
strengths which include:
o A strong credit culture which consistently originates quality
performing loans. Our delinquency rates are among the lowest
in the subprime industry.
10
o Long-term broker relationships at American Business Mortgage
Services.
o Upland Mortgage brand identity.
o Relationships with participating financial institutions in the
Bank Alliance Services program.
o Institutional investors' interest in the bonds issued in our
securitizations.
Our business strategy is dependent on our ability to emphasize lending
related activities that 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 and to profitably securitize or
sell our loans on a regular basis. Our failure with respect to any of these
factors could impair our ability to successfully implement our 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
adjusted business strategy, which focuses on whole loan sales, we may be unable
to attain profitable operations which could impair our ability to repay our
subordinated debt and negatively impact the value of our common stock."
The Company
We were incorporated in Delaware in 1985 and began operations as a
finance company in 1988, initially offering business purpose loans to customers
whose borrowing needs we believed were not being adequately serviced by
commercial banks. Since our inception, we have significantly expanded our
product line and geographic scope and currently have licenses, or are in the
process of becoming licensed, to offer our home equity loan products in 44
states.
Our principal corporate office in Delaware 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
100 Penn Square East, Philadelphia, Pennsylvania 19107. The telephone number at
our principal operating office is (215) 940-4000. We maintain a site on the
World Wide Web at www.abfsonline.com as well as web sites for most of our
primary subsidiary companies.
We file annual, quarterly and current reports, proxy statements and
other information with the SEC. You may read and copy our reports or other
filings made with the SEC at the SEC's Public Reference Room, located at 450
Fifth Street, N.W., Washington, DC 20549. You can obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You
can also access these reports and other filings electronically on the SEC's web
site, www.sec.gov.
We also make these reports and other filings available free of charge
on our web site, www.abfsonline.com, as soon as reasonably practicable after
filing with the SEC. We will provide, at no cost, paper or electronic copies of
our reports and other filings made with the SEC. Requests should be directed to:
11
Stephen M. Giroux, Esquire
American Business Financial Services, Inc.
100 Penn Square East
Philadelphia, PA 19107
(215) 940-4000
The information on the web sites listed above, is not and should not be
considered part of this Annual Report on Form 10-K and is not incorporated by
reference in this document. These web sites are and are only intended to be
inactive textual references.
Subsidiaries
As a holding company, our activities have been limited to:
(1) holding the shares of our subsidiaries, and
(2) raising capital for use in the subsidiaries' lending and loan
servicing operations.
We are the parent holding company of American Business Credit, Inc. and
its primary subsidiaries, HomeAmerican Credit, Inc. (doing business as Upland
Mortgage), American Business Mortgage Services, Inc., and Tiger Relocation
Company.
American Business Credit, Inc., a Pennsylvania corporation incorporated
in 1988 and acquired by us in 1993, originates, sells and services business
purpose loans and services home equity loans.
HomeAmerican Credit, Inc., a Pennsylvania corporation incorporated in
1991, originates, purchases and sells home equity loans. HomeAmerican Credit
acquired Upland Mortgage Corp in 1996 and since that time has conducted business
as "Upland Mortgage." HomeAmerican Credit also administers the Bank Alliance
Services program.
American Business Mortgage Services, Inc., a New Jersey corporation
organized in 1938 and acquired by us in October 1997, is currently engaged in
the origination and sale of home equity loans.
12
Tiger Relocation Company, a Pennsylvania corporation, was incorporated
in 1992 to hold, maintain and sell real estate properties acquired due to the
default of a borrower under the terms of our loan documents.
We also have numerous special purpose subsidiaries that were
incorporated solely to facilitate our securitizations and off-balance sheet
mortgage conduit facility. 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 completed securitizations. See
"-- Securitizations" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Securitizations." We also utilize special
purpose subsidiaries in connection with our financing activities, including
credit facilities. We also have several additional subsidiaries that are
inactive or not significant to our operations.
13
The following chart sets forth our basic organizational structure and
our primary subsidiaries.(a)
------------------------------------
AMERICAN BUSINESS FINANCIAL
SERVICES, INC.
------------------------------------
Holding company
Issues subordinated debt securities
----------------|-------------------
|
|
----------------|-------------------
AMERICAN BUSINESS CREDIT, INC.
------------------------------------
Originates, sells and services business
purpose loans and services home equity loans
----------------|-------------------
|
|-----------------------------|------------------------|
| | |
- --------|------------ -------------|------------- -------|--------
AMERICAN HOMEAMERICAN TIGER
BUSINESS CREDIT, INC. RELOCATION
MORTGAGE D/B/A COMPANY
SERVICES, INC. UPLAND
MORTGAGE
- --------------------- --------------------------- ---------------
Originates, Originates, Holds
purchases, sells purchases, sells and foreclosed real
and services services home estate
home equity equity loans and
loans administers the
Bank Alliance
Services program
- --------------------- --------------------------- ---------------
_____________________
(a) In addition to the corporations pictured in this chart, we organized at
least one special purpose corporation for each securitization and have
several other subsidiaries that are inactive or not significant to our
operations.
14
Lending Activities
General. The following table sets forth information concerning our loan
origination, purchase and sale activities for the periods indicated.
Year Ended June 30,
-------------------------------------
2003 2002 2001
-------------------------------------
(dollars in thousands)
Loans Originated/Purchased
Business purpose loans........................... $ 122,790 $ 133,352 $ 120,537
Home equity loans................................ $1,543,730 $1,246,505 $1,096,440
Number of Loans Originated/Purchased
Business purpose loans........................... 1,340 1,372 1,318
Home equity loans................................ 17,003 14,015 13,443
Average Loan Size
Business purpose loans........................... $ 92 $ 97 $ 91
Home equity loans................................ $ 91 $ 89 $ 82
Weighted-Average Interest Rate on Loans
Originated/Purchased
Business purpose loans........................... 15.76% 15.75% 15.99%
Home equity loans................................ 9.99% 10.91% 11.46%
Combined......................................... 10.42% 11.38% 11.91%
Weighted-Average Term (in months)
Business purpose loans........................... 160 161 163
Home equity loans................................ 272 260 259
Loans Securitized or Sold
Business purpose loans........................... $ 112,025 $ 129,074 $ 109,892
Home equity loans................................ $1,339,752 $1,279,740 $1,068,507
Number of Loans Securitized or Sold
Business purpose loans........................... 1,195 1,331 1,208
Home equity loans................................ 14,952 14,379 13,031
The following table sets forth information regarding the average
loan-to-value ratios for loans we originated and purchased during the periods
indicated.
Year Ended June 30,
---------------------------------------
Loan Type 2003 2002 2001
- --------------------------------------------------------------------------------
Business purpose loans................. 62.2% 62.6% 62.2%
Home equity loans...................... 78.2 77.8 78.4
15
The following table shows the geographic distribution of our loan
originations and purchases during the periods indicated.
Year Ended June 30,
-------------------------------------------------------------------
2003 2002 2001
------------------- ------------------- -------------------
Amount % Amount % Amount %
---------- ----- --------- ----- ---------- -----
(dollars in thousands)
New York $ 376,425 22.59% $ 341,205 24.73% $ 337,218 27.71%
New Jersey 212,035 12.72 159,117 11.53 161,087 13.24
Florida 135,164 8.11 97,686 7.08 89,169 7.33
Massachusetts 134,342 8.06 101,383 7.35 75,958 6.24
Pennsylvania 118,915 7.14 103,865 7.53 102,789 8.44
Michigan 92,009 5.52 89,224 6.47 40,477 3.33
Illinois 90,111 5.41 73,152 5.30 51,904 4.26
Ohio 70,957 4.26 65,884 4.77 66,877 5.50
North Carolina 47,806 2.87 38,060 2.76 34,065 2.80
Virginia 46,508 2.79 33,169 2.40 33,739 2.77
Connecticut 42,525 2.55 30,461 2.21 18,741 1.54
Maryland 36,542 2.19 25,307 1.83 26,632 2.19
Indiana 33,671 2.02 27,833 2.02 21,489 1.76
Other(a) 229,510 13.77 193,511 14.02 156,832 12.89
---------- ------ ---------- ------ ----------- ------
Total $1,666,520 100.00% $1,379,857 100.00% $ 1,216,977 100.00%
========== ====== ========== ====== =========== ======
____________________________
(a) No individual state included in "Other" constitutes more than 2% of total
loan originations for fiscal 2003.
Customers. Our loan customers are primarily credit-impaired borrowers
who are generally unable to obtain financing from banks or savings and loan
associations and who are attracted to our products and services. 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. 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,
our 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. See "-- Business Strategy."
Home Equity Loans. We originate home equity loans through Upland
Mortgage and American Business Mortgage Services. We also process and purchase
loans through the Bank Alliance Services program. We originate home equity loans
primarily to credit-impaired borrowers through various channels of retail
marketing which include direct mail and our subsidiaries' interactive web sites,
and have included radio and television advertisements. We entered the home
equity loan market in 1991. Currently, we are licensed or otherwise qualified to
originate home equity loans in 44 states and originate home equity loans
predominantly in the eastern and central portions of the United States. We
generally securitize or sell on a whole loan basis with servicing released, the
home equity loans originated and funded by our subsidiaries.
The business strategy that we are emphasizing beginning in fiscal 2004
will impact our origination of home equity loans. Our business strategy includes
broadening our mortgage loan product line to include adjustable rate and alt-A
mortgage loans and competitive interest rates in order to appeal to a broader
prospective customer base and increase the amount of loan originations, and
16
reducing our cost to originate loans by expanding our broker network and
reducing marketing costs. Our business strategy also focuses on shifting from a
predominantly publicly underwritten securitization strategy and gain-on-sale
business model to a strategy focused on a combination of whole loan sales and
smaller securitization transactions. For a discussion of our business strategy
and its potential impact on our home equity loan business see "-- Business
Strategy."
Home equity loan applications are obtained from potential borrowers
over the phone, in writing, in person or through our Internet web site. The loan
request is then evaluated for possible loan approval. The loan processing staff
generally provides its home equity applicants who qualify for loans with a
conditional loan approval within 24 hours and closes its home equity loans
within approximately fifteen to twenty days of obtaining a conditional loan
approval.
Home equity loans generally ranged from $5,000 to $580,000 and had an
average loan size of approximately $91,000 for the loans originated during
fiscal 2003 and $89,000 during fiscal 2002. We originated $1.5 billion of home
equity loans during the fiscal year ended June 30, 2003 and $1.2 billion during
the fiscal year ended June 30, 2002. Home equity loans are generally made at
fixed rates of interest and for terms ranging from five to thirty years,
generally, with average origination fees of approximately 1.5% of the aggregate
loan amount. The weighted-average interest rate received on home equity loans
during fiscal 2003 was 9.99% and during fiscal 2002 was 10.91%. The average
loan-to-value ratio for the loans originated by us during fiscal 2003 was 78.2%
and was 77.8% for the loans originated during fiscal 2002. We attempt to
maintain our interest and other charges on home equity loans to be competitive
with the lending rates of other non-conforming mortgage finance companies.
Interest on home equity loans originated subsequent to January 2001 is generally
computed based on the scheduled interest method. Prior to January 2001, most of
the home equity loans we originated computed interest on the simple interest
method. To the extent permitted by law, borrowers are given an option to choose
between a loan without a prepayment fee at a higher interest rate, or a loan
with a prepayment fee at a lower interest rate. We may waive the collection of a
prepayment fee, if any, in the event the borrower refinances a home equity loan
with us.
We have exclusive business arrangements with several financial
institutions which provide for our purchase of home equity loans that meet our
underwriting criteria, but do not meet the guidelines of the selling institution
for loans to be held in its portfolio. This program is called the Bank Alliance
Services program. The Bank Alliance Services 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 for loans held in their portfolio 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 one of our
subsidiaries.
Under the Bank Alliance Services program, we enter into business
arrangements with financial institutions which provide for the purchase by our
lending subsidiaries of home equity loans which do not meet the underwriting
criteria of the financial institutions for home equity loans to be held in the
financial institutions' portfolios. Pursuant to the program, a financial
institution adopts our underwriting criteria for home equity loans not intended
to be held in its portfolio. If an applicant meets our underwriting criteria, as
adopted by the program, we process the application materials and underwrite the
loan for final approval by the financial institution. If the financial
institution approves the loan, we close the loan for the financial institution
in its name with funding provided by the financial institution. We purchase the
loan from the financial institution shortly after the closing. 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 or whole
loan sale.
17
During fiscal 2003 we received referrals from approximately 20
financial institutions participating in this program. These financial
institutions provide us with the opportunity to process and purchase loans
generated by the branch networks of such institutions, which consist of over
1,700 branches located in various states throughout the country. Pursuant to
this program, our subsidiaries purchased approximately $201.9 million of loans
during the fiscal year ended June 30, 2003 and $145.9 million during fiscal
2002. In fiscal 2003, our top three financial institutions under the Bank
Alliance Services program accounted for approximately 96.1% of our loan volume
from this program. We intend to continue to expand the Bank Alliance Services
program with financial institutions across the United States. See " -- Business
Strategy."
During fiscal 1999, we launched an Internet loan distribution channel
through Upland Mortgage's web site. Through this interactive web site, borrowers
can examine available loan options and calculate monthly principal and interest
payments. The Upland Mortgage Internet platform provides borrowers with
convenient access to the mortgage loan information 7 days a week, 24 hours a
day. Throughout the loan processing period, borrowers who submit applications
are supported by our staff of highly trained loan officers. Currently, in
addition to the ability to utilize an automated rapid pre-approval process,
which we believe reduces time and manual effort required for loan approval, the
site features our proprietary software, Easy Loan Advisor, 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.
Business Purpose Loans. Through our subsidiary, American Business
Credit, we originate business purpose loans predominantly in the eastern and
central portions of the United States through a network of salespeople, loan
brokers and through our business loan web site. We focus our marketing efforts
on small businesses that 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,
tax payments and debt-consolidation. We do not target any particular industries
or trade groups and, in fact, take precautions against a concentration of loans
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 and apartment buildings and mixed use buildings, owned
by the borrower, a principal of the borrower, or a guarantor of the borrower. 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 assets. Prior to the
fourth quarter of fiscal 2003, we generally securitized business purpose loans
subsequent to their origination. Under our business strategy, we intend to
reduce the level of business purpose loans that we will originate, but we will
continue to originate business purpose loans to meet demand in the whole loan
sale and securitization markets. See "-- Business Strategy."
Our business purpose loans generally ranged from $14,000 to $685,000
and had an average loan size of approximately $92,000 for the loans originated
18
during the fiscal year ended June 30, 2003 and $97,000 in fiscal 2002.
Generally, our business purpose loans are made at fixed interest rates and for
terms ranging from five to fifteen years. We generally charge origination fees
for these loans of 4.75% to 5.75% of the original principal balance. The
weighted-average interest rate charged on the business purpose loans originated
by us was 15.76% for the fiscal year ended June 30, 2003 and 15.75% for fiscal
2002. Business purpose loans we originated during fiscal 2003 had a
loan-to-value ratio of 62.2%, based solely upon the real estate collateral
securing the loans. Business purpose loans we originated during fiscal 2002 had
a loan-to-value ratio, based solely upon the real estate collateral securing the
loans, of 62.6%. We originated $122.8 million of business purpose loans during
fiscal 2003 and $133.4 million of business purpose loans during fiscal 2002.
Generally, we compute interest due on our outstanding business purpose
loans using the simple interest method. 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 can be a significant
portion of the outstanding loan balance. 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. We may waive the
collection of a prepayment fee, if any, in the event the borrower refinances a
business loan with us.
Prepayment Fees. At origination, approximately 80% to 85% of our home
equity loans had prepayment fees and approximately 90% to 95% of our business
purpose loans had prepayment fees. Home equity loans comprise approximately 93%
of all loans we originate and the remaining 7% are business purpose loans. On
home equity loans where the borrower has elected the prepayment fee option, the
prepayment fee is generally a certain percentage of the outstanding principal
balance of the loan. Our typical prepayment fee structure provides for a fee of
5% or less of the outstanding principal loan balance and will not extend beyond
the first three years after a loan's origination. Prepayment fees on our
existing home equity loans range from 1% to 5% of the outstanding principal
balance and remain in effect for one to five years. The prepayment fee on
business purpose loans is generally 8% to 12% of the outstanding principal
balance, provided that no prepayment option is available until after the 24th
scheduled payment is made and no prepayment fee is due after the 60th scheduled
payment is made. From time to time, a different prepayment fee arrangement may
be negotiated or we may waive prepayment fees for borrowers who refinance their
loans with us. At June 30, 2003, approximately 60% to 65% of securitized home
equity loans in our managed portfolio had prepayment fees and approximately 50%
to 55% of securitized business purpose loans in our managed portfolio had
prepayment fees.
State law sometimes restricts our ability to charge a prepayment fee
for both home equity and business purpose loans. We have used the Parity Act to
preempt these state laws for home equity loans which meet the definition of
alternative mortgage transactions under the Parity Act. However, the Office of
Thrift Supervision has adopted a rule effective in July 2003, which precludes us
and other non-bank, non-thrift creditors from using the Parity Act to preempt
state prepayment penalty and late fee laws on new loan originations. Under the
provisions of this rule, we are required to modify or eliminate the practice of
charging prepayment and other fees in some of the states where we originate
loans. We are continuing to evaluate the impact of the adoption of the new rule
by the Office of Thrift Supervision on our future lending activities and results
of operations. We currently expect that the percentage of home equity loans
containing prepayment fees that we will originate in the future will decrease to
approximately 65% to 70%, from 80% to 85% prior to this rule becoming effective.
19
Additionally, in a recent decision, the Appellate Division of the Superior Court
of New Jersey determined that the Parity Act's preemption of state law was
invalid and that the state laws precluding some lenders from imposing prepayment
fees are applicable to loans made in New Jersey, including alternative mortgage
transactions. Although this New Jersey decision is subject to appeal and may not
be final, we are currently evaluating its impact on our future lending
activities and results of operations.
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. Federal law restrictions in connection with certain high
interest rate and fee loans may also preclude the imposition of prepayment fees
on these loans. Similarly, in the case of business purpose loans, some states
prohibit or limit prepayment fees when the loan is below a specific dollar
threshold or is secured by residential property.
Marketing Strategy
Historically, we concentrated our marketing efforts for home equity
loans primarily on credit-impaired borrowers who are generally unable to obtain
financing from banks or savings and loan associations and who are attracted to
our products and services. Although we still intend to lend to credit-impaired
borrowers under our business strategy, we intend to broaden our mortgage loan
product line to include adjustable rate and alt-A mortgage loans and to offer
competitive interest rates in order to appeal to a wider range of customers. See
"-- Business Strategy" and "Risk Factors -- Lending to credit-impaired borrowers
may result in higher delinquencies in our managed portfolio, which could hinder
our ability to operate profitably, impair our ability to repay our subordinated
debt and negatively impact the value of our common stock."
We market home equity loans through direct mail campaigns and our
interactive web sites, and have in the past used telemarketing, radio and
television advertising. We believe that our targeted direct mail strategy
delivers more leads at a lower cost than broadcast marketing channels. Our
integrated approach to media advertising that utilizes a combination of direct
mail and Internet advertising is intended to maximize the effect of our
advertising campaigns. We expect the implementation of our business strategy to
improve our response and conversion rates, which will reduce our overall
marketing costs. We also use a network of loan brokers along with the Bank
Alliance Services program as additional sources of loans. We intend to expand
our network of loan brokers as part of our focus on whole loan sales in order to
increase the amount of loans originated and reduce origination costs.
Our marketing efforts for home equity loans are focused on the eastern
and central portions of the United States with plans to expand to the western
portion of the United States. We previously utilized branch offices in various
states to market our loans. Effective June 30, 2003, we no longer originate
loans through retail branch offices. Loan processing and underwriting procedures
are performed at our centralized operating office located in Philadelphia,
Pennsylvania and a regional processing center in Roseland, New Jersey. Our
centralized operating office relocated from Bala Cynwyd, Pennsylvania on July 7,
2003.
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 and central portions of the United States.
20
We target businesses, which might 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,
including large direct mail campaigns, our business loan web site and a direct
sales force and loan brokers, and have in the past used newspaper and radio
advertising. Our commissioned sales staff, which consists of full-time
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. While we
intend to reduce the level of business purpose loans that we will originate
under our business strategy, we will continue to originate business purpose
loans to meet demand in the whole loan sale and securitization markets. See "--
Business Strategy" and "-- Lending Activities -- Business Purpose Loans."
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 and home
equity loans. These policies and practices may be altered, amended and
supplemented, from time to time, as conditions warrant. We reserve the right to
make changes in our day-to-day practices and policies at any time.
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 provide pertinent credit information in order to
complete a detailed loan application. 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.
21
The following table outlines the key parameters of the major credit
grades of our current home equity loan underwriting guidelines. Home equity
loans represent approximately 90% of the loans we originate.
- ---------------------------------- ------------------------------- --------------------------------
"A" Credit Grade "B" Credit Grade
- ---------------------------------- ------------------------------- --------------------------------
General Repayment Has good credit but might have Pays the majority of accounts
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 four 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% to 90% for a Generally 80% to 85% for a 1-4
Loan-to-value ratio 1-4 family dwelling family dwelling residence; 80%
residence; 80% for a for a condominium.
condominium.
- ---------------------------------- ------------------------------- --------------------------------
Non-Owner Occupied: Generally 80% for a 1-4 Generally 70% for a 1-4 family
Loan-to-value ratio family dwelling or dwelling or condominium.
condominium.
- ---------------------------------- ------------------------------- --------------------------------
(a) Purchasers in the whole loan sale market generally do not accept "D" credit
grade loans. As a result, we will also originate "C-" credit grade loans, which
are substantially similar to "D" credit grade loans except that the acceptable
mortgage delinquency is limited to 90 days at time of loan closing.
22
The following table outlines the key parameters of the major credit
grades of our current home equity loan underwriting guidelines. Home equity
loans represent approximately 90% of the loans we originate.
- ---------------------------------- --------------------------------- ---------------------------------
"C" Credit Grade "D" Credit Grade (a)
- ---------------------------------- --------------------------------- ---------------------------------
Marginal credit history which is Designed to provide a borrower
General Repayment 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 and/or two 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 1 year Discharged prior to closing or
with reestablished credit. payoff of bankruptcy debts with
proceeds.
- ---------------------------------- --------------------------------- ---------------------------------
Debt Service-to-Income Generally not to exceed 55%. Generally not to exceed 55%.
- ---------------------------------- --------------------------------- ---------------------------------
Owner Occupied: Generally 70% to 80% for a 1-4 Generally 60% to 65% for a 1-4
Loan-to-value ratio family dwelling residence; 70% family dwelling residence.
for a condominium.
- ---------------------------------- --------------------------------- ---------------------------------
Non-Owner Occupied: Generally 60% for a 1-4 family N/A
Loan-to-value ratio dwelling or condominium.
- ---------------------------------- --------------------------------- ---------------------------------
(a) Purchasers in the whole loan sale market generally do not accept "D" credit
grade loans. As a result, we will also originate "C-" credit grade loans, which
are substantially similar to "D" credit grade loans except that the acceptable
mortgage delinquency is limited to 90 days at time of loan closing.
23
In addition to the home equity loans we originate under the standard
home equity loan underwriting guidelines outlined in the preceding table, we
also originate a limited number of second mortgages that have loan-to-value
ratios ranging from 90% to 100%. We consider these loans to be high
loan-to-value home equity loans and we underwrite these loans with a more
restrictive approach to evaluating the borrowers' qualifications and we require
a stronger credit history than our standard guidelines. The borrowers' existing
mortgage and installment debt payments must generally be paid as agreed, with no
more than one 30-day delinquency on a mortgage within the last 12 months. No
bankruptcy or foreclosure is permitted in the last 36 months.
Pursuant to our business strategy, a greater number of loans that we
originate will be offered to the secondary market through whole loan sales.
These loans will be underwritten, allocated and sold to specific third party
purchasers based on agreed upon products and underwriting guidelines. The
purchaser products and guidelines currently being utilized generally conform to
key parameters outlined in the preceding table. See "-- Business Strategy."
Generally, business purpose loans are secured by residential real
estate and at times commercial real estate. Loan amounts generally range from
$14,000 to $685,000. The loan-to-value ratio (based solely on the appraised fair
market value of the real estate collateral securing the loan) on the properties
collateralizing the loans generally have a maximum range of 50% to 75%. The
actual maximum loan-to-value ratio varies depending on a variety of factors
including, the credit grade of the borrower, whether the collateral is a one to
four family residence, a condominium or a commercial property and whether the
property is owner occupied or non-owner occupied. The credit grade of a business
purpose loan borrower will vary depending on the payment history of their
existing mortgages, major lines of credit and minor lines of credit, allowing
for delinquency but generally requiring major credit to be current at closing.
The underwriting of the business purpose loan includes confirmation of income or
cash flow through tax returns, bank statements and other forms of proof of
income and business cash flow. Generally, we make loans to businesses whose
bankruptcy was discharged at least two years prior to closing, but we may make
exceptions to allow for the bankruptcy to be discharged just prior to or at
closing. In addition, we generally receive additional collateral in the form of,
among other things, personal guarantees, pledges of securities, assignments of
contract rights, assignments of life insurance and lease payments and liens on
business equipment and other business assets, as available. Based solely on the
value of the real estate collateral securing our business purpose loans, the
average loan-to-value ratio of business purpose loans we originated during the
fiscal year ended June 30, 2003 was 62.2% and during fiscal 2002 was 62.6%.
Generally, the maximum acceptable loan-to-value ratio for home equity
loans to be securitized is 100%. The average loan-to-value ratio of home equity
loans we originated during fiscal 2003 was 78.2% and during fiscal 2002 was
77.8%. We generally obtain title insurance in connection with our loans.
In determining whether the mortgaged property is adequate as
collateral, we have an appraisal performed for each property considered for
financing. The appraisal is completed by a licensed qualified appraiser on a
Fannie Mae form and generally includes pictures of comparable properties and
pictures of the property securing the loan.
24
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 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 hinder our ability to attain profitable operations,
limit our ability to repay our subordinated debt and negatively impact the value
of our common stock."
Loan Servicing and Administrative Procedures
We service the loans we hold as available for sale or that we
securitize, in accordance with our established servicing procedures. Our
servicing procedures include practices regarding processing of mortgage
payments, processing of disbursements for tax and insurance payments,
maintenance of mortgage loan records, performance of collection efforts,
including disposition of delinquent loans, foreclosure activities and
disposition of real estate owned and performance of investor accounting and
reporting processes, which in general conform to the mortgage servicing
practices of prudent mortgage lending institutions. We generally receive
contractual servicing fees for our servicing responsibilities for securitized
loans, calculated as a percentage of the outstanding principal amount of the
loans serviced. In addition, we receive other ancillary fees related to the
loans serviced. Our servicing and collections activities are principally located
at our operating office in Bala Cynwyd, Pennsylvania, but we expect to relocate
these activities to our Philadelphia, Pennsylvania office. At June 30, 2003, the
total managed portfolio consisted of 44,538 loans with an aggregate outstanding
balance of $3.6 billion. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Reconciliation of Non-GAAP Financial
Measures" for a reconciliation of total managed portfolio to our balance sheet.
In servicing loans, we send an invoice to borrowers on a monthly basis
advising them of the required payment and its scheduled due date. We begin the
collection process promptly after a borrower fails to make a scheduled monthly
payment. When a loan becomes 45 to 60 days delinquent for a home equity loan or
90 days delinquent for a business purpose loan, it is transferred to a senior
collector in the collections department. The senior collector tries to resolve
the delinquency by reinstating a delinquent loan, seeking a payoff, or entering
into a deferment or forbearance arrangement with the borrower to avoid
foreclosure. All proposed arrangements are evaluated on a case-by-case basis,
based on, among other things, the borrower's past credit history, current
financial status, cooperativeness, future prospects and the reasons for the
delinquency. If a mortgage loan becomes 45 days delinquent and we do not reach a
satisfactory arrangement with the borrower, our legal department will mail a
notice of default to the borrower. If the delinquency is not cured within the
time period provided for in the loan documents, we generally start a foreclosure
action. The collection department maintains normal collection efforts during the
cure periods following a notice of default and the initiation of foreclosure
action. If a borrower declares bankruptcy, our in-house attorneys and paralegals
promptly act to protect our interests. We may initiate legal action earlier than
45 days following a delinquency if we determine that the circumstances warrant
such action.
25
We employ a staff of experienced mortgage collectors and managers
working in shifts seven days a week to manage delinquent loans. In addition, a
staff of in-house attorneys and paralegals works closely with the collections
staff to optimize collection efforts. The primary goal of our labor-intensive
collections program is to emphasize delinquency and loss prevention.
From time to time, borrowers are confronted with events, usually
involving hardship circumstances or temporary financial setbacks that adversely
affect their ability to continue payments on their loan. To assist borrowers, we
may agree to enter into a deferment or forbearance arrangement. Prevailing
economic conditions, which affect the borrower's ability to make their regular
payments, may also have an impact on the value of the real estate or other
collateral securing the loans, resulting in a change to the loan-to-value
ratios. We may take these conditions into account when we evaluate a borrower's
request for assistance for a relief from their financial hardship.
Our policies and practices regarding deferment and forbearance
arrangements, like all of our collections policies and practices, are designed
to manage customer relationships, maximize collections and avoid foreclosure (or
repossession of other collateral, as applicable) if reasonably possible. We
review and regularly revise these policies and procedures in order to enhance
their effectiveness in achieving these goals. We permit exceptions to the
policies and practices from time to time based on individual borrowers'
situations.
In a deferment arrangement, we make advances to a securitization trust
on behalf of the borrower in amounts equal to the delinquent loan payments,
which include principal and interest. Additionally, we may pay taxes, insurance
and other fees on behalf of the borrower. Based on our review of the borrower's
current financial circumstances, the borrower must repay the advances and other
payments and fees we make on borrower's behalf either at the termination of the
loan or on a monthly payment plan. Borrowers must provide a written explanation
of their hardship, which generally requests relief from their loan payments. We
review the borrower's current financial situation and based upon this review, we
may create a payment plan for the borrower which allows the borrower to pay past
due amounts over a period from 12 to 42 months, but not beyond the maturity date
of the loan, in addition to making regular monthly loan payments. Each deferment
arrangement must be approved by two of our managers. Deferment arrangements
which defer two or more past due payments must also be approved by a senior vice
president.
Principal guidelines currently applicable to the deferment process are:
(i) the borrower may have up to six payments deferred during the life of the
loan; (ii) no more than three payments may be deferred during a twelve-month
period; and (iii) the borrower must have made a minimum of six payments on the
loan and twelve months must have passed since the last deferment in order to
qualify for a new deferment arrangement. Any deferment arrangement which
includes an exception to our guidelines must be approved by the senior vice
president of collections and an executive vice president. If the deferment
arrangement is approved, a collector contacts the borrower regarding the
approval and the revised payment terms.
For borrowers who are two or more payments delinquent, we will consider
using a forbearance arrangement if permitted under applicable state law. In a
forbearance arrangement, we make advances to a securitization trust on behalf of
the borrower in amounts equal to the delinquent loan payments, which include
principal and interest. Additionally, we may pay taxes, insurance and other fees
on behalf of the borrower. We assess the borrower's current financial situation
and based upon this assessment, we may create a payment plan for the borrower
which generally allows the borrower to pay past due amounts over a longer period
than a typical deferment arrangement, but not beyond the maturity date of the
loan. We typically structure a forbearance arrangement to require the borrower
to make payments of principal and interest equivalent to the original loan terms
plus additional monthly payments, which in the aggregate represent the amount
that we advanced to the securitization trust and other fees we paid on behalf of
the borrower. We currently require the borrower to provide a written explanation
of their financial hardship, and we offer these arrangements to borrowers who we
believe have the ability to remit post-forbearance principal and interest
payments in addition to the amounts advanced or paid by us. As part of the
written forbearance agreement, the borrower must execute a deed in lieu of
foreclosure. If the borrower subsequently defaults before repaying the amount
due under the forbearance agreement in full and becomes 60 days delinquent on
principal and interest payments, we may elect to record the deed after providing
proper notification to the borrower and a reasonable period of time to cure.
Recording the deed in lieu of foreclosure gives us immediate legal title to the
property without the need for further legal action.
26
Principal guidelines currently applicable to the forbearance process
are: (i) the subject loan should be at least six months old; (ii) the loan
should be a minimum of three payments delinquent; and (iii) each forbearance
arrangement must be approved by a manager, the senior vice president of
collections and the senior vice president of asset allocation. Forbearance
arrangements which defer ten or more past due payments, involve advances or
other payments of more than $25,000 or include an exception to our guidelines
must also be approved by an executive vice president.
For delinquent borrowers with business purpose loans, we may enter into
written forbearance agreements pursuant to which we do not obtain a deed in lieu
of foreclosure. These arrangements typically allow the borrower to pay past due
amounts over a period of 12-36 months, but not beyond the maturity date of the
loan and generally require the borrower to make a payment at the time of
entering into a forbearance agreement.
We do not enter into a deferment or forbearance arrangement based
solely on the fact that a loan meets the criteria for one of the arrangements.
Our use of any of these arrangements depends upon one or more of the following
factors: our assessment of the individual borrower's current financial situation
and reasons for the delinquency, a valuation of the real estate securing the
loan and our view of prevailing economic conditions. Because deferment and
forbearance arrangements are account management tools which help us to manage
customer relationships, maximize collection opportunities and increase the value
of our account relationships, the application of these tools generally is
subject to constantly shifting complexities and variations in the marketplace.
We attempt to tailor the type and terms of the arrangement we use to the
borrower's circumstances, and we prefer to use deferment over forbearance
arrangements, if possible.
As a result of these arrangements, we reset the contractual status of a
loan in our managed portfolio from delinquent to current based upon the
borrower's resumption of making their loan payments. Generally, a loan remains
current after a deferment or forbearance arrangement with the borrower only if
the borrower makes the principal and interest payments as required under the
terms of the original note (exclusive of delinquent payments advanced or fees
paid by us on the borrower's behalf as part of the deferment or forbearance
arrangement), and we do not reflect it as a delinquent loan in our delinquency
statistics. However, if the borrower fails to make principal and interest
payments, the account will generally be declared in default and collection
actions resumed. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Managed Portfolio Quality -- Deferment
and Forbearance Arrangements" for information regarding the impact of these
arrangements on our operations. See also "Regulation -- Equal Credit Opportunity
Fair Credit Reporting and Other Laws" and "Risk Factors -- The inquiry regarding
our forbearance practices by the U.S. Attorney could result in concerns
regarding our loan servicing and limit our ability to sell or service our loans,
sell subordinated debt, or obtain additional credit facilities, which would
hinder our ability to operate profitably and repay our subordinated debt, which
could negatively impact the value of our common stock."
We believe we are among a small number of non-conforming mortgage
lenders that have 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.
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 by foreclosure or deed in lieu of foreclosure, we record it at the
lower of cost or estimated fair value. After acquisition, all costs incurred in
maintaining the property are accounted for as expenses.
27
Most foreclosures are handled by outside counsel who are managed by our
in-house legal staff to ensure that the time period for handling foreclosures
meets or exceeds established industry standards. Frequent contact between
in-house and outside counsel ensures that the process moves quickly and
efficiently in an attempt to achieve a timely and economical resolution to
contested matters.
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 owner's
ability to sell or rent the property and prevent the owner from using the
property as collateral for another loan. Even parties who arrange for the
disposal or treatment of hazardous or toxic substances may be liable for the
costs of removal and remediation, whether or not the facility is owned or
operated by the party who arranged for the disposal or treatment. See "Risk
Factors -- Environmental laws and regulations and other environmental
considerations may restrict our ability to foreclose on loans secured by real
estate or increase costs associated with those loans which could hinder our
ability to operate profitably and the funds available to repay our subordinated
debt and negatively impact the value of our common stock." The technical nature
of some laws and regulations, such as the Truth in Lending Act, can also
contribute to difficulties in foreclosing on real estate and other assets, as
even immaterial errors can trigger foreclosure delays or other difficulties.
As the servicer of securitized loans, we are obligated to advance funds
for scheduled interest payments that have not been received from the borrower
unless we determine that our advances will not be recoverable from subsequent
collections of the related loan payments. See "-- Securitizations" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Off-Balance Sheet Arrangements." We are also required to
compensate investors (without a right to reimbursement) for interest shortfall
resulting from loan prepayments up to the amount of our servicing fee. See "Risk
Factors -- Our securitization agreements impose obligations on us to make cash
outlays which could impair our ability to operate profitably and our ability to
repay the subordinated debt and negatively impact the value of our common
stock."
Securitizations
We were unable to complete our typical quarterly securitization during
the fourth quarter of fiscal 2003. Our inability to complete our typical
publicly underwritten securitization during the fourth quarter of fiscal 2003
was the result of our investment bankers' decision in late June 2003 not to
underwrite the contemplated June 2003 securitization transaction. Management
believes that a number of factors contributed to this decision, including a
highly-publicized lawsuit finding liability of an underwriter in connection with
the securitization of loans for another unaffiliated subprime lender, an inquiry
by the U.S. Attorney's Office in Philadelphia regarding our forbearance
practices, an anonymous letter regarding the Company received by one of our
investment bankers, the SEC's recent enforcement action against another
unaffiliated subprime lender related to its loan restructuring practices and
related disclosure, a federal regulatory agency investigation of practices by
another subprime servicer and our investment bankers' prior experience with
securitization transactions with non-affiliated originators.
28
During fiscal 2003, we securitized $112.0 million of business purpose
loans and $1.3 billion of home equity loans. During fiscal 2002, we securitized
$129.1 million of business purpose loans and $1.2 billion of home equity loans.
During fiscal 2001, we securitized $109.9 million of business purpose loans and
$992.2 million of home equity loans. The securitization of loans generated gains
on sale of loans of $171.0 million during fiscal 2003, $185.6 million during
fiscal 2002 and $129.0 million during fiscal 2001. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Off-Balance
Sheet Arrangements -- Securitizations" for additional information regarding our
securitizations.
Securitization is a financing technique often used by originators of
financial assets to raise capital. A securitization involves the sale of a pool
of financial assets, in our case loans, to a trust in exchange for cash and a
retained interest in the securitized loans which is called an interest-only
strip. The trust issues multi-class securities which derive their cash flows
from a pool of securitized loans. These securities, which are senior to our
retained interest-only strips in the trust, are sold to public or private
investors. We also retain servicing on securitized loans. See "-- Loan Servicing
and Administrative Procedures"
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 the sum of the scheduled and prepaid principal and pass-through interest
paid to trust investors, 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. These cash flows also include cash flows
from overcollateralization. Overcollateralization is the excess of the aggregate
principal balances of loans in a securitized pool over investor interests.
Overcollateralization requirements are established to provide credit enhancement
for the trust investors.
We may be required either to repurchase or to substitute loans which do
not conform to the representations and warranties we made in the agreements
entered into when the loans are sold through a securitization. As of June 30,
2003, we have been required to substitute only one such loan from the
securitization trusts for this reason.
When borrowers are delinquent in making scheduled payments on loans
included in a securitization trust, we are obligated to advance interest
payments with respect to such delinquent loans if we deem that these advances
will ultimately be recoverable. These advances can first be made out of funds
available in the trust's collection account. If the funds available from the
collection account are insufficient to make the required interest advances, then
we are required to make the advances from our operating cash. The advances made
from a trust's collection account, if not recovered from the borrower or
proceeds from the liquidation of the loan, require reimbursement from us. These
advances may require funding from our capital resources and may create greater
demands on our cash flow than either selling loans with servicing released or
maintaining a portfolio of loans on our balance sheet. However, any advances we
make from our operating cash can be recovered from the subsequent mortgage loan
payments to the applicable trust prior to any distributions to the certificate
holders. See "Risk Factors -- Our securitization agreements impose obligations
on us to make cash outlays which could impair our ability to operate profitably
and our ability to repay the subordinated debt and negatively impact the value
of our common stock."
29
At times we elect to repurchase some delinquent loans from the
securitization trusts, some of which may be in foreclosure. Repurchasing loans
benefits us by allowing us to limit the level of delinquencies and losses in the
securitization trusts and as a result, we can avoid exceeding specified limits
on delinquencies and losses that trigger a temporary reduction or
discontinuation of residual or stepdown overcollateralization cash flows from
our interest-only strips until the delinquencies or losses no longer exceed the
triggers. We have the right, but are not obligated, to repurchase a limited
amount of delinquent loans from securitization trusts. The purchase price of a
delinquent loan is at the loan's outstanding contractual balance plus accrued
and unpaid interest and unreimbursed servicing advances, however unpaid interest
and unreimbursed servicing advances are returned to us by the trust. 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 31 days or
more past due. The foreclosed and delinquent loans we typically elect to
repurchase are usually 90 days or more delinquent and the subject of foreclosure
proceedings, or where a completed foreclosure is imminent. In addition, 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. See "Risk Factors -- Our securitization agreements impose obligations
on us to make cash outlays which could impair our ability to operate profitably
and our ability to repay the subordinated debt and negatively impact the value
of our common stock." See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Off-Balance Sheet Arrangements -- Trigger
Management" for a description of the impact of these repurchases on our
business.
Our securitizations can include a prefunding option where a portion of
the cash received from investors is withheld until additional loans are
transferred to the trust. The loans 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 initially transferred to the trust. We had no prefund obligations at June
30, 2003.
Whole Loan Sales
Our determination to engage in whole loan sales depends upon a variety
of factors, including market conditions in the securitization markets and the
secondary loan markets, profitability and cash flow considerations. In recent
years, we experienced a decrease in our whole loan sales as a result of our
decision to emphasize the securitization of additional loans, due to the
favorable conditions we experienced in the securitization markets during those
years and, to a lesser extent, our decision to de-emphasize conventional first
mortgage loans which we primarily sold on a whole loan basis. Due to our
inability to complete our typical quarterly securitization during the fourth
quarter of fiscal 2003, we adjusted our business strategy from a predominantly
publicly underwritten securitization strategy to a strategy focused on a
combination of whole loan sales and securitizations. See "-- Business Strategy."
In whole loan sale transactions, the gain on sale is generally significantly
lower than the gains realized in securitization transactions, but we receive the
gain in cash. Whole loan sales enable us to immediately generate cash flow,
protect against the potential volatility of the securitization market and reduce
the risks inherent in retaining securitization assets. However, unlike
securitizations, where we retain the servicing rights and receive securitization
assets in the form of interest-only strips which generate future cash flows,
whole loan sales are typically structured as a sale with servicing rights
released and do not result in our receipt of securitization assets. As a result,
using whole loan sales more extensively in the future will reduce our income
from servicing activities and limit the amount of securitization assets created.
30
Competition
We have significant competition for home equity loans. We concentrate
our marketing efforts for home equity loans on credit-impaired borrowers.
Through Upland Mortgage and American Business Mortgage Services, Inc., 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. See "-- Business Strategy" for discussion of
our emphasis on broadening our mortgage loan product line and offering
competitive interest rates. In addition, we implemented our Bank Alliance
Services program in order to generate additional loan volume. See "Risk Factors
- -- Competition from other lenders could adversely affect our ability to attain
profitable operations and our ability to repay our subordinated debt and
negatively impact the value of our common stock."
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.
Regulation
General. Our business is regulated by federal, state and, in certain
cases, local laws. All home equity 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, and their
associated Regulations Z, X and B, respectively.
Truth in Lending. The Truth in Lending Act and Regulation Z contain
disclosure requirements designed to provide consumers with uniform,
understandable information about the 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 certain transactions
described in the act and imposes specific loan feature restrictions on some
loans, including some of the same types of loans originated by us. If we were
found not to be in compliance with the Truth in Lending Act, some aggrieved
borrowers could, depending on the nature of the non-compliance, have the right
to recover actual damages, statutory damages, penalties, rescind their loans
and/or to demand, among other things, the return of finance charges and fees
paid to us and third parties. Other fines and penalties can also be imposed
under the Truth in Lending Act and Regulation Z.
Equal Credit Opportunity, Fair Credit Reporting Act 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 certain types of
information from loan applicants. Among other things, it also requires lenders
to advise applicants of the reasons for any credit denial. Equal Credit
Opportunity Act violations can also result in fines, penalties and other
remedies.
31
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 making such determinations.
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
discriminatory practices in connection with our home equity and other lending
businesses.
Pursuant to the Home Mortgage Disclosure Act and Regulation C, we are
also required to report information on loan applicants and certain other
borrowers to the Department of Housing and Urban Development, which is among
numerous federal and state agencies which monitor compliance with fair lending
laws.
We are also subject to the Real Estate Settlement Procedures Act and
Regulation X. This law and this regulation, which are administered by the
Department of Housing and Urban Development, imposes 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 and other
requirements.
We are subject to various other federal, state and local laws, rules
and regulations governing the licensing of mortgage lenders and servicers. We
must comply with procedures mandated for mortgage lenders and servicers, and
must provide disclosures to consumer applicants and 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 conducting business. 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, disclosure obligations, payment feature restrictions 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/or
administrative enforcement actions. Our in-house compliance staff, which
includes attorneys, and our outside counsel review and monitor the lending
policies of our subsidiaries for compliance with the various federal and state
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 or amended. Some of these laws and
regulations are rarely challenged in, or interpreted by, the courts. Infrequent
interpretations, an insignificant number of interpretations and/or conflicting
interpretations of these enacted or amended laws and regulations can make it
difficult for us to always know what is permitted conduct under these laws and
regulations.
32
Any ambiguity or vagueness 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,
as well as private litigation, which may hinder our ability to operate
profitably and repay our subordinated debt which would negatively impact the
value of our common stock."
The Gramm-Leach-Bliley Act, which was signed into law at the end of
1999, contains comprehensive consumer financial privacy restrictions. Various
federal enforcement agencies, including the Federal Trade Commission, have
issued final regulations to implement this act. These restrictions fall into two
basic categories. First, a financial institution must provide various notices to
consumers about such institution's privacy policies and practices. Second, this
act imposes restrictions on a financial institution and gives consumers the
right to prevent a financial institution from disclosing non-public personal
information about the consumer to non-affiliated third parties, with exceptions.
We have prepared the appropriate consumer disclosures and internal procedures to
address these requirements.
In addition, we are subject to review by state attorneys general and
the U.S. Department of Justice. We received a civil subpoena, dated May 14,
2003, from the Civil Division of the U.S. Attorney for the Eastern District of
Pennsylvania requesting that we provide certain documents and information with
respect to us and our lending subsidiaries for the period from May 1, 2000 to
May 1, 2003: (i) all loan files in which we entered into a forbearance agreement
with a borrower who is in default; (ii) the servicing, processing, foreclosing,
and handling of delinquent loans and non-performing loans, the carrying,
processing and sale of real estate owned, and forbearance agreements; and
(iii) agreements to sell or otherwise transfer mortgage loans (including but not
limited to, any pooling or securitization agreements) or to obtain funds to
finance the underwriting, origination or provision of mortgage loans, any
transaction in which mortgage loans were sold or transferred, any instance in
which we were not to service or not to act as custodian for a mortgage loan,
representations and warranties made in connection with mortgage loans, secondary
market loan sale schedules, and credit loss, delinquency, default, and
foreclosure rates of mortgage loans. We have directed our attorneys to cooperate
fully with this inquiry. Currently, this inquiry appears to be focused on our
practices relating to obtaining forbearance agreements from delinquent borrowers
who would otherwise be subject to foreclosure. Because the inquiry is at a
preliminary stage, we cannot reach any conclusions at this time as to the
ultimate scope of the inquiry or the potential liability or financial
consequences for us.
Predatory Lending Regulations. State and federal banking regulatory
agencies, state attorneys general offices, the Federal Trade Commission, the
U.S. Department of Justice, the U.S. Department of Housing and Urban Development
and state and local governmental authorities have increased their focus on
lending practices by some companies in the subprime lending industry, more
commonly referred to as "predatory lending" practices. State, local and federal
governmental agencies have imposed sanctions for practices including, but not
limited to, charging borrowers excessive fees, imposing higher interest rates
33
than the borrower's credit risk warrants and failing to adequately disclose the
material terms of loans to the borrowers. For example, the Pennsylvania Attorney
General reviewed fees our subsidiary, Home American Credit, Inc., charged
Pennsylvania customers. Although we believe that these fees were fair and in
compliance with applicable federal and state laws, in April 2002 we agreed to
reimburse borrowers approximately $221,000 with respect to a particular fee paid
by borrowers from January 1, 1999 to mid-February 2001 and to reimburse the
Commonwealth of Pennsylvania $50,000 for its costs of investigation and for
future public protection purposes. We discontinued charging this particular fee
in mid-February 2001. As a result of these initiatives, we are unable to predict
whether state, local or federal authorities will require changes in our lending
practices in the future, including reimbursement of fees charged to borrowers,
or will impose fines on us. These changes, if required, could impact our
profitability. These laws and regulations may limit our ability to securitize
loans originated in certain states or localities due to rating agency, investor
or market restrictions. As a result, we have limited the types of loans we offer
in some states and may discontinue originating loans in other states or
localities. See "Risk Factors -- Our residential lending business is subject to
government regulation and licensing requirements, as well as private litigation,
which may hinder our ability to operate profitably and repay our subordinated
debt, which would negatively impact the value of our common stock."
Additionally, the United States Congress is currently considering a
number of proposed bills or proposed amendments to existing laws, such as the
"Ney - Lucas Responsible Lending Act of 2003" introduced on February 11, 2003
into the U.S. House of Representatives, which could affect our lending
activities and make our business less profitable. These bills and amendments, if
adopted as proposed, could reduce our profitability by limiting the fees we are
permitted to charge, including prepayment fees, restricting the terms we are
permitted to include in our loan agreements and increasing the amount of
disclosure we are required to give to potential borrowers. While we cannot
predict whether or in what form Congress may enact legislation, we are currently
evaluating the potential impact of these legislative initiatives, if adopted, on
our lending practices and results of operations.
In addition to new regulatory initiatives with respect to so-called
"predatory lending" practices, current laws or regulations in some states
restrict our ability to charge prepayment penalties and late fees. We have used
the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer
to as the Parity Act, to preempt these state laws for home equity loans which
meet the definition of alternative mortgage transactions under the Parity Act.
However, the Office of Thrift Supervision has adopted a rule effective in July
2003, which precludes us and other non-bank, non-thrift creditors from using the
Parity Act to preempt state prepayment penalty and late fee laws on new loan
originations. Under the provisions of this rule, we are required to modify or
eliminate the practice of charging prepayment and other fees in some of the
states where we originate loans. We are continuing to evaluate the impact of the
adoption of the new rule by the Office of Thrift Supervision on our future
lending activities and results of operations. We currently expect that the
percentage of home equity loans containing prepayment fees that we will
originate in the future will decrease to approximately 65% to 70%, from 80% to
85% prior to this rule becoming effective. Additionally, in a recent decision,
the Appellate Division of the Superior Court of New Jersey determined that the
Parity Act's preemption of state law was invalid and that the state laws
precluding some lenders from imposing prepayment fees are applicable to loans
made in New Jersey, including alternative mortgage transactions. Although this
New Jersey decision is subject to appeal and may not be final, we are currently
evaluating its impact on our future lending activities in the State of New
Jersey and results of operations. See " -- Lending Activities -- Prepayment
Fees."
Soldiers' and Sailors' Civil Relief Act of 1940. Under the Soldiers'
and Sailors' Civil Relief Act of 1940, members of all branches of the military
on active duty, including draftees and reservists in military service and state
national guard called to federal duty:
o are entitled to have interest rates reduced and capped at 6% per annum,
on obligations (including mortgage loans) incurred prior to the
commencement of military service for the duration of military service;
o may be entitled to a stay of proceeding on any kind of foreclosure or
repossession action in the case of defaults on obligations entered into
prior to military service for the duration of military service; and
o may have the maturity of obligations incurred prior to military service
extended, the payments lowered and the payment schedule readjusted for
a period of time after the completion of military service.
If a borrower's obligation to repay amounts otherwise due on a mortgage
loan included in a trust is relieved pursuant to the Relief Act, none of the
trust, the servicer, the back-up servicer, the seller, the depositor, the
originators or the trustee will be required to advance these amounts, and any
resulting loss may reduce the amounts available to be paid to the holders of the
certificates. Any shortfalls in interest collections on mortgage loans included
in the trust resulting from application of the Relief Act will be allocated to
the certificates in reduction of the amounts payable to such certificates on the
related distribution date.
As a result of the current military actions in Iraq and Afghanistan,
President Bush authorized the placement of tens of thousands of military
reservists and members of the National Guard on active duty status. To the
extent that any such person is a borrower under a loan, the interest rate
limitations and other provisions of the Relief Act would apply to the loan
during the period of active duty. The number of reservists and members of the
National Guard placed on active duty status in the near future may increase. In
addition, other borrowers who enter military service after the origination of
their loans (including borrowers who are members of the National Guard at the
time of the origination of their loans and are later called to active duty)
would be covered by the terms of the Relief Act. See "Risk Factors -- If many of
our borrowers become subject to the Soldiers' and Sailors' Civil Relief Act of
1940, our cash flows, interest income and profitability may be adversely
affected which would negatively impact our ability to repay our subordinated
debt."
We have procedures and controls to monitor compliance with numerous
federal, state and local laws and regulations. However, because these laws and
regulations are complex and often subject to interpretation, or as a result of
inadvertent errors, we may, from time to time, inadvertently violate these laws
and regulations.
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.
34
Risk Factors
Investors in our common stock or subordinated debt should carefully consider
these risk factors together with all of the information contained in this Form
10-K and incorporated by reference in this Form 10-K which could impact the
value of our common stock.
If we are unable to obtain additional financing, we may not be able to
restructure our business to permit profitable operations or repay our
subordinated debt when due, which would negatively impact the value of our
common stock.
Our inability to complete our typical publicly underwritten
securitization during the fourth quarter of fiscal 2003 and our loss for fiscal
2003 adversely impacted our short-term liquidity position and resulted in our
inability to comply with financial covenants contained in our credit facilities.
The expiration of our $300.0 million mortgage conduit facility and the temporary
discontinuation of the sale of new subordinated debentures also adversely
impacted our short-term liquidity position.
Although we have obtained one new $200.0 million credit facility, this
new $200.0 million credit facility could terminate as early as October 3, 2003
if we cannot close by that date another credit facility for at least an
additional $200.0 million. We have also received a written commitment letter for
a $250.0 million credit facility and, although we are currently negotiating the
definitive terms of this $250.0 million new credit facility, we cannot assure
you that these negotiations will be successful. Our ability to obtain
alternative sources of financing may be limited to the extent we have agreed to
pledge our interest-only strips, which represent a significant amount of our
assets, to secure the $250.0 million credit facility. To the extent that we are
not successful in maintaining, replacing or obtaining alternative financing
sources on acceptable terms, we may have to limit our loan originations, sell
loans earlier than intended and restructure our operations under our contingent
business plan. Limiting our originations or earlier sales of our loans could
prevent us from operating profitably and restrict our ability to repay our
subordinated debt. Likewise, there can be no assurance that we can successfully
implement our contingent business plan, if necessary, or that the assumptions
underlying the contingent business plan can be achieved. Our failure to
successfully implement our contingent business plan, if necessary, would impair
our ability to operate profitably and repay the subordinated debt.
Even if we are able to obtain adequate financing, our inability to securitize
our loans could hinder our ability to operate profitably in the future and repay
our subordinated debt when due, which would negatively impact the value of our
common stock.
Since 1995, we have relied on the quarterly securitization of our loans
to generate cash for the repayment of our credit facilities and the origination
of additional loans. Our inability to complete our typical publicly underwritten
quarterly securitization during the fourth quarter of 2003 and the $45.2 million
pre-tax valuation adjustments to our securitization assets resulted in a loss of
$29.9 million for fiscal 2003 and caused our shift in focus to less profitable
whole loan sales. The loss resulted in our inability to comply with certain
financial covenants contained in our credit facilities. The loss and the
expiration of our mortgage conduit facility adversely impacted our short-term
liquidity position. The temporary discontinuation of subordinated debt sales
further impaired our liquidity.
Our continued inability to complete securitization transactions could
result in losses during the next several quarters causing us to fail to comply
with the financial covenants in our credit facilities, increase our reliance on
less profitable whole loan sales which will require us to originate more loans
to reach the same level of profitability as we experienced in securitization
transactions, and increase our need for additional financing to fund our loan
originations. Our continued inability to securitize our loans could result in us
reaching our capacity under our existing credit facilities or require us to sell
our loans when market conditions are less favorable and could cause us to incur
a loss on the sale transaction. See "-- An interruption or reduction in the
securitization or whole loan sale markets would hinder our ability to operate
profitably and repay our subordinated debt when due, which could negatively
impact the value of our common stock."
Because we have historically experienced negative cash flows from operations and
expect to do so in the foreseeable future, our ability to repay our subordinated
debt could be impaired, which would negatively impact the value of our common
stock.
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 a combination of cash proceeds received and 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 our
subordinated debt. At June 30, 2003, there was $343.6 million of subordinated
debt and accrued interest, which will mature through June 30, 2004.
35
We obtain the funds to repay our subordinated debt at their maturities
by securitizing our loans, selling whole loans, collecting cash from our
securitization assets and selling additional 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, our ability to repay our subordinated debt would be impaired,
which would negatively impact the value of our common stock. 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 limit our ability
to operate profitably and impair our ability to repay our subordinated debt,
which would negatively impact the value of our common stock.
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, prepayment
and credit loss rate assumptions established by the management of our company.
The value of our interest-only strips totaled $598.3 million and the value of
our servicing rights totaled $119.3 million at June 30, 2003. Together, these
two assets represent 61.9% of our total assets at June 30, 2003. 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 rate, prepayment rate and
credit loss rate assumptions established by us. 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 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 accounting
adjustment, consisting of a corresponding reduction in pre-tax income or
stockholders' equity or both in the period of adjustment. Adjustments to income
could impair our ability to repay our subordinated debt. During fiscal 2003, we
recorded a write down of $63.3 million on our interest-only strips and servicing
rights, which we collectively refer to in this document as our securitization
assets. The write down consisted of a $45.2 million reduction of pre-tax income
and an $18.1 million pre-tax reduction of stockholders' equity. The write down
was mainly due to actual prepayment experience that was higher than our
assumptions, but was reduced by the favorable valuation impact of reducing the
discount rates used to value our securitization assets at June 30, 2003. During
fiscal 2002, we recorded a write down of $44.1 million on our securitization
assets, consisting of a $22.1 million reduction of pre-tax income and a $22.0
million pre-tax reduction of stockholders' equity due to actual prepayment
experience that was higher than anticipated. We cannot predict with certainty
what our future prepayment experience will be. Any unfavorable difference
between the assumptions used to value our securitization assets and our actual
experience may have a significant adverse impact on the value of these assets.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Application of Critical Accounting Policies -- Impact of Changes
in Critical Accounting Estimates in Prior Fiscal Years" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Off-Balance Sheet Arrangements -- Securitizations" for information on the
sensitivities of interest-only strips and servicing rights to changes in
assumptions. In addition, our servicing rights (and the related fees) can be
terminated under certain circumstances, such as failure to make required
servicer payments, defined changes in control and reaching certain loss and
delinquency levels on the underlying pool.
36
We depend upon the availability of financing to fund our continuing operations.
Any failure to obtain adequate funding could hurt our ability to operate
profitably and restrict our ability to repay our subordinated debt, and
negatively impact the value of our common stock.
For our ongoing operations, we depend upon frequent financings,
including the sale of our unsecured subordinated debt and warehouse credit
facilities or lines of credit. If we are unable to maintain, renew or obtain
adequate funding under a warehouse credit facility, or other borrowings,
including the sale of our subordinated debt, the lack of adequate funds would
hinder our ability to operate profitably and restrict our ability to repay our
subordinated debt upon maturity. During volatile times in the capital markets,
access to financing has been severely constricted. On July 5, 2003, our $300.0
million mortgage conduit facility expired pursuant to its terms and was not
renewed. In addition, further advances under a non-committed portion of one of
our credit facilities were subject to the discretion of the lender and
subsequent to June 30, 2003 there were no new advances under the non-committed
portion. On August 20, 2003 this credit facility was amended to reduce the
committed portion to $50.0 million (from $100.0 million), eliminate the
non-committed portion and accelerate its expiration date from November 2003 to
no later than September 30, 2003. Our ability to repay this facility upon
termination is dependent on our ability to refinance the loans in one of our new
facilities or our sale of loans currently warehoused in the terminating facility
by September 30, 2003.
On September 22, 2003, we entered into definitive agreements with a
financial institution for a new $200.0 million credit facility, which requires,
among other things that we obtain a written commitment for another credit
facility of at least $200.0 million and close that additional facility by
October 3, 2003. On September 22, 2003, we also executed a commitment letter,
which includes a senior secured credit facility in the aggregate of up to $250.0
million. The commitment letter requires that we enter into a definitive
agreement no later than October 17, 2003. While we anticipate that we will close
this transaction by such date, we cannot assure you that these negotiations will
result in a definitive agreement or that such agreement, as negotiated, will be
on terms and conditions acceptable to us. In the event we are unable to close
this facility or another facility within the time frame provided under the new
$200.0 million credit facility described above, the lender on that facility
would be under no obligation to make further advances under the terms of that
facility and outstanding advances would be repaid over a period of time.
Additionally, our ability to obtain alternative financing sources may be limited
to the extent we have agreed to pledge our interest-only strips, which represent
a significant amount of our assets, to secure the $250.0 million credit
facility. See "--Recent Developments" for further discussion of these
facilities.
We cannot assure you that we will be successful in maintaining,
replacing or obtaining alternative financing sources necessary to fund our
operations, and to the extent that we are not successful, we may have to limit
our loan originations or sell loans earlier than intended and restructure our
operations. As a result of these liquidity issues, since June 30, 2003, we
substantially reduced our loan origination volume. Limiting our originations or
earlier sales of loans could hinder our ability to operate profitably or result
in losses and restrict our ability to repay our subordinated debt upon maturity.
Our ability to repay our subordinated debt at maturity may depend, in part, on
our ability to raise new funds through the sale of additional subordinated debt.
As the servicer of securitized loans, we could also incur certain additional
cash requirements with respect to the securitization trusts which could increase
our dependence on borrowed funds to the extent funds from non-credit sources
were unavailable. If this additional cash requirement were to arise at a time
when our access to borrowed funds was restricted, our ability to repay some or
all of the subordinated debt as it came due could be impaired. See "-- Our
securitization agreements impose obligations on us to make cash outlays which
could impair our ability to operate profitably and our ability to repay the
subordinated debt and negatively impact the value of our common stock" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
37
Because our business operations are generally not subject to regulation and
examination by federal banking regulators, these protections are not available
to protect investors in our subordinated debt or our stockholders.
Currently, our operations are not regulated or subject to examination
in the same manner as commercial banks, savings banks and thrift institutions.
Our operations are not subject to the stringent regulatory requirements imposed
upon the operations of those entities and are not subject to periodic compliance
examinations by federal banking regulators designed to protect investors.
See "Business -- Regulation"
Our residential lending business is subject to government regulation and
licensing requirements, as well as private litigation, which may hinder our
ability to operate profitably and repay our subordinated debt, which would
negatively impact the value of our common stock.
Our residential lending business is subject to extensive regulation,
supervision and licensing by various state departments of banking and other
state, local and federal agencies. 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 lending activities.
We are also subject to examinations by state departments of banking or
similar agencies in the 44 states where we are licensed or otherwise qualified
with respect to originating, processing, underwriting, selling and servicing
home equity loans. We are also subject to Federal Reserve Board, Federal Trade
Commission, Department of Housing and Urban Development and other federal and
state agency regulations related to residential mortgage lending, servicing and
reporting. Failure to comply with these requirements can lead to, among other
remedies, termination or suspension of licenses, rights of rescission for
mortgage loans, class action lawsuits and administrative enforcement actions. In
addition, we are subject to review by state attorneys general and the U.S.
Department of Justice and recently received a civil subpoena from the Civil
Division of the U.S. Attorney for the Eastern District of Pennsylvania. See "--
The inquiry regarding our forbearance practices by the U.S. Attorney could
result in concerns regarding our loan servicing and limit our ability to sell or
service our loans, sell subordinated debt, or obtain additional credit
facilities, which would hinder our ability to operate profitably and repay our
subordinated debt, which would negatively impact the value of our common stock."
State and federal banking regulatory agencies, state attorneys general
offices, the Federal Trade Commission, the U.S. Department of Justice, the U.S.
Department of Housing and Urban Development and state and local governmental
authorities have increased their focus on lending practices by some companies in
the subprime lending industry, more commonly referred to as "predatory lending"
practices. State, local and federal governmental agencies have imposed sanctions
for practices, including, but not limited to, charging borrowers excessive fees,
imposing higher interest rates than the borrower's credit risk warrants and
failing to adequately disclose the material terms of loans to the borrowers. For
example, the Pennsylvania Attorney General reviewed fees our subsidiary,
HomeAmerican Credit, Inc., charged Pennsylvania customers. Although we believe
that these fees were fair and in compliance with applicable federal and state
38
laws, in April 2002, we agreed to reimburse borrowers approximately $221,000
with respect to a particular fee paid by borrowers from January 1, 1999 to
mid-February 2001 and to reimburse the Commonwealth of Pennsylvania $50,000 for
its costs of investigation and for future public protection purposes. We
discontinued charging this particular fee in mid-February 2001. As a result of
these initiatives, we are unable to predict whether state, local or federal
authorities will require changes in our lending practices in the future,
including reimbursement of fees charged to borrowers, or will impose fines on
us. These changes, if required, could impact our profitability. These laws and
regulations may limit our ability to securitize loans originated in some states
or localities due to rating agency, investor or market restrictions. As a
result, we have limited the types of loans we offer in some states and may
discontinue originating loans in other states or localities.
Additionally, the United States Congress is currently considering a
number of proposed bills or proposed amendments to existing laws, such as the
"Ney - Lucas Responsible Lending Act of 2003" introduced on February 11, 2003
into the U.S. House of Representatives, which could affect our lending
activities and make our business less profitable. These bills and amendments, if
adopted as proposed, could reduce our profitability by limiting the fees we are
permitted to charge, including prepayment fees, restricting the terms we are
permitted to include in our loan agreements and increasing the amount of
disclosure we are required to give to potential borrowers. See "Business --
Lending Activities" and "Business -- Regulation"
In addition to new regulatory initiatives with respect to so-called
"predatory lending" practices, current laws or regulations in some states
restrict our ability to charge prepayment penalties and late fees. We have used
the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer
to as the Parity Act, to preempt these state laws for home equity loans which
meet the definition of alternative mortgage transactions under the Parity Act.
However, the Office of Thrift Supervision has adopted a rule, effective in July
2003, which precludes us and other non-bank, non-thrift creditors from using the
Parity Act to preempt state prepayment penalty and late fee laws on new loan
originations. Under the provisions of this rule, we are required to modify or
eliminate the practice of charging prepayment and other fees in some of the
states where we originate loans. We are continuing to evaluate the impact of the
adoption of the new rule by the Office of Thrift Supervision on our future
lending activities and results of operations. We currently expect that the
percentage of home equity loans containing prepayment fees that we will
originate in the future will decrease to approximately 65% to 70%, from 80% to
85% prior to this rule becoming effective. Additionally, in a recent decision,
the Appellate Division of the Superior Court of New Jersey determined that the
Parity Act's preemption of state law was invalid and that the state laws
precluding some lenders from imposing prepayment fees are applicable to loans
made in New Jersey, including alternative mortgage transactions. Although this
New Jersey decision is subject to appeal and may not be final, we are currently
evaluating its impact on our future lending activities in the State of New
Jersey and results of operations.
We are also subject, from time to time, to private litigation,
including actual and purported class action suits, resulting from alleged
"predatory lending" practices. Our lending subsidiaries, including HomeAmerican
Credit, Inc., which does business as Upland Mortgage, are involved in class
action lawsuits, other litigation, claims, investigations by governmental
39
authorities, and legal proceedings arising out of their lending and servicing
activities. For example, the purported class action entitled, Calvin Hale v.
HomeAmerican Credit, Inc., d/b/a Upland Mortgage, was filed on behalf of
borrowers in several states alleging that the charging of, and failure to
properly disclose the nature of, a document preparation fee were improper under
applicable state law and ultimately settled. Due to the inherent uncertainty in
litigation and because the ultimate resolution of these proceedings are
influenced by factors outside of our control, our estimated liability under
these proceedings may change or actual results may differ from our estimates. We
expect, that as a result of the publicity surrounding "predatory lending"
practices, we may be subject to other class action suits in the future. See
"Business -- Legal Proceedings."
We have procedures and controls to monitor compliance with numerous
federal, state and local laws and regulations. However, because these laws and
regulations are complex and often subject to interpretation, or as a result of
inadvertent errors, we may, from time to time, inadvertently violate these laws
and regulations.
More restrictive laws, rules and regulations may be adopted in the
future that could make compliance more difficult or expensive or we may be
subject to additional litigation or governmental reviews of our lending
practices which could hinder our ability to operate profitably and repay our
subordinated debt, which could negatively impact the value of our common stock.
See "Business -- Regulation."
The inquiry regarding our forbearance practices by the U.S. Attorney could
result in concerns regarding our loan servicing and limit our ability to sell or
service our loans, sell subordinated debt, or obtain additional credit
facilities, which would hinder our ability to operate profitably and repay our
subordinated debt, which would negatively impact the value of our common stock.
We received a civil subpoena, dated May 14, 2003, from the Civil
Division of the United States Attorney for the Eastern District of Pennsylvania,
requesting that we provide certain documents and information with respect to us
and our lending subsidiaries for the period from May 1, 2000 to May 1, 2003:
(i) all loan files in which we entered into a forbearance agreement with a
borrower who is in default; (ii) the servicing, processing, foreclosing, and
handling of delinquent loans, and non-performing loans, the carrying, processing
and sale of real estate owned, and forbearance agreements; and (iii) agreements
to sell or otherwise transfer mortgage loans (including but not limited to, any
pooling or securitization agreements) or to obtain funds to finance the
underwriting, origination or provision of mortgage loans, any transaction in
which mortgage loans were sold or transferred, any instance in which we were not
to service or not to act as custodian for a mortgage loan, representations and
warranties made in connection with mortgage loans, secondary market loan sale
schedules, and credit loss, delinquency, default, and foreclosure rates of
mortgage loans. We have directed our attorneys to cooperate fully with this
inquiry. Currently, this inquiry appears to be focused on our practices relating
to obtaining forbearance agreements from delinquent borrowers who would
otherwise be subject to foreclosure. Because the inquiry is at a preliminary
stage, we cannot reach any conclusions at this time as to the ultimate scope of
the inquiry or the potential liability or financial consequences for us.
40
Management believes the disclosure of the receipt of the civil
subpoena, among other things, resulted in our investment bankers' decision not
to underwrite our quarterly loan securitization. Our failure to complete this
quarterly securitization contributed to our loss for the year ended June 30,
2003. To the extent management is unsuccessful in resolving this matter, the
ongoing review by the U.S. Attorney's Office could limit our ability to engage
in publicly underwritten securitization transactions or otherwise sell or
service our loans. In addition, the U.S. Attorney's inquiry could reduce sales
of subordinated debt upon which we rely to fund our operations and limit our
ability to obtain additional credit facilities, which are necessary in
connection with the implementation of our business strategy. Furthermore, the
U.S. Attorney could impose sanctions or otherwise restrict our ability to
restructure loans, which could negatively impact our profitability and our
ability to repay the subordinated debt, which would negatively impact the value
of our common stock.
41
Lending to credit-impaired borrowers may result in higher delinquencies in our
managed portfolio, which could hinder our ability to operate profitably, impair
our ability to repay our subordinated debt and negatively impact the value of
our common stock.
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. This type of borrower is commonly referred to as a subprime
borrower. 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 higher rates of delinquency on loans made to
these credit-impaired borrowers as compared to delinquency rates experienced by
banks on loans to borrowers who are not credit-impaired. 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 managed portfolio
could reduce the cash flow we receive from our securitization assets which would
hinder our ability to operate profitably and could restrict our ability to repay
our subordinated debt upon maturity, which would negatively impact the value of
our common stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Managed Portfolio Quality" and "Business
- -- Lending Activities."
Delinquencies and prepayments in the pools of securitized loans could adversely
affect the cash flow we receive from our interest-only strips, impair our
ability to sell or securitize loans in the future and impair our ability to
repay the subordinated debt and negatively impact the value of our common stock.
Levels of delinquencies or losses in a particular securitized pool of
loans, which exceed maximum percentage limits, or "triggers," set in the
securitization agreement governing that pool, impact some or all of the cash
that we would otherwise receive from our interest-only strips. If delinquencies
or losses exceed maximum limits, the securitization trust withholds cash from
our interest-only strips. The trust then uses the cash to repay outside
investors, which reduces the proportionate interest of outside investors in the
pool and results in additional overcollateralization. Additionally, for losses,
the securitization trust utilizes cash from our interest-only strips to pay off
investors. Our receipt of cash payments on the interest-only strip resumes when
the additional overcollateralization created for outside investors meets
specified targets or delinquency and loss rates for the pool of loans no longer
exceed trigger levels. However, to adequately fund our ongoing operations during
a period of suspended cash flow, we may need to borrow funds to replace the cash
being withheld. The additional interest expense would hinder our ability to
operate profitably and could impair our ability to repay subordinated debt as it
matures and negatively impact the value of our common stock. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Off-Balance Sheet Arrangements -- Trigger Management."
We have the ability to repurchase a limited number of delinquent loans
from securitized pools. This ability to repurchase loans enables us to avoid
disruptions in securitization cash flows by repurchasing delinquent loans before
trigger limits are reached, or to restore suspended cash flows by repurchasing
sufficient delinquent loans to lower delinquency and loss rates below trigger
limits. However, the repurchase of loans for this purpose, called "trigger
management," would require funding from the same sources we rely on for our
other cash needs and could require us to borrow additional funds. If funds were
not available to permit us to repurchase these loans, our cash flow from the
interest-only strips would be reduced and our ability to repay the subordinated
42
debt could be impaired. Lack of liquidity in these circumstances could result in
more pools reaching trigger levels, which, in turn, would further tighten
liquidity. In addition, the additional interest expense resulting from
additional outstanding debt would reduce our profitability and could impair our
ability to repay subordinated debt as it matures. We depend upon the
availability of financing to fund our continuing operations. Any failure to
obtain adequate funding could hurt our profitability and restrict our ability to
repay our subordinated debt, which could negatively impact the value of our
common stock. See "-- We depend upon the availability of financing to fund our
continuing operations. Any failure to obtain adequate funding could hurt our
ability to operate profitably and restrict our ability to repay our subordinated
debt which could negatively impact the value of our common stock."
Prepayments by borrowers also make it more difficult for us to maintain
delinquencies below trigger limits set in securitization agreements. By reducing
current loans in a securitized pool, prepayments mathematically increase the
percentage of delinquent loans remaining in the pool. The consequences resulting
from either a suspension of cash flow or our repurchase of delinquent loans from
the securitized pool could impair our ability to repay subordinated debt, which
could negatively impact the value of our common stock. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Off-Balance Sheet Arrangements -- Securitizations -- Trigger Management,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Managed Portfolio Quality" and "Business -- Lending Activities."
For the fiscal year ended June 30, 2003, we repurchased delinquent
loans with an aggregate unpaid principal balance of $55.0 million from
securitization trusts primarily for trigger management. We received $37.6
million of proceeds from the liquidation of repurchased loans and real estate
owned during fiscal year 2003. We had repurchased loans and real estate owned
remaining on our balance sheet of $9.6 million at June 30, 2003. All loans and
real estate owned were repurchased at the contractual outstanding balances at
the time of repurchase and are carried at the lower of their cost basis or fair
value. Because the contractual outstanding balance is typically greater than the
fair value, we generally incur a loss on these repurchases.
An interruption or reduction in the securitization or whole loan sale markets
would hinder our ability to operate profitably and repay our subordinated debt
when due, which could negatively impact the value of our common stock.
A significant portion of our revenue and net income represents gain on
the sale of loans. Our strategy is to sell substantially all of the loans we
originate at least quarterly. Operating results for a given period can fluctuate
significantly as a result of the timing and size of securitizations or whole
loan sales. If we do not close securitizations or whole loan sales on a
quarterly basis, we could experience a loss for that quarter. In addition, we
rely on the quarterly sale of our loans 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;
o general economic conditions, including conditions in the subprime
industry;
o the performance of our previously securitized loans;
o the credit quality of our managed portfolio; and
o changes in federal tax laws.
43
If we are not able to sell substantially all of the loans that we
originate during the quarter in which the loans are made, we would likely not be
profitable for the quarter. 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 our subordinated debt upon maturity which
would have a material adverse effect on our results of operations, financial
condition and business prospects. If it is not possible or economical for us to
complete a securitization or whole loan sale within favorable timeframes, we
may exceed our capacity under our warehouse financing and lines of credit. We
may be required to sell the accumulated loans at a time when market conditions
for our loans are less favorable, and potentially to incur a loss on the sale
transaction. If we cannot generate sufficient liquidity upon any such loan sale
or through the sale of subordinated debt, we will be required to restrict or
restructure our operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" and "Business -- Securitizations."
If we are unable to successfully implement our adjusted business strategy which
focuses on whole loan sales, we may be unable to attain profitable operations
which could impair our ability to repay our subordinated debt and negatively
impact the value of our common stock.
Our adjusted business strategy seeks to increase our loan volume by
broadening our loan product line, offering competitive interest rates and
through further development of existing markets while maintaining our
origination fees, underwriting criteria and the interest rate spread between
loan interest rates and the interest rates we pay for capital. Implementation of
this strategy will depend in large part on our ability to:
o Expand in markets with a sufficient concentration of borrowers who
meet our underwriting criteria;
o Obtain and maintain adequate financing on favorable terms to fund
our operations;
o Profitably sell and securitize our loans in the secondary market on
a regular basis;
o Hire, train and retain skilled employees; and
o Successfully implement our marketing campaigns.
Our inability to achieve any or all of these factors could impair our
ability to successfully implement our business strategy and successfully
leverage our fixed costs which could hinder our ability to operate profitably,
result in continued losses and impair our ability to repay our subordinated
debt, which would negatively impact the value of our common stock.
Changes in interest rates could negatively impact our ability to operate
profitably and impair our ability to repay the subordinated debt and negatively
impact the value of our common stock.
Rising interest rates could reduce our overall profitability in one or more
of the following ways:
o Reducing the demand for our loan products, which could reduce our
profitability.
o Causing investors in asset-backed securities to increase the interest
rate spread requirements and overcollateralization requirements for
our future securitizations, which could reduce the profitability of
our securitizations.
o Increasing interest rates required by purchasers of our loans in
whole loan sales.
o Reducing the spread between the interest rates we receive on loans we
originate and the interest rates we pay to fund the originations,
which among other effects, increases our carrying costs for these
loans during the period they are being pooled for securitization.
o Increasing the interest rates we must pay on our subordinated debt to
attract investors at the levels we require to fund our operations.
o Increasing our interest expense on all sources of borrowed funds,
such as subordinated debt, credit facilities and lines of credit, and
could restrict our access to the capital markets.
o Negatively impacting the value and profitability of loans from the
date of origination until the date we sell the loans.
o Reducing the spread between the average interest rate on the loans in
a securitization pool and the pass-through interest rate to investors
issued in connection with the securitization. This reduction in the
spread occurs because interest rates on loans in a securitization
pool are typically set over the three months preceding a
securitization while the pass-through rate on securities issued in
the securitization is based on market rates at the time a
securitization is priced. Therefore, if market interest rates
44
required by investors increase prior to securitization of the loans,
the interest rate spread between the average interest rate on the
loans and the pass-through interest rate to investors may be reduced
or eliminated. This factor would reduce our profit on the sale of the
loans. Any reduction in our profitability could impair our ability to
repay our subordinated debt upon maturity.
o Increasing the cost of floating rate certificates issued in certain
securitizations without a corresponding increase in the interest
income of the underlying fixed rate loan collateral. This situation
would reduce the cash flow we receive from the interest-only strips
related to those securitizations and reduce the fair value or
expected future cash flow of that asset as well. At June 30, 2003,
floating interest rate certificates represent 3.5% of total debt
issued by loan securitization trusts. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--
Interest Rate Risk Management" for further discussion of the impact
on our interest-only strips of interest rate changes in floating
interest rate certificates issued by securitization trusts and
outstanding debt issued by the securitization trusts.
Declining interest rates could reduce our profitability in one or more
of the following ways:
o Subordinated debt with terms of one year or more which is not
redeemable at our option represents an unfavorable source of
borrowing in an environment where market rates fall below those paid
on the subordinated debt. At June 30, 2003, $97.5 million in
non-redeemable subordinated debt with maturities of greater than one
year was outstanding.
o A decline in market interest rates generally induces borrowers to
refinance their loans, which are held in the securitization trusts,
and could reduce our profitability. Prepayment levels in excess of
our assumptions reduce the value of our securitization assets. A
significant decline in market interest rates would 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 and could
impair our ability to repay our subordinated debt. See "-- Our
estimates of the value of interest-only strips and servicing rights
we retain when we securitize loans could be inaccurate and could
limit our ability to operate profitably and impair our ability to
repay our subordinated debt, which could negatively impact the value
of our common stock."
Although both rising and falling interest rates negatively impact our
business and profitability, the speed at which rates fluctuate, the duration of
high or low interest rate environments and the nature and magnitude of any
favorable interest rate consequences, as well as economic events and business
conditions outside of our control, affect the overall manner in which interest
rate changes impact our operations and the magnitude of such impact. In
addition, because of the volatile and unpredictable manner in which these
factors interact, we may experience interest rate risks in the future that we
have not previously experienced or identified. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Interest Rate Risk
Management."
45
Our securitization agreements impose obligations on us to make cash outlays
which could impair our ability to operate profitably and our ability to repay
the subordinated debt and negatively impact the value of our common stock.
Our securitization agreements require us to replace or repurchase loans
which do not conform to representations and warranties we made in the
agreements. Additionally, as servicer, we are required to:
o compensate investors for interest shortfalls on loan prepayments (up
to the amount of the related servicing fee); and
o advance interest payments for delinquent loans if we believe in good
faith the advances will ultimately be recoverable by the
securitization trust. These advances can first be made out of funds
available in the trusts' collection accounts. If the funds available
from the trusts' collection accounts are insufficient to make the
required advances, then we are required to make the advances from our
operating cash. The advances made from the trusts' collection
accounts, if not recovered from the borrowers or proceeds from the
liquidation of the loans, require reimbursement from us. These
advances, if ultimately not recoverable by us, require funding from
our capital resources and may create greater demands on our cash
flow, which could limit our ability to repay subordinated debt as it
comes due and negatively impact the value of our common stock. See
"Business -- Securitizations."
Our servicing rights may be terminated if we fail to satisfactorily perform our
servicing obligations, or fail to meet minimum net worth requirements or
financial covenants which could hinder our ability to operate profitably and
impair our ability to repay our subordinated debt, which would negatively impact
the value of our common stock.
As part of the securitization of our loans, we generally retain the
servicing rights, which is the right to service the loans for a fee. At June 30,
2003, 92.7% of the managed portfolio we serviced was owned by third parties. The
value of servicing rights related to our managed portfolio is an asset on our
balance sheet called servicing rights. We enter into agreements in connection
with the securitizations that allow third parties to terminate us as the
servicer if we breach our servicing obligations, fail to perform satisfactorily
or fail to meet a minimum net worth requirement or other financial covenants.
For example, our servicing rights may be terminated if losses on the pool of
loans in a particular securitization exceed prescribed levels for specified
periods of time. If we lose the right to service some or all of the loans in our
managed portfolio, the servicing fees will no longer be paid to us and we would
be required to write down or write off this asset, which would decrease our
earnings and our net worth, impair our ability to repay the subordinated debt
and negatively impact the value of our common stock. In addition, if we do not
meet eligibility criteria to act as servicer in future securitizations, we would
not receive income from these future servicing rights.
If we are not able to sustain the levels of loan originations that we
experienced in the past, we may be unable to attain profitable operations and
our ability to repay our subordinated debt may be impaired, which would
negatively impact the value of our common stock.
During fiscal 2003 and 2002, we experienced record levels of loan
originations. Our ability to sustain the levels of loan originations experienced
in prior periods depends upon a variety of factors outside our control,
including:
o interest rates;
o ability to obtain adequate financing on favorable terms;
o conditions in the asset-backed securities markets;
o economic conditions in our primary market area;
o competition; and
o regulatory restrictions.
In addition, current economic conditions have had an adverse impact on
smaller businesses and finding qualified borrowers has become more difficult. If
we are unable to sustain our levels of loan originations, we may be unable to
attain profitable operations and our ability to repay the subordinated debt upon
maturity may be impaired. See " -- Changes in interest rates could negatively
impact our ability to operate profitably and impair our ability to repay the
subordinated debt and negatively impact the value of our common stock." and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
46
A decline in real estate values could result in a reduction in originations,
which could hinder our ability to attain profitable operations, impair
our ability to repay our subordinated debt and negatively impact the value of
our common stock.
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 hinder our ability to attain profitable operations and limit our ability
to repay our subordinated debt upon maturity and negatively impact the value of
our common stock. See "-- Lending Activities."
A decline in value of the collateral securing our loans could result in an
increase in losses on foreclosure, which could hinder our ability to attain
profitable operations, limit our ability to repay our subordinated debt and
negatively impact the value of our common stock.
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, foreclosures on loans and losses from
delinquent and foreclosed loans generally increase during economic slowdowns or
recessions, and the increase in delinquencies, foreclosures on loans and losses
from delinquent and foreclosed loans we experience may be particularly
pronounced because we lend to credit-impaired borrowers. 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 which could hinder our ability to attain profitable operations and limit
our ability to repay our subordinated debt. In addition, any sustained period of
increased delinquencies, foreclosures or losses from delinquent and foreclosed
loans could adversely affect our ability to sell loans, the prices we receive
for our loans or the value of our interest-only strips which could have a
material adverse effect on our results of operations, financial condition and
business prospects. See "Business -- Lending Activities."
47
If we are unable to implement an effective hedging strategy, we may be unable to
attain profitable operations, which would reduce the funds we have available to
repay our subordinated debt and negatively impact the value of our common stock.
In a declining interest rate environment, even an effective hedging strategy
could result in losses in the current period.
From time to time we use hedging strategies in an attempt to mitigate
the effect of changes in interest rates on our fixed interest rate mortgage
loans prior to securitization. These strategies may involve the use of, among
other things, derivative financial instruments including 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. We recorded losses on the fair value of derivative financial instruments
of $14.2 million during fiscal 2003, $9.4 million in fiscal 2002 and $4.3
million in fiscal 2001. The amount of losses settled in cash was $7.7 million in
fiscal 2003, $9.4 million in fiscal 2002 and $4.3 million in fiscal 2001. In
addition, an interest rate hedging strategy may not be effective against the
risk that the interest rate spread 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."
Competition from other lenders could adversely affect our ability to attain
profitable operations and our ability to repay our subordinated debt and
negatively impact the value of our common stock.
The lending markets in which we compete are evolving. Some competitors
have been acquired by companies with substantially greater resources, lower cost
of funds, and a more established market presence than we have. Government
sponsored entities are expanding their participation in our market. In addition,
we have experienced increased competition over the Internet, where barriers to
entry are relatively low. If these companies or entities increase their
marketing efforts to include our market niche of borrowers, we may be forced to
reduce the interest rates and fees we currently charge in order to maintain and
expand our market share. Any reduction in our interest rates or fees could have
an adverse impact on our profitability and our ability to repay our subordinated
debt. As we expand our business further, we will face a significant number of
new competitors, many of whom are well established in the markets we seek to
penetrate. The profitability of other similar lenders may attract additional
competitors into this market.
The competition in the subprime lending industry has also led to rapid
technological developments, evolving industry standards, and frequent releases
of new products and enhancements. As loan products are offered more widely
through alternative distribution channels, such as the Internet, we may be
required to make significant changes to our current retail structure, broker
structure and information systems to compete effectively. Our ability to adapt
to other technological changes in the industry could have a material adverse
effect on our business.
48
The need to maintain loan volume in this competitive environment
creates a risk of price competition in the subprime lending industry.
Competition in the industry can take many forms, including interest rates and
costs of a loan, convenience in obtaining a loan, customer service, amount and
term of a loan, marketing and distribution channels, and competition in
attracting and retaining qualified employees. Price competition would lower the
interest rates that we are able to charge borrowers, which would lower our
interest income. Price-cutting or discounting reduces profits and will depress
earnings if sustained for any length of time. Increased competition may also
reduce the volume of our loan originations and result in a decrease in gain on
sale from the securitization or sale of such loans which would decrease our
income. As a result, any increase in these pricing pressures could have a
material adverse effect on our business. See "Business -- Competition."
An economic downturn or recession in the eastern half of the United States could
hinder our ability to operate profitably, which would reduce the funds available
to repay the subordinated debt and negatively impact the value of our common
stock.
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 or recession 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
or recession in this region could result in decreases in loan originations and
increases in delinquencies and foreclosures in our managed portfolio which could
negatively impact our ability to sell or securitize loans and hinder our ability
to operate profitably and the funds available to repay our subordinated debt
which could negatively impact the value of our common stock. See "-- Our
securitization agreements impose obligations on us to make cash outlays which
could impair our ability to operate profitably and our ability to repay the
subordinated debt and negatively impact the value of our common stock." and
"Business -- Lending Activities."
49
Claims by borrowers or investors in loans could hinder our ability to operate
profitably, which would reduce the funds we have available to repay our
subordinated debt and negatively impact the value of our common stock.
In the ordinary course of our business, we are subject to claims made
against us by borrowers and investors in loans 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.
If claims asserted, pending legal actions or judgments against us
result in legal expenses or liability, these expenses could hinder our ability
to operate profitably, which would reduce funds available to repay our
subordinated debt. See "Business -- Legal Proceedings."
If we are unable to realize cash proceeds from the sale of loans in excess of
the cost to originate the loans, our financial position and our ability to repay
the subordinated debt upon maturity could be adversely affected, which could
negatively impact the value of our common stock.
The net cash proceeds received from loan sales consist of the premiums
we receive on sales of loans in excess of the outstanding principal balance,
plus the cash proceeds we receive from securitizations, minus the discounts on
loans that we have to sell for less than the outstanding principal balance. If
we are unable to originate loans at a cost lower than the cash proceeds realized
from loan sales, our results of operations, financial condition, business
prospects and ability to repay the subordinated debt upon maturity could be
adversely affected.
The amount of our outstanding debt could impair our financial condition, our
ability to fulfill our debt obligations and repay the subordinated debt, which
would negatively impact the value of our common stock.
As of June 30, 2003, we had total indebtedness of approximately $932.5
million, comprised of amounts outstanding under our credit facilities, warehouse
lines, subordinated debt and capitalized lease obligations. At June 30, 2003,
our ratio of total debt and liabilities to equity was approximately 26.5 to 1.
At June 30, 2003, we also had availability to incur additional indebtedness of
approximately $30.2 million under our revolving warehouse and credit facilities.
The amount of our outstanding indebtedness could:
o require us to dedicate a substantial portion of our cash flow to
payment on our indebtedness, thereby reducing the availability of our
cash flow to fund working capital, capital expenditures and other
general corporate requirements;
o limit our flexibility in planning for, or reacting to, changes in
operations and the subprime industry in which we operate; and
o place us at a competitive disadvantage compared to our competitors
that have proportionately less debt.
If we are unable to meet our debt service obligations, we could be
forced to restructure or refinance our indebtedness, seek additional equity
capital or sell assets. Our ability to obtain additional financing could be
limited to the extent that our interest-only strips, which represent a
significant portion of our assets, are pledged to secure existing debt. Our
inability to obtain financing or sell assets on satisfactory terms could impair
our ability to operate profitably and our ability to repay the subordinated debt
which would negatively impact the value of our common stock.
50
Restrictive covenants in the agreements governing our indebtedness may reduce
our operating flexibility, limit our ability to operate profitably and our
ability to repay our subordinated debt, which could negatively impact the value
of our common stock.
The agreements governing our credit facilities and warehouse lines of
credit contain various covenants that may restrict our ability to:
o incur other senior indebtedness;
o engage in transactions with affiliates;
o incur liens;
o make certain restricted payments;
o enter into certain business combinations and asset sale transactions;
o engage in new lines of business; and
o make certain investments.
These restrictions may limit our ability to obtain future financings,
make needed capital expenditures, withstand a future downturn in our business or
the economy in general, conduct operations or otherwise take advantage of
business opportunities that may arise. Our credit facilities and warehouse lines
of credit also require us to maintain specified financial ratio covenants and
satisfy other financial conditions. Our ability to meet those ratio covenants
and conditions can be affected by events beyond our control, such as interest
rates and general economic conditions.
Pursuant to the terms of these credit facilities, the failure to comply
with the financial covenants constitutes an event of default and at the option
of the lender, entitles the lender to, among other things, terminate commitments
to make future advances to us, declare all or a portion of the loan due and
payable, foreclose on the collateral securing the loan, require servicing
payments be made to the lender or other third party or assume the servicing of
the loans securing the credit facility. As a result of the loss experienced
during fiscal 2003, we were not in compliance with the terms of certain of the
financial covenants under two of our principal credit facilities (one for $50.0
million and the other for $200.0 million, of which $100.0 million was
non-committed) and we requested and obtained waivers of these requirements from
our lenders. The lender under the $50.0 million warehouse credit facility has
granted us a waiver for our non-compliance with a financial covenant in that
credit facility through September 30, 2003. This facility was amended to reduce
the available credit to $8.0 million and the financial covenants were replaced
with new covenants with which we are currently in compliance. We also entered
into an amendment to the $200.0 million credit facility which provides for the
waiver of our non-compliance with the financial covenants in that facility, the
reduction of the committed portion of this facility from $100.0 million to $50.0
million, the elimination of the $100.0 million non-committed portion of this
credit facility and the acceleration of the termination date of this facility
from November 2003 to September 30, 2003. Our ability to repay this facility
upon termination is dependent on our ability to refinance the loans in one of
our new facilities or our sale of loans currently warehoused in the terminating
facility by September 30, 2003. In addition, if the anticipated loss for the
first quarter of fiscal 2004 described above results in our non-compliance with
any financial covenants, we intend to seek the appropriate waivers. There can be
no assurances that we will obtain any of these waivers. We may also need to
obtain additional waivers in future periods from our lenders but we cannot give
you any assurances as to whether or in what form these waivers will be granted.
Our breach of our financial covenants under our revolving credit
facilities could result in a default under the terms of those facilities, which
could cause that indebtedness and other senior indebtedness, by reason of
cross-default provisions in such indebtedness, to become immediately due and
payable. Our failure to repay those amounts could result in a bankruptcy
proceeding or liquidation proceeding or our lenders could proceed against the
collateral granted to them to secure that indebtedness. If the lenders under the
credit facilities and warehouse lines of credit accelerate the repayment of
borrowings, we may not have sufficient cash to repay our indebtedness and may be
forced to sell assets on less than optimal terms and conditions which would
negatively impact the value of our common stock.
51
We are dependent on financial institutions and brokers for 50.7% of our loan
production and our failure to maintain these relationships could negatively
impact the volume and pricing of our loans and adversely affect our results of
operations and ability to repay subordinated debt, which could negatively impact
the value of our common stock.
We depend on financial institutions who enter into agreements with us
under the Bank Alliance Services program and brokers for 50.7% of our loan
originations. Moreover, our total loan purchases from Bank Alliance Services
lenders, historically, have been highly concentrated. Our top three financial
institutions under the Bank Alliance Services program accounted for
approximately 96.1% of our loan volume from the Bank Alliance Services program
and 11.6% of our total volume for fiscal 2003. Further, our competitors also
have relationships with our brokers and other lenders, and actively compete with
us in our efforts to expand our broker and Bank Alliance networks. Accordingly,
we cannot assure you that we will be successful in maintaining our existing
relationships or expanding our broker and Bank Alliance networks which could
negatively impact the volume and pricing of our loans, which could have a
material adverse effect on our results of operations.
Some of our warehouse financing agreements include margin calls based on the
lender's opinion of the value of our loan collateral. An unanticipated large
margin call could adversely affect our liquidity and our ability to repay the
subordinated debt upon maturity, which could negatively impact the value of our
common stock.
The amount of financing we receive under our warehouse agreements
depends in large part on the lender's valuation of the mortgage loans that
secure the financings. Each warehouse line provides the lender the right, under
certain circumstances, to reevaluate the loan collateral that secures our
outstanding borrowings at any time. In the event the lender determines that the
value of the loan collateral has decreased, it has the right to initiate a
margin call. A margin call would require us to provide the lender with
additional collateral or to repay a portion of the outstanding borrowing. Any
such margin call could have a material adverse effect on our results of
operations, financial condition and business prospects and our ability to repay
the subordinated debt upon maturity, which could negatively impact the value of
our common stock.
Environmental laws and regulations and other environmental considerations may
restrict our ability to foreclose on loans secured by real estate or increase
costs associated with those loans which could hinder our ability to operate
profitably and limit the funds available to repay our subordinated debt and
negatively impact the value of our common stock.
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 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, we may not discover the environmental contamination until after we
had made the loan or after we had foreclosed on a loan. If we foreclosed upon a
property and environmental liabilities subsequently arose, we could face
significant liability.
52
Since the commencement of operations by the Company, there have been
approximately eight instances where we have determined not to foreclose on the
real estate collateralizing a delinquent loan because of environmental
considerations. None are currently under administration. Any losses we sustained
on these loans did not have a material adverse effect on our profitability.
In addition to federal or state laws, owners or former owners of a
contaminated site may be subject to common law claims, including tort claims, by
third parties based on damages and costs resulting from environmental
contamination migrating from the property. Other environmental considerations,
such as pervasive mold infestation of real estate securing our loans, may also
restrict our ability to foreclose on delinquent loans. See "Business -- Loan
Servicing and Administrative Procedures."
Terrorist attacks in the United States may cause disruption in our business and
operations and other attacks or acts of war may adversely affect the markets in
which our common stock trades, the markets in which we operate, our ability to
operate profitably and our ability to repay our subordinated debt, which would
negatively impact the value of our common stock.
Terrorists' attacks in the United States in September 2001 caused major
instability in the U.S. financial markets. These attacks or new events and
responses on behalf of the U.S. government may lead to further armed hostilities
or to further acts of terrorism in the U.S. which may cause a further decline in
the financial market and may contribute to a further decline in economic
conditions. These events may cause disruption in our business and operations
including reductions in demand for our loan products and our subordinated debt,
increases in delinquencies and credit losses in our managed loan portfolio,
changes in historical prepayment patterns and declines in real estate collateral
values. To the extent we experience an economic downturn, unusual economic
patterns and unprecedented behaviors in financial markets, these developments
may affect our ability to originate loans at profitable interest rates, to price
future loan securitizations profitably, to effect whole loan sales and to
effectively hedge our loan portfolio against market interest rate changes which
could cause our stock price to decline. Should these disruptions and unusual
activities occur, our ability to operate profitably and cash flow could be
reduced and our ability to make principal and interest payments on our
subordinated debt could be impaired which would negatively impact the value of
our common stock.
If many of our borrowers become subject to the Soldiers' and Sailors' Civil
Relief Act of 1940, our cash flows and interest income may be adversely
affected which would negatively impact our ability to repay our subordinated
debt and negatively impact the value of our common stock.
Under the Soldiers' and Sailors' Civil Relief Act of 1940, a borrower
who enters military service after the origination of his or her loan generally
may not be charged interest above an annual rate of six percent. Additionally,
this Relief Act may restrict or delay our ability to foreclose on an affected
loan during the borrower's active duty status. The Relief Act also applies to a
borrower who was on reserve status and is called to active duty after
origination of the loan. A significant mobilization by the U.S. Armed Forces
could increase the number of our borrowers who are the subject of this Relief
Act, thereby reducing our cash flow and the interest payments we collect from
those borrowers, and in the event of default, delaying or preventing us from
exercising the remedies for default that otherwise would be available to us.
53
We are subject to losses due to fraudulent and negligent acts on the part of
loan applicants, mortgage brokers, other vendors and our employees which could
hinder our ability to operate profitably, impair our ability to repay the
subordinated debt and negatively impact the value of our common stock.
When we originate mortgage loans, we rely heavily upon information
supplied by third parties including the information contained in the loan
application, property appraisal, title information and employment and income
documentation. If any of this information is intentionally or negligently
misrepresented and such misrepresentation is not detected prior to loan funding,
the value of the loan may be significantly lower than expected. Whether a
misrepresentation or fraudulent act is made by the loan applicant, the mortgage
broker, another third party or one of our employees, we generally bear the risk
of loss. A loan subject to a material misrepresentation or fraudulent act is
typically unsaleable or subject to repurchase if it is sold prior to detection,
such persons and entities are often difficult to locate and it is often
difficult to collect any monetary losses we have suffered from them.
We have controls and processes designed to help us identify
misrepresented or fraudulent information in our loan origination operations. We
cannot assure you, however, that we have detected or will detect all
misrepresented or fraudulent information in our loan originations.
Employees
At June 30, 2003, we employed 1,095 people on a full-time basis and 24
employees on a part-time basis. None of our employees are covered by a
collective bargaining agreement. We consider our employee relations to be good.
Between June 30, 2003 and August 14, 2003, we reduced our workforce by 170
employees as part of adjustments made to our business strategy. See" -- Business
Strategy."
54
Executive Officers Who Are Not Also Directors
The following is a description of the business experience of our
executive officers who are not also directors.
Beverly Santilli, age 44, 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 the day-to-day operation of American Business Credit. Mrs. Santilli is also
responsible for human resources of American Business Financial Services, Inc.
and its subsidiaries. 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 40, is Executive Vice President, a position he
has held since September 1998. Mr. Ruben was general counsel from April 1992 to
April 2001. He is also Executive Vice President of some of our subsidiaries,
positions he has held since April 1992. Mr. Ruben is responsible for the loan
servicing and collections departments, the asset allocation unit and the legal
department. Mr. Ruben served as Vice President from April 1992 to 1995 and
Senior Vice President from 1995 to 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. Mr. Ruben holds a New Jersey Mortgage Banker License
and a New Jersey Secondary Mortgage Banker License.
Albert W. Mandia, age 56, is Executive Vice President and Chief
Financial Officer of American Business Financial Services, Inc., positions he
has held since June 1998 and October 1998, respectively. Mr. Mandia is
responsible for all financial, treasury, information systems, facilities and
investor relations functions. Mr. Mandia also has responsibility for American
Business Mortgage Services Broker Division. 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.
Milton Riseman, age 66, was formerly the Chairman of our Consumer
Mortgage Group. Mr. Riseman held that position from the time he joined the
Company in June 1999 until his resignation on July 2, 2003. Currently, Mr.
Riseman serves as a consultant to us. As Chairman of the Consumer Mortgage
Group, Mr. Riseman was responsible for the sales, marketing and day-to-day
management of Upland Mortgage's retail operation and he held supervisory
responsibility for the Bank Alliance Services program. From February 1994 until
he joined the Company, Mr. Riseman served as President of Advanta Mortgage. Mr.
Riseman joined Advanta in 1992 as Senior Vice President, Administration. From
1965 until 1992, Mr. Riseman served in various capacities at Citicorp, including
serving as President of Citicorp Acceptance Corp. from 1986 to 1992.
55
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 moved our corporate headquarters from Bala Cynwyd, Pennsylvania to
Philadelphia, Pennsylvania on July 7, 2003. We lease office space for our
corporate headquarters in Philadelphia, Pennsylvania. The current lease term
expires in June 2014. The terms of the rental agreement require increased
payments annually for the term of the lease with average minimum annual rental
payments of $4.2 million. We have entered into contracts, or may engage parties
in the future, related to the relocation of our corporate headquarters such as
contracts for building improvements to the leased space, office furniture and
equipment and moving services. The provisions of the lease and local and state
grants will provide us with reimbursement of a substantial amount of our costs
related to the relocation, subject to certain conditions and limitations. We do
not believe our unreimbursed expenses or unreimbursed cash outlay related to the
relocation will be material to our operations.
The lease requires us to maintain a letter of credit in favor of the
landlord to secure our obligations to the landlord throughout the term of the
lease. The amount of the letter of credit is $8.0 million and declines over time
to $4.0 million. The letter of credit is currently issued by JPMorgan Chase Bank
under our $8.0 million facility with JPMorgan Chase Bank.
We continue to lease some office space in Bala Cynwyd under a five-year
lease expiring in November 2004 at an annual rental of approximately $0.7
million. We perform our loan servicing and collection activities at this office,
but expect to relocate these activities to our Philadelphia office.
In May 2003, we moved our regional processing center to a different
location in Roseland, New Jersey. We lease the office space in Roseland, New
Jersey and the nine-year lease expires in January 2012. The terms of the rental
agreement require increased payments periodically for the term of the lease with
average minimum annual rental payments of $0.8 million. The expenses and cash
outlay related to the relocation were not material to our operations.
Item 3. Legal Proceedings
On February 26, 2002, a purported class action titled Calvin Hale v.
HomeAmerican Credit, Inc., No. 02 C 1606, United States District Court for the
Northern District of Illinois, was filed in the Circuit Court of Cook County,
Illinois (subsequently removed by Upland Mortgage to the captioned federal
court) against our subsidiary, HomeAmerican Credit, Inc., which does business as
Upland Mortgage, on behalf of borrowers in Illinois, Indiana, Michigan and
Wisconsin who paid a document preparation fee on loans originated since February
4, 1997. The case consisted of three purported class action counts and two
individual counts. The plaintiff alleged that the charging of, and the failure
to properly disclose the nature of, a document preparation fee were improper
under applicable state law. In November 2002 the Illinois Federal District Court
dismissed the three class action counts and an agreement in principle was
reached in August 2003 to settle the matter. The terms of the settlement have
been finalized and did not have a material effect on our consolidated financial
position or results of operations.
56
Our lending subsidiaries, including HomeAmerican Credit, Inc. which
does business as Upland Mortgage, are involved, from time to time, in class
action lawsuits, other litigation, claims, investigations by governmental
authorities, and legal proceedings arising out of their lending and servicing
activities, including the purported class action entitled, Calvin Hale v.
HomeAmerican Credit, Inc., d/b/a Upland Mortgage, described above. Due to our
current expectation regarding the ultimate resolution of these actions,
management believes that the liabilities resulting from these actions will not
have a material adverse effect on our consolidated financial position or results
of operations. However, due to the inherent uncertainty in litigation and
because the ultimate resolution of these proceedings are influenced by factors
outside of our control, our estimated liability under these proceedings may
change or actual results may differ from our estimates.
Additionally, court decisions in litigation to which we are not a party
may also affect our lending activities and could subject us to litigation in the
future. For example, in Glukowsky v. Equity One, Inc., (Docket No. A-3202 -
01T3), dated April 24, 2003, to which we are not a party, the Appellate Division
of the Superior Court of New Jersey determined that the Parity Act's preemption
of state law was invalid and that the state laws precluding some lenders from
imposing prepayment fees are applicable to loans made in New Jersey. We expect
that, as a result of the publicity surrounding predatory lending practices and
this recent New Jersey court decision regarding the Parity Act, we may be
subject to other class action suits in the future.
In addition, 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, management believes 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, 2003.
57
PART II
Item 5. Market for 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. The following table sets forth the
high and low sales prices of our common stock for the periods indicated.
Quarter Ended High Low
- --------------------------------------------------- ------ ------
September 30, 2001................................. $15.76 $10.68
December 31, 2001.................................. 21.98 14.65
March 31, 2002..................................... 17.49 8.16
June 30, 2002 ..................................... 14.36 8.74
September 30, 2002................................. 15.86 6.36
December 31, 2002.................................. 12.67 9.69
March 31, 2003..................................... 14.92 10.05
June 30, 2003...................................... 12.70 6.35
September 30, 2003 (through September 23, 2003).... 7.97 4.76
On September 23, 2003, the closing price of the common stock on the
NASDAQ National Market System was $7.20.
As of September 5, 2003, there were 216 record holders and
approximately 1,681 beneficial holders of our common stock.
During the first quarter of fiscal 2004, we suspended our practice of
paying quarterly dividends. During the fiscal year ended June 30, 2003, we paid
dividends of $0.32 per share on our common stock for an aggregate dividend
payment of $0.9 million. During the fiscal year ended June 30, 2002, we paid
dividends of $0.28 per share on our common stock for an aggregate dividend
payment of $0.8 million.
On August 21, 2002, the Board of Directors declared a 10% stock
dividend which was paid September 13, 2002 to shareholders of record September
3, 2002. On October 1, 2001, the Board of Directors declared a 10% stock
dividend which was paid November 5, 2001 to shareholders of record October 22,
2001. All cash dividends reported above have been adjusted to reflect all stock
dividends.
The payment of dividends in the future is at the sole discretion of our
Board of Directors and will depend upon, among other things, our earnings,
capital requirements and financial condition, as well as other relevant factors.
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.
58
The following table details information regarding our existing equity
compensation plans as of June 30, 2003:
Number of Number of securities
securities issued remaining available
or to be under equity for future issuance
issued upon Weighted-average compensation plans
exercise of exercise price (excluding
outstanding of outstanding securities reflected
options (a) options in column (a))
------------------- ---------------- ----------------------
Equity compensation plans approved by
security holders
Stock Option Plans...................... 732,637(1) $11.21 230,024 (2)
Restricted Stock Plan................... -- -- 126,225 (3)
Equity compensation plans not approved
by security holders(4)................... 4,000(5) -- --
------------------- ----------------------
Total....................................... 736,637 356,249
=================== ======================
- ------------------
(1) Includes options granted pursuant to the 1995 Stock Option Plan for
Non-Employee Directors, the Amended and Restated 1993 Stock Option Plan,
and the Amended and Restated 1999 Stock Option Plan. Does not include
options granted pursuant to the 1997 Stock Option Plan for Non-Employee
Directors because all options granted pursuant to this plan expired
unexercised.
(2) Includes shares of common stock issuable pursuant to the Amended and
Restated 1999 Stock Option Plan and does not include shares of common stock
authorized pursuant to our other stock option plans because we intend that
all future option grants will be under the Amended and Restated 1999 Stock
Option Plan.
(3) Includes shares of common stock issuable pursuant to the 2002 Stock
Incentive Plan.
(4) Does not include shares of our common stock held by the ABFS 401(k) Plan
for the benefit of the participants. As of the latest statement dated June
30, 2003, the ABFS 401(k) Plan held approximately 53,115 shares of our
common stock.
(5) Includes grants of 2,000 shares of common stock issued to each of Warren E.
Palitz and Jeffrey S. Steinberg in consideration for their board service.
On February 11, 2003, the Board of Directors issued 2,000 shares of common
stock to each of Warren E. Palitz and Jeffrey S. Steinberg in consideration for
their board service. On April 2, 2001, we issued 2,500 shares (3,025 shares
after the effect of stock dividends) to our director, Richard Kaufman as a
result of services rendered in connection with the stock buyback program. These
issuances were exempt from registration under the Securities Act of 1933
pursuant to Section 4(2) of the Securities Act of 1933.
59
Item 6. Selected Financial Data
You should consider our selected consolidated financial information set
forth below together with the more detailed consolidated financial statements,
including the related notes, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this
document. Also see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Reconciliation of Non-GAAP Financial Measures" for
a reconciliation of total managed portfolio and managed real estate owned,
referred to as REO, to our balance sheet.
Year Ended June 30,
---------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- -------
Statement of Income Data: (In thousands, except per share data)
Revenues:
Gain on sale of loans and leases:
Securitizations............................ $170,950 $185,580 $128,978 $ 90,380 $64,490
Whole loan sales........................... 655 2,448 2,742 1,717 2,272
Interest and fees............................ 19,395 18,890 19,840 17,683 14,281
Interest accretion on interest-only strips 47,347 35,386 26,069 16,616 2,021
Other........................................ 3,059 5,597 5,707 4,250 3,360
-------- -------- -------- -------- -------
Total revenues................................. 241,406 247,901 183,336 130,646 86,424
Total expenses(a).............................. 290,426 234,351 170,151 120,284 64,573
-------- -------- -------- -------- -------
Operating income (loss) before income taxes (49,020) 13,550 13,185 10,362 21,851
Income tax expense (benefit)................... (19,118) 5,691 5,274 3,938 7,763
-------- -------- -------- -------- -------
Income (loss) before cumulative effect of a change
in accounting principle...................... (29,902) 7,859 7,911 6,424 14,088
Cumulative effect of a change in accounting
principle.................................... -- -- 174 -- --
-------- -------- -------- -------- -------
Net income (loss).............................. $(29,902) $ 7,859 $ 8,085 $ 6,424 $14,088
======== ======== ======== ======== =======
Per Common Share Data:
Income (loss) before cumulative effect of a change
in accounting principle (b):
Basic earnings (loss) per common share....... $ (10.25) $ 2.68 $ 2.08 $ 1.55 $ 3.16
Diluted earnings (loss) per common share..... (10.25) 2.49 2.04 1.51 3.07
Net income (loss):
Basic earnings (loss) per common share....... $ (10.25) $ 2.68 $ 2.13 $ 1.55 $ 3.16
Diluted earnings (loss) per common share..... (10.25) 2.49 2.08 1.51 3.07
Cash dividends declared per common share....... 0.32 0.28 0.26 0.25 0.14
____________________________
(a) Includes securitization assets fair value adjustments of $45.2 million for
the fiscal year ended June 30, 2003, $22.1 million in the year ended June
30, 2002 and $12.6 million in the year ended June 30, 2000.
(b) Amounts for all periods have been retroactively adjusted to reflect the
effect of a 10% stock dividend declared August 21, 2002 as if the
additional shares had been outstanding for each period presented. Amounts
for the years ended June 30, 2001 and prior have been similarly adjusted to
reflect the effect of a 10% stock dividend declared October 1, 2001.
60
June 30,
-------------------------------------------------------
2003 2002 2001 2000 1999
---------- -------- -------- -------- --------
(In thousands)
Balance Sheet Data:
Cash and cash equivalents............... $ 47,475 $108,599 $ 91,092 $ 69,751 $ 22,395
Loan and lease receivables, net
Available for sale..................... 271,402 57,677 94,970 50,696 41,171
Interest and fees...................... 15,179 12,292 16,549 13,002 6,863
Other.................................. 23,761 9,028 2,428 -- --
Interest-only strips.................... 598,278 512,611 398,519 277,872 178,218
Servicing rights........................ 119,291 125,288 102,437 74,919 43,210
Receivable for sold loans and leases.... 26,734 -- -- 46,333 58,691
Total assets............................ 1,159,351 876,375 766,487 594,282 396,301
Subordinated debt....................... 719,540 655,720 537,950 390,676 211,652
Total liabilities....................... 1,117,282 806,997 699,625 532,167 338,055
Stockholders' equity.................... 42,069 69,378 66,862 62,115 58,246
Years Ended June 30,
---------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Other Data:
Total managed loan and lease
portfolio.......................... $3,651,074 $3,066,189 $2,589,395 $1,918,540 $1,176,918
Originations (a):
Business purpose loans............ 122,790 133,352 120,537 106,187 64,818
Home equity loans................. 1,543,730 1,246,505 1,096,440 949,014 634,820
Average loan size of loans
originated (a):
Business purpose loans............ 92 97 91 89 80
Home equity loans................. 91 89 82 70 74
Weighted average interest rate of
loans originated(a):
Business purpose loans............ 15.76% 15.75% 15.99% 15.99% 15.91%
Home equity loans................. 9.99 10.91 11.46 11.28 11.05
Combined.......................... 10.42 11.38 11.91 11.64 11.17
Loans and leases sold:
Securitizations................... $1,423,764 $1,351,135 $1,102,066 $1,001,702 $ 777,598
Whole loan sales.................. 28,013 57,679 76,333 102,670 105,751
____________________________
(a) Conventional first mortgages and leases originated in fiscal 2000 and prior
have been excluded because we no longer originate these types of loans and
leases.
Year Ended June 30,
------------------------------------------------
2003 2002 2001 2000 1999
------ ----- ----- ----- -----
Financial Ratios:
Return on average assets................................. (3.07)% 0.94% 1.22% 1.31% 4.56%
Return on average equity................................. (44.20) 11.75 12.22 10.29 28.10
Total delinquencies as a percentage of total managed
portfolio at end of period (a)........................ 6.27 5.57 4.13 2.91 3.19
Real estate owned as a percentage of total managed
portfolio at end of period............................ 0.77 1.11 1.10 0.68 0.85
Loan and lease losses as a percentage of the average
total managed portfolio during the period (b) 0.90 0.60 0.53 0.31 0.12
Pre-tax income (loss) as a percentage of total revenues (20.00) 5.47 7.19 7.93 25.28
Ratio of earnings to fixed charges (c)................... 0.31x 1.19x 1.23x 1.26x 1.92x
____________________________
(a) Includes loans delinquent 31 days or more and excludes REO and previously
delinquent loans subject to deferment and forbearance agreements if the
borrower with this arrangement is current on principal and interest
payments as required under the terms of the orginal note (exclusive of
delinquent payments advanced or fees paid by us on the borrower's behalf as
part of the deferment or forbearance arrangement).
(b) Percentage based on annualized losses and average managed portfolio.
(c) Earnings (loss) before income taxes and fixed charges were insufficient
to cover fixed charges by $49.0 million for the year ended June 30, 2003.
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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 fiscal years ended June 30, 2003, 2002 and
2001 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 organization operating
predominantly in the eastern and central portions of the United States. Through
our principal direct and indirect subsidiaries, we originate, sell and service
home equity and business purpose loans. We also process and purchase home equity
loans through our Bank Alliance Services program.
Our loans primarily consist of fixed interest rate loans secured by
first or second mortgages on one-to-four family residences. Our customers are
primarily credit-impaired borrowers who are generally unable to obtain financing
from banks or savings and loan associations and who are attracted to our
products and services. We originate loans through a combination of channels
including a national processing center located at our centralized operating
office in Philadelphia, Pennsylvania and a regional processing center in
Roseland, New Jersey. Our centralized operating office was located in Bala
Cynwyd, Pennsylvania prior to July 7, 2003. Prior to June 30, 2003 we also
originated home equity loans through several retail branch offices. Effective
June 30, 2003, we no longer originate loans through retail branch offices. Our
loan servicing and collection activities are performed at our Bala Cynwyd,
Pennsylvania office, but we expect to relocate these activities to our
Philadelphia office. In addition, we offer subordinated debt securities to the
public, the proceeds of which are used for repayment of existing debt, loan
originations, our operations (including repurchases of delinquent assets from
securitization trusts), investments in systems and technology and for general
corporate purposes.
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Recent Development
Fiscal 2003 Loss of $29.9 Million. In fiscal 2003, we recorded a net
loss of $29.9 million. The loss was primarily due to our inability to complete
our typical quarterly securitization of loans during the fourth quarter of our
fiscal year and to $45.2 million of pre-tax charges for net valuation
adjustments on our securitization assets charged to the income statement,
compared to $22.1 million of net valuation adjustments in fiscal 2002. Our
business strategy requires the sale of substantially all of the loans we
originate at least on a quarterly basis through a combination of securitizations
and whole loan sales. From 1995 until the fourth quarter of fiscal 2003, we had
elected to utilize securitization transactions extensively due to the favorable
conditions we had experienced in the securitization markets and the higher gains
recorded on securitizations through the application of gain-on-sale accounting
versus the gain realized on whole loan sales.
During fiscal 2003, we charged to the income statement total pre-tax
valuation adjustments on our interest-only strips and servicing rights, which we
refer to as securitization assets, of $63.1 million, which primarily reflect the
impact of higher than anticipated prepayments on securitized loans experienced
in fiscal 2003 due to the low interest rate environment experienced during
fiscal 2003. The pre-tax valuation adjustments charged to the income statement
were partially offset by $17.9 million due to the impact of a decrease in the
discount rates used to value our securitization assets, resulting in the $45.2
million of pre-tax charges for net valuation adjustments charged to the income
statement. We reduced the discount rates on our interest-only strips and our
servicing rights primarily to reflect the impact of the sustained decline in
market interest rates. The discount rate on the projected residual cash flows
from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The
discount rate used to determine the fair value of the overcollateralization
portion of the cash flows from our interest-only strips was minimally impacted
by the decline in interest rates and remained at 7% on average. As a result, the
blended rate used to value our interest-only strips, including the
overcollateralization cash flows, was 9% at June 30, 2003. The discount rate on
our servicing rights was reduced from 11% to 9% at June 30, 2003.
Our inability to complete our typical publicly underwritten
securitization during the fourth quarter of fiscal 2003 was the result of our
investment bankers' decision in late June not to underwrite the contemplated
June 2003 securitization transaction. Management believes that a number of
factors contributed to this decision, including a highly-publicized lawsuit
finding liability of an underwriter in connection with the securitization of
loans for another unaffiliated subprime lender, an inquiry by the U.S.
Attorney's Office in Philadelphia regarding our forbearance practices, an
anonymous letter regarding the Company received by our investment bankers, the
SEC's recent enforcement action against another unaffiliated subprime lender
related to its loan restructuring practices and related disclosure, a federal
regulatory agency investigation of practices by another subprime servicer and
our investment bankers' prior experience with securitization transactions with
non-affiliated originators.
Short-Term Liquidity and Remedial Steps Taken. 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 short term liquidity was negatively
impacted by several recent events. Our inability to complete our typical
publicly underwritten securitization during the fourth quarter of fiscal 2003
contributed to our loss for fiscal 2003 and adversely impacted our short-term
liquidity position. In addition, further advances under a non-committed portion
of one of our credit facilities were subject to the discretion of the lender and
subsequent to June 30, 2003, there were no new advances under the non-committed
portion. Additionally, on August 20, 2003, this credit facility was amended and,
among other changes, the non-committed portion was eliminated. We also had a
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$300.0 million mortgage conduit facility with a financial institution that
enabled us to sell our loans into an off-balance sheet facility, which expired
pursuant to its terms on July 5, 2003. At June 30, 2003, of the $516.1 million
in revolving credit and conduit facilities available to us, $453.4 million was
drawn upon. At September 19, 2003, of the $117.0 million in revolving credit
facilities available to us, $102.3 million was drawn upon. Our revolving credit
facilities and mortgage conduit facility had $62.7 million of unused capacity
available at June 30, 2003 (and $14.7 million of unused capacity at September
19, 2003), which significantly reduced our ability to fund future loan
originations until we sell existing loans, extend or expand existing credit
facilities, or add new credit facilities. In addition, we have temporarily
discontinued sales of new subordinated debt, which further impaired our
liquidity.
As a result of these liquidity issues, since June 30, 2003, we
substantially reduced our loan origination volume. From July 1, 2003 through
August 31, 2003, we originated $85.7 million of loans which represents a
significant reduction as compared to originations of $245.8 million of loans for
the same period in fiscal 2003. Our inability to originate loans at previous
levels may adversely impact the relationships our subsidiaries have or are
developing with their brokers and our ability to retain employees. As a result
of the decrease in loan originations and liquidity issues described above, we
anticipate incurring a loss for the first quarter of fiscal 2004. The amount of
the loss will depend, in part, upon our ability to complete a securitization
prior to September 30, 2003 and, if completed, the size and terms of the
securitization. Further, we can provide no assurances that we will be able to
sell our loans, extend existing facilities or expand or add new credit
facilities. If we are unable to obtain additional financing, we may not be able
to restructure our business to permit profitable operations or repay our
subordinated debt when due. Even if we are able to obtain adequate financing,
our inability to securitize our loans could hinder our ability to operate
profitably in the future and repay our subordinated debt when due.
We undertook specific remedial actions to address short-term liquidity
concerns including entering into an agreement on June 30, 2003 with an
investment bank to sell up to $700.0 million of mortgage loans, subject to the
satisfactory completion of the purchaser's due diligence review and other
conditions, and soliciting bids and commitments from other participants in the
whole loan sale market. In total, from June 30, 2003 through September 17, 2003,
we sold approximately $482.9 million (which includes $221.9 million of loans
sold by the expired mortgage conduit facility) of loans through whole loan
sales. We are continuing the process of selling our loans. We also suspended
paying quarterly cash dividends on our common stock.
On September 22, 2003, we entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding our loan originations. Pursuant to the terms of this facility, we are
required to, among other things: (i) obtain a written commitment for another
credit facility of at least $200.0 million and close that additional facility by
October 3, 2003 (which condition would be satisfied by the closing of the $225.0
million facility described below); (ii) have a net worth of at least $28.0
million by September 30, 2003; with quarterly increases of $2.0 million
thereafter; (iii) apply 60% of our net cash flow from operations each quarter to
reduce the outstanding amount of subordinated debt commencing with the quarter
ending March 31, 2004, and (iv) provide a parent company guaranty of 10% of the
outstanding principal amount of loans under the facility. Prior to the closing
of the second facility, our borrowing capacity on this $200.0 million credit
facility is limited to $80.0 million. This facility has a term of 12 months
expiring in September 2004 and is secured by the mortgage loans which are funded
by advances under the facility with interest equal to LIBOR plus a margin. This
facility is subject to representations and warranties and covenants, which are
customary for a facility of this type, as well as amortization events and events
of default related to our financial condition. These provisions require, among
other things, our maintenance of a delinquency ratio for the managed portfolio
at the end of each fiscal quarter of less than 12.0%, our subordinated debt not
to exceed $705.0 million at any time, our ownership of an amount of repurchased
loans not to exceed 1.5% of the managed portfolio and our registration statement
registering $295.0 million of subordinated debt be declared effective by the SEC
no later than October 31, 2003.
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On September 22, 2003, we executed a commitment letter for a mortgage
warehouse credit facility with a warehouse lender, which consists of a senior
secured revolving credit facility of up to $225.0 million and a secured last out
revolver facility up to $25.0 million to fund loan originations. The commitment
letter is subject to certain conditions, including, among other things: (i)
entering into definitive agreements, except as provided in the commitment
letter; (ii) the absence of a material adverse change in the business,
operations, property, condition (financial or otherwise) or prospects of us or
our affiliates; and (iii) our receipt of another credit facility in an amount
not less than $200.0 million, subject to terms and conditions acceptable to this
lender (which condition is satisfied by the new $200.0 million facility
described above). The commitment letter provides that these facilities will have
a term of three years with an interest rate on amounts outstanding under the
$225.0 million portion of the credit facility equal to the greater of one-month
LIBOR plus a margin or the difference between the yield maintenance fee (as
defined in the commitment letter) and the one month LIBOR plus a margin.
Advances under this facility would be collateralized by substantially all of our
present and future assets including pledged loans and a security interest in
substantially all of our interest-only strips and residual interests which will
be contributed to a special purpose entity organized by us to facilitate this
transaction. We also agreed to pay fees of approximately $14.6 million annually
plus a nonusage fee based on the difference between the average daily
outstanding balance for the current month and the maximum credit amount under
the facility and the lender's out-of-pocket expenses.
We anticipate that these facilities will be subject to representations
and warranties, events of default and covenants which are customary for
facilities of this type, as well as our agreement to: (i) maintain sales or
renewals of our subordinated debt securities of $10.0 million per month;
(ii) restrict total principal and interest outstanding on our subordinated debt
to $750.0 million or less; (iii) make quarterly reductions commencing in April
2004 of an amount of subordinated debt outstanding to be determined; (iv)
maintain maximum interest rates payable on subordinated debt securities not to
exceed 10 percentage points above comparable rates for FDIC insured products;
and (v) the lender's receipt of our audited financial statements for the period
ended June 30, 2003. The definitive agreements will grant the lender an option
at any time after the first anniversary of entering into definitive agreements
to increase the credit amount on the $250.0 million facility to $400.0 million
with additional fees payable by us plus additional interest as may be required
by the institutions or investors providing the lender with these additional
funds. The commitment letter requires that we enter into definitive agreements
not later than October 17, 2003. While we anticipate that we will close this
transaction prior to such date, we cannot assure you that these negotiations
will result in definitive agreements or that such agreements, as negotiated,
will be on terms and conditions acceptable to us. In the event we are unable to
close these facilities or another facility within the time frame provided under
the new $200.0 million credit facility described above, the lender on that
facility would be under no obligation to make further advances under the terms
of that facility and outstanding advances would have to be repaid over a period
of time.
During the first quarter of fiscal 2004, we explored a number of
strategic alternatives to address these liquidity issues in the event we are
unable to borrow under the new $200.0 million credit facility, close the $250.0
million credit facilities or obtain alternative financing. In the event we were
unable to obtain the additional credit facilities necessary to operate our
business, we developed a contingent business plan (described more fully under
"Business Strategy Adjustments") which contemplates, among other things, the
sale of $100 million principal amount of additional subordinated debt through
March 2004 and the renewal of approximately 50% of outstanding subordinated debt
upon maturity. We believe that this contingent business plan addresses our
liquidity issues and may permit us to restructure our operations, if necessary,
without the receipt of an expanded or additional credit facility. There can be
no assurance that our contingent business plan will be successful or that it
will enable us to repay our subordinated debt when due.
65
To the extent that we are not successful in maintaining, replacing or
obtaining alternative financing sources on acceptable terms, we may have to
limit our loan originations, sell loans earlier than intended and further
restructure our operations. Limiting our originations or earlier than intended
sales of our loans could reduce our profitability or result in losses and
restrict our ability to repay our subordinated debt upon maturity. While we
currently believe that we would be able to restructure our operations, if
necessary, we cannot assure you that such restructuring will enable us to attain
profitable operations or repay the subordinated debt when due. See "Risk Factors
- -- We depend upon the availability of financing to fund our continuing
operations. Any failure to obtain adequate funding could hurt our ability to
operate profitably and restrict our ability to repay our subordinated debt and
negatively impact the value of our common stock." and "Risk Factors -- If we are
unable to obtain additional financing, we may be not able to restructure our
business to permit profitable operations or repay our subordinated debt when
due, which would negatively impact the value of our common stock."
Credit Facilities and Waivers Related to Financial Covenants. We borrow
against various warehouse credit facilities as the primary funding source for
our loan originations. The sale of our loans through a securitization or whole
loan sale generates the cash proceeds necessary to repay the borrowings under
the warehouse facilities. In addition, we have the availability of revolving
credit facilities, which we may use to fund our operations. Each credit
agreement requires that we comply with specific financial covenants and has
multiple individualized financial covenant thresholds and ratio limits that we
must meet as a condition to drawing on that particular facility. Pursuant to the
terms of these credit facilities, the failure to comply with the financial
covenants constitutes an event of default and the lender may, at its option,
take certain actions including: terminate commitments to make future advances to
us, declare all or a portion of the loan due and payable, foreclose on the
collateral securing the loan, require servicing payments be made to the lender,
or other third party, or assume the servicing of the loans securing the credit
facility. An event of default under these credit facilities could result in
defaults pursuant to cross-default provisions of our other agreements, including
our other loan agreements and lease agreements. The failure to comply with the
terms of these credit facilities or to obtain the necessary waivers from the
lenders related to any default would have a material adverse effect on our
liquidity and capital resources, could result in us not having sufficient cash
to repay our indebtedness, require us to restructure our operations and may
force us to sell assets on less than optimal terms and conditions.
As a result of the loss experienced during fiscal 2003, we were not in
compliance with the terms of certain of the financial covenants under two of our
principal credit facilities (one for $50.0 million and the other for $200.0
million, of which $100.0 million was non-committed) and we requested and
obtained waivers of these requirements from our lenders. The lender under the
$50.0 million warehouse credit facility has granted us a waiver for our
non-compliance with a financial covenant in that credit facility through
September 30, 2003. This facility was amended to reduce the available credit to
$8.0 million and the financial covenants were replaced with new covenants with
which we are currently in compliance.
We also entered into an amendment to the $200.0 million credit facility
which provides for the waiver of our non-compliance with the financial covenants
in that facility, the reduction of the committed portion of this facility from
$100.0 million to $50.0 million, the elimination of the $100.0 million
non-committed portion of this credit facility and the acceleration of the
termination date of this facility from November 2003 to September 30, 2003. Our
ability to repay this facility upon termination is dependent on our ability to
refinance the loans in one of our new facilities or our sale of loans currently
warehoused in the terminating facility by September 30, 2003.
In addition, if the anticipated loss for the first quarter of fiscal
2004 described above results in our non-compliance with any financial covenants,
we intend to seek the appropriate waivers. There can be no assurances that we
will obtain any of these waivers.
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Business Strategy Adjustments. Our business strategy requires the sale
of substantially all of the loans we originate at least on a quarterly basis
through a combination of securitizations and whole loan sales. Our determination
as to whether to dispose of loans through securitizations or whole loan sales
depends on a variety of factors including market conditions, profitability and
cash flow considerations. From 1995 until the fourth quarter of fiscal 2003, we
had elected to utilize securitization transactions extensively due to the
favorable conditions we had experienced in the securitization markets. During
fiscal 2003, 2002, and 2001, we securitized $1.42 billion, $1.35 billion, and
$1.1 billion of loans, respectively. During the same periods, we sold $28.3
million, $57.7 million, and $76.3 million of loans, respectively, through whole
loan sales. Under generally accepted accounting principles, we are permitted to
record the gain on the sale of these securitized loans utilizing an accounting
method referred to as "gain-on-sale" accounting. This accounting method permits
us to record a non-cash gain based upon the estimated value of securitization
assets generated in connection with the securitization of our loans even though
only a small portion of the gain is received in cash during the period the gain
is recorded. We are then required to reevaluate these assets quarterly and make
adjustments based upon changes in the fair value of these assets.
After we recognized our inability to securitize our assets in the
fourth quarter of fiscal 2003, we adjusted our business strategy to emphasize
more whole loan sales. We intend to continue to evaluate both public and
privately placed securitization transactions, subject to market conditions. We
generally realized higher gain on sale in our securitization transactions than
on whole loan sales for cash. Although the gain on whole loan sales is generally
significantly lower than gains realized in securitization transactions, we
receive the gain in cash immediately and generally receive more cash immediately
in a whole loan sale transaction than from securitizations of an equal principal
amount of loans. As a result of the emphasis on whole loan sales in late June
and July 2003, at July 31, 2003, our cash position was consistent with our
projected cash position, which assumed the completion of a fourth quarter
securitization.
The use of whole loan sales will enable us to immediately generate cash
flow, protect against volatility in the securitization markets and reduce risks
inherent in retaining securitization assets. However, unlike securitizations,
where we retain servicing rights, and receive interest-only strips, which
generate future cash flows, whole loan sales are typically structured as a sale
with servicing rights released and do not result in our receipt of interest-only
strips. As a result, using whole loan sales more extensively in the future will
reduce our income from servicing activities and limit the amount of
securitization assets created.
We believe that our adjustments to our business strategy focus on a
more diversified strategy of selling our loans, while protecting revenues,
controlling costs and improving liquidity. However, if we are unable to generate
sufficient liquidity through the sales of our loans, the sale of our
subordinated debt, the receipt of new credit facilities or a combination of the
foregoing, we will be required to restrict loan originations and make additional
changes to our business strategy, including restricting or restructuring our
operations which could reduce our profitability or result in losses and impair
our ability to repay the subordinated debt.
We have historically experienced negative cash flow from operations. To
the extent we are unable to successfully implement our adjusted business
strategy, which requires access to capital to originate loans and our ability to
profitably sell these loans, we would continue to experience negative cash flows
from operations which would impair our ability to repay our subordinated debt.
See "Risk Factors -- If we are unable to successfully implement our adjusted
business strategy which focuses on whole loan sales, we may be unable to attain
profitable operations which could impair our ability to repay our subordinated
debt and negatively impact the value of our common stock."
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In the event we are unable to maintain the new $200.0 million credit
facility described above, close the $250.0 million credit facilities described
above within the required timeframes or obtain other credit facilities, we have
developed a contingent business plan which management believes will enable us to
repay the subordinated debt when due and continue operations, although with a
materially reduced amount of loan originations as compared to historical levels.
The major assumptions of our contingent business plan include, but are not
limited to, the following: (i) the sale of $100.0 million of subordinated debt
over a five month period ending in March 2004; (ii) the renewal of approximately
50% of our outstanding subordinated debt upon maturity; (iii) the securitization
of approximately $40.0 million of business purpose loans which are less
attractive to purchasers in the secondary loan market; (iv) the sale of
substantially all of the home equity loans we originate in whole loan sales in
the secondary market with servicing released; and (v) substantial cost
reductions in our operations. If we utilize the contingent business plan, we
currently anticipate incurring losses through the second quarter of fiscal 2004.
Although management believes that the contingent business plan is feasible,
there can be no assurance that we will be able to successfully implement it.
Civil Subpoena from the U.S. Attorney's Office. We received a civil
subpoena, dated May 14, 2003, from the Civil Division of the U.S. Attorney for
the Eastern District of Pennsylvania. The subpoena requests that we provide
certain documents and information with respect to us and our lending
subsidiaries for the period from May 1, 2000 to May 1, 2003: (i) all loan files
in which we entered into a forbearance agreement with a borrower who is in
default; (ii) the servicing, processing, foreclosing, and handling of delinquent
loans and non-performing loans, the carrying, processing and sale of real estate
owned, and forbearance agreements; and (iii) agreements to sell or otherwise
transfer mortgage loans (including, but not limited to, any pooling or
securitization agreements) or to obtain funds to finance the underwriting,
origination or provision of mortgage loans, any transaction in which mortgage
loans were sold or transferred, any instance in which we were not to service or
not to act as custodian for a mortgage loan, representations and warranties made
in connection with mortgage loans, secondary market loan sale schedules, and
credit loss, delinquency, default, and foreclosure rates of mortgage loans. We
have directed our attorneys to cooperate fully with this inquiry. Currently,
this inquiry appears to be focused on our practices relating to obtaining
forbearance agreements from delinquent borrowers who would otherwise be subject
to foreclosure. Because the inquiry is at a preliminary stage, we cannot reach
any conclusions about the ultimate scope of the inquiry or the potential
liability or financial consequences to us at this time.
To the extent management is unsuccessful in resolving this matter, the
ongoing review by the U.S. Attorney's Office could limit our ability to engage
in publicly underwritten securitization transactions or otherwise sell or
service our loans. In addition, the U.S. Attorney's inquiry could reduce sales
of subordinated debt upon which we rely to fund our operations and limit our
ability to obtain additional credit facilities, which are necessary for the
implementation of our business strategy. Furthermore, the U.S. Attorney could
impose sanctions or otherwise restrict our ability to restructure loans, which
could negatively impact our profitability and our ability to repay the
subordinated debt.
Delinquencies; Forbearance and Deferment Arrangements. During fiscal
2003, we experienced an increase in the total delinquencies in our total managed
portfolio to $229.1 million at June 30, 2003 from $170.8 million and $107.0
million at June 30, 2002 and 2001, respectively. Total delinquencies (loans and
leases, excluding real estate owned, with payments past due for more than 30
days) as a percentage of the total managed portfolio were 6.27% at June 30, 2003
compared to 5.57% and 4.13% at June 30, 2002 and 2001, respectively.
As the managed portfolio continues to season and if our economy
continues to lag or worsen, the delinquency rate may continue to increase, which
could negatively impact our ability to sell or securitize loans and reduce our
profitability and the funds available to repay our subordinated debt. Continuing
low market interest rates could continue to encourage borrowers to refinance
their loans and increase the levels of loan prepayments we experience which
would negatively impact our delinquency rate.
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Delinquencies in our total managed portfolio do not include $197.7
million of previously delinquent loans at June 30, 2003, which are subject to
deferment and forbearance arrangements. Generally, a loan remains current after
we enter into a deferment or forbearance arrangement with the borrower only if
the borrower makes the principal and interest payments as required under the
terms of the original note (exclusive of the delinquent payments advanced or
fees paid by us on the borrower's behalf as part of the deferment or forbearance
arrangement) and we do not reflect it as a delinquent loan in our delinquency
statistics. However, if the borrower fails to make principal and interest
payments, the account will generally be declared in default and collection
actions resumed.
During the final six months of fiscal 2003, we experienced a pronounced
increase in the number of borrowers under deferment arrangements than in prior
periods. At June 30, 2003, there was approximately $197.7 million of cumulative
unpaid principal balance under deferment and forbearance arrangements as
compared to approximately $138.7 million of cumulative unpaid principal balance
at June 30, 2002. Total cumulative unpaid principal balances under deferment or
forbearance arrangements as a percentage of the total managed portfolio were
5.41% at June 30, 2003 compared to 4.52% at June 30, 2002. Additionally, there
are loans under deferment and forbearance arrangements which have returned to
delinquent status. At June 30, 2003 there was $28.7 million of cumulative unpaid
principal balance under deferment arrangements and $51.5 million of cumulative
unpaid principal balance under forbearance arrangements that are now reported as
delinquent 31 days or more.
Business Strategy
The business strategy that we are emphasizing beginning in fiscal 2004
focuses on a shift from gain-on-sale accounting and the use of securitization
transactions as our primary method of selling loans to a more diversified loan
sale strategy which utilizes a combination of whole loan sales and
securitizations, while protecting revenues,controlling costs and improving
liquidity. Our business strategy includes the following:
o Selling substantially all of the loans we originate on at least
a quarterly basis through a combination of securitizations and
whole loan sales. Whole loan sales may be completed on a more
frequent basis.
o Shifting from a predominantly publicly underwritten
securitization strategy and gain-on-sale business model to a
strategy focused on a combination of whole loan sales and
smaller securitization transactions. Quarterly loan
securitization levels will be reduced significantly from
previous levels. Securitizations for the foreseeable future are
expected to be executed as private placements to institutional
investors or publicly underwritten securitizations, subject to
market conditions. Historically, the market for whole loan sales
has provided reliable liquidity for numerous originators as an
alternative to securitization. Whole loan sales provide
immediate cash premiums to us, while securitizations generate
cash over time but generally result in higher gains at the time
of sale. We intend to rely less on gain-on-sale accounting and
loan servicing activities for our revenue and earnings and will
rely more on cash premiums earned on whole loan sales. This
strategy is expected to result in relatively lower earnings
levels at current loan origination volumes, but will increase
cash flow, accelerate the timeframe for becoming cash flow
positive and improve our liquidity position. See "--Liquidity
and Capital Resources" for more detail on cash flow.
69
o Broadening our mortgage loan product line and increasing loan
originations. We currently originate primarily fixed-rate loans.
Under our business strategy, we plan to originate
adjustable-rate and alt-A mortgage loans as well as a wide array
of fixed-rate mortgage loans in order to appeal to a broader
base of prospective customers and increase loan originations.
o Offering competitive interest rates charged to borrowers on new
products. By offering competitive interest rates charged on new
products, we expect to originate loans with higher credit
quality. In addition, by offering competitive interest rates we
expect to appeal to a wider customer base and substantially
reduce our marketing costs, make more efficient use of marketing
leads and increase loan origination volume.
o Reducing origination of the types of loans that are not well
received in the whole loan sale and securitization markets. We
intend to reduce the level of business purpose loans that we
will originate, but we will continue to originate business
purpose loans to meet demand in the whole loan sale and
securitization markets.
o Reducing the cost of loan originations. We have implemented
plans to:
- Eliminate our high cost origination branches.
- Reduce the cost to originate in Upland Mortgage by: a)
broadening the product line and offering competitive
interest rates in order to increase origination volume, b)
reducing marketing costs, and c) developing broker
relationships.
- Reduce the cost to originate in American Business Mortgage
Services by increasing volume through a broadening of the
mortgage loan product line.
- Reduce the cost to originate in the Bank Alliance Services
program by broadening our product line and increasing the
amount of fees we charge to participating financial
institutions.
o Reducing the amount of outstanding subordinated debt. The
increase in cash flow expected under our business strategy is
expected to accelerate a reduction in our reliance on issuing
subordinated debt to meet our liquidity needs and allow us to
begin to pay down existing subordinated debt.
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o Reducing operating costs. Since June 30, 2003, we reduced our
workforce by 170 employees. With our shift in focus to whole
loan sales, with servicing released, and offering a broader
mortgage product line that we expect will appeal to a wider
array of customers, we currently require a smaller employee base
with fewer sales, servicing and support positions. These
workforce reductions represent more than a 15% decrease in
staffing levels.
Our business strategy is expected to leverage our demonstrated
strengths which include:
o A strong credit culture which consistently originates quality
performing loans. Our delinquency rates are among the lowest in
the subprime industry.
o Long-term broker relationships at American Business Mortgage
Services.
o Upland Mortgage brand identity.
o Relationships with participating financial institutions in the
Bank Alliance Services program.
o Institutional investors' interest in the bonds issued in our
securitizations.
Our business strategy is dependent on our ability to emphasize lending
related activities that 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 and to profitably securitize or
sell our loans on a regular basis. Our failure with respect to any of these
factors could impair our ability to successfully implement our 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
adjusted business strategy, which focuses on whole loan sales, we may be unable
to attain profitable operations, which could impair our ability to repay our
subordinated debt and negatively impact the value of our common stock."
Legal and Regulatory Considerations
Local, state and federal legislatures, state and federal banking
regulatory agencies, state attorneys general offices, the Federal Trade
Commission, the U.S. Department of Justice, the U.S. Department of Housing and
Urban Development and state and local governmental authorities have increased
their focus on lending practices by companies in the subprime lending industry,
more commonly referred to as "predatory lending" practices. State, local and
federal governmental agencies have imposed sanctions for practices including,
but not limited to, charging borrowers excessive fees, imposing higher interest
rates than the borrower's credit risk warrants, failing to adequately disclose
the material terms of loans to the borrowers and abusive servicing and
collections practices. As a result of initiatives such as these, we are unable
to predict whether state, local or federal authorities will require changes in
our lending practices in the future, including reimbursement of fees charged to
borrowers, or will impose fines on us. These changes, if required, could impact
our profitability. These laws and regulations may limit our ability to
securitize loans originated in some states or localities due to rating agency,
investor or market restrictions. As a result, we have limited the types of loans
we offer in some states and may discontinue originating loans in other states or
localities.
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We received a civil subpoena, dated May 14, 2003, from the Civil
Division of the U.S. Attorney for the Eastern District of Pennsylvania. See
"-- Recent Developments" and "Risk Factors -- The inquiry regarding our
forbearance practices by the U.S. Attorney could result in concerns regarding
our loan servicing and limit our ability to sell or service our loans, sell
subordinated debt, or obtain additional credit facilities, which would hinder
our ability to operate profitably and repay our subordinated debt, which would
negatively impact the value of our common stock."
Additionally, the United States Congress is currently considering a
number of proposed bills or proposed amendments to existing laws, such as the
"Ney - Lucas Responsible Lending Act of 2003" introduced on February 11, 2003
into the U.S. House of Representatives, which could affect our lending
activities and make our business less profitable. These bills and amendments, if
adopted as proposed, could reduce our profitability by limiting the fees we are
permitted to charge, including prepayment fees, restricting the terms we are
permitted to include in our loan agreements and increasing the amount of
disclosure we are required to give to potential borrowers. While we cannot
predict whether or in what form Congress may enact legislation, we are currently
evaluating the potential impact of these legislative initiatives, if adopted, on
our lending practices and results of operations.
In addition to new regulatory initiatives with respect to so-called
"predatory lending" practices, current laws or regulations in some states
restrict our ability to charge prepayment penalties and late fees. We have used
the Federal Alternative Mortgage Transactions Parity Act of 1982, which we refer
to as the Parity Act, to preempt these state laws for loans which meet the
definition of alternative mortgage transactions under the Parity Act. However,
the Office of Thrift Supervision has adopted a rule effective in July 2003,
which precludes us and other non-bank, non-thrift creditors from using the
Parity Act to preempt state prepayment penalty and late fee laws on new loan
originations. Under the provisions of this rule, we are required to modify or
eliminate the practice of charging prepayment and other fees in some of the
states where we originate loans. We are continuing to evaluate the impact of the
adoption of the new rule by the Office of Thrift Supervision on our future
lending activities and results of operations. We currently expect that the
percentage of home equity loans containing prepayment fees that we will
originate in the future will decrease to approximately 65% to 70%, from 80% to
85% prior to this rule becoming effective. Additionally, in a recent decision,
the Appellate Division of the Superior Court of New Jersey determined that the
Parity Act's preemption of state law was invalid and that the state laws
precluding some lenders from imposing prepayment fees are applicable to loans
made in New Jersey, including alternative mortgage transactions. Although this
New Jersey decision is subject to appeal and may not be final, we are currently
evaluating its impact on our future lending activities in the State of New
Jersey and results of operations.
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We are also subject, from time to time, to private litigation,
including actual and purported class action suits. We expect that, as a result
of the publicity surrounding predatory lending practices and the recent New
Jersey court decision regarding the Parity Act, we may be subject to other class
action suits in the future. See "Risk Factors -- Our residential lending
business is subject to government regulation and licensing requirements, as well
as private litigation, which may hinder our ability to operate profitably and
repay our subordinated debt, which would negatively impact the value of our
common stock."
Although we are licensed or otherwise qualified to originate loans in
44 states, our loan originations are concentrated 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 or recession 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
or recession in this region could result in reduced profitability. See "Risk
Factors -- An economic downturn or recession in the eastern half of the United
States could hinder our ability to operate profitably, which would reduce the
funds available to repay the subordinated debt and negatively impact the value
of our common stock."
Application of Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America,
referred to as GAAP. The accounting policies discussed below are considered by
management to be critical to understanding our financial condition and results
of operations. The application of these accounting policies requires significant
judgment and assumptions by management, which are based upon historical
experience and future expectations. The nature of our business and our
accounting methods make our financial condition, changes in financial condition
and results of operations highly dependent on management's estimates. The line
items on our income statement and balance sheet impacted by management's
estimates are described below.
Revenue Recognition. Revenue recognition is highly dependent on the
application of Statement of Financial Accounting Standards, referred to as SFAS
in this document, No. 140 "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities" and "gain-on-sale" accounting to our
quarterly loan securitizations. Gains on sales of loans through securitizations
for the fiscal year ended June 30, 2003 were 70.8% of total revenues.
Securitization gains represent the difference between the net proceeds to us,
including retained interests in the securitization, and the allocated cost of
loans securitized. The allocated cost of loans securitized is determined by
allocating their net carrying value between the loans, the interest-only strips
and the servicing rights we retain based upon their relative fair values.
Estimates of the fair values of the interest-only strips and the servicing
rights we retain are discussed below. We believe the accounting estimates
related to gain on sale are critical accounting estimates because more than 80%
in fiscal 2003 and 2002 of the securitization gains were based on estimates of
the fair value of retained interests. The amount recognized as gain on sale for
the retained interests we receive as proceeds in a securitization, in accordance
with accounting principles generally accepted in the United States of America,
is highly dependent on management's estimates.
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Interest-Only Strips. Interest-only strips, which represent the right
to receive future cash flows from securitized loans, represented 51.6% of our
total assets at June 30, 2003 and are carried at their fair values. Fair value
is based on a discounted cash flow analysis which estimates the present value of
the future expected residual cash flows and overcollateralization cash flows
utilizing assumptions made by management at the time the loans are sold. These
assumptions include the rates used to calculate the present value of expected
future residual cash flows and overcollateralization cash flows, referred to as
the discount rates, and expected prepayment and credit loss rates on pools of
loans sold through securitizations. We believe the accounting estimates used in
determining the fair value of interest-only strips are critical accounting
estimates because estimates of prepayment and credit loss rates are made based
on management's expectation of future experience, which is based in part, on
historical experience, current and expected economic conditions and in the case
of prepayment rate assumptions, consideration of the impact of changes in market
interest rates. The actual loan prepayment rate may be affected by a variety of
economic and other factors, including prevailing interest rates, the
availability of alternative financing to borrowers and the type of loan. We
re-evaluate expected future cash flows from our interest-only strips on a
quarterly basis. We monitor the current assumptions for prepayment and credit
loss rates against actual experience and other economic and market conditions
and we adjust assumptions if deemed appropriate. Even a small unfavorable change
in our assumptions made as a result of unfavorable actual experience or other
considerations could have a significant adverse impact on our estimate of
residual cash flows and 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 accounting adjustment. In accordance with the
provisions of Emerging Issues Task Force guidance on issue 99-20, "Recognition
of Interest Income and Impairment on Purchased and Retained Beneficial Interests
in Securitized Financial Assets", referred to as EITF 99-20 in this document,
changes in the fair value of interest-only strips that are deemed to be
temporary changes are recorded through other comprehensive income, a component
of stockholders' equity. Other than temporary adjustments to decrease the fair
value of interest-only strips are recorded through the income statement which
would adversely affect our income in the period of adjustment.
During fiscal 2003, we recorded total pre-tax valuation adjustments on
our interest only-strips of $58.0 million, of which, in accordance with EITF
99-20, $39.9 million was charged to the income statement and $18.1 million was
charged to other comprehensive income. The valuation adjustment reflects the
impact of higher than anticipated prepayments on securitized loans experienced
in fiscal 2003 due to the low interest rate environment experienced during
fiscal 2003, which has impacted the entire mortgage industry. The valuation
adjustment on interest-only strips for fiscal 2003 was reduced by a $20.9
million favorable valuation impact as a result of reducing the discount rates
applied in valuing the interest-only strips at June 30, 2003. The amount of the
valuation adjustment charged to the income statement was reduced by a $10.8
million favorable valuation impact as a result of reducing the discount rates
and the charge to other comprehensive income was reduced by $10.1 million for
the favorable impact of reducing discount rates. The discount rates were reduced
at June 30, 2003 primarily to reflect the impact of the sustained decline in
market interest rates. The discount rate on the projected residual cash flows
from our interest-only strips was reduced from 13% to 11% at June 30, 2003. The
discount rate used to determine the fair value of the overcollateralization
portion of the cash flows from our interest-only strips was minimally impacted
by the decline in interest rates and remained at 7% on average. As a result, the
blended rate used to value our interest-only strips, including the
overcollateralization cash flows, was 9% at June 30, 2003. See
"-- Securitizations -- Discount rates" for more detail. See "-- Off-Balance
Sheet Arrangements -- Securitizations" for more detail on the estimation of the
fair value of interest-only strips and the sensitivities of these balances to
changes in assumptions and the impact on our financial statements of changes in
assumptions. See "Risk Factors -- Our estimates of the value of interest-only
strips and servicing rights we retain when we securitize loans could be
inaccurate and could limit our ability to operate profitably and impair our
ability to repay our subordinated debt, which would negatively impact the value
of our common stock."
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Interest accretion income represents the yield component of cash flows
received on interest-only strips. We use a prospective approach to estimate
interest accretion. As previously discussed, we update estimates of residual
cash flow from our securitizations on a quarterly basis. Under the prospective
approach, when it is probable that there is a favorable or unfavorable change in
estimated residual cash flow from the cash flow previously projected, we
recognize a larger or smaller percentage of the cash flow as interest accretion.
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. The managed portfolio
includes loans held as available for sale on our balance sheet and loans
serviced for others.
Servicing Rights. Servicing rights, which represent the rights to
receive contractual servicing fees from securitization trusts and ancillary fees
from borrowers, net of adequate compensation that would be required by a
substitute servicer, represented 10.3% of our total assets at June 30, 2003.
Servicing rights are carried at the lower of cost or fair value. The fair value
of servicing rights is determined by computing the benefits of servicing in
excess of adequate compensation, which would be required by a substitute
servicer. The benefits of servicing are the present value of projected net cash
flows from contractual servicing fees and ancillary servicing fees. We believe
the accounting estimates used in determining the fair value of servicing rights
are critical accounting estimates because the projected cash flows from
servicing fees incorporate assumptions made by management, 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. We
monitor the current assumptions for prepayment and credit loss rates against
actual experience and other economic and market conditions and we adjust
assumptions if deemed appropriate. Even a small unfavorable change in our
assumptions, made as a result of unfavorable actual experience or other
considerations 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 fiscal 2003, we recorded total pre-tax valuation adjustments on
our servicing rights of $5.3 million, which was charged to the income statement.
The valuation adjustment reflects the impact of higher than anticipated
prepayments on securitized loans experienced in fiscal 2003 due to the low
interest rate environment experienced during fiscal 2003. The valuation
adjustment on servicing rights for fiscal 2003 was reduced by a $7.1 million
favorable valuation impact as a result of reducing the discount rate applied in
valuing the servicing rights at June 30, 2003. The discount rate was reduced at
June 30, 2003 primarily to reflect the impact of the sustained decline in market
interest rates. The discount rate on our servicing rights was reduced from 11%
to 9% at June 30, 2003. See "-- Securitizations -- Servicing rights" for more
detail. See "-- Off-Balance Sheet Arrangements -- Securitizations" for more
detail on the estimation of the fair value of servicing rights and the
sensitivities of these balances to changes in assumptions and the impact on our
financial statements of changes in assumptions.
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Amortization of the servicing rights asset for securitized loans is
calculated individually for each securitized loan pool and is recognized in
proportion to, and over the period of, estimated future servicing income on that
particular pool of loans. A review for impairment is performed on a quarterly
basis by stratifying the serviced loans by loan type, which is considered to be
the predominant risk characteristic. If our analysis indicates the carrying
value of servicing rights is not recoverable through future cash flows from
contractual servicing and other ancillary fees, a valuation allowance or write
down would be required. During fiscal 2003, our valuation analysis indicated
that valuation adjustments of $5.3 million were required for impairment of
servicing rights due to higher than expected prepayment experience. The write
downs were recorded in the income statement. Impairment is measured as the
excess of carrying value over fair value.
Allowance for Loan and Lease Losses. The allowance for loan and lease
losses is maintained primarily to account for loans and leases that are
delinquent and are expected to be ineligible for sale into a future
securitization and for delinquent loans that have been repurchased from
securitization trusts. The allowance is calculated based upon management's
estimate of our ability to collect on outstanding loans and leases based upon a
variety of factors, including, 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. If the actual collection of outstanding loans and leases
is less than we anticipate, further write downs would be required which would
reduce our net income in the period the write down was required.
Development of Critical Accounting Estimates. On a quarterly basis,
senior management reviews the estimates used in our critical accounting
policies. As a group, senior management discusses the development and selection
of the assumptions used to perform its estimates described above. Management has
discussed the development and selection of the estimates used in our critical
accounting policies as of June 30, 2003 with the Audit Committee of our Board of
Directors. In addition, management has reviewed its disclosure of the estimates
discussed in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" with the Audit Committee.
Impact of Changes in Critical Accounting Estimates. For a description
of the impact of changes in critical accounting estimates in the fiscal year
ended June 30, 2003, see "-- Off-Balance Sheet Arrangements -- Securitizations."
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Initial Adoption of Accounting Policies. In conjunction with the
relocation of our corporate headquarters to new leased office space, we have
entered into a lease agreement and are in the process of finalizing certain
governmental grant agreements that will provide us with reimbursement for
certain expenditures related to our office relocation. The reimbursable
expenditures include both capitalizable items for leasehold improvements,
furniture and equipment and expense items such as legal costs, moving costs and
employee communication programs. Amounts reimbursed to us in accordance with our
lease agreement will be initially recorded as a liability on our balance sheet
and will be amortized in the income statement on a straight-line basis over the
term of the lease as a reduction of rent expense. Amounts received from
government grants will be initially recorded as a liability. Grant funds
received to offset expenditures for capitalizable items will be reclassified as
a reduction of the related fixed asset and amortized to income over the
depreciation period of the related asset as an offset to depreciation expense.
Amounts received to offset expense items will be recognized in the income
statement as an offset to the expense item.
In fiscal 2002 we entered into a derivative financial instrument
contract, which we have not designated as an accounting hedge and therefore is
accounted for as a trading asset or liability. This contract was designed to
reduce our exposure to changes in the fair value of certain interest-only strips
due to changes in the one-month London Inter-Bank Offered Rate, referred to in
this document as LIBOR. The structure of certain securitization trusts includes
a floating interest rate tranche based on one-month LIBOR plus an interest rate
spread. Floating interest rate tranches in a securitization expose us to gains
or losses due to changes in the fair value of the interest-only strip from
changes in the floating interest rate paid to the certificate holders. In order
to manage this exposure we have entered into an interest rate swap agreement.
The swap agreement requires a net cash settlement on a monthly basis of the
difference between the fixed interest rate on the swap and the LIBOR paid on the
certificates. The fair value of this swap agreement is based on estimated market
values for the sale of the contract provided by a third party. As of June 30,
2003, the unrealized loss in the fair value of this derivative financial
instrument was $0.3 million and an additional $1.0 million in net cash
settlements were paid on the contract during fiscal 2003. Our interest-only
strips are held as available for sale securities and therefore changes in the
fair value of the interest-only strips are recorded as a component of equity
unless the fair value of the interest-only strip falls below its cost basis,
which would require a write down through current period income. See "-- Interest
Rate Risk Management -- Strategies for Use of Derivative Financial Instruments"
for further details of this interest rate swap agreement.
Impact of Changes in Critical Accounting Estimates in Prior Fiscal Years.
Discount rates. During fiscal 2000, a write down of $12.6 million was
recorded on our interest-only strips, of which $11.2 million was due to a change
in the discount rate used to value our interest-only strips. At June 30, 2000,
we increased the discount rate applicable to the residual portion of our
interest-only strips from 11% to 13%. No changes were made in the discount rate
used to determine the fair value of the overcollateralization portion of the
cash flows from our interest-only strips. The change in the discount rate was
considered to be an other than temporary fair value adjustment and was recorded
as expense in fiscal 2000. The factors that led to this other than temporary
decline in fair value of our interest-only strips included:
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o Sustained increase in market interest rates through the fourth quarter
of fiscal 2000;
o Increases in the all-in cost of our mortgage loan trust investor
certificates from September 1998 through June 2000;
o Increases in the cost of funding our interest-only strips, particularly
the interest rate paid on subordinated debt; and
o Events and conditions in the mortgage lending industry and the actions
by others in that industry.
Prepayment rates. During the nine-month period ended October 1998, the
percentage of home equity loans that we originated containing prepayment fees
increased from less than 50% of loans originated to over 85%, a percentage which
has been maintained since that time. Due to this increase in the volume of loans
originated with prepayment fees, we had reduced the initial annual prepayment
rate assumption on business loans and 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 beginning with the 2000-2 mortgage
loan securitization. Our experience indicated that when a loan has a prepayment
fee provision, fewer borrowers will prepay, and those prepaying will do so more
slowly. Our actual cumulative prepayment experience through March 31, 2000
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 was nearly twice as likely that a loan without a prepayment
fee would be prepaid. The effect of these changes in prepayment rate assumptions
increased the gains on securitizations for fiscal 2000.
In the third quarter of fiscal 2001, we evaluated our accumulated
experience with pools of loans that had a high percentage of loans with
prepayment fees. We had begun using a static pool analysis of prepayments,
whereby we analyzed historical prepayments by period, to determine average
prepayments expected by period. For business purpose loans, we found that
prepayments for the first year are generally lower than we had anticipated, peak
at a higher rate than previously anticipated by month 24 and decline by month
40. Home equity loan prepayments generally ramped faster in the first year than
we had anticipated but leveled more slowly over 30 months and to a lower final
rate than we had been using previously. We utilized this information to modify
our loan prepayment rates and ramp periods to better reflect the amount and
timing of expected prepayments. The effect of these changes implemented in the
third quarter of fiscal 2001 was a net reduction in the value of our
interest-only strips of $3.1 million or less than 1% and an insignificant net
impact on securitization gains for fiscal 2001. The effect on the interest-only
strips of this change in assumptions was recorded through an adjustment to
comprehensive income in accordance with SFAS No. 115 "Accounting for Certain
Investments in Debt and Equity Securities."
Credit loss rates. In fiscal 2000, 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 originated and
our concerns regarding high levels of real estate values. The average percentage
of first mortgage loans securitized had declined approximately 10% from the
fiscal 1999 securitizations to the fiscal 2000 securitizations. High real estate
values also affected our loss assumptions because in the event of an economic
downturn, the loan-to-value ratios of the loans could be understated. Both of
these factors increased the potential that the underlying real estate collateral
would not be sufficient to satisfy the loan if a foreclosure were required.
Although our percentage of first mortgages has subsequently increased, we
believe real estate values may limit our ability to maintain the credit loss
experience realized in prior securitizations. The effect of these changes in
credit loss assumptions reduced the gains on securitizations in fiscal 2000 by
approximately $1.7 million.
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Off-Balance Sheet Arrangements
We use off-balance sheet arrangements extensively in our business
activities. The types of off-balance sheet arrangements we use include special
purpose entities for the securitization of loans, obligations we incur as the
servicer of securitized loans and other contractual obligations such as
operating leases for corporate office space. See "-- Liquidity and Capital
Resources" for additional information regarding our off-balance sheet
contractual obligations.
Special purpose entities and off-balance sheet facilities are used in
our mortgage loan securitizations. Asset securitizations are one of the most
common off-balance sheet arrangements in which a company transfers assets off of
its balance sheet by selling them to a special purpose entity. We sell our loans
into off-balance sheet facilities to generate the cash to pay off revolving
credit facilities and to generate revenue through securitization gains. The
special purpose entities described below meet our objectives for mortgage loan
securitization structures and comply with accounting principles generally
accepted in the United States of America.
Our securitizations involve a two-step transfer that qualifies for sale
accounting under SFAS No. 140. First, we sell the loans to a special purpose
entity, which has been established for the limited purpose of buying and
reselling the loans and establishing a true sale under legal standards. Next,
the special purpose entity sells the loans to a qualified special purpose
entity, which we refer to as the trust. The trust is a distinct legal entity,
independent from us. By transferring title of the loans to the trust, we isolate
those assets from our assets. Finally, the trust issues certificates to
investors to raise the cash purchase price for the loans we have sold. Cash from
the sale of certificates to third party investors is returned to us in exchange
for our loan receivables and we use this cash, in part, to repay any borrowings
under warehouse and credit facilities. The off-balance sheet trusts' activities
are restricted to holding title to the loan collateral, issuing certificates to
investors and distributing loan payments to the investors and us in accordance
with the relevant agreement.
In each securitization, we also retain the right to service the loans.
We have no additional obligations to the off-balance sheet facilities other than
those required as servicer of the loans and for breach of covenants or warranty
obligations. We are not required to make any additional investments in the
trusts. Under current accounting rules, the trusts do not qualify for
consolidation in our financial statements. The trusts carry the loan collateral
as assets and the certificates issued to investors as liabilities. Residual cash
from the loans after required principal and interest payments are made to the
investors and after payment of certain fees and expenses provides us with cash
flows from our interest-only strips. We expect 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 and our operating cash
needs.
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We retain the rights to service the loans we sell through
securitizations. As the servicer of securitized loans, we are obligated to
advance interest payments for delinquent loans if we deem that the advances will
ultimately be recoverable. These advances can first be made out of funds
available in a trust's collection account. If the funds available from the
collection account are insufficient to make the required interest advances, then
we are required to make the advance from our operating cash. The advances made
from a trust's collection account, if not recovered from the borrower or
proceeds from the liquidation of the loan, require reimbursement from us. These
advances may require funding from our capital resources and may create greater
demands on our cash flow than either selling loans with servicing released or
maintaining a portfolio of loans on our balance sheet. However, any advances we
make on a mortgage loan from our operating cash can be recovered from the
subsequent mortgage loan payments to the applicable trust prior to any
distributions to the certificate holders.
At June 30, 2003 and June 30, 2002, the mortgage securitization trusts
held loans with an aggregate principal balance due of $3.4 billion and $2.9
billion as assets and owed $3.2 billion and $2.8 billion to third party
investors, respectively. Revenues from the sale of loans to securitization
trusts were $171.0 million, or 70.8% of total revenues for the fiscal year ended
June 30, 2003 and $185.6 million, or 74.9% of total revenues for the fiscal year
ended June 30, 2002. These amounts are net of $5.1 million in fiscal 2003 and
$5.7 million in fiscal 2002 of expenses for underwriting fees, legal fees and
other expenses associated with securitization transactions during the periods.
We have interest-only strips and servicing rights with fair values of $598.3
million and $119.3 million, respectively at June 30, 2003, which represent 61.9%
of our total assets. Cash flows received from interest-only strips and servicing
rights were $132.1 million for the fiscal year ended June 30, 2003 and $88.7
million for the fiscal year ended June 30, 2002. These amounts are included in
our operating cash flows.
We also used special purpose entities in our sales of loans to a $300.0
million off-balance sheet mortgage conduit facility. Sales into the off-balance
sheet facility involved a two-step transfer that qualified for sale accounting
under SFAS No. 140, similar to the process described above. This facility had a
revolving feature and could be directed by the third party sponsor to dispose of
the loans. Typically, the loans were disposed of by securitizing the loans in a
term securitization. The third party note purchaser also has the right to have
the loans sold in whole loan sale transactions. Under this off-balance sheet
facility arrangement, the loans have been isolated from us and our subsidiaries
and as a result, transfers to the facility were treated as sales for financial
reporting purposes. When loans were sold to this facility, we assessed the
likelihood that the sponsor would transfer the loans into a term securitization.
As the sponsor had typically transferred the loans to a term securitization
prior to the fourth quarter of fiscal 2003, the amount of gain on sale we had
recognized for loans sold to this facility was estimated based on the terms we
would obtain in a term securitization rather than the terms of this facility.
For the fourth quarter of fiscal 2003, the likelihood that the facility sponsor
would ultimately transfer the underlying loans to a term securitization was
significantly reduced and the amount of gain recognized for loans sold to this
facility was based on terms expected in a whole loan sale transaction. Our
ability to sell loans into this facility expired pursuant to its terms on July
5, 2003. At June 30, 2003, the off-balance sheet mortgage conduit facility held
loans with principal balances due of $275.6 million as assets and owed $267.5
million to third parties. Through September 17, 2003, $221.9 million of the
loans in the facility at June 30, 2003 were sold in whole loan sales as directed
by the facility sponsor.
80
Securitizations
In our mortgage loan securitizations, pools of mortgage loans are sold
to a trust. The trust then issues certificates or notes, which we refer to as
certificates in this document, to third-party investors, representing the right
to receive a pass-through interest rate and principal collected on the mortgage
loans each month. These certificates, which are senior in right to our
interest-only strips in the trusts, are sold in public or private offerings. The
difference between the weighted-average interest rate that is charged to
borrowers on the fixed interest rate pools of mortgage loans and the
weighted-average pass-through interest rate paid to investors is referred to as
the interest rate spread. The interest rate spread after payment of certain fees
and expenses and subject to certain conditions is distributed from the trust to
us and is the basis of the value of our interest-only strips. In addition, when
we securitize our loans we retain the right to service the loans for a fee,
which is the basis for our servicing rights. Servicing includes processing of
mortgage payments, processing of disbursements for tax and insurance payments,
maintenance of mortgage loan records, performance of collection efforts,
including disposition of delinquent loans, foreclosure activities and
disposition of real estate owned, referred to as REO, and performance of
investor accounting and reporting processes.
Declines in securitization pass-through interest rates resulted in
interest rate spreads improving by approximately 235 basis points from the
fourth quarter of fiscal 2000 securitization, to our most recent securitization
in the third quarter of fiscal 2003. Increased interest rate spreads resulted in
increases in the residual cash flow we expect to receive on securitized loans,
the amount we received at the closing of a securitization from the sale of
notional bonds or premiums on investor certificates and corresponding increases
in the gains we recognized on the sale of loans in a securitization. No
assurances can be made that market interest rates will remain at current levels
or that we can complete securitizations in the future. However, in a rising
interest rate environment and under our business strategy we would expect our
ability to originate loans at interest rates that will maintain our most recent
level of securitization gain profitability to become more difficult than during
a stable or falling interest rate environment. We would seek to address the
challenge presented by a rising interest rate environment by carefully
monitoring our product pricing, the actions of our competition, market trends
and the use of hedging strategies in order to continue to originate loans in as
profitable a manner as possible. See "-- Strategies for Use of Derivative
Financial Instruments" for a discussion of our hedging strategies.
A rising interest rate environment could unfavorably impact our
liquidity and capital resources. Rising interest rates could impact our
short-term liquidity by limiting our ability to sell loans at favorable premiums
in whole loan sales, widening investor interest rate 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
interest rate 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. These effects may be offset to some degree by the
positive effect of a decline in prepayment activity that we would expect in a
rising interest rate environment. See "-- Liquidity and Capital Resources" for a
discussion of both long and short-term liquidity.
81
Conversely, a declining interest rate environment could unfavorably
impact the valuation of our interest-only strips. In a declining interest rate
environment the level of mortgage refinancing activity tends to increase, which
could result in an increase in loan prepayment experience and may require
increases in assumptions for prepayments for future periods.
After a two-year period during which management's estimates required no
valuation adjustments to our interest-only strips and servicing rights,
declining interest rates and high prepayment rates over the last seven quarters
have required revisions to management's estimates of the value of these retained
interests. Beginning in the second quarter of fiscal 2002 and on a quarterly
basis thereafter, we increased the prepayment rate assumptions used to value our
securitization assets, thereby decreasing the fair value of these assets.
However, because our prepayment rates as well as those throughout the mortgage
industry continued to remain at higher than expected levels due to continuous
declines in interest rates during this period to 40-year lows, our prepayment
experience exceeded even our revised assumptions. As a result, over the last
seven quarters we have recorded cumulative pre-tax write downs to our
interest-only strips in the aggregate amount of $102.0 million and pre-tax
adjustments to the value of servicing rights of $5.3 million, for total
adjustments of $107.3 million, mainly due to our higher than expected prepayment
experience. Of this amount, $67.2 million was expensed through the income
statement and $40.1 million resulted in a write down through other comprehensive
income, a component of stockholders' equity.
During fiscal 2003, we recorded total pre-tax valuation adjustments on
our securitization assets of $63.3 million, of which $45.2 million was charged
to the income statement and $18.1 million was charged to other comprehensive
income. The breakout of the total adjustments in fiscal 2003 between
interest-only strips and servicing rights was a follows:
o We recorded total pre-tax valuation adjustments on our interest
only-strips of $58.0 million, of which, in accordance with EITF
99-20, $39.9 million was charged to the income statement and
$18.1 million was charged to other comprehensive income. The
valuation adjustment reflects the impact of higher than
anticipated prepayments on securitized loans experienced in
fiscal 2003 due to the low interest rate environment experienced
during fiscal 2003, which has impacted the entire mortgage
industry. The valuation adjustment on interest-only strips for
fiscal 2003 was reduced by a $20.9 million favorable valuation
impact as a result of reducing the discount rates applied in
valuing the interest-only strips at June 30, 2003. The amount of
the valuation adjustment charged to the income statement was
reduced by a $10.8 million favorable valuation impact as a
result of reducing the discount rates and the charge to other
comprehensive income was reduced by $10.1 million for the
favorable impact of reducing discount rates. The discount rates
were reduced at June 30, 2003 primarily to reflect the impact of
the sustained decline in market interest rates. The discount
rate on the projected residual cash flows from our interest-only
strips was reduced from 13% to 11% at June 30, 2003. The
discount rate used to determine the fair value of the
overcollateralization portion of the cash flows from our
interest-only strips was minimally impacted by the decline in
interest rates and remained at 7% on average. As a result, the
blended rate used to value our interest-only strips, including
the overcollateralization cash flows, was 9% at June 30, 2003.
o We recorded total pre-tax valuation adjustments on our servicing
rights of $5.3 million, which was charged to the income
statement. The valuation adjustment reflects the impact of
higher than anticipated prepayments on securitized loans
experienced in fiscal 2003 due to the low interest rate
environment experienced during fiscal 2003. The valuation
adjustment on servicing rights for fiscal 2003 was reduced by a
$7.1 million favorable valuation impact as a result of reducing
the discount rate applied in valuing the servicing rights at
June 30, 2003. The discount rate was reduced at June 30, 2003
primarily to reflect the impact of the sustained decline in
market interest rates. The discount rate on our servicing rights
was reduced from 11% to 9% at June 30, 2003.
82
The long duration of historically low interest rates has given
borrowers an extended opportunity to engage in mortgage refinancing activities
which resulted in elevated prepayment experience. The persistence of
historically low interest rate levels, unprecedented in the last 40 years, has
made the forecasting of prepayment levels in future fiscal periods difficult. We
had assumed that the decline in interest rates had stopped and a rise in
interest rates would occur in the near term. Consistent with this view, we had
utilized derivative financial instruments to manage interest rate risk exposure
on our loan production and loan pipeline to protect the fair value of these
fixed rate items against potential increases in market interest rates. Based on
current economic conditions and published mortgage industry surveys including
the Mortgage Bankers Association's Refinance Indexes available at the time of
our quarterly revaluation of our interest-only strips and servicing rights, and
our own prepayment experience, we believe prepayments will continue to remain at
higher than normal levels for the near term before returning to average
historical levels. The Mortgage Bankers Association of America has forecast as
of June 13, 2003 that mortgage refinancings as a percentage share of total
mortgage originations will decline from 71% in the first quarter of calendar
2003 to 50% in the first quarter of calendar 2004 and to 34% in the second
quarter of calendar 2004. The Mortgage Bankers Association of America has also
projected in its June 2003 economic forecast that the 10-year treasury rate
(which generally affects mortgage rates) will increase over the next three
quarters. As a result of our analysis of these factors, we have increased our
prepayment rate assumptions for home equity loans for the near term, but at a
declining rate, before returning to our historical levels. However, we cannot
predict with certainty what our prepayment experience will be in the future. Any
unfavorable difference between the assumptions used to value our securitization
assets and our actual experience may have a significant adverse impact on the
value of these assets.
The following tables detail the pre-tax write downs of the
securitization assets by quarter and details the impact to the income statement
and to other comprehensive income in accordance with the provisions of SFAS No.
115 "Accounting for Certain Investments in Debt and Equity Securities" and EITF
99-20 as they relate to interest-only strips and SFAS No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
as it relates to servicing rights (in thousands):
Fiscal Year 2003:
Income Other
Total Statement Comprehensive
Quarter Ended Write down Impact Income Impact
- ----------------------------------------- ---------- --------- -------------
September 30, 2002....................... $ 16,739 $ 12,078 $ 4,661
December 31, 2002........................ 16,346 10,568 5,778
March 31, 2003........................... 16,877 10,657 6,220
June 30, 2003............................ 13,293 11,879 1,414
-------- -------- --------
Total Fiscal 2003........................ $ 63,255 $ 45,182 $ 18,073
======== ======== ========
83
Fiscal Year 2002:
Income Other
Total Statement Comprehensive
Quarter Ended Write down Impact Income Impact
- ----------------------------------------- ---------- --------- -------------
December 31, 2001........................ $ 11,322 $ 4,462 $ 6,860
March 31, 2002........................... 15,513 8,691 6,822
June 30, 2002............................ 17,244 8,900 8,344
-------- -------- --------
Total Fiscal 2002........................ $ 44,079 $ 22,053 $ 22,026
======== ======== ========
Note: The impacts of prepayments on our securitization assets in the quarter
ended September 30, 2001 were not significant.
The following table summarizes the volume of loan securitizations and
whole loan sales for the fiscal years ended June 30, 2003, 2002 and 2001
(dollars in thousands):
Year Ended June 30,
------------------------------------
Securitizations: 2003 2002 2001
---------- ---------- --------
Business loans......................... $ 112,025 $ 129,074 $ 109,892
Home equity loans...................... 1,311,739 1,222,061 992,174
---------- ---------- ----------
Total.................................. $1,423,764 $1,351,135 $1,102,066
========== ========== ==========
Gain on sale of loans through
securitization....................... $ 170,950 $ 185,580 $ 128,978
Securitization gains as a percentage
of total revenue..................... 70.8% 74.9% 70.4%
Whole loan sales....................... $ 28,013 $ 57,679 $ 76,333
Gains on whole loan sales.............. $ 655 $ 2,448 $ 2,742
As demonstrated in the fourth quarter of fiscal 2003, our quarterly
revenues and net income may fluctuate in the future principally as a result of
the timing, size and profitability of our securitizations. The business strategy
of selling loans through securitizations and whole loan sales requires building
an inventory of loans over time, during which time we incur costs and expenses.
Since a gain on sale is not recognized until a securitization is closed or whole
loan sale is settled, which may not occur until a subsequent quarter, operating
results for a given quarter can fluctuate significantly. If securitizations or
whole loan sales do not close when expected, we could experience a material
adverse effect on our results of operations for a quarter. See "-- Liquidity and
Capital Resources" for a discussion of the impact of securitizations and whole
loan sales on our cash flow.
Several factors affect our ability to complete securitizations on a
profitable basis. These factors include conditions in the securities markets,
such as fluctuations in interest rates described below, conditions in the
asset-backed securities markets relating to the loans we originate, credit
quality of the managed portfolio of loans or potential changes to the legal and
accounting principles underlying securitization transactions.
84
Interest-Only Strips. As the holder of the interest-only strips, we are
entitled to receive excess (or residual) cash flows and cash flows from
overcollateralization. These cash flows are the difference between the payments
made by the borrowers on securitized loans and the sum of the scheduled and
prepaid principal and pass-through interest paid to trust investors, servicing
fees, trustee fees and, if applicable, surety fees. In most of our
securitizations, surety fees are paid to an unrelated insurance entity to
provide credit enhancement for the trust investors.
Generally, all residual cash flows are initially retained by the trust
to establish required overcollateralization levels in the trust.
Overcollateralization is the excess of the aggregate principal balances of loans
in a securitized pool over the aggregate principal balance of investor
interests. Overcollateralization requirements are established to provide credit
enhancement for the trust investors.
The overcollateralization requirements for a mortgage loan
securitization are different for each securitization and include:
(1) The initial requirement, if any, which is a percentage of the
original unpaid principal 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 unpaid
principal balance of loans securitized and is funded from the
monthly excess cash flow. Specific securitizations contain
provisions requiring an increase above the final target
overcollateralization levels during periods in which
delinquencies exceed specified limits. The
overcollateralization levels return to the target levels when
delinquencies fall below the specified limits; and
(3) The stepdown requirement, which is a percentage of the
remaining unpaid principal balance of securitized loans.
During the stepdown period, the overcollateralization amount
is gradually reduced through cash payments to us until the
overcollateralization balance declines to a specific floor.
The stepdown period generally begins at the later of 30 to 36
months after the initial securitization of the loans or when
the remaining balance of securitized loans is less than 50% of
the original balance of securitized loans.
The fair value of our interest-only strips is a combination of the fair
values of our residual cash flows and our overcollateralization cash flows. At
June 30, 2003, investments in interest-only strips totaled $598.3 million,
including the fair value of overcollateralization related cash flows of $279.2
million.
Trigger Management. Repurchasing delinquent loans from securitization
trusts benefits us by allowing us to limit the level of delinquencies and losses
in the securitization trusts and as a result, we can avoid exceeding specified
limits on delinquencies and losses that trigger a temporary reduction or
discontinuation of cash flow from our interest-only strips until the delinquency
or loss triggers are no longer exceeded. We have the right, but are not
obligated, to repurchase a limited amount of delinquent loans from
securitization trusts. In addition, we elect to repurchase loans in situations
requiring more flexibility for the administration and collection of these loans.
The purchase price of a delinquent loan is at the loan's outstanding contractual
balance. 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 31 days or more past due. The foreclosed and delinquent loans we typically
elect to repurchase are usually 90 days or more delinquent and the subject of
foreclosure proceedings, or where a completed foreclosure is imminent. The
related allowance for loan losses on these repurchased loans is included in our
provision for credit losses in the period of repurchase. Our ability to
repurchase these loans does not disqualify us for sale accounting under SFAS No.
140, which was adopted on a prospective basis in the fourth quarter of fiscal
2001, or other relevant accounting literature because we are not required to
repurchase any loan and our ability to repurchase a loan is limited by contract.
85
At June 30, 2003, none of our 25 mortgage securitization trusts were
under a triggering event, an improvement from three trusts at March 31, 2003.
For the fiscal year ended June 30, 2003, we repurchased delinquent loans with an
aggregate unpaid principal balance of $55.0 million from securitization trusts
primarily for trigger management. If delinquencies increase and we cannot cure
the delinquency or liquidate the loans in the mortgage securitization trusts
without exceeding loss triggers, the levels of repurchases required to manage
triggers may increase. Our ability to continue to manage triggers in our
securitization trusts in the future is affected by our availability of cash from
operations or through the sale of subordinated debt to fund these repurchases.
See "Risk Factors -- Delinquencies and prepayments in the pools of securitized
loans could adversely affect the cash flow we receive from our interest-only
strips, impair our ability to sell or securitize loans in the future and impair
our ability to repay the subordinated debt and negatively impact the value of
our common stock." Additionally, our repurchase activity increases prepayments
which may result in unfavorable prepayment experience. See "-- Securitizations"
for more detail of the effect prepayments have on our financial statements. Also
see "Managed Portfolio Quality -- Delinquent Loans and Leases" for further
discussion of the impact of delinquencies.
The following table summarizes the principal balances of loans and REO
we have repurchased from the mortgage loan securitization trusts for fiscal
years 2003, 2002 and 2001. We received $37.6 million, $19.2 million and $10.9
million of proceeds from the liquidation of repurchased loans and REO for fiscal
years 2003, 2002 and 2001, respectively. We had repurchased loans and REO
remaining on our balance sheet in the amounts of $9.6 million, $9.4 million and
$4.8 million at June 30, 2003, 2002 and 2001, respectively. All loans and REO
were repurchased at the contractual outstanding balances at the time of
repurchase and are carried at the lower of their cost basis or fair value.
Because the contractual outstanding balance is typically greater than the fair
value, we generally incur a loss on these repurchases. Mortgage loan
securitization trusts are listed only if repurchases have occurred.
86
Summary of Loans and REO Repurchased from Mortgage Loan Securitization Trusts
(dollars in thousands)
2001-3 2001-1 2000-4 2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1
------ ------ ------ ------ ------ ------ ------ ----- ------ ------
Year ended June 30, 2003:
Business loans ................... $ 349 $ 543 $ 223 $ 144 $ 2,065 $ 1,573 $ 2,719 $ 2,138 $ 1,977 $ 1,199
Home equity loans ................ 853 4,522 520 839 4,322 4,783 5,175 3,697 3,140 4,432
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total .......................... $ 1,202 $ 5,065 $ 743 $ 983 $ 6,387 $ 6,356 $ 7,894 $ 5,835 $ 5,117 $ 5,631
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized ...................... 0.40% 1.84% 0.27% 0.66% 2.11% 2.68% 3.56% 2.63% 2.33% 3.04%
Number of loans repurchased ...... 11 51 9 11 59 65 97 83 59 60
Year ended June 30, 2002:
Business loans ................... $ -- $ -- $ -- $ -- $ -- $ -- $ 194 $ 1,006 $ 341 $ 438
Home equity loans ................ -- -- -- -- -- 84 944 3,249 2,688 2,419
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total .......................... $ -- -- $ -- $ -- $ -- $ 84 $ 1,138 $ 4,255 $ 3,029 $ 2,857
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized ...................... -- -- -- -- -- 0.04% 0.51% 1.92% 1.38% 1.54%
Number of loans repurchased ...... -- -- -- -- -- 2 18 47 31 33
Year ended June 30, 2001:
Business loans ................... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ --
Home equity loans ................ -- -- -- 88 330 -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total .......................... $ -- $ -- $ -- $ 88 $ 330 $ -- $ -- $ -- $ -- $ --
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized ...................... -- -- -- 0.06% 0.11% -- -- -- -- --
Number of loans repurchased ...... -- -- -- 1 2 -- -- -- -- --
(Continued) 1998-4 1998-3 1998-2 1998-1 1997-2 1997-1 1996-2 1996-1 Total
------ ------ ------ ------ ------ ------ ------ ------ -----
Year ended June 30, 2003:
Business loans ................... $ 72 $ 1,455 $ 205 $ 395 $ 30 $ 714 $ 313 $ 138 $16,252
Home equity loans ................ 549 3,211 1,386 610 224 157 355 -- 38,775
------- ------- ------- ------- ------- ------- ------- ------- -------
Total .......................... $ 621 $ 4,666 $ 1,591 $ 1,005 $ 254 $ 871 $ 668 $ 138 $55,027
======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized ...................... 0.78% 2.33% 1.33% 0.96% 0.34% 0.87% 3.04% 0.35%
Number of loans repurchased ...... 7 60 23 13 4 12 12 1 637
Year ended June 30, 2002:
Business loans ................... $ 632 $ 260 $ 516 $ 1,266 $ 1,729 $ 183 $ -- $ 104 $ 6,669
Home equity loans ................ 4,649 5,575 1,548 1,770 223 239 60 123 23,571
------- ------- ------- ------- ------- ------- ------- ------- -------
Total .......................... $ 5,281 $ 5,835 $ 2,064 $ 3,036 $ 1,952 $ 422 $ 60 $ 227 $30,240
======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized ...................... 6.60% 2.92% 1.72% 2.89% 1.95% 0.56% 0.15% 1.03%
Number of loans repurchased ...... 58 61 24 37 18 8 1 3 341
Year ended June 30, 2001:
Business loans ................... $ 173 $ 803 $ 215 $ 428 $ 2,252 $ -- $ 380 $ 250 $ 4,501
Home equity loans ................ 1,310 3,886 1,284 1,686 1,764 -- 92 109 10,549
------- ------- ------- ------- ------- ------- ------- ------- -------
Total .......................... $ 1,483 $ 4,689 $ 1,499 $ 2,114 $ 4,016 $ -- $ 472 $ 359 $15,050
======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized ...................... 1.85% 2.34% 1.25% 2.01% 4.02% -- 1.18% 1.63%
Number of loans repurchased ...... 10 48 13 31 37 -- 8 4 154
87
SFAS No. 140 was effective on a prospective basis for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. SFAS No. 140 requires that we record an obligation to repurchase
loans from securitization trusts at the time we have the contractual right to
repurchase the loans, whether or not we actually repurchase them. For
securitization trusts 2001-2 and forward, to which this rule applies, we have
the contractual right to repurchase a limited amount of loans greater than 180
days past due. In accordance with the provisions of SFAS No. 140, we have
recorded on our June 30, 2003 balance sheet a liability of $27.9 million for the
repurchase of loans subject to these removal of accounts provisions. A
corresponding asset for the loans, at the lower of their cost basis or fair
value, has also been recorded.
88
Mortgage Loan Securitization Trust Information. The following tables
provide 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, 2003
(dollars in millions)
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 2001-1 2000-4
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Original balance of loans
securitized:
Business loans ................... $ 33 $ 30 $ 34 $ 34 $ 32 $ 29 $ 31 $ 35 $ 29 $ 27
Home equity loans ................ 417 350 336 346 288 287 269 320 246 248
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ............................ $ 450 $ 380 $ 370 $ 380 $ 320 $ 316 $ 300 $ 355 $ 275 $ 275
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Current balance of loans
securitized:
Business loans ................... $ 32 $ 28 $ 30 $ 30 $ 26 $ 23 $ 22 $ 26 $ 19 $ 15
Home equity loans ................ 410 324 283 259 190 163 139 146 103 93
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ............................ $ 442 $ 352 $ 313 $ 289 $ 216 $ 186 $ 161 $ 172 $ 122 $ 108
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Weighted-average interest rate on
loans securitized:
Business loans ................... 15.89% 16.00% 15.94% 16.01% 15.76% 15.80% 15.95% 15.95% 16.05% 16.11%
Home equity loans ................ 9.77% 10.53% 10.85% 10.91% 10.84% 10.70% 11.10% 11.22% 11.43% 11.61%
Total ............................ 10.21% 10.96% 11.34% 11.44% 11.43% 11.32% 11.76% 11.94% 12.16% 12.26%
Percentage of first mortgage loans . 86% 86% 87% 86% 90% 90% 89% 90% 89% 85%
Weighted-average loan-to-value ... 77% 76% 77% 77% 76% 77% 76% 76% 75% 76%
Weighted-average remaining term
(months) on loans securitized .... 267 260 253 240 234 232 223 220 216 206
Original balance of Trust
Certificates ..................... $ 450 $ 376 $ 370 $ 380 $ 320 $ 322 $ 306 $ 355 $ 275 $ 275
Current balance of Trust
Certificates ..................... $ 437 $ 339 $ 302 $ 276 $ 201 $ 172 $ 149 $ 157 $ 111 $ 95
Weighted-average pass-through
interest rate to Trust
Certificate holders(a) ........... 5.03% 5.87% 6.87% 7.48% 6.84% 5.35% 5.73% 8.11% 7.73% 7.05%
Highest Trust Certificate
pass-through interest rate ....... 3.78% 8.61% 6.86% 7.39% 6.51% 5.35% 6.14% 6.99% 6.28% 7.05%
Overcollateralization requirements:
Required percentages:
Initial .......................... -- 1.00% -- -- -- -- -- -- -- --
Final target ..................... 5.50% 5.75% 3.50% 3.50% 4.50% 4.25% 4.00% 4.40% 4.10% 4.50%
Stepdown overcollateralization ... 11.00% 11.50% 7.00% 7.00% 9.00% 8.50% 8.00% 8.80% 8.20% 9.00%
Required dollar amounts:
Initial .......................... -- $ 4 -- -- -- -- -- -- -- --
Final target ..................... $ 25 $ 22 $ 13 $ 13 $ 14 $ 13 $ 12 $ 16 $ 11 $ 12
Current status:
Overcollateralization amount ..... $ 5 $ 13 $ 11 $ 13 $ 15 $ 14 $ 12 $ 15 $ 11 $ 13
Final target reached or
anticipated date to reach ...... 10/2004 3/2004 9/2003 7/2003 7/2003 7/2003 Yes Yes Yes Yes
Stepdown reached or anticipated
date to reach .................. 9/2006 3/2006 10/2006 7/2005 10/2004 7/2004 4/2004 1/2004 10/2003 1/2004
Annual surety wrap fee ............. 0.20% (b) (b) (b) 0.21% 0.20% 0.20% 0.20% 0.20% 0.21%
Servicing rights:
Original balance ................. $ 16 $ 14 $ 13 $ 15 $ 13 $ 13 $ 12 $ 15 $ 11 $ 14
Current balance .................. $ 16 $ 13 $ 11 $ 11 $ 9 $ 7 $ 7 $ 7 $ 5 $ 5
- -------------
(a) Rates for securitizations 2001-1 and forward include rates on notional
bonds, or the impact of premiums to loan collateral received on trust
certificates, included in securitization structure. The sale of notional
bonds allows us to receive more cash at the closing of a securitization. See
"-- Year Ended June 30, 2003 Compared to Year Ended June 30, 2002 -- Gain on
Sale of Loans -- Securitizations" for further description of the notional
bonds.
(b) Credit enhancement was provided through a senior / subordinate certificate
structure.
89
Summary of Selected Mortgage Loan Securitization Trust Information (Continued)
Current Balances as of June 30, 2003
(dollars in millions)
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998(a) 1997(a) 1996(a)
------ ------ ------ ------ ------ ------ ------ ------- ------- -------
Original balance of loans
securitized:
Business loans ................... $ 16 $ 28 $ 25 $ 25 $ 28 $ 30 $ 16 $ 57 $ 45 $ 29
Home equity loans ................ 134 275 212 197 194 190 169 448 130 33
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ............................ $ 150 $ 303 $ 237 $ 222 $ 222 $ 220 $ 185 $ 505 $ 175 $ 62
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Current balance of loans securitized:
Business loans ................... $ 8 $ 14 $ 12 $ 11 $ 11 $ 11 $ 6 $ 14 $ 10 $ 5
Home equity loans ................ 50 97 69 71 66 71 54 111 21 5
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ............................ $ 58 $ 111 $ 81 $ 82 $ 77 $ 82 $ 60 $ 125 $ 31 $ 10
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Weighted-average interest rate on
loans securitized:
Business loans ................... 16.06% 16.04% 16.03% 16.09% 15.78% 15.71% 15.96% 15.93% 15.91% 15.89%
Home equity loans ................ 11.42% 11.43% 11.35% 11.05% 10.85% 10.46% 10.66% 10.80% 11.55% 11.00%
Total ............................ 12.09% 12.03% 12.03% 11.73% 11.54% 11.20% 11.17% 11.37% 12.93% 13.73%
Percentage of first mortgage loans . 88% 83% 80% 85% 87% 89% 93% 90% 77% 75%
Weighted-average loan-to-value ..... 77% 77% 77% 76% 77% 76% 77% 77% 74% 66%
Weighted-average remaining term
(months) on loans securitized .... 205 214 203 200 204 213 209 191 149 110
Original balance of Trust
Certificates ..................... $ 150 $ 300 $ 235 $ 220 $ 219 $ 219 $ 184 $ 498 $ 171 $ 61
Current balance of Trust
Certificates ..................... $ 51 $ 98 $ 72 $ 73 $ 69 $ 74 $ 54 $ 112 $ 27 $ 7
Weighted-average pass-through
interest rate to Trust
Certificate holders .............. 7.61% 7.06% 7.06% 6.87% 6.79% 6.64% 6.56% 6.30% 7.19% 7.67%
Highest Trust Certificate
pass-through interest rate ....... 7.61% 8.04% 7.93% 7.68% 7.49% 7.13% 6.58% 6.86% 7.53% 7.95%
Overcollateralization requirements:
Required percentages:
Initial .......................... -- 0.90% 0.75% 1.00% 1.00% 0.50% 0.50% 1.50% 2.43% 1.94%
Final target ..................... 4.75% 5.95% 5.95% 5.50% 5.00% 5.00% 5.00% 5.10% 7.43% 8.94%
Stepdown overcollateralization ... 9.50% 11.90% 11.90% 11.00% 10.00% 10.00% 10.00% 10.21% 14.86% 12.90%
Required dollar amounts:
Initial .......................... -- $ 3 $ 2 $ 2 $ 2 $ 1 $ 1 $ 7 $ 4 $ 1
Final target ..................... $ 7 $ 18 $ 14 $ 12 $ 11 $ 11 $ 9 $ 26 $ 13 $ 6
Current status:
Overcollateralization amount ..... $ 7 $ 13 $ 9 $ 9 $ 8 $ 8 $ 6 $ 13 $ 4 $ 3
Final target reached or
anticipated date to reach ...... Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Stepdown reached or anticipated
date to reach .................. 10/2003 7/2003 Yes Yes Yes Yes Yes Yes Yes Yes
Annual surety wrap fee ............. 0.21% 0.21% 0.19% 0.21% 0.21% 0.19% 0.19% 0.22% 0.26% 0.18%
Servicing rights:
Original balance ................. $ 7 $ 14 $ 10 $ 10 $ 10 $ 10 $ 8 $ 18 $ 7 $ 4
Current balance .................. $ 3 $ 5 $ 3 $ 3 $ 3 $ 3 $ 2 $ 3 $ 1 $ 1
- ------------------
(a) Amounts represent combined balances and weighted-average percentages for
four 1998 securitization pools, two 1997 securitization pools and two 1996
securitization pools.
Discounted Cash Flow Analysis. The estimation 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 residual cash flows and
overcollateralization cash flows utilizing assumptions made by management at the
time loans are sold. These assumptions include the rates used to calculate the
present value of expected future residual cash flows and overcollateralization
cash flows, referred to as the discount rates, prepayment rates and credit loss
rates on the pool of loans. These assumptions are monitored against actual
experience and other economic and market conditions and are changed if deemed
appropriate. Our methodology for determining the discount rates, prepayment
rates and credit loss rates used to calculate the fair value of our
interest-only strips is described below.
90
Discount rates. We use discount rates, which we believe are
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-conforming 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.
In determining the discount rate that we apply to residual cash flows,
we follow what we believe to be the practice of other companies in the
non-conforming mortgage industry. That is, to determine the discount rate by
adding an interest rate spread to the all-in cost of securitizations to account
for the risks involved in securitization assets. The all-in cost of the
securitization 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, where applicable, generally
range from 19 to 22 basis points combined. From industry experience comparisons
and our evaluation of the risks inherent in our securitization assets, we have
determined an interest rate spread, which is added to the all-in cost of our
mortgage loan securitization trusts' investor certificates. From June 30, 2000
through March 31, 2003, we had applied a discount rate of 13% to residual cash
flows. On June 30, 2003, we reduced that discount rate to 11% based on the
following factors:
o We have experienced a period of sustained decreases in market
interest rates. Interest rates on three and five-year term US
Treasury securities have been on the decline since mid-2000.
Three-year rates have declined approximately 475 basis points
and five-year rates have declined approximately 375 basis
points.
o The interest rates on the bonds issued in our securitizations
over this same timeframe also have experienced a sustained
period of decline. The highest trust certificate pass-through
interest rate has declined 426 basis points, from 8.04% in the
2000-2 securitization to 3.78% in the 2003-1 securitization.
o The weighted average interest rate on loans securitized has
declined from a high of 12.01% in the 2000-3 securitization to
10.23% in the 2003-1 securitization.
o Market factors and the economy favor the continuation of low
interest rates for the foreseeable future.
o Economic analysis of interest rates and data currently being
released support declining mortgage refinancings even though
predicting the continuation of low interest rates for the
foreseeable future.
o The interest rates paid on recently issued subordinated debt,
which is used to fund our interest-only strips, has declined
from a high of 11.85% in February 2001 to a current rate of
7.49% in June 2003.
However, because the discount rate is applied to projected cash flows,
which consider expected prepayments and losses, the discount rate assumption was
not evaluated in isolation. These risks involved in our securitization assets
were considered in establishing a discount rate. The impact of this reduction in
discount rate from 13% to 11% was to increase the valuation of our interest-only
strips by $17.6 million at June 30, 2003. The 11% discount rate that we apply to
our residual cash flow portion of our interest-only strips compared to rates
used by others in the industry reflects our historically 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:
91
o Underlying loan collateral with fixed interest rates, which are
higher than others in the non-conforming mortgage industry.
Average interest rate of securitized loans exceeds the industry
average by 100 basis points or more. All of the securitized
loans have fixed interest rates, which are more predictable than
adjustable rate loans.
o At origination, approximately 90% to 95% of securitized business
purpose loans have prepayment fees and approximately 80% to 85%
of securitized home equity loans have prepayment fees. Currently
in our managed portfolio, approximately 50% to 55% of
securitized business purpose loans have prepayment fees and
approximately 60% to 65% of securitized home equity loans have
prepayment fees. Our historical experience indicates that
prepayment fees lengthen the prepayment ramp periods and slow
annual prepayment speeds, which have the effect of increasing
the life of the securitized loans.
o A portfolio mix of first and second mortgage loans of 80-85% and
15-20%, respectively. Historically, the high proportion of first
mortgages has resulted in lower delinquencies and losses.
o A portfolio credit grade mix comprised of 60% A credits, 23% B
credits, 14% C credits, and 3% D credits. In addition, our
historical loss experience is below what is experienced by
others in the non-conforming mortgage industry.
We apply a second discount rate to projected cash flows from the
overcollateralization portion of our interest-only strips. The discount rate
applied to projected overcollateralization cash flows in each mortgage
securitization is based on the highest trust certificate pass-through interest
rate in the mortgage securitization. In fiscal 2001, we instituted the use of a
minimum discount rate of 6.5% on overcollateralization cash flows. At June 30,
2003 we reduced the minimum discount rate to 5.0% to reflect the sustained
decline in interest rates. This reduction in the minimum discount rate impacted
the valuation of three securitizations and increased the June 30, 2003 valuation
of our interest-only strips by $3.3 million. At June 30, 2003, the average
discount rate applied to projected overcollateralization cash flows was 7%. This
discount rate is lower than the discount rate applied to residual cash flows
because the risk characteristics of the projected overcollateralization cash
flows do not include prepayment risk and have minimal credit risk. For example,
if the entire unpaid principal balance in a securitized pool of loans was
prepaid by borrowers, we would fully recover the overcollateralization portion
of the interest-only strips. In addition, historically, these
overcollateralization balances have not been impacted by credit losses as the
residual cash flow portion of our interest-only strips has always been
sufficient to absorb credit losses and stepdowns of overcollateralization have
generally occurred as scheduled. Overcollateralization represents our investment
in the excess of the aggregate principal balance of loans in a securitized pool
over the aggregate principal balance of trust certificates.
The blended discount rate used to value the interest-only strips,
including the overcollateralization cash flows, was 9% at June 30, 2003.
92
Prepayment rates. The assumptions we use to estimate future prepayment
rates are regularly compared to actual prepayment experience of the individual
securitization pools of mortgage loans and an average of the actual experience
of other similar pools of mortgage loans at the same number of months after
their inception. It is our practice to use an average historical prepayment rate
of similar pools for the expected constant prepayment rate assumption while a
pool of mortgage loans is less than a year old even though actual experience may
be different. During this period, before a pool of mortgage loans reaches its
expected constant prepayment rate, actual experience both quantitatively and
qualitatively is generally not sufficient to conclude that final actual
experience for an individual pool of mortgage loans would be materially
different from the average. For pools of mortgage loans greater than one year
old, prepayment experience trends for an individual pool is considered to be
more significant. For these pools, adjustments to prepayment assumptions may be
made to more closely conform the assumptions to actual experience if the
variance from average experience is significant and is expected to continue.
Current economic conditions, current interest rates and other factors are also
considered in our analysis.
As was previously discussed, for the past seven quarters, our actual
prepayment experience was generally higher, most significantly on home equity
loans, than our historical averages for prepayments. See "-- Off-Balance Sheet
Arrangements -- Securitizations" for further detail of our recent prepayment
experience.
In addition to the use of prepayment fees on our loans, we have
implemented programs and strategies in an attempt to reduce loan prepayments in
the future. These programs and strategies may include providing information to a
borrower regarding costs and benefits of refinancing, which at times may
demonstrate a refinancing option is not in the best economic interest of the
borrower. Other strategies include offering second mortgages to existing
qualified borrowers or offering financial incentives to qualified borrowers to
deter prepayment of their loan. We cannot predict with certainty what the impact
these efforts will have on our future prepayment experience.
Credit loss rates. Credit loss rates are analyzed in a similar manner
to prepayment rates. Credit loss assumptions are compared to actual loss
experience averages for similar mortgage loan pools and for individual mortgage
loan pools. Delinquency trends and economic conditions are also considered. If
our analysis indicates that loss experience may be different from our
assumptions, we would adjust our assumptions as necessary.
Floating interest rate certificates. Some of the securitization trusts
have issued floating interest rate certificates supported by fixed interest rate
mortgages. The fair value of the excess cash flow we will receive may be
affected by any changes in the interest rates paid on the floating interest rate
certificates. The interest rates paid on the floating interest rate certificates
are based on one-month LIBOR. The assumption used to estimate the fair value of
the excess cash flows received from these securitization trusts is based on a
forward yield curve. See "--Interest Rate Risk Management -- Strategies for Use
of Derivative Financial Instruments" for further detail of our management of the
risk of changes in interest rates paid on floating interest rate certificates.
93
Sensitivity analysis. The table below outlines the sensitivity of the
current fair value of our interest-only strips and servicing rights to 10% and
20% adverse changes in the key assumptions used in determining the fair value of
those assets. Our base prepayment, loss and discount rates are described in the
table "Summary of Material Mortgage Loan Securitization Valuation Assumptions
and Actual Experience." (dollars in thousands):
Securitized collateral balance.....................................$ 3,354,071
Balance sheet carrying value of retained interests (a).............$ 717,569
Weighted-average collateral life (in years)........................ 3.9
- -------------------------
(a) Amount includes interest-only strips and servicing rights.
Sensitivity of assumptions used to determine the fair value of retained
interests (dollars in thousands):
Impact of
Adverse Change
---------------------------
10% Change 20% Change
---------- ----------
Prepayment speed.......................... $ 29,916 $ 56,656
Credit loss rate.......................... 5,247 10,495
Floating interest rate certificates (a)... 829 1,614
Discount rate............................. 20,022 38,988
- -------------------------
(a) The floating interest rate certificates are indexed to one-month LIBOR plus
a trust specific interest rate spread. The base one-month LIBOR assumption
used in this sensitivity analysis was derived from a forward yield curve
incorporating the effect of rate caps where applicable to the individual
deals.
The sensitivity analysis in the table above is hypothetical and should
be used with caution. As the figures indicate, changes in fair value based on a
10% or 20% variation in management's assumptions generally cannot easily be
extrapolated because the relationship of the change in the assumptions to the
change in fair value may not be linear. Also, in this table, the effect that a
change in a particular assumption may have on the fair value is calculated
without changing any other assumption. Changes in one assumption may result in
changes in other assumptions, which might magnify or counteract the impact of
the intended change.
These sensitivities reflect the approximate amount of the fair values
that our interest-only strips and servicing rights would be reduced for the
indicated adverse changes. These reductions would result in a charge to expense
in the income statement in the period incurred and a resulting reduction of
stockholders' equity, net of income taxes. The effect on our liquidity of
changes in the fair values of our interest-only strips and servicing rights are
discussed in "-- Liquidity and Capital Resources."
94
The following tables provide information regarding the initial and
current assumptions applied in determining the fair values of mortgage loan
related interest-only strips and servicing rights for each securitization trust.
Summary of Material Mortgage Loan Securitization
Valuation Assumptions and Actual Experience at June 30, 2003
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 2001-1 2000-4
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Interest-only strip residual discount rate:
Initial valuation......................... 13% 13% 13% 13% 13% 13% 13% 13% 13% 13%
Current valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation......................... 7% 9% 7% 7% 7% 7% 7% 7% 6% 7%
Current valuation........................ 5% 9% 7% 7% 7% 5% 6% 7% 6% 7%
Servicing rights discount rate:
Initial valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Current valuation......................... 9% 9% 9% 9% 9% 9% 9% 9% 9% 9%
Prepayment rates:
Initial assumption (a):
Expected Constant Prepayment Rate (CPR):
Business loans.......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 10%
Home equity loans....................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 24%
Ramp period (months):
Business loans.......................... 27 27 27 27 27 27 24 24 24 24
Home equity loans....................... 30 30 30 30 30 30 30 30 30 24
Current assumptions (b):
Expected Constant Prepayment Rate (CPR):
Business loans ......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Home equity loans ...................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 22%
Ramp period (months):
Business loans.......................... 27 27 27 27 27 27 27 27 27 27
Home equity loans....................... 30 30 30 30 30 30 30 30 30 30
CPR adjusted to reflect ramp:
Business loans.......................... 5% 8% 10% 12% 15% 17% 20% 22% 22% 19%
Home equity loans....................... 15% 32% 40% 51% 42% 46% 40% 40% 37% 41%
Current prepayment experience (c):
Business loans.......................... 8% 5% 13% 12% 15% 23% 19% 9% 21% 23%
Home equity loans....................... 5% 9% 20% 28% 39% 42% 40% 37% 36% 37%
Annual credit loss rates:
Initial assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Current assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.50% 0.40%
Actual experience......................... -- -- 0.03% 0.03% 0.03% 0.12% 0.24% 0.17% 0.43% 0.36%
Servicing fees:
Contractual fees.......................... 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.70%
Ancillary fees............................ 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
- -----------------
(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 ramps to an expected peak rate over 27 months
then declines to the final expected CPR by month 40. The home equity loan
prepayment ramp begins at 2% in month one and ramps to an expected rate over
30 months.
(b) Current assumptions for business loans are the estimated expected
weighted-average prepayment rates over the securitization's estimated
remaining life. The majority of the home equity loan prepayment rate ramps
have been increased for the next 6 months to provide for the expected near
term continuation of higher than average prepayment. Generally, trusts for
both business and home equity loans that are out of the ramping period are
based on historical averages.
(c) Current experience is a six-month historical average.
95
Summary of Material Mortgage Loan Securitization
Valuation Assumptions and Actual Experience at June 30, 2003 (Continued)
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998(d) 1997(d) 1996(d)
------ ------ ------ ------ ------ ------ ------ ------- ------- -------
Interest-only strip residual discount rate:
Initial valuation........................ 13% 13% 11% 11% 11% 11% 11% 11% 11% 11%
Current valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation......................... 8% 8% 8% 8% 7% 7% 7% 7% 7% 8%
Current valuation......................... 8% 8% 8% 8% 7% 7% 7% 7% 7% 8%
Servicing rights discount rate:
Initial valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Current valuation........................ 9% 9% 9% 9% 9% 9% 9% 9% 9% 9%
Prepayment rates:
Initial assumption (a):
Expected Constant Prepayment Rate (CPR):
Business loans ........................ 10% 10% 10% 10% 10% 10% 10% 13% 13% 13%
Home equity loans...................... 24% 24% 24% 24% 24% 24% 24% 24% 24% 24%
Ramp period (months):
Business loans......................... 24 24 24 24 24 24 24 24 24 24
Home equity loans...................... 24 24 18 18 18 18 18 12 12 12
Current assumptions (b):
Expected Constant Prepayment Rate (CPR):
Business loans ........................ 11% 11% 11% 11% 10% 10% 10% 10% 22% 14%
Home equity loans...................... 22% 22% 22% 22% 22% 22% 22% 23% 25% 25%
Ramp period (months):
Business loans......................... 27 Na Na Na Na Na Na Na Na Na
Home equity loans...................... 30 30 Na Na Na Na Na Na Na Na
CPR adjusted to reflect ramp:
Business loans......................... 16% 13% 23% 35% 29% 27% 30% 20% 20% 10%
Home equity loans...................... 32% 31% 37% 33% 32% 29% 26% 33% 22% 13%
Current prepayment experience (c):
Business loans......................... 23% 15% 23% 35% 29% 26% 30% 18% 19% 3%
Home equity loans...................... 32% 31% 37% 32% 32% 29% 25% 33% 21% 13%
Annual credit loss rates:
Initial assumption....................... 0.40% 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Current assumption....................... 0.45% 0.45% 0.65% 0.65% 0.60% 0.35% 0.55% 0.60% 0.40% 0.45%
Actual experience........................ 0.41% 0.41% 0.65% 0.63% 0.58% 0.35% 0.49% 0.57% 0.36% 0.42%
Servicing fees:
Contractual fees......................... 0.50% 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% 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 ramps to an expected peak rate over 27 months
then declines to the final expected CPR by month 40. The home equity loan
prepayment ramp begins at 2% in month one and ramps to an expected rate over
30 months.
(b) Current assumptions for business loans are the estimated expected
weighted-average prepayment rates over the securitization's estimated
remaining life. Generally, trusts for both business and home equity loans
that are out of the ramping period are based on historical averages.
(c) Current experience is a six-month historical average.
(d) Amounts represent weighted-average percentages for four 1998 securitization
pools, two 1997 securitization pools and two 1996 securitization pools.
Na = not applicable
96
Servicing Rights. As the holder of servicing rights on securitized
loans, we are entitled to receive annual contractual servicing fees of 50 basis
points (70 basis points in the case of the 2000-4 securitization) on the
aggregate outstanding loan balance. These fees are paid out of accumulated
mortgage loan payments before payments of principal and interest are made to
trust certificate holders. In addition, ancillary fees such as prepayment fees,
late charges, nonsufficient fund fees and other fees are retained directly by
us, as servicer, as payments are collected from the borrowers. We also retain
the interest paid on funds held in a trust's collection account until these
funds are distributed from a trust.
The fair value of servicing rights is determined by computing the
benefits of servicing in excess of adequate compensation, which would be
required by a substitute servicer. The benefits of servicing are the present
value of projected net cash flows from contractual servicing fees and ancillary
servicing fees. 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. On a
quarterly basis, we evaluate capitalized servicing rights for impairment, which
is measured as the excess of unamortized cost over fair value. See
"--Securitizations" for a discussion of the $5.3 million write down of servicing
rights recorded in fiscal 2003.
From June 2000 to March 2003, the discount rate applied in determining
the fair value of servicing rights was 11% which is 200 basis points lower than
the 13% discount rate applied to value residual cash flows from interest-only
strips during that period. On June 30, 2003, we reduced the discount rate on
servicing rights cash flows to 9%. In determining the discount rate applied to
calculate the present value of cash flows from servicing rights, management has
subtracted a factor from the discount rate used to value residual cash flows
from interest-only strips to provide for the lower risks inherent in servicing
assets. Unlike the interest-only strips, the servicing asset is not exposed to
credit losses. Additionally, the distribution of the contractual servicing fee
cash flow from the securitization trusts is senior to both the trusts' investor
certificates and our interest-only strips. This priority of cash flow reduces
the risks associated with servicing rights and thereby supports a lower discount
rate than the rate applied to residual cash flows from interest-only strips.
Cash flows related to ancillary servicing fees, such as prepayment fees, late
fees, and non-sufficient fund fees are retained directly by us.
The impact of this reduction in discount rate from 11% to 9% was to
increase the valuation of our servicing rights by $7.1 million at June 30, 2003.
This favorable impact was offset by a decrease of $12.4 million mainly due to
prepayment experience in fiscal 2003.
Servicing rights can be terminated under certain circumstances, such as
our failure to make required servicer payments, defined changes of control and
reaching specified loss levels on underlying mortgage pools.
The origination of a high percentage of loans with prepayment fees
impacts our servicing rights and 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.
97
In addition, although prepayments increased in recent periods compared
to our historical averages, we have generally found that the non-conforming
mortgage market is less sensitive to prepayments due to changes in interest
rates than the conforming 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' opportunities to refinance. Second, interest rates available to
non-conforming borrowers tend to adjust much slower than conforming mortgage
interest rates which reduces the non-conforming borrowers' opportunity to
capture economic value from refinancing.
As a result of the use of prepayment fees and the reduced sensitivity
to interest rate changes in the non-conforming mortgage market, we believe the
prepayment experience on our managed portfolio is more stable than the mortgage
market in general. We believe this stability has favorably impacted our ability
to value the future cash flows from our servicing rights and interest-only
strips because it increased the predictability of future cash flows. However,
for the past six quarters, our prepayment experience has exceeded our
expectations for prepayments on our managed portfolio and as a result we have
written down the value of our securitization assets. See "-- Off-Balance Sheet
Arrangements -- Securitizations" for further detail of the effects prepayments
that were above our expectations have had on the value of our securitization
assets.
Whole Loan Sales
We also sell loans with servicing released, which we refer to as whole
loan sales. Gains on whole loan sales equal the difference between the net
proceeds from such sales and the net carrying value of the loans. The net
carrying value of a loan is equal to its principal balance plus its unamortized
origination costs and fees. See "-- Off-Balance Sheet Arrangements --
Securitizations" for information on the volume of whole loan sales and premiums
recorded for fiscal years ended June 30, 2003, 2002 and 2001. Loans reported as
sold on a whole loan basis were generally loans that we originated specifically
for a whole loan sale and exclude impaired loans, which may be liquidated by
selling the loan with servicing released. However, see "-- Business
Strategy" for detail on our adjustment in business strategy from originating
loans predominantly for publicly underwritten securitizations, to originating
loans for a combination of whole loan sales and smaller securitizations. Also,
see "Business -- Whole Loan Sales."
98
Results of Operations
Summary Financial Results
(dollars in thousands, except per share data)
Year Ended June 30, Percentage Change
--------------------------------- -----------------
2003 2002 2001 '03/'02 '02/'01
------ ------ ------ ------- -------
Total revenues............ $ 241,406 $ 247,901 $ 183,336 (2.6)% 35.2%
Total expenses............ $ 290,426 $ 234,351 $ 170,151 23.9% 37.7%
Net income (loss)......... $ (29,902) $ 7,859 $ 8,085 (480.5)% (2.8)%
Return on average assets.. (3.07)% 0.94% 1.22%
Return on average equity.. (44.20)% 11.75% 12.22%
Earnings (loss) per share:
Basic............. $ (10.25) $ 2.68 $ 2.13 (482.5)% 25.8%
Diluted........... $ (10.25) $ 2.49 $ 2.08 (511.6)% 19.7%
Dividends declared per
share................... $ 0.32 $ 0.28 $ 0.26 14.3% 7.7%
Overview
Fiscal Year Ended June 30, 2003. For fiscal 2003, a net loss of $29.9
million was recorded as compared to $7.9 million net income for fiscal 2002. The
loss was primarily due to our inability to complete our typical quarterly
securitization of loans during the fourth quarter of our fiscal year as well as
$45.2 million of pre-tax charges for valuation adjustments recorded on our
securitization assets during the 2003 fiscal year, compared to $22.1 million of
pre-tax charges for valuation adjustments in fiscal 2002.
During fiscal 2003, we charged to the income statement total pre-tax
valuation adjustments on our interest-only strips and servicing rights of $63.1
million, which primarily reflect the impact of higher than anticipated
prepayments on securitized loans experienced in fiscal 2003 due to the low
interest rate environment experienced during fiscal 2003. The pre-tax valuation
adjustments charged to the income statement were partially offset by $17.9
million due to the impact of a decrease in the discount rates used to value our
securitization assets, resulting in the $45.2 million of pre-tax charges for net
valuation adjustments charged to the income statement. We reduced the discount
rates on our interest-only strips and our servicing rights primarily to reflect
the impact of the sustained decline in market interest rates. The discount rate
on the projected residual cash flows from our interest-only strips was reduced
from 13% to 11% at June 30, 2003. The discount rate used to determine the fair
value of the overcollateralization portion of the cash flows from our
interest-only strips was minimally impacted by the decline in interest rates and
remained at 7% on average. As a result, the blended rate used to value our
interest-only strips, including the overcollateralization cash flows, was 9% at
June 30, 2003. The discount rate on our servicing rights was reduced from 11% to
9% at June 30, 2003. See "-- Off-Balance Sheet Arrangements -- Securitizations,"
"-- Off-Balance Sheet Arrangements -- Securitizations -- Discount rates" and "--
Off-Balance Sheet Arrangements -- Securitizations -- Servicing rights" for more
detail.
The diluted loss per common share for fiscal 2003 was $10.25 per share
on average common shares of 2,918,000 compared to diluted net income per share
of $2.49 per share on average common shares of 3,155,000 for fiscal 2002.
Dividends of $0.32 and $0.28 per share were paid for the fiscal years ended June
30, 2003 and 2002, respectively. The common dividend payout ratio based on
diluted earnings per share was 11.2% for fiscal 2002.
In fiscal 1999, the Board of Directors initiated a stock repurchase
program in view of the price level of our common stock, which at the time traded
and has continued to trade at below book value. In addition, our consistent
earnings growth at that time did not result in a corresponding increase in the
market value of our common stock. The repurchase program was extended in fiscal
2000, 2001 and 2002. The total number of shares repurchased under the stock
repurchase program was: 117,000 shares in fiscal 1999; 327,000 shares in fiscal
2000; 627,000 shares in fiscal 2001; and 352,000 shares in fiscal 2002. The
cumulative effect of the stock repurchase program was an increase in diluted net
earnings per share of $0.41 and $0.32 for the years ended 2002 and 2001,
respectively. We currently have no plans to continue to repurchase additional
shares or extend the repurchase program.
99
On August 21, 2002, the Board of Directors declared a 10% stock
dividend, which was paid on September 13, 2002 to shareholders of record on
September 3, 2002. As a result of the stock dividend, all outstanding stock
options and related exercise prices were adjusted. Accordingly, we adjusted all
outstanding common shares, earnings per common share, average common share and
stock option amounts presented in this document to reflect the effect of this
stock dividend. Amounts presented for fiscal 2001 and 2000 have been similarly
adjusted for the effect of a 10% stock dividend declared on October 1, 2001
which was paid on November 5, 2001 to shareholders of record on October 22,
2001.
In December 2002, the Company's shareholders approved an increase in
the number of shares of authorized preferred stock from 1.0 million shares to
3.0 million shares. The preferred shares may be used to raise equity capital,
redeem outstanding debt or acquire other companies, although no such
acquisitions are currently contemplated. The Board of Directors has discretion
with respect to designating and establishing the terms of each series of
preferred stock prior to issuance.
The following schedule details our loan originations during the fiscal
years ended June 30, 2003, 2002 and 2001 (in thousands):
Year Ended June 30,
--------------------------------------
2003 2002 2001
---------- ---------- ----------
Business purpose loans....... $ 122,790 $ 133,352 $ 120,537
Home equity loans............ 1,543,730 1,246,505 1,096,440
---------- ---------- ----------
$1,666,520 $1,379,857 $1,216,977
========== ========== ==========
Loan originations for our subsidiary, American Business Credit, Inc.,
which offers business purpose loans secured by real estate, decreased $10.6
million, or 7.9%, for the year ended June 30, 2003, to $122.8 million from
$133.4 million for the year ended June 30, 2002. Current economic conditions
have had an adverse impact on smaller businesses and our ability to find
qualified borrowers has become more difficult. Due to less favorable response
for our business purpose loans in the whole loan sale market, pursuant to our
business strategy, we plan to continue to originate business purpose loans, but
at lower volumes to meet demand in the whole loan sale and securitization
markets.
Home equity loans originated by our subsidiaries, HomeAmerican Credit,
doing business as Upland Mortgage and American Business Mortgage Services, Inc.,
and purchased through the Bank Alliance Services program, increased $297.2
million, or 23.8%, for the year ended June 30, 2003, to $1.5 billion from $1.2
billion for the year ended June 30, 2002. Our home equity loan origination
subsidiaries continue to focus on increasing efficiencies and productivity gains
by refining marketing techniques and integrating technological improvements into
the loan origination process. In addition, American Business Mortgage Services,
Inc. is focusing on its broker relationships, a lower cost source of
originations, in executing our new business strategy in the future. As a result
of these efforts, as well as the favorable environment for originating home
equity loans due to low interest rates, American Business Mortgage Services,
Inc. home equity loan originations for the fiscal year ended June 30, 2003
increased by $157.4 million, or 32.4%, over the prior year period. In addition,
the historically low interest rate environment and productivity gains in our
Upland Mortgage branch operations have resulted in an increase in loan
originations of $33.1 million, or 26.0%, over the prior year period. The Bank
Alliance Services program's loan originations for the fiscal year ended June 30,
2003 increased $56.0 million, or 38.4%, over the comparable prior year period.
Based on our business strategy, which emphasizes whole loan sales and smaller
securitizations and reducing costs, effective June 30, 2003 we no longer
originate loans through our retail branches, which were a high cost origination
channel, and plan to increase our focus on broker and Bank Alliance Services'
origination sources.
100
Year Ended June 30, 2003 Compared to Year Ended June 30, 2002
Total Revenues. For fiscal 2003, total revenues decreased $6.5 million,
or 2.6%, to $241.4 million from $247.9 million for fiscal 2002. Our inability to
complete our typical quarterly securitization of loans during the fourth quarter
of our fiscal year accounted for this decrease in total revenues.
Gain on Sale of Loans - Securitizations. For the year ended June 30,
2003, gains of $171.0 million were recorded on the securitization of $1.4
billion of loans. This was a decrease of $14.6 million, or 7.9% over gains of
$185.6 million recorded on securitizations of $1.4 billion of loans for the year
ended June 30, 2002.
The decrease in gains recorded was a direct result of our inability to
complete a quarterly securitization during the fourth quarter of our fiscal
year. See "-- Recent Developments." During the year ended June 30, 2003,
securitization gains as a percentage of loans securitized on our term
securitization deals increased to 14.6% on loans securitized from 13.9% on loans
securitized for the year ended June 30, 2002. Securitization gains as a
percentage of loans securitized through our off-balance sheet facility, however,
decreased to 5.5% for the year ended June 30, 2003 from 12.9% for the year ended
June 30, 2002. At June 30, 2003, the likelihood that the facility sponsor would
ultimately transfer the underlying mortgage loans to a term securitization was
significantly reduced and the amount of gain recognized for loans sold to this
facility in the fourth quarter of fiscal 2003 was based on terms expected in a
whole loan sale transaction. Our ability to sell loans into this facility
expired pursuant to its terms on July 5, 2003. See "-- Off-Balance Sheet
Arrangements -- Securitizations" for further discussion of this facility.
During fiscal 2003, we saw increases in interest rate spreads on our
three permanent securitizations that increased residual cash flows to us and the
amount of cash we received at the closing of a securitization from notional
bonds or premiums on the sale of trust certificates. Increases in the cash
received at the closing of a securitization and residual cash flows resulted in
increases in the gains we recognized on the sale of loans into securitizations
as compared to the year ended June 30, 2002. See "-- Off-Balance Sheet
Arrangements -- Securitizations" for further detail of how securitization gains
are calculated.
The increase in interest rate spread realized in term securitization
transactions during the year ended June 30, 2003 compared to the year ended June
30, 2002 resulted from decreases in pass-through interest rates on investor
certificates issued by securitization trusts. For loans securitized during the
year ended June 30, 2003, the weighted average loan interest rate was 10.82%, a
58 basis point decrease from the weighted average interest rate of 11.40% on
loans securitized during the year ended June 30, 2002. However, the weighted
average interest rate on trust certificates issued in mortgage loan
securitizations during the year ended June 30, 2003 was 4.47%, a 104 basis point
decrease from 5.51% during the year ended June 30, 2002. The resulting net
improvement in interest rate spread was approximately 46 basis points.
101
The improvement in the interest rate spread through fiscal 2002 to the
third quarter of fiscal 2003 enabled us to enter into securitization
transactions structured to provide cash at the closing of our term
securitizations through the sale of notional bonds, sometimes referred to as
interest-only bonds, or the sale of trust certificates at a premium to total
loan collateral. During the year ended June 30, 2003 we received additional cash
at the closing of our three securitizations, due to these modified structures,
of $30.2 million compared to $32.9 million received for four securitizations for
fiscal 2002. Securitization gains and cash received at the closing of
securitizations were partially offset by initial overcollateralization
requirements of $10.6 million in fiscal 2003. There was no initial
overcollateralization requirement in fiscal 2002.
The Office of Thrift Supervision has adopted a rule effective in July
2003, which precludes us and other non-bank, non-thrift creditors from using the
Parity Act to preempt state prepayment penalty and late fee laws and regulations
on new loan originations. Under the provisions of this rule we are required to
modify or eliminate the practice of charging a prepayment fee and other fees in
some of the states where we originate loans. This new rule will potentially
reduce the gain on sale recorded in new securitizations in two ways. First,
because the percentage of loans with prepayment fees will be reduced, the
prepayment rates on securitized loan pools may increase and therefore the value
of our interest-only strips will decrease due to the shorter average life of the
securitized loan pool. Second, the value of our servicing rights retained in a
securitization may decrease due to a reduction in our ability to charge certain
fees. We are continuing to evaluate the impact of the adoption of this rule on
our future lending activities and results of operations.
Gain on Sale of Loans - Whole Loan Sales. Gains on whole loan sales
decreased $1.7 million, to $0.7 million for the year ended June 30, 2003 from
$2.4 million for the year ended June 30, 2002. The volume of whole loan sales
decreased 51.4%, to $28.0 million for the year ended June 30, 2003 from $57.7
million for the year ended June 30, 2002. The decrease in the volume of whole
loan sales for the year ended June 30, 2003 resulted from management's decision
to securitize additional loans as the securitization market's experience during
the past year was more favorable than the whole loan sale market. However, our
inability to complete a securitization in the fourth quarter of fiscal 2003
created a need for short-term liquidity which resulted in management utilizing
whole loan sales to sell our fourth quarter of fiscal 2003 loan originations.
See "-- Recent Developments " and "-- Liquidity and Capital Resources" for
further detail.
Interest and Fees. For the year ended June 30, 2003, interest and fee
income increased $0.5 million, or 2.7%, to $19.4 million compared to $18.9
million in the same period of fiscal 2002. Interest and fee income consists
primarily of interest income earned on loans available for sale, interest income
on invested cash and other ancillary fees collected in connection with loan and
lease originations.
102
During the year ended June 30, 2003, total interest income increased
$1.0 million, or 10.5%, to $10.5 million from $9.5 million for the year ended
June 30, 2002. Loan interest income increased $2.1 million from June 30, 2002 as
a result of our carrying a higher average loan balance during fiscal 2003 as
compared to fiscal 2002. This increase was offset by a decrease of $1.1 million
of investment interest income due to lower interest rates earned on invested
cash balances caused by general decreases in market interest rates.
Other fees decreased $0.5 million for fiscal 2003 compared to the same
periods in fiscal 2002. The decrease was mainly due to a decrease in leasing
income, which resulted from our decision in fiscal 2000 to discontinue the
origination of new leases. Our ability to collect certain fees on loans we
originate in the future may be impacted by proposed laws and regulations by
various authorities.
Interest Accretion on Interest-Only Strips. Interest accretion of $47.3
million was earned in the year ended June 30, 2003 compared to $35.4 million in
the year ended June 30, 2002. The increase reflects the growth in the balance of
our interest-only strips of $85.7 million, or 16.7%, to $598.3 million at June
30, 2003 from $512.6 million at June 30, 2002. In addition, cash flows from
interest-only strips for the year ended June 30, 2003 totaled $87.2 million, an
increase of $26.9 million, or 50.4%, from the year ended June 30, 2002 due to
the larger size of our more recent securitizations and additional
securitizations reaching final target overcollateralization levels and stepdown
overcollateralization levels.
Servicing Income. Servicing income is comprised of contractual and
ancillary fees collected on securitized loans serviced for others, less
amortization of the servicing rights assets that are recorded at the time loans
are securitized. Ancillary fees include prepayment fees, late fees and other
servicing fee compensation. For the year ended June 30, 2003, servicing income
decreased $2.4 million, or 44.4%, to $3.1 million from $5.5 million for the year
ended June 30, 2002. Because loan prepayment levels in fiscal 2003 increased
from fiscal 2002, the amortization of servicing rights has also increased.
Amortization is recognized in proportion to contractual and ancillary fees
collected. Therefore the collection of additional prepayment fees in fiscal 2003
has resulted in higher levels of amortization.
The following table summarizes the components of servicing income for
the years ended June 30, 2003, 2002 and 2001 (in thousands):
Year Ended June 30,
-------------------------------------------
2003 2002 2001
-------- -------- --------
Contractual and ancillary fees.......... $ 44,935 $ 35,314 $ 25,651
Amortization of servicing rights........ (41,886) (29,831) (19,951)
-------- -------- --------
$ 3,049 $ 5,483 $ 5,700
======== ======== ========
Total Expenses. Total expenses increased $56.0 million, or 23.9%, to
$290.4 million for the year ended June 30, 2003 compared to $234.4 million for
the year ended June 30, 2002. As described in more detail below, this increase
was mainly a result of increases in securitization asset valuation adjustments
recorded during the year ended June 30, 2003, increases in employee related
costs and increases in general and administrative expenses.
103
Interest Expense. During fiscal 2003, interest expense decreased $0.6
million, or 0.9%, to $68.1 million compared to $68.7 million for fiscal 2002.
Average subordinated debt outstanding during the year ended June 30, 2003 was
$690.7 million compared to $615.2 million during the year ended June 30, 2002.
Average interest rates paid on subordinated debt outstanding decreased to 9.27%
during the year ended June 30, 2003 from 10.64% during the year ended June 30,
2002.
Rates offered on subordinated debt were reduced beginning in the fourth
quarter of fiscal 2001 and have continued downward through the fourth quarter of
fiscal 2003 in response to decreases in market interest rates as well as
declining cash needs during that period. The average interest rate of
subordinated debt issued at its peak rate, which was the month of February 2001,
was 11.85% compared to the average interest rate of subordinated debt issued in
the month of June 2003 of 7.49%. We expect the average interest rate paid on
subordinated debt to remain near current levels provided that market rates do
not significantly increase.
The average outstanding balances under warehouse lines of credit were
$51.1 million during the year ended June 30, 2003, compared to $29.5 million
during the year ended June 30, 2002. The increase in the average balance on
warehouse lines was due to a higher volume of loans originated and lower average
cash balances available for loan funding during the period. Interest rates paid
on warehouse lines are generally based on one-month LIBOR plus an interest rate
spread ranging from 0.95% to 1.75%. One-month LIBOR has decreased from
approximately 1.8% at June 30, 2002 to 1.12% at June 30, 2003.
Provision for Credit Losses. The provision for credit losses on loans
and leases available for sale increased $0.1 million, or 1.5%, to $6.6 million
for the year ended June 30, 2003 from $6.5 million for the year ended June 30,
2002. A related allowance for loan losses on repurchased loans is included in
our provision for credit losses in the period of repurchase. See "-- Off-Balance
Sheet Arrangements -- Securitizations" and "-- Off-Balance Sheet Arrangements --
Trigger Management" for further discussion of repurchases from securitization
trusts. Non-accrual loans were $5.4 million at June 30, 2003, compared to $7.0
million at June 30, 2002. See "-- Managed Portfolio Quality" for further detail.
The allowance for credit losses was $2.8 million, or 1.0% of loans and
leases available for sale at June 30, 2003 compared to $3.7 million, or 6.0% of
loans and leases available for sale at June 30, 2002. The allowance for credit
losses as a percentage of gross receivables decreased from June 30, 2002 due to
the decrease of the non-accrual loan balance being carried on our balance sheet
at June 30, 2003 as well as an increase in the balance of loans available for
sale. Although we maintain an allowance for credit losses at the level we
consider adequate to provide for potential losses, there can be no assurances
that actual losses will not exceed the estimated amounts or that an additional
provision will not be required, particularly if economic conditions deteriorate.
104
The following table summarizes changes in the allowance for credit
losses for the years ended June 30, 2003, 2002 and 2001 (in thousands):
Year Ended June 30,
-----------------------------------------
2003 2002 2001
--------- -------- --------
Balance at beginning of period .............. $ 3,705 $ 2,480 $ 1,289
Provision for credit losses ................. 6,553 6,457 5,190
(Charge-offs) recoveries, net ............... (7,410) (5,232) (3,999)
--------- -------- --------
Balance at end of period .................... $ 2,848 $ 3,705 $ 2,480
========= ======== ========
The following table summarizes the changes in the allowance for credit
losses by loan and lease type for the fiscal year ended June 30, 2003 (in
thousands):
Business Home
Purpose Equity Equipment
Year Ended June 30, 2003: Loans Loans Leases Total
- ------------------------------- --------- -------- --------- --------
Balance at beginning of period .............. $ 1,388 $ 1,998 $ 319 $ 3,705
Provision for credit losses ................. 1,189 5,000 364 6,553
(Charge-offs) recoveries, net ............... (1,984) (4,913) (513) (7,410)
-------- -------- ------ --------
Balance at end of period .................... $ 593 $ 2,085 $ 170 $ 2,848
======== ======== ====== ========
The following table summarizes net charge-off experience by loan type
for the fiscal years ended June 30, 2003, 2002 and 2001 (in thousands):
Year Ended June 30,
-----------------------------------------
2003 2002 2001
--------- -------- --------
Business purpose loans ...................... $ 1,984 $ 924 $ 1,374
Home equity loans ........................... 4,913 2,892 1,634
Equipment leases ............................ 513 1,416 991
--------- -------- --------
Total ....................................... $ 7,410 $ 5,232 $ 3,999
========= ======== ========
Employee Related Costs. For the year ended June 30, 2003, employee
related costs increased $5.3 million, or 14.6%, to $41.6 million from $36.3
million in the prior year. The increase in employee related costs for the year
ended June 30, 2003 was primarily attributable to additions of personnel to
originate, service and collect loans. Total employees at June 30, 2003 were
1,119 compared to 1,019 at June 30, 2002. Since June 30, 2003, we reduced our
workforce by 170 employees. With our business strategy's focus on whole loan
sales and offering a broader mortgage product line that we expect will appeal to
a wider array of customers, we currently require a smaller employee base with
fewer sales, servicing and support positions. These workforce reductions
represent more than a 15% decrease in staffing levels. Increases in payroll and
benefits expenses for the increased number of employees were offset by
reductions of management bonus accruals due to the overall financial performance
of the Company in fiscal 2003. The remaining increase was attributable to annual
salary increases as well as increases in the costs of providing insurance
benefits to employees during fiscal 2003.
Sales and Marketing Expenses. For the year ended June 30, 2003, sales
and marketing expenses increased $1.8 million, or 7.0%, to $27.8 million from
$26.0 million for the year ended June 30, 2002. The increase was primarily due
to increases in expenses for direct mail advertising and broker commissions for
home equity and business loan originations partially offset by decreases in
newspaper advertisements for subordinated debt. We expect to be able to
streamline our sales and marketing costs in the future by offering a wider array
of loan products and targeting segments that we believe will enable us to
increase our loan origination conversion rates. By increasing our conversion
rates, we expect to be able to lower our overall sales and marketing costs per
dollar originated. See "-- Business Strategy" for further discussion.
105
General and Administrative Expenses. For the year ended June 30, 2003,
general and administrative expenses increased $26.3 million, or 35.2%, to $101.2
million from $74.9 million for the year ended June 30, 2002. This increase was
primarily attributable to increases of approximately $16.9 million in costs
associated with servicing and collecting our larger total managed portfolio
including expenses associated with REO and delinquent loans, $8.0 million
increase in costs associated with customer retention incentives and an increase
of $3.9 million in net losses on interest rate swaps.
Securitization Assets Valuation Adjustment. During fiscal 2003, write
downs through the Statement of Income of $45.2 million were recorded compared to
$22.1 million for fiscal 2002. Of these adjustments, $39.9 million and $22.1
million were write downs of our interest-only strips in fiscal 2003 and 2002,
respectively. The remaining $5.3 million in fiscal 2003 was a write down of our
servicing rights. These adjustments primarily reflect the impact of higher
prepayment experience on home equity loans than anticipated during the periods.
The valuation adjustment recorded on securitization assets in fiscal 2003 was
reduced by a $17.9 million favorable valuation impact to the income statement as
a result of reducing the discount rates applied in valuing the securitization
assets at June 30, 2003. The discount rates were reduced at June 30, 2003
primarily to reflect the impact of the sustained decline in market interest
rates. The discount rate on the projected residual cash flows from our
interest-only strips was reduced from 13% to 11% at June 30, 2003. The discount
rate used to determine the fair value of the overcollateralization portion of
the cash flows from our interest-only strips was minimally impacted by the
decline in interest rates and remained at 7% on average. As a result, the
blended rate used to value our interest-only strips, including the
overcollateralization cash flows, was 9% at June 30, 2003. The discount rate on
our servicing rights was reduced from 11% to 9% at June 30, 2003. The
adjustments were considered to be other than temporary and were therefore
recorded as an adjustment to earnings in the current period in accordance with
SFAS No. 115 and EITF 99-20 as they relate to interest-only strips and SFAS No.
140 as it relates to servicing rights. See "-- Off-Balance Sheet Arrangements --
Securitizations" for further detail of these adjustments.
Provision for Income Tax Expense (Benefit). For fiscal 2003, the
provision for income taxes decreased $24.8 million as a result of a $62.6
million decline in pre-tax income and a reduction in our effective tax rate from
42% to 39%. The change in the effective tax rate was made due to an anticipated
decrease in our overall tax liabilities. The utilization of net operating loss
carryforwards is not dependent on future taxable income from operations, but on
the reversal of timing differences principally related to existing
securitization assets. These timing differences are expected to absorb the
available net operating loss carryforwards during the carryforward period.
Year Ended June 30, 2002 Compared to Year Ended June 30, 2001
Total Revenues. For fiscal 2002, total revenues increased $64.6
million, or 35.2%, to $247.9 million from $183.3 million for fiscal 2001. Growth
in total revenue was mainly the result of increases in gains on the
securitization of mortgage loans and increases in interest accretion earned on
our interest-only strips.
Gain on Sale of Loans - Securitizations. For the year ended June 30,
2002, gains of $185.6 million were recorded on the securitization of $1.4
billion of loans. This represents an increase of $56.6 million, or 43.9%, over
gains of $129.0 million recorded on securitizations of $1.1 billion of loans for
the year ended June 30, 2001.
106
The increase in securitization gains for the year ended June 30, 2002
was due to both an increase in interest rate spreads earned in our
securitizations and an increase in the volume of loans securitized. The
securitization gain as a percentage of loans securitized increased to 13.7% for
the year ended June 30, 2002 from 11.7% on loans securitized for the year ended
June 30, 2001. Increases in interest rate spreads increase expected residual
cash flows to us and result in increases in the gains we recognize on the sale
of loans into securitizations. See "-- Off-Balance Sheet Arrangements --
Securitizations" for further detail of how securitization gains are calculated.
The increase in interest rate spread for the year ended June 30, 2002
compared to the year ended June 30, 2001 resulted from decreases in pass-through
interest rates on investor certificates issued by securitization trusts. For
loans securitized during the year ended June 30, 2002, the average loan interest
rate was 11.40%, a 0.50% decrease from 11.90% on loans securitized during the
year ended June 30, 2001. However, the average interest rate on trust
certificates issued in mortgage loan securitizations during the year ended June
30, 2002 was 5.51%, a 1.54% decrease from 7.05% during the year ended June 30,
2001. The resulting net improvement in interest rate spread was approximately
104 basis points.
Also contributing to the increase in the securitization gain
percentages for the year ended June 30, 2002, was the increase in the amount of
cash received at the closing of our securitizations. The improvement in the
interest rate spread this fiscal year enabled us to enter into securitization
transactions structured to provide additional cash at the closing of the
securitization through the sale of trust certificates to investors at a premium,
or through the sale of notional bonds, sometimes referred to as interest-only
bonds. During the year ended June 30, 2002 we received additional cash at the
closing of our securitizations, due to these modified structures, of $32.9
million compared to $10.1 million in fiscal 2001. Securitization gains and cash
received at the closing of securitizations were reduced by hedging losses of
$9.4 million in fiscal 2002, compared to losses of $4.3 million in fiscal 2001.
Gain on Sale of Loans - Whole Loan Sales. Gains on whole loan sales
decreased $0.3 million, to $2.4 million for the year ended June 30, 2002 from
$2.7 million for the year ended June 30, 2001. The volume of whole loan sales
decreased 24.3%, to $57.7 million for the year ended June 30, 2002 from $76.3
million for the year ended June 30, 2001. The decrease in the volume of whole
loan sales for the year ended June 30, 2002 resulted from management's decision
to securitize additional loans in the favorable securitization market
experienced during the year.
Interest and Fees. For the year ended June 30, 2002, interest and fee
income decreased $0.9 million, or 4.8%, to $18.9 million compared to $19.8
million for the year ended June 30, 2001. Interest and fee income consists
primarily of interest income earned on available for sale loans and other
ancillary fees collected in connection with loans and leases.
During the year ended June 30, 2002, interest income decreased $0.7
million, or 7.1%, to $9.5 million from $10.2 million for the year ended June 30,
2001. This decrease was due to a lower weighted-average interest rate on loans
available for sale from the prior fiscal year and lower interest rates earned on
invested cash balances due to general decreases in market interest rates. This
decrease was partially offset by the effect of a modification of the terms of
our securitizations beginning in the second quarter of fiscal 2001, which
allowed us to retain interest income we had accrued up until the point of the
sale. Prior to the second quarter of fiscal 2001, all accrued interest income
was retained by the securitization trust when collected.
107
Other fees decreased $0.2 million for the year ended June 30, 2002 from
the prior year mainly due to the decrease in fees collected in connection with
our leasing portfolio. Our leasing portfolio has decreased due to our decision
in fiscal 2000 to discontinue the origination of new leases. The ability to
collect certain fees on loans we originate in the future may be impacted by
proposed laws and regulations by various authorities. See "Business--
Regulation" for more information regarding how our practices related to fees
could be affected.
Interest Accretion on Interest-Only Strips. Interest accretion of $35.4
million was earned in the year ended June 30, 2002 compared to $26.1 million in
the year ended June 30, 2001. The increase reflects the growth in the balance of
our interest-only strips of $114.1 million, or 28.6%, to $512.6 million at June
30, 2002 from $398.5 million at June 30, 2001. In addition, cash flows from
interest-only strips for the year ended June 30, 2002 totaled $100.7 million, an
increase of $17.8 million, or 21.5%, from fiscal 2001 due to the larger size of
our more recent securitizations and additional securitizations reaching final
target overcollateralization levels and step-down overcollateralization levels.
Servicing Income. For the year ended June 30, 2002, servicing income
decreased $0.2 million, or 3.8%, to $5.5 million from $5.7 million for the year
ended June 30, 2001. This decrease was attributable to an increase in prepayment
fee collections resulting from higher prepayment rates, which caused an increase
in servicing rights amortization.
Total Expenses. Total expenses increased $64.2 million, or 37.7%, to
$234.4 million for the year ended June 30, 2002 compared to $170.2 million for
the year ended June 30, 2001. As described in more detail below, this increase
was mainly a result of a $22.1 million interest-only strips valuation adjustment
recorded during the year ended June 30, 2002, increased interest expense
attributable to the issuance of additional subordinated debt, increases in
employee related costs and increases in general and administrative expenses.
Interest Expense. During fiscal 2002 interest expense increased $12.1
million, or 21.5%, to $68.7 million from $56.5 million for fiscal 2001. The
increase in interest expense was primarily due to an increase in the level of
subordinated debt outstanding. Average subordinated debt outstanding during the
year ended June 30, 2002 was $615.2 million compared to $448.5 million during
the year ended June 30, 2001. The effect of the increase in outstanding debt was
partially offset by a decrease in the average interest rates paid on
subordinated debt. Average interest rates paid on subordinated debt outstanding
decreased to 10.64% during the year ended June 30, 2002 from 11.04% during the
year ended June 30, 2001.
Rates offered on subordinated debt were reduced beginning in the fourth
quarter of fiscal 2001 and continued downward in fiscal 2002 in response to
decreases in market interest rates as well as our lower cash needs. The average
issuance rate of subordinated debt at its peak, which was the month of February
2001, was 11.85% compared to the average rate of subordinated debt issued in the
month of June 2002 of 8.39%.
108
The increase in interest expense for the year ended June 30, 2002
related to subordinated debt was partially offset by the impact of a decrease in
the average outstanding balances under warehouse lines of credit and decreased
interest rates paid on warehouse lines. The average outstanding balances under
warehouse lines of credit were $29.5 million during the year ended June 30,
2002, compared to $52.5 million during the year ended June 30, 2001. This
decrease was due to the increased utilization of our available cash balances and
proceeds from the sale of subordinated debt to fund loan originations and
greater utilization of an off-balance sheet mortgage conduit facility for the
sale of loans. Interest rates paid on warehouse lines are generally based on
one-month LIBOR plus an interest rate spread ranging from 1.25% to 2.5%.
One-month LIBOR decreased from approximately 3.9% at June 30, 2001 to 1.8% at
June 30, 2002.
Provision for Credit Losses. The provision for credit losses on
loans and leases available for sale for the year ended June 30, 2002 increased
$1.3 million, or 24.4%, to $6.5 million, compared to $5.2 million for the year
ended June 30, 2001. The increase in the provision for credit losses was
primarily due to increases in loans in non-accrual status, which were generally
repurchased from securitization trusts. See "-- Off Balance Sheet Arrangements
- -- Trigger Management" for further discussion of repurchases from securitization
trusts. Non-accrual loans were $7.0 million and $4.5 million at June 30, 2002
and 2001, respectively.
The allowance for credit losses was $3.7 million, or 6.0% of loans and
leases available for sale at June 30, 2002 compared to $2.5 million, or 2.5% of
loans and leases available for sale at June 30, 2001. This increase was due to
an additional provision for delinquent and non-accrual loans. Although we
maintain an allowance for credit losses at the level we consider adequate to
provide for potential losses, there can be no assurances that actual losses will
not exceed the estimated amounts or that an additional provision will not be
required.
The following table summarizes the changes in the allowance for credit
losses by loan and lease type for the fiscal year ended June 30, 2002 (in
thousands):
Business Home
Purpose Equity Equipment
Loans Loans Leases Total
--------- -------- ---------- -------
Balance at beginning of period........... $ 591 $ 1,473 $ 416 $ 2,480
Provision for credit losses.............. 1,721 3,417 1,319 6,457
(Charge-offs) recoveries, net............ (924) (2,892) (1,416) (5,232)
-------- --------- --------- --------
Balance at end of period................. $ 1,388 $ 1,998 $ 319 $ 3,705
======== ========= ========= ========
Employee Related Costs. For the year ended June 30, 2002, employee
related costs increased $7.4 million, or 25.7%, to $36.3 million from $28.9
million in the prior year. The increase was primarily attributable to additions
of personnel primarily in the loan servicing and collections areas to service
the larger managed portfolio. Total employees at June 30, 2002 were 1,019
compared to 884 at June 30, 2001. The remaining increase was attributable to
annual salary increases as well as increases in the costs of providing insurance
benefits to employees.
Sales and Marketing Expenses. For the year ended June 30, 2002, sales
and marketing expenses increased $1.0 million, or 4.1%, to $26.0 million from
$24.9 million for the year ended June 30, 2001. Expenses for direct mail
advertising for loan originations and subordinated debt increased $3.8 million
and $0.7 million, respectively, for the year ended June 30, 2002, compared to
the prior fiscal year. This increase was partially offset by a decrease of $2.7
million in newspaper advertising.
109
General and Administrative Expenses. For the year ended June 30, 2002,
general and administrative expenses increased $20.3 million, or 37.2%, to $74.9
million from $54.6 million for the year ended June 30, 2001. This increase was
primarily attributable to increases of approximately $14.3 million in costs
associated with servicing and collection of our larger total managed portfolio
including expenses associated with REO and delinquent loans, in addition to
increases of $1.1 million in costs related to the issuance of our subordinated
debt, $0.6 million in depreciation expense and $0.4 million in business
insurance expense.
Securitization Assets Valuation Adjustment. During fiscal 2002, a write
down through the Statement of Income of $22.1 million was recorded on our
interest-only strips. This adjustment reflects the impact of higher prepayment
experience on home equity loans than anticipated during the period. This portion
of the impact of increased prepayments was considered to be other than temporary
and was therefore recorded as an adjustment to earnings in the current period in
accordance with SFAS No. 115 and EITF 99-20. See "-- Off-Balance Sheet
Arrangements -- Securitizations" for further detail of this adjustment.
110
Balance Sheet Information
See "-- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of
the below four ratios to the most directly comparable financial measure prepared
in accordance with GAAP. (Dollars in thousands, except per share data)
Balance Sheet Data
June 30,
----------------------------------
2003 2002 2001
------ ------ ------
Cash and cash equivalents .................. $ 47,475 $ 108,599 $ 91,092
Loan and lease receivables, net:
Available for sale ....................... 271,402 57,677 94,970
Interest and fees ........................ 15,179 12,292 16,549
Other .................................... 23,761 9,028 2,428
Interest-only strips ....................... 598,278 512,611 398,519
Servicing rights ........................... 119,291 125,288 102,437
Receivable for sold loans .................. 26,734 -- --
Total assets ............................... 1,159,351 876,375 766,487
Subordinated debt .......................... 719,540 655,720 537,950
Warehouse lines and other notes payable .... 212,916 8,486 51,064
Accrued interest payable ................... 45,448 43,069 32,699
Deferred income taxes ...................... 17,036 35,124 30,954
Total liabilities .......................... 1,117,282 806,997 699,625
Total stockholders' equity ................. 42,069 69,378 66,862
Book value per common share ................ $ 14.28 $ 24.40 $ 20.47
Ratios:
Total liabilities to tangible equity(c) .... 41.5x 14.9x 13.5x
Adjusted debt to tangible equity (a)(c) .... 30.5x 12.2x 10.2x
Subordinated debt to tangible equity(c) .... 26.7x 12.1x 10.4x
Interest-only strips to adjusted
tangible equity (b)(c) ................... 7.3x 4.3x 3.5x
- -----------------
(a) Total liabilities less cash and secured borrowings to tangible equity.
(b) Interest-only strips less overcollateralization interests to tangible
equity plus subordinated debt with a remaining maturity greater than five
years.
(c) Tangible equity is calculated as total stockholders' equity less goodwill.
June 30, 2003 Compared to June 30, 2002
Total assets increased $283.0 million, or 32.3%, to $1.2 billion at
June 30, 2003 from $876.4 million at June 30, 2002 primarily due to increases in
loan and lease receivables, interest-only strips and receivable for sold loans,
offset by a decrease in cash and cash equivalents.
Cash and cash equivalents decreased mainly due to higher levels of loan
receivables funded with cash, a reduction in the amount of subordinated debt
issued during fiscal year 2003 and also due to our inability to complete our
typical quarterly securitization in the fourth quarter of fiscal year 2003.
Loan and lease receivables - Available for sale increased $213.7
million due to our inability to complete our typical quarterly securitization in
the fourth quarter of fiscal 2003.
111
Loan and lease receivables - Other increased $14.7 million or 163.2%
due to increases in the amount of delinquent loans eligible for repurchase from
securitization trusts. See Note 2 of the Consolidated Financial Statements and
"-- Off-Balance Sheet Arrangements -- Securitizations -- Trigger Management" for
an explanation of these receivables.
Activity of our interest-only strips for the fiscal years ended June
30, 2003, 2002 and 2001 were as follows (in thousands):
June 30,
---------------------------------------
2003 2002 2001
------ ------ ------
Balance at beginning of period ............................. $ 512,611 $ 398,519 $ 277,872
Initial recognition of interest-only strips, including
initial overcollateralization of $10,641, $0 and $611 ... 160,116 153,463 125,408
Cash flow from interest-only strips ........................ (160,417) (100,692) (82,905)
Required purchases of additional overcollateralization ..... 73,253 47,271 43,945
Interest accretion ......................................... 47,347 35,386 26,069
Termination of lease securitization (a) .................... (1,890) -- --
Net temporary adjustments to fair value (b) ................ 7,158 717 8,130
Other than temporary adjustments to fair value (b) ......... (39,900) (22,053) --
---------- ---------- ---------
Balance at end of period ................................... $ 598,278 $ 512,611 $ 398,519
========== ========== =========
(a) Reflects release of lease collateral from two lease securitization trusts
which were terminated in accordance with the trust documents after the full
payout of trust note certificates. Net lease receivables of $1.7 million
were recorded on our balance sheet as a result of these terminations.
(b) Net temporary adjustments to fair value are recorded through other
comprehensive income, which is a component of equity. Other than temporary
adjustments to decrease the fair value of interest-only strips are recorded
through the income statement.
The following table summarizes our purchases of overcollateralization
by securitization trust for the fiscal years ended June 30, 2003, 2002 and 2001.
Purchases of overcollaterization represent amounts of residual cash flows from
interest-only strips retained by the securitization trusts to establish required
overcollateralization levels in the trust. Overcollateralization represents our
investment in the excess of the aggregate principal balance of loans in a
securitized pool over the aggregate principal balance of trust certificates. See
"-- Off-Balance Sheet Arrangements -- Securitizations" for a discussion of
overcollateralization requirements.
112
Summary of Mortgage Loan Securitization Overcollateralization Purchases
(in thousands)
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 Other Total
------ ------ ------ ------ ------ ------ ------ ------ ----- -----
Year Ended June 30, 2003:
Initial
overcollateralization ..... $ -- $ 3,800 $ -- $ -- $ -- $ -- $ -- $ -- $ 6,841 $10,641
Required purchases
of additional
overcollateralization ..... 4,807 8,728 10,972 13,300 10,586 12,522 7,645 3,007 1,686 73,253
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ..................... $ 4,807 $12,528 $10,972 $13,300 $10,586 $12,522 $ 7,645 $ 3,007 $ 8,527 $83,894
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
2002-1 2001-4 2001-3 2001-2 2001-1 2000-4 2000-3 2000-2 2000-1 Other Total
------ ------ ------ ------ ------ ------ ------ ------ ------ ----- -----
Year Ended June 30, 2002:
Required purchases
of additional
overcollateralization ..... $ 3,814 $ 908 $ 4,354 $11,654 $ 8,700 $ 6,326 $ 3,074 $ 4,978 $ 2,490 $ 973 $47,271
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
2001-2 2001-1 2000-4 2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 Other Total
------ ------ ------ ------ ------ ------ ------ ------ ------ ----- -----
Year Ended June 30, 2001:
Initial
overcollateralization ..... $ -- $ -- $ -- $ -- $ 611 $ -- $ -- $ -- $ -- $ -- $ 611
Required purchases
of additional
overcollateralization ..... 959 2,574 6,049 4,051 10,160 7,519 5,960 3,719 2,316 638 43,945
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ..................... $ 959 $ 2,574 $ 6,049 $ 4,051 $10,771 $ 7,519 $ 5,960 $ 3,719 $ 2,316 $ 638 $44,556
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Servicing rights decreased $6.0 million, or 4.8%, to $119.3 million at
June 30, 2003 from $125.3 million at June 30, 2002, primarily due to our
inability to complete a securitization in the fourth quarter of fiscal 2003 and
a $5.3 million write down of the servicing asset mainly due to the impact of
higher than expected prepayment experience.
The receivable for sold loans of $26.7 million at June 30, 2003
resulted from a whole loan sale transaction which closed on June 30, 2003, but
settled in cash on July 1, 2003.
Total liabilities increased $310.3 million, or 38.4%, to $1.1 billion
from $807.0 million at June 30, 2002 primarily due to increases in warehouse
lines and other notes payable, subordinated debt outstanding, accounts payable
and accrued expenses and other liabilities. The increase in warehouse lines and
other notes payable was due to not completing a securitization in the fourth
quarter of fiscal 2003. A fourth quarter securitization would have provided the
cash to pay down the warehouse lines. Accounts payable and accrued expenses
increased $16.7 million, or 121.7%, primarily due to accruals for costs
associated with customer retention incentives to help mitigate loan prepayments
and liabilities to our securitization trust collection accounts for periodic
interest advances. Other liabilities increased $41.1 million, or 80.7%, to 92.0
million from $50.9 due to a $17.3 million increase in the obligation for the
repurchase of loans subject to removal of accounts provisions, recording an
unearned rent incentive of $9.5 million related to our corporate headquarters
lease and a $6.3 million recorded liability for unsettled interest rate swaps.
113
During fiscal 2003, subordinated debt increased $63.8 million, or 9.7%,
to $719.5 million due to sales of subordinated debt used to repay existing debt,
to fund loan originations and our operations and for general corporate purposes.
Approximately $33.7 million of the increase in subordinated debt was due to the
reinvestment of accrued interest on the subordinated debt at maturity.
Subordinated debt was 26.7 times tangible equity at June 30, 2003, compared to
12.1 times at June 30, 2002. See "-- Liquidity and Capital Resources" for
further information regarding outstanding debt.
Deferred income taxes decreased $18.1 million, or 51.5%, to $17.0
million at June 30, 2003 from $35.1 million at June 30, 2002. This decrease is
primarily due to a $4.4 million net increase in expected benefits from net
operating loss carryforwards, less a valuation allowance, and an $8.2 million
increase in other deferred tax debits. The increase in other deferred tax debits
primarily resulted from recognizing the benefit of governmental grants and lease
incentives associated with the relocation of our corporate headquarters earlier
for tax purposes than for financial reporting purposes. In addition, deferred
tax payables on our interest-only strips decreased by $5.6 million due to loan
prepayment experience.
June 30, 2002 Compared to June 30, 2001
Total assets increased $109.9 million, or 14.3%, to $876.4 million at
June 30, 2002 from $766.5 million at June 30, 2001 primarily due to increases in
cash and cash equivalents, interest-only strips and servicing rights which were
partially offset by decreases in loan and lease receivables available for sale
and receivables for sold loans.
Cash and cash equivalents increased $17.5 million, or 19.2%, due to
receipts from sales of subordinated debt, cash receipts on the sale of loans in
securitizations and cash receipts from our interest-only strips.
Servicing rights increased $22.9 million, or 22.3%, to $125.3 million
at June 30, 2002 from $102.4 at June 30, 2001, due to the securitization of $1.4
billion of loans during the year ended June 30, 2002, partially offset by
amortization of the servicing asset for fees collected during the same period.
Loan and lease receivables - Available for sale decreased $37.3 million
or 39.3% due to the securitization of more loans than were originated during the
period.
Total liabilities increased $107.4 million, or 15.3%, to $807.0 million
from $699.6 million at June 30, 2001 primarily due to increases in subordinated
debt outstanding, accrued interest payable and other liabilities partially
offset by a decrease in warehouse lines and other notes payable.
During fiscal 2002 subordinated debt increased $117.8 million, or
21.9%, to $655.7 million due to sales of subordinated debt used to repay
existing debt, to fund loan originations and our operations and for general
corporate purposes including, but not limited to, repurchases of our outstanding
common stock. Approximately $31.7 million of the increase in subordinated debt
was due to the reinvestment of accrued interest on the subordinated debt.
Subordinated debt was 12.1 times tangible equity at June 30, 2002, compared to
10.4 times as of June 30, 2001. See "-- Liquidity and Capital Resources" for
further information regarding outstanding debt. Warehouse lines and other notes
payable decreased $42.6 million due to the lower balance of loan receivables
held at June 30, 2002, and greater use of available cash to fund loans. Accrued
interest payable increased $10.4 million, or 31.7%, to $43.1 million from $32.7
million at June 30, 2001 due to an increase in the level of subordinated debt
outstanding partially offset by a decrease in average interest rates paid on
debt.
114
Deferred income taxes increased $4.2 million, or 13.5%, to $35.1
million from $31.0 million. This increase was mainly due to higher levels of
debt for tax securitization structures in the first and second quarters of
fiscal 2002. 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. These structures created additional deferred tax credits
of $22.1 million which were partially offset by an increase in our federal tax
loss carryforward receivable of $11.9 million to a cumulative $31.3 million. In
addition, miscellaneous deferred tax assets increased by $4.3 million and
miscellaneous deferred tax credits decreased by $1.7 million resulting in a net
increase of $6.0 million. The net operating loss carryforward will be utilized
in future periods by structuring more securitization transactions as taxable
transactions.
115
Managed Portfolio Quality
The following table provides data concerning delinquency experience,
real estate owned and loss experience for the managed loan and lease portfolio.
See "-- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of
total managed portfolio and managed REO measures to our balance sheet. See "--
Deferment and Forbearance Arrangements" for the amounts of previously delinquent
loans subject to these deferment and forbearance arrangements which are not
included in this table if borrowers are current on principal and interest
payments as required under the terms of the original note (exclusive of
delinquent payments advanced or fees paid by us on the borrower's behalf as part
of a deferment or forbearance arrangement (dollars in thousands):
June 30,
--------------------------------------------------------------------
2003 2002 2001
----------------- ----------------- -----------------
Delinquency by Type Amount % Amount % Amount %
- ------------------- ---------- ----- ---------- ----- ---------- -----
Business Purpose Loans
Total managed portfolio ............ $ 393,098 $ 361,638 $ 300,192
========== ========== ==========
Period of delinquency:
31-60 days ....................... $ 4,849 1.23% $ 2,449 0.68% $ 3,460 1.15%
61-90 days ....................... 4,623 1.18 1,648 0.46 1,837 0.61
Over 90 days ..................... 38,466 9.79 32,699 9.03 22,687 7.56
---------- ----- ---------- ----- ---------- ----
Total delinquencies .............. $ 47,938 12.20% $ 36,796 10.17% $ 27,984 9.32%
========== ===== ========== ===== ========== ====
REO ................................ $ 5,744 $ 6,220 $ 4,530
========== ========== ==========
Home Equity Loans
Total managed portfolio ............ $3,249,501 $2,675,559 $2,223,429
========== ========== ==========
Period of delinquency:
31-60 days ....................... $ 48,332 1.49% $ 37,213 1.39% $ 16,227 0.73%
61-90 days ....................... 24,158 0.74 22,919 0.86 14,329 0.64
Over 90 days ..................... 108,243 3.33 72,918 2.72 47,325 2.13
---------- ----- ---------- ----- ---------- ----
Total delinquencies .............. $ 180,733 5.56% $ 133,050 4.97% $ 77,881 3.50%
========== ==== ========== ==== ========== ====
REO ................................ $ 22,256 $ 27,825 $ 23,902
========== ========== ==========
Equipment Leases
Total managed portfolio ............ $ 8,475 $ 28,992 $ 65,774
========== ========== ==========
Period of delinquency:
31-60 days ....................... $ 162 1.91% $ 411 1.42% $ 595 0.90%
61-90 days ....................... 83 0.98 93 0.32 206 0.31
Over 90 days ..................... 154 1.82 423 1.46 347 0.53
---------- ----- ---------- ----- ---------- ----
Total delinquencies .............. $ 399 4.71% $ 927 3.20% $ 1,148 1.74%
========== ==== ========== ==== ========== ====
Combined
Total managed portfolio ............ $3,651,074 $3,066,189 $2,589,395
========== ========== ==========
Period of delinquency:
31-60 days ....................... $ 53,343 1.46% $ 40,073 1.31% $ 20,282 0.78%
61-90 days ....................... 28,864 0.79 24,660 0.80 16,372 0.63
Over 90 days ..................... 146,863 4.02 106,040 3.46 70,359 2.72
---------- ----- ---------- ----- ---------- ----
Total delinquencies .............. $ 229,070 6.27% $ 170,773 5.57% $ 107,013 4.13%
========== ==== ========== ==== ========== ====
REO ................................ $ 28,000 0.77% $ 34,045 1.11% $ 28,432 1.10%
========== ==== ========== ==== ========== ====
Losses experienced during the
period(a)(b):
Loans ............................ $ 29,507 0.89% $ 15,478 0.56% $ 10,886 0.50%
==== ==== ====
Leases ........................... 497 2.82% 1,415 3.20% 1,003 1.20%
---------- ==== ---------- ==== ---------- ====
Total managed portfolio .......... $ 30,004 0.90% $ 16,893 0.60% $ 11,889 0.53%
========== ==== ========== ==== ========== ====
(a) Percentage based on annualized losses and average managed portfolio.
(b) Losses recorded on our books were $16.8 million ($6.8 million from
charge-offs through the provision for credit losses and $10.0 million for write
downs of real estate owned) for the year ended June 30, 2003. Losses absorbed by
loan securitization trusts were $13.2 million for fiscal 2003. Losses recorded
on our books were $9.0 million ($4.4 million from charge-offs through the
provision for loan losses and $4.6 million for write downs of real estate owned)
and losses absorbed by loan securitization trusts were $7.9 million for fiscal
2002. Losses recorded on our books were $7.1 million ($4.0 million from
charge-offs through the provision for loan losses and $3.1 million for write
downs of real estate owned) and losses absorbed by loan securitization trusts
were $4.8 million for fiscal 2001. Losses recorded on our books include losses
for loans we hold as available for sale or real estate owned and loans
repurchased from securitization trusts.
116
The following table summarizes key delinquency statistics related to
loans, leases and REO recorded on our balance sheet and their related percentage
of our available for sale portfolio (dollars in thousands):
June 30,
--------------------------------------
2003 2002 2001
------- ------- -------
Delinquent loans and leases on balance sheet (a) $ 5,412 $ 5,918 $ 3,382
% of on balance sheet loan and lease receivables 2.04% 10.5% 3.9%
Loans and leases in non-accrual status on
balance sheet (b).......................... $ 5,358 $ 6,991 $ 4,514
% of on balance sheet loan and lease receivables 2.02% 12.3% 5.1%
Allowance for losses on available for sale
loans and leases........................... $ 2,848 $ 3,705 $ 2,480
% of available for sale loans and leases....... 1.0% 6.0% 2.5%
Real estate owned on balance sheet............. $ 4,776 $ 3,784 $ 2,322
- ----------
(a) Delinquent loans and leases are included in total delinquencies in the
previously presented "Managed Portfolio Quality" table. Included in total
delinquencies are loans in non-accrual status of $5.0 million, $5.6
million, and $3.2 million at June 30, 2003, 2002 and 2001, respectively.
(b) It is our policy to suspend the accrual of interest income when a loan is
contractually delinquent for 90 days or more. Non-accrual loans and leases
are included in total delinquencies in the previously presented "Managed
Portfolio Quality" table.
Deferment and Forbearance Arrangements. From time to time, borrowers
are confronted with events, usually involving hardship circumstances or
temporary financial setbacks that adversely affect their ability to continue
payments on their loan. To assist borrowers, we may agree to enter into a
deferment or forbearance arrangement. Prevailing economic conditions, which
affect the borrower's ability to make their regular payments, may also have an
impact on the value of the real estate or other collateral securing the loans,
resulting in a change to the loan-to-value ratios. We may take these conditions
into account when we evaluate a borrower's request for assistance for relief
from their financial hardship.
Our policies and practices regarding deferment and forbearance
arrangements, like all of our collections policies and practices, are designed
to manage customer relationships, maximize collections and avoid foreclosure (or
repossession of other collateral, as applicable) if reasonably possible. We
review and regularly revise these policies and procedures in order to enhance
their effectiveness in achieving these goals. We permit exceptions to the
policies and practices from time to time based on individual borrowers'
situations.
In a deferment arrangement, we make advances to a securitization trust
on behalf of the borrower in amounts equal to the delinquent loan payments,
which include principal and interest. Additionally, we may pay taxes, insurance
and other fees on behalf of the borrower. Based on our review of the
borrower's current financial circumstances, the borrower must repay the advances
and other payments and fees we make on the borrower's behalf either at the
termination of the loan or on a monthly payment plan. Borrowers must provide a
written explanation of their hardship, which generally requests relief from
their loan payments. We review the borrower's current financial situation and
based upon this review, we may create a payment plan for the borrower which
allows the borrower to pay past due amounts over a period from 12 to 42 months,
but not beyond the maturity date of the loan, in addition to making regular
monthly loan payments. Each deferment arrangement must be approved by two of our
managers. Deferment arrangements which defer two or more past due payments must
also be approved by a senior vice president.
Principal guidelines currently applicable to the deferment process are:
(i) the borrower may have up to six payments deferred during the life of the
loan; (ii) no more than three payments may be deferred during a twelve-month
period; and (iii) the borrower must have made a minimum of six payments on the
loan and twelve months must have passed since the last deferment in order to
qualify for a new deferment arrangement. Any deferment arrangement which
includes an exception to our guidelines must be approved by the senior vice
president of collections and an executive vice president. If the deferment
arrangement is approved, a collector contacts the borrower regarding the
approval and the revised payment terms.
117
For borrowers who are two or more payments delinquent, we will consider
using a forbearance arrangement if permitted under applicable state law. In a
forbearance arrangement, we make advances to a securitization trust on behalf of
the borrower in amounts equal to the delinquent loan payments, which include
principal and interest. Additionally, we may pay taxes, insurance and other fees
on behalf of the borrower. We assess the borrower's current financial situation
and based upon this assessment, we may create a payment plan for the borrower
which generally allows the borrower to pay past due amounts over a longer period
than a typical deferment arrangement, but not beyond the maturity date of the
loan. We typically structure a forbearance arrangement to require the borrower
to make payments of principal and interest equivalent to the original loan terms
plus additional monthly payments, which in the aggregate represent the amount
that we advanced to the securitization trust and other fees paid by us on behalf
of the borrower. We currently require the borrower to provide written
documentation outlining their financial hardship, and we offer these
arrangements to borrowers who we believe have the ability to remit
post-forbearance principal and interest payments in addition to the amounts
advanced or paid by us. As part of the written forbearance agreement, the
borrower must execute a deed in lieu of foreclosure. We retain the unrecorded
deed until such time as the entire amount due under the forbearance agreement is
repaid. If the borrower subsequently defaults before repaying the amount due
under the forbearance agreement in full and becomes 60 days delinquent on
principal and interest payments, we may elect to record the deed after providing
proper notification to the borrower and a reasonable period of time to cure.
Recording the deed in lieu of foreclosure gives us immediate legal title to the
property without the need for further legal action.
Principal guidelines currently applicable to the forbearance process
are: (i) the subject loan should be at least six months old; (ii) the loan
should be a minimum of three payments delinquent; and (iii) each forbearance
arrangement must be approved by a manager, the senior vice president of
collections and the senior vice president of asset allocation. Forbearance
arrangements which defer ten or more past due payments, involve advances or
other payments of more than $25,000 or include an exception to our guidelines
must also be approved by an executive vice president.
For delinquent borrowers with business purpose loans, we may enter into
written forbearance agreements pursuant to which we do not obtain a deed in lieu
of foreclosure. These arrangements typically allow the borrower to pay past due
amounts over a period of 12-36 months, but not beyond the maturity date of the
loan, and generally require the borrower to make a payment at the time of
entering into the forbearance agreement.
We do not enter into a deferment or forbearance arrangement based
solely on the fact that a loan meets the criteria for one of the arrangements.
Our use of any of these arrangements depends upon one or more of the following
factors: our assessment of the individual borrower's current financial situation
and reasons for the delinquency, a valuation of the real estate securing the
loan and our view of prevailing economic conditions. Because deferment and
forbearance arrangements are account management tools which help us to manage
customer relationships, maximize collection opportunities and increase the value
of our account relationships, the application of these tools generally is
subject to constantly shifting complexities and variations in the marketplace.
We attempt to tailor the type and terms of the arrangement we use to the
borrower's circumstances, and we prefer to use deferment over forbearance
arrangements, if possible.
As a result of these arrangements, we reset the contractual status of a
loan in our managed portfolio from delinquent to current based upon the
borrower's resumption of making their loan payments. Generally, a loan remains
current after a deferment or forbearance arrangement with the borrower only if
the borrower makes the principal and interest as required under the terms of the
original note (exclusive of delinquent payments advanced or fees paid by us on
the borrower's behalf as part of the deferment or forbearance arrangement), and
we do not reflect it as a delinquent loan in our delinquency statistics.
However, if the borrower fails to make principal and interest payments, the
account will generally be declared in default and collection actions resumed.
See "Regulation -- Equal Credit Opportunity Fair Credit Reporting and Other
Laws" and " Risk Factors -- The inquiry regarding our forbearance practices by
the U.S. Attorney could result in concerns regarding our loan servicing and
limit our ability to sell or service our loans, sell subordinated debt, or
obtain additional credit facilities, which would hinder our ability to operate
profitably and repay our subordinated debt, which could negatively impact the
value of our common stock."
The following table presents, as of the end of our last five quarters,
information regarding loans under deferment and forbearance arrangements, which
are reported as current loans if borrowers are current on principal and interest
payments (exclusive of delinquent payments advanced or fees paid by us on the
borrower's behalf as part of the deferment or forbearance arrangement) and thus
not included in delinquencies in the delinquency table. (dollars in thousands):
Cumulative Unpaid Principal Balance
----------------------------------------------
% of
Under Under Managed
Deferment Forbearance Total(a) Portfolio
---------- ----------- ------- ---------
June 30, 2002................. $64,958 $73,705 $138,663 4.52%
September 30, 2002............ 67,282 76,649 143,931 4.50
December 31, 2002............. 70,028 81,585 151,613 4.55
March 31, 2003................ 85,205 84,751 169,956 4.89
June 30, 2003................. 110,487 87,199 197,686 5.41
118
- ------------------------
(a)Included in cumulative unpaid principal balance are loans with
arrangements that were entered into longer than twelve months ago. At June
30, 2003, there was $64.6 million of cumulative unpaid principal balance
under deferment arrangements and $47.4 million of cumulative unpaid
principal balance under forbearance arrangements that were entered into
prior to July 2002.
Additionally, there are loans under deferment and forbearance
arrangements which have returned to delinquent status. At June 30, 2003 there
was $28.7 million of cumulative unpaid principal balance under deferment
arrangements and $51.5 million of cumulative unpaid principal balance under
forbearance arrangements that are now reported as delinquent 31 days or more.
During the final six months of fiscal 2003, we experienced a pronounced
increase in the number of borrowers under deferment arrangements and in light of
the weakened economic environment we made use of deferment arrangements to a
greater degree than in prior periods. We currently expect this condition to be
temporary and will attempt to actively manage the loan accounts under deferment
arrangements to maximize our chances for full recovery of the borrowed amount
while still accommodating borrower needs during their period of hardship.
The following table presents the amount of unpaid principal balance of
loans that entered into a deferment or forbearance arrangement in each quarter
of fiscal 2003 (dollars in thousands):
Unpaid Principal Balance Impacted by
Arrangements
------------------------------------------------
% of
Under Under Managed
Quarter Ended: Deferment Forbearance Total Portfolio
-------------- -------------- ------------ -----------
September 30, 2002............ $11,619 $23,564 $35,183 1.10%
December 31, 2002............. 17,015 27,004 44,019 1.32
March 31, 2003................ 37,117 28,051 65,168 1.87
June 30, 2003................. 44,840 18,064 62,904 1.72
Delinquent loans and leases. Total delinquencies (loans and leases with
payments past due greater than 30 days, excluding REO) in the total managed
portfolio were $229.1 million at June 30, 2003 compared to $170.8 million and
$107.0 million at June 30, 2002 and 2001, respectively. Total delinquencies as a
percentage of the total managed portfolio were 6.27% at June 30, 2003 compared
to 5.57% and 4.13% at June 30, 2002 and 2001, respectively. The increase in
delinquencies and delinquency percentages in fiscal 2003 and 2002 were mainly
due to the impact on our borrowers of continued uncertain economic conditions,
which may include the reduction in other sources of credit to our borrowers and
the seasoning of the managed portfolio. These factors have resulted in a
significant increase in the usage of deferment and forbearance activities. In
addition, the delinquency percentage has increased due to increased prepayment
rates resulting from refinancing activities. Refinancing is not typically
available to delinquent borrowers, and therefore the remaining portfolio is
experiencing a higher delinquency rate. A decrease in the growth rate for the
origination of new loans also contributed to the increase in the delinquency
percentage in fiscal 2003 and 2002 from 2001. As the managed portfolio continues
to season, and if our economy continues to lag or worsen, the delinquency rate
may continue to increase. Delinquent loans and leases held as available for sale
on our balance sheet decreased from $5.9 million at June 30, 2002 to $5.4
million at June 30, 2003.
Real estate owned. Total REO, comprising foreclosed properties and
deeds acquired in lieu of foreclosure, decreased to $28.0 million, or 0.77% of
the total managed portfolio at June 30, 2003 compared to $34.0 million, or 1.11%
at June 30, 2002 and $28.4 million, or 1.10% at June 30, 2001. The decrease in
the volume of REO was mainly due to a concerted effort by management to reduce
the time a loan remains in seriously delinquent status until the sale of an REO
property. The acceleration of the foreclosure process had caused a substantial
increase in the balance of properties classified as REO during fiscal 2001 and
fiscal 2002. We have implemented processes to decrease the cycle time in the
disposition of REO properties. Part of this strategy includes bulk sales of REO
properties as evidenced by the leveling of REO as a percentage of the managed
portfolio. Reducing the time properties are carried reduces carrying costs for
interest on funding the cost of the property, legal fees, taxes, insurance and
maintenance related to these properties. As our portfolio seasons and if our
economy continues to lag or worsen, the REO balance may increase. REO held by us
on our balance sheet increased from $3.8 million at June 30, 2002 to $4.8
million at June 30, 2003 primarily due to repurchases of foreclosed loans from
our mortgage securitization trusts.
Loss experience. During the year ended June 30, 2003, we experienced
net loan and lease charge-offs in the total managed portfolio of $30.0 million
or 0.90% on an annualized basis. During the year ended June 30, 2002, we
experienced net loan and lease charge-offs in the total managed portfolio of
$16.9 million, or 0.60% of the total managed portfolio. During fiscal 2001, we
experienced net loan and lease charge-offs in the total managed portfolio of
$11.9 million, or 0.53% of the average total managed portfolio. Principal loss
severity experience on delinquent loans generally has ranged from 10% to 30% of
principal and loss severity experience on REO generally has ranged from 25% to
40% of principal. The increase in net charge-offs from the prior periods were
due to a larger volume of loans that became delinquent, and or, were liquidated
during the period as well as economic conditions and the seasoning of the
managed portfolio. As noted above, we have attempted to reduce the time a loan
remains in seriously delinquent status until the sale of an REO property in
order to reduce carrying costs on the property. The increase in the charge-off
percentage was partially offset by reductions in our carrying costs due to the
acceleration of the timing of the disposition of REO. See "-- Summary of Loans
119
and REO Repurchased from Mortgage Loan Securitization Trusts" for further detail
of loan repurchase activity. See "-- Off-Balance Sheet Arrangements --
Securitizations" for more detail on credit loss assumptions used to estimate the
fair value of our interest-only strips and servicing rights compared to actual
loss experience.
Real estate values have generally experienced an increase in recent
periods and their increases have exceeded the rate of increase of many other
types of investments in the current economy. If in the future this trend
reverses and real estate values begin to decline our loss severity could
increase. See "Risk Factors -- A decline in value of the collateral securing our
loans could result in an increase in losses on foreclosure, which could hinder
our ability to attain profitable operations, limit our ability to repay our
subordinated debt and negatively impact the value of our common stock" for
further detail of the effect that declining real estate values could have on our
business.
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 interest rate
swap yields, one-month LIBOR yields and the interest rate spread between the
effective rate of interest received on loans available for sale or securitized
(all fixed interest rates) and the interest rates paid pursuant to credit
facilities or the pass-through interest rate to investors for interests issued
in connection with securitizations. Profitability and financial performance is
also sensitive to the impact of changes in interest rates on the fair value of
loans which are expected to be sold in whole loan sales. A substantial and
sustained increase in market interest rates could adversely affect our ability
to originate and purchase loans and maintain our profitability. 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 available for sale,
interest-only strips, servicing rights and subordinated debt). We would address
this challenge by carefully monitoring our product pricing, the actions of our
competition and market trends and the use of hedging strategies in order to
continue to originate loans in as profitable a manner as possible.
A component of our interest rate risk exposure relates to changes in
the fair value of certain interest-only strips due to changes in one-month
LIBOR. The structure of certain securitization trusts includes a floating
interest rate certificate, which pays interest based on one-month LIBOR plus an
interest rate spread. Floating interest rate certificates in a securitization
expose us to gains or losses due to changes in the fair value of the
interest-only strip from changes in the floating interest rate paid to the
certificate holders.
A rising interest rate environment could unfavorably impact our
liquidity and capital resources. Rising interest rates could impact our
short-term liquidity by limiting our ability to sell loans at favorable premiums
in whole loan sales, widening investor interest rate 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
interest rate spreads on our securitized loans, which would reduce our cash
flows. See "-- Liquidity and Capital Resources" for a discussion of both
long-term and short-term liquidity.
120
Interest Rate Sensitivity. The following table provides information
about financial instruments that are sensitive to changes in interest rates. For
interest-only strips and servicing rights, the table presents projected
principal cash flows utilizing assumptions including prepayment and credit loss
rates. See "-- Off-Balance Sheet Arrangements -- Securitizations" 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):
Amount Maturing After June 30, 2003
-------------------------------------------------------------------------------------
Months Months Months Months Months There- Fair
1 to 12 13 to 24 25 to 36 37 to 48 49 to 60 after Total Value
-------- --------- --------- -------- -------- -------- -------- ---------
Rate Sensitive Assets:
Loans and leases available for sale (a) ... $265,770 $ 75 $ 84 $ 94 $ 105 $ 5,274 $271,402 $272,991
Interest-only strips ...................... 146,273 119,532 113,746 96,530 76,825 272,298 825,204 598,278
Servicing rights .......................... 37,295 28,997 22,773 17,832 13,964 44,929 165,790 119,291
Investments held to maturity .............. 156 137 296 292 -- -- 881 946
Rate Sensitive Liabilities:
Fixed interest rate borrowings ............ $321,961 $170,627 $157,813 $27,668 $14,998 $ 26,473 $719,540 $718,387
Average interest rate ..................... 8.01% 9.07% 9.17% 9.68% 9.72% 11.26% 9.49%
Variable interest rate borrowings ......... $186,757 $ -- $ -- $ -- $ -- $ -- $186,757 $186,757
Average interest rate ..................... 2.23% -- -- -- -- -- 2.23%
- ----------
(a) For purposes of this table, all loans and leases which qualify for
securitization or whole loan sale are reflected as maturing within twelve
months, since loans and leases available for sale are generally held for
less than three months prior to securitization or whole loan sale.
Loans Available for Sale. Gain on sale of loans may be unfavorably
impacted to the extent we hold loans with fixed interest rates prior to their
sale. See "-- Business Strategy" for a discussion of our intent to add
adjustable rate mortgage loans to our loan product line.
A significant variable affecting the gain on sale of loans in a
securitization is the interest rate spread between the average interest rate on
fixed interest rate loans and the weighted-average pass-through interest rate to
investors for interests issued in connection with the securitization. Although
the average loan interest rate is fixed at the time the loan is originated, the
pass-through interest rate to investors is not fixed until the pricing of the
securitization which occurs just prior to the sale of the loans. Generally, the
period between loan origination and pricing of the pass-through interest rate is
less than three months. If market interest rates required by investors increase
prior to securitization of the loans, the interest rate spread between the
average interest rate on the loans and the pass-through interest rate to
investors may be reduced or eliminated. This factor could have a material
adverse effect on our future results of operations and financial condition. We
estimate that each 0.1% reduction in the interest rate spread reduces the gain
on sale of loans as a percentage of loans securitized by approximately 0.22%.
See "-- Strategies for Use of Derivative Financial Instruments" for further
detail of our interest rate risk management for available for sale loans.
A significant variable affecting the gain on sale of fixed interest
rate loans sold in whole loan sale transactions is the change in market interest
rates between the date the loan was originated at a fixed rate of interest and
the date the loan was sold in a whole loan sale. If market interest rates
required by investors increase prior to sale of the loans, the premium expected
121
on sale of the loans would be reduced. This factor could have a material adverse
effect on our future results of operations and financial condition.
Interest-Only Strips and Servicing Rights. A portion of the
certificates issued to investors by certain securitization trusts are floating
interest rate certificates based on one-month LIBOR plus an interest rate
spread. The fair value of the excess cash flow we will receive from these trusts
would be affected by any changes in interest rates paid on the floating interest
rate certificates. At June 30, 2003, $115.1 million of debt issued by loan
securitization trusts was floating interest rate certificates based on one-month
LIBOR, representing 3.5% of total debt issued by loan securitization trusts. In
accordance with accounting principles generally accepted in the United States of
America, the changes in fair value are generally recognized as part of net
adjustments to other comprehensive income, which is a component of retained
earnings. As of June 30, 2003, the interest rate sensitivity for $44.5 million
of floating interest rate certificates issued by securitization trusts is
managed with an interest rate swap contract effectively fixing our cost for this
debt. See "-- Strategies for Use of Derivative Financial Instruments" for
further detail. In addition, the interest rate sensitivity for $63.0 million of
floating interest rate certificates issued from the 2003-1 Trust is managed by
an interest rate cap which was entered into by the Trust at the inception of the
securitization. This interest rate cap limits the one-month LIBOR to a maximum
rate of 4.0% and was structured to automatically unwind as the floating interest
rate certificates pay down.
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. We attempt to
minimize prepayment risk on interest-only strips and servicing rights by
requiring prepayment fees on business loans and home equity loans, where
permitted by law. When originally recorded, approximately 90-95% of business
loans and 80-85% of home equity loans in the total managed portfolio were
subject to prepayment fees. Currently, approximately 50-55% of business loans
and 60-65% of home equity loans in the total managed portfolio are subject to
prepayment fees. However, higher than anticipated rates of loan prepayments
could result in a write down of the fair value of related interest-only strips
and servicing rights, adversely impacting earnings during the period of
adjustment. We perform revaluations of our interest-only strips and servicing
rights on a quarterly basis. As part of the revaluation process, we monitor the
assumptions used for prepayment rates against actual experience, economic
conditions and other factors and we adjust the assumptions, if warranted. See
"-- Off-Balance Sheet Arrangements -- Securitizations" for further information
regarding these assumptions and the impact of prepayments during this period.
Subordinated Debt. We also experience interest rate risk to the extent
that as of June 30, 2003 approximately $397.6 million of our liabilities were
comprised of fixed interest rate subordinated debt with scheduled maturities of
greater than one year. To the extent that market interest rates demanded on
subordinated debt increase in the future, the interest rates paid on replacement
debt could exceed interest rates currently paid thereby increasing interest
expense and reducing net income.
Strategies for Use of Derivative Financial Instruments. All derivative
financial instruments are recorded on the balance sheet at fair value with
realized and unrealized gains and losses included in the statement of income in
the period incurred.
122
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Financial Instruments and Hedging Activities." 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 criteria 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. If a derivative is a hedge, depending on the nature of the hedge
designation, changes in the fair value of a derivative are either offset against
the change in the fair value of assets, liabilities, or firm commitments through
earnings or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in fair
value will be recognized in earnings immediately.
SFAS No. 133 was effective on a prospective basis for all fiscal
quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS No.
133 on July 1, 2000 resulted in the cumulative effect of a change in accounting
principle of $15 thousand pre-tax being recognized as expense in the
Consolidated Statement of Income for the year ended June 30, 2001. Due to the
immateriality of the cumulative effect of adopting SFAS No. 133, the $15
thousand pre-tax expense is included in general and administrative expense in
the Consolidated Statement of Income. The tax effects and earnings per share
amounts related to the cumulative effect of adopting SFAS No. 133 are not
material.
Hedging activity
From time to time, we utilize derivative financial instruments in an
attempt to mitigate the effect of changes in interest rates between the date
loans are originated at fixed interest rates and the date the fixed interest
rate pass-through certificates to be issued by a securitization trust are priced
or the date the terms and pricing for a whole loan sale are fixed. Generally,
the period between loan origination and pricing of the pass-through interest
rate or whole loan sale is less than three months. Derivative financial
instruments we use for hedging changes in fair value due to interest rate
changes may include interest rate swaps, futures and forward contracts. The
nature and quantity of hedging transactions are determined based on various
factors, including market conditions and the expected volume of mortgage loan
originations and purchases.
The unrealized gain or loss derived from these derivative financial
instruments, which are designated as fair value hedges, is reported in earnings
as it occurs with an offsetting adjustment to the fair value of the item hedged.
The fair value of derivative financial instruments is based on quoted market
prices. The fair value of the items hedged is based on current pricing of these
assets in a securitization or whole loan sale. Cash flow related to hedging
activities is reported as it occurs. The effectiveness of our hedge
relationships is continuously monitored. If highly effective correlation did not
exist, the related gain or loss on the hedged item would no longer be recognized
as an adjustment to income.
Related to Loans Expected to Be Sold Through Securitizations. At the
time the derivative contracts are executed, they are specifically designated as
hedges of mortgage loans or our residual interests in mortgage
123
loans in our mortgage conduit facility, which we would expect to be included in
a term securitization at a future date. The mortgage loans and mortgage loans
underlying residual interests in mortgage pools consist of essentially similar
pools of fixed interest rate loans, collateralized by real estate (primarily
residential real estate) with similar maturities and similar credit
characteristics. Fixed interest rate pass-through certificates issued by
securitization trusts are generally priced to yield an interest rate spread
above interest rate swap yield curves with maturities matching the maturities of
the pass-through certificates. We may hedge potential interest rate changes in
interest rate swap yield curves with forward starting interest rate swaps,
Eurodollar futures, forward treasury sales or derivative contracts of similar
underlying securities. This practice has provided strong correlation between our
hedge contracts and the ultimate pricing we will receive on the subsequent
securitization.
Related to Loans Expected to Be Sold Through Whole Loan Sale
Transactions. We may also utilize derivative financial instruments in an attempt
to mitigate the effect of changes in market interest rates between the date
loans are originated at fixed interest rates and the date that the loans will be
sold in a whole loan sale. At the time the derivative contracts are executed,
they are specifically designated as hedges of mortgage loans or
our residual interests in mortgage loans in our mortgage conduit facility, which
we would expect to be included in a whole loan sale transaction at a future
date. We may hedge the effect of changes in market interest rates with forward
sale commitments, forward starting interest rate swaps, Eurodollar futures,
forward treasury sales or derivative contracts of similar underlying securities.
On June 30, 2003, we entered into a forward sale agreement providing for the
sale of $275.0 million of home equity mortgage loans at a price of 105.0%.
Disqualified Hedging Relationship. The securitization market was not
available to us in the fourth quarter of fiscal 2003. As a result, we realized
that the expected high correlation between the changes in the fair values of the
derivative contracts and the mortgage loans would not be achieved and
discontinued hedge accounting. During the fourth quarter of fiscal 2003, $4.0
million of losses on $170.0 million notional amount of forward starting interest
rate swaps previously designated as a hedge of mortgage loans expected to be
securitized was charged to earnings. An offsetting increase of $3.7 million in
the value of the hedged mortgage loans was recorded in earnings, representing
the changes in value of the loans until the date that we learned that the
securitization market was not available.
124
We recorded the following gains and losses on the fair value of
derivative financial instruments accounted for as hedging transactions or on
disqualified hedging relationships for the years ended June 30, 2003, 2002 and
2001. Ineffectiveness related to qualified hedging relationships during the
period was immaterial. Ineffectiveness is a measure of the difference in the
change in fair value of the derivative financial instrument as compared to the
change in the fair value of the item hedged (in thousands):
Year Ended June 30,
----------------------------------
2003 2002 2001
---------- ---------- ----------
Offset by gains and losses recorded on
securitizations:
Losses on derivative financial
instruments......................... $ (3,806) $ (9,401) $ (4,343)
Offset by gains and losses recorded on
the fair value of hedged items:
Losses on derivative financial
instruments......................... $ (7,037) $ -- $ --
Amount settled in cash - paid............ $ (5,041) $ (9,401) $ (4,343)
At June 30, 2003, forward sale agreements and outstanding forward
starting interest rate swap contracts accounted for as hedges and unrealized
losses recorded as liabilities on the balance sheet were as follows (in
thousands):
Notional Unrealized
Amount Loss
--------------- ---------------
Forward sale agreement.............. $ 275,000 $ --
Forward starting interest rate
swaps............................ $ -- $ (6,776)(a)
(a) Represents the liability carried on the balance sheet at June 30, 2003
for previously recorded losses not yet settled in cash.
There were no outstanding derivatives contracts accounted for as hedges
at June 30, 2002 or 2001.
Trading activity
Generally, we do not enter into derivative financial instrument
contracts for trading purposes. However, we have entered into derivative
financial instrument contracts which we have not designated as hedges in
accordance with SFAS No. 133 and were therefore accounted for as trading assets
or liabilities.
Related to Loans Expected to Be Sold Through Securitizations. During
fiscal 2003, we used interest rate swap contracts to protect the future
securitization spreads on loans in our pipeline. Loans in the pipeline represent
loan applications for which we are in the process of obtaining all the
documentation required for a loan approval or approved loans, which have not
been accepted by the borrower and are not considered to be firm commitments. We
believed there was a greater chance that market interest rates we would obtain
on the subsequent securitization of these loans would increase rather than
decline, and chose to protect the spread we could earn in the event of rising
rates.
125
However due to a decline in market interest rates during the period the
derivative contracts were used to manage interest rate risk on loans in our
pipeline, we recorded losses on forward starting interest rate swap contracts
during the fiscal year ended June 30, 2003. The losses are summarized in the
table below.
Related to Loans Expected to Be Sold Through Whole Loan Sale
Transactions. The $170.0 million notional amount of forward starting interest
rate swap contracts carrying over from the disqualified hedging relationship
discussed above are currently being utilized to manage the effect of changes in
market interest rates on the fair value of fixed-rate mortgage loans that were
previously expected to be sold in a fourth quarter securitization, but are now
expected to be sold in whole loan sale transactions. We have elected not to
designate these derivative contracts as an accounting hedge.
We recorded the following gains and losses on the fair value of
derivative financial instruments classified as trading for the year ended June
30, 2003. There were no derivative contracts classified as trading for the years
ended June 30, 2002 and 2001 except those noted below to manage the exposure to
changes in the fair value of certain interest-only strips due to changes in
one-month LIBOR. (in thousands):
Trading gains(losses) on forward
starting interest rate swaps:
Related to loan pipeline........... $ (3,796)
Related to whole loan sales........ $ 441
Amount settled in cash - paid...... $ (2,671)
At June 30, 2003, outstanding forward starting interest rate swap
contracts used to manage interest rate risk on loans expected to be sold in
whole loan sale transactions and the associated unrealized gains recorded as
assets on the balance sheet are summarized in the table below. There were no
open derivative contracts classified as trading for the years ended June 30,
2002 and 2001 except those noted below to manage the exposure to changes in the
fair value of certain interest-only strips due to changes in one-month LIBOR.
(in thousands):
Notional Unrealized
Amount Gain
--------------- ---------------
Forward starting interest rate
swaps.......................... $170,000 $441
The sensitivity of the forward starting interest rate swap contracts
held as trading as of June 30, 2003 to a 0.1% change in market interest rates is
$0.1 million.
Related to Interest-only Strips. For fiscal years ended June 30, 2003
and 2002, respectively, we recorded net losses of $0.9 million and $0.7 million
on an interest rate swap contract which is not designated as an accounting
hedge. This contract was designed to reduce the exposure to changes in the fair
value of certain interest-only strips due to changes in one-month LIBOR. The
loss on the swap contract was due to decreases in the interest rate swap yield
curve
126
during the periods the contract was in place. Included in the $0.9 million net
loss recorded in the fiscal year ended June 30, 2003, were unrealized gains of
$0.1 million representing the net change in the fair value of the contract
during the fiscal year and $1.0 million of cash losses paid during the fiscal
year. Included in the $0.7 million net loss recorded in the fiscal year ended
June 30, 2002, were unrealized losses of $0.5 million representing the net
change in the fair value of the contract during the fiscal year and $0.2 million
of cash losses paid during the fiscal year. The cumulative net unrealized loss
of $0.3 million is included as a trading liability in Other liabilities. Terms
of the interest rate swap contract at June 30, 2003 were as follows (dollars in
thousands):
Notional amount................................. $ 44,535
Rate received - Floating (a).................... 1.18%
Rate paid - Fixed............................... 2.89%
Maturity date................................... April.2004
Unrealized loss................................. $ 334
Sensitivity to 0.1% change in interest rates.... $ 17
____________________________
(a) Rate represents the spot rate for one-month LIBOR paid on the securitized
floating interest rate certificate at the end of the period.
Derivative transactions are measured in terms of a notional amount, but
this notional amount is not carried on the balance sheet. The notional amount is
not exchanged between counterparties to the derivative financial instrument, but
is only used as a basis to determine fair value, which is recorded on the
balance sheet and to determine interest and other payments between the
counterparties. Our exposure to credit risk in a derivative transaction is
represented by the fair value of those derivative financial instruments in a
gain position. We attempt to manage this exposure by limiting our derivative
financial instruments to those traded on major exchanges and where our
counterparties are major financial institutions. At June 30, 2003, we held no
derivative financial instruments in a cumulative gain position.
In the future, we may expand the types of derivative financial
instruments we use to hedge interest rate risk to include other types of
derivative contracts. 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. Hedging involves
transaction and other costs that could increase as the period covered by the
hedging protection increases. Although it is expected that such costs would be
offset by income realized from securitizations in that period or in future
periods, we may be prevented from effectively hedging fixed interest rate loans
held for sale without reducing income in current or future periods. In addition,
while Eurodollar rates, interest rate swap yield curves and the pass-through
interest 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).
Liquidity and Capital Resources
Liquidity and capital resource management is a process focused on
providing the funding to meet our short and long-term cash needs. We have used a
substantial portion of our funding sources to build our managed portfolio and
investments in securitization residual assets with the expectation that they
will generate sufficient cash flows in the future to cover our operating
requirements, including repayment of maturing subordinated debt. Our cash needs
change as the mix of loan sales through securitization shifts to whole loan
sales, as the managed portfolio grows, as our interest-only strips grow and
release more cash, as subordinated debt matures, as operating expenses change
and as revenues increase. Because we have historically experienced negative cash
127
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 (although no
acquisitions are currently contemplated).
Initially, we finance our loans under several secured and partially
committed credit facilities. These credit facilities are generally revolving
lines of credit, which we have with several financial institutions that enable
us to borrow on a short-term basis against our loans. We then securitize or sell
our loans to unrelated third parties on a whole loan basis to generate the cash
to pay off these revolving credit facilities.
In fiscal 2003, we recorded a net loss of $29.9 million. The loss was
due in part to our inability to complete our typical quarterly securitization
of loans during the fourth quarter of our fiscal year. Also contributing to the
loss was $45.2 million of net pre-tax charges for valuation adjustments
(compared to $22.1 million of valuation adjustments in fiscal 2002) recorded on
our securitization assets during the 2003 fiscal year. See "-- Off-Balance Sheet
Arrangements -- Securitizations" for more detail on the valuation adjustments.
Our short term liquidity was negatively impacted by several recent
events. Our inability to complete our typical publicly underwritten
securitization during the fourth quarter of fiscal 2003 contributed to our loss
for fiscal 2003 and adversely impacted our short-term liquidity position. In
addition, further advances under a non-committed portion of one of our credit
facilities were subject to the discretion of the lender and subsequent to June
30, 2003, there were no new advances under the non-committed portion.
Additionally, on August 20, 2003, this credit facility was amended and, among
other changes, the non-committed portion was eliminated. We also had a $300.0
million mortgage conduit facility with a financial institution that enabled us
to sell our loans into an off-balance sheet facility, which expired pursuant to
its terms on July 5, 2003. At June 30, 2003, of the $516.1 million in revolving
credit and conduit facilities available to us, $453.4 million was drawn upon. At
September 19, 2003, of the $117.0 million in revolving credit facilities
available to us, $102.3 million was drawn upon. Our revolving credit facilities
and mortgage conduit facility had $62.7 million of unused capacity available at
June 30, 2003 (and $14.7 million of unused capacity at September 19, 2003),
which significantly reduced our ability to fund future loan originations until
we sell existing loans, extend or expand existing credit facilities, or add new
credit facilities. In addition, we have temporarily discontinued sales of new
subordinated debt, which further impaired our liquidity.
As a result of these liquidity issues, since June 30, 2003, we
substantially reduced our loan origination volume. From July 1, 2003 through
August 31, 2003, we originated $85.7 million of loans, which represents a
significant reduction as compared to originations of $245.8 million of loans for
the same period in fiscal 2003. Our inability to originate loans at previous
levels may adversely impact the relationships our subsidiaries have or are
developing with their brokers and our ability to retain employees. As a result
of the decrease in loan originations and liquidity issues described above, we
anticipate incurring a loss for the first quarter of fiscal 2004. The amount of
the loss will depend, in part, upon our ability to complete a securitization
prior to September 30, 2003 and, if completed, the size and terms of the
securitization. Further, we can provide no assurances that we will be able to
sell our loans, extend existing facilities or expand or add new credit
facilities. If we are unable to obtain additional financing, we may not be able
to restructure our business to permit profitable operations or repay our
subordinated debt when due. Even if we are able to obtain adequate financing,
our inability to securitize our loans could hinder our ability to operate
profitably in the future and repay our subordinated debt when due.
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We undertook specific remedial actions to address short-term liquidity
concerns including entering into an agreement on June 30, 2003 with an
investment bank to sell up to $700.0 million of mortgage loans, subject to the
satisfactory completion of the purchaser's due diligence review and other
conditions, and soliciting bids and commitments from other participants in the
whole loan sale market. In total, from June 30, 2003 through September 17, 2003,
we sold approximately $482.9 million (which includes $221.9 million of loans
sold by the expired mortgage conduit facility) of loans through whole loan
sales. We are continuing the process of selling our loans. We also suspended
paying quarterly cash dividends on our common stock.
As a result of the loss experienced during fiscal 2003, we were not in
compliance with the terms of certain of the financial covenants under two of our
principal credit facilities (one for $50.0 million and the other for $200.0
million, of which $100.0 million was non-committed) and we requested and
obtained waivers of these requirements from our lenders. See "-- Credit
Facilities." The lender under the $50.0 million warehouse credit facility has
granted us a waiver for our non-compliance with a financial covenant in that
credit facility through September 30, 2003. This facility was amended to reduce
the available credit to $8.0 million and the financial covenants were replaced
with new covenants with which we are currently in compliance.
We also entered into an amendment to the $200.0 million credit facility
which provides for the waiver of our non-compliance with the financial covenants
in that facility, the reduction of the committed portion of this facility from
$100.0 million to $50.0 million, the elimination of the $100.0 million
non-committed portion of this credit facility and the acceleration of the
termination date of this facility from November 2003 to September 30, 2003. Our
ability to repay this facility upon termination is dependent on our ability to
refinance the loans in one of our new facilities or our sale of loans currently
warehoused in the terminating facility by September 30, 2003.
In addition, if the anticipated loss for the first quarter of fiscal
2004 described above results in our non-compliance with any financial covenants,
we intend to seek the appropriate waivers. There can be no assurances that we
will obtain any of these waivers.
On September 22, 2003, we entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding our loan originations. Pursuant to the terms of this facility, we are
required to, among other things: (i) obtain a written commitment for another
credit facility of at least $200.0 million and close that additional facility by
October 3, 2003 (which condition would be satisfied by the closing of the $225.0
million facility described below); (ii) have a net worth of at least $28.0
million by September 30, 2003; with quarterly increases of $2.0 million
thereafter; (iii) apply 60% of our net cash flow from operations each quarter to
reduce the outstanding amount of subordinated debt commencing with the quarter
ending March 31, 2004; and (iv) provide a parent company guaranty of 10% of the
outstanding principal amount of loans under the facility. Prior to the closing
of the second facility, our borrowing capacity on this $200.0 million credit
facility is limited to $80.0 million. This facility has a term of 12 months
expiring in September 2004 and is secured by the mortgage loans which are funded
by advances under the facility with interest equal to LIBOR plus a margin. This
facility is subject to representations and warranties and covenants, which are
customary for a facility of this type, as well as amortization events and events
of default related to our financial condition. These provisions require, among
other things, our maintenance of a delinquency ratio for the managed portfolio
at the end of each fiscal quarter of less than 12.0%, our subordinated debt not
to exceed $705.0 million at any time, our ownership of an amount of repurchased
loans not to exceed 1.5% of the managed portfolio and our registration statement
registering $295.0 million of subordinated debt be declared effective by the SEC
no later than October 31, 2003.
129
On September 22, 2003, we executed a commitment letter for a mortgage
warehouse credit facility with a warehouse lender, which consists of a senior
secured revolving credit facility of up to $225.0 million to fund loan
originations and a secured last out revolver facility up to $25.0 million. The
commitment letter is subject to certain conditions, including, among other
things: (i) entering into definitive agreements, except as provided in the
commitment letter; (ii) the absence of a material adverse change in the
business, operations, property, condition (financial or otherwise) or prospects
of us or our affiliates; and (iii) our receipt of another credit facility in an
amount not less that $200.0 million, subject to terms and conditions acceptable
to this lender (which condition is satisfied by the new $200.0 million facility
described above). The commitment letter provides that these facilities will have
a term of three years with an interest rate on amounts outstanding under the
$225.0 million portion of the credit facility equal to the greater of one-month
LIBOR plus a margin or the difference between the yield maintenance fee (as
defined in the commitment letter) and the one-month LIBOR plus a margin.
Advances under this facility would be collateralized by substantially all of our
present and future assets including pledged loans and a security interest in
substantially all of our interest-only strips and residual interests which will
be contributed to a special purpose entity organized by us to facilitate this
transaction. We also agreed to pay fees of approximately $14.6 million annually
plus a nonusage fee based on the difference between the average daily
outstanding balance for the current month and the maximum credit amount under
the facility and the lender's out-of-pocket expenses.
We anticipate that these facilities will be subject to representations
and warranties, events of default and covenants which are customary for
facilities of this type, as well as our agreement to: (i) maintain sales or
renewals of our subordinated debt securities of $10.0 million per month;
(ii) restrict total principal and interest outstanding on our subordinated debt
to $750.0 million or less; (iii) make quarterly reductions commencing in April
2004 of an amount of subordinated debt outstanding to be determined; (iv)
maintain maximum interest rates payable on subordinated debt securities not to
exceed 10 percentage points above comparable rates for FDIC insured products;
and (v) the lender's receipt of our audited financial statements for the period
ended June 30, 2003. The definitive agreements will grant the lender an option
at any time after the first anniversary of entering into the definitive
agreements to increase the credit amount on the $250.0 million facility to
$400.0 million with additional fees payable by us plus additional interest as
may be required by the institutions or investors providing the lender with these
additional funds. The commitment letter requires that we enter into definitive
agreements not later than October 17, 2003. While we anticipate that we will
close this transaction prior to such date, we cannot assure you that these
negotiations will result in definitive agreements or that such agreements, as
negotiated, will be on terms and conditions acceptable to us. In the event we
are unable to close these facilities or another facility within the time frame
provided under the new $200.0 million credit facility described above, the
lender on that facility would be under no obligation to make further advances
under the terms of that facility and outstanding advances would have to be
repaid over a period of time.
During the first quarter of fiscal 2004, we explored a number of
strategic alternatives to address these liquidity issues in the event we are
unable to borrow under the new $200.0 million credit facility, close the $250.0
million credit facilities or obtain alternative financing. In the event we were
unable to obtain the additional credit facilities necessary to operate our
business, we developed a contingent business plan (described more fully under
"-- Recent Developments -- Business Strategy Adjustments") which contemplates,
among other things, the sale of $100 million principal amount of additional
subordinated debt through March 2004 and the renewal of approximately 50% of
outstanding subordinated debt upon maturity. We believe that this contingent
business plan addresses our liquidity issues and may permit us to restructure
our operations, if necessary, without the receipt of an expanded or additional
credit facility. There can be no assurance that our contingent business plan
will be successful or that it will enable us to repay our subordinated debt when
due.
130
The following discussion of liquidity and capital resources should be
read in conjunction with the discussion contained in "-- Application of Critical
Accounting Policies." When loans are sold through a securitization, we retain
the rights to service the loans. Servicing loans obligates us to advance
interest payments for delinquent loans under certain circumstances and allows us
to repurchase a limited amount of delinquent loans from securitization trusts.
See "-- Off-Balance Sheet Arrangements," "-- Off-Balance Sheet Arrangements --
Securitizations" and "-- Off-Balance Sheet Arrangements -- Trigger Management"
for more information on how the servicing of securitized loans affects
requirements on our capital resources and cash flow.
Cash flow from operations, the issuance of subordinated debt and lines
of credit fund our operating cash needs. We expect these sources of funds to be
sufficient to meet our cash needs. Loan originations are funded through
borrowings against warehouse credit facilities and sales into an off-balance
sheet facility. Each funding source is described in more detail below.
Cash flow from operations. One of our corporate goals is to achieve
positive cash flow from operations. However, we cannot be certain that we will
achieve our projections regarding declining negative cash flow or positive cash
flow from operations. The achievement of this goal is dependent on our ability
to successfully implement our business strategy and on the following items:
o Manage the mixture of whole loan sales and securitization
transactions to maximize cash flow and economic value;
o Manage levels of securitizations to maximize cash flows received at
closing and subsequently from interest-only strips and servicing
rights;
o Maintain a portfolio of mortgage loans which will generate
income and cash flows through our servicing activities and the
residual interests we hold in the securitized loans;
131
o Build on our established approaches to underwriting loans,
servicing and collecting loans and managing credit risks in
order to control delinquency and losses;
o Continue to identify and invest in technology and other
efficiencies to reduce per unit costs in our loan origination
and servicing process; and
o Control overall expense levels.
Historically, our cash flow from operations has been negatively
impacted by a number of factors. The growth of our loan originations negatively
impacts our cash flow from operations because we incur the cash expenses of the
origination, but generally do not recover the cash outflow from these
origination expenses until we securitize or sell the underlying loans. With
respect to loans securitized, we may be required to wait more than one year to
begin recovering the cash outflow from loan origination expenses through cash
inflows from our residual assets retained in securitization. A second factor,
which could negatively impact our cash flow, is an increase in market interest
rates. If market interest rates increase, the premiums we would be paid on whole
loan sales could be reduced and the interest rates that investors will demand on
the certificates issued in future securitizations will increase. The increase in
interest rates paid to investors reduces the cash we will receive from
interest-only strips created in future securitizations. Although we may have the
ability in a rising interest rate market to charge higher loan interest rates to
our borrowers, competition, laws and regulations and other factors may limit or
delay our ability to do so.
Cash flow from operations for the year ended June 30, 2003 was a
negative $285.4 million compared to negative $13.3 million for fiscal 2002.
Negative cash flow from operations increased $272.1 million for the year ended
June 30, 2003 mainly due to our inability to complete a securitization in the
fourth quarter of fiscal 2003. At June 30, 2003 we carried $271.4 million of
loans available for sale, compared to $57.7 million at June 30, 2002. We also
carried a receivable of $26.7 million for the proceeds on loans sold in a whole
loan sale transaction, which closed on June 30, 2003, but settled in cash on
July 1, 2003. Also contributing to the increase in negative cash flow for fiscal
2003 was an increase in the amount of delinquent loans repurchased from
securitization trusts in order to avoid delinquency and loss triggers and the
funding of $3.8 million in initial overcollateralization from the proceeds of
our December 2002 securitization and $6.8 million on our fourth quarter of
fiscal 2003 sales to a mortgage conduit facility. Increases in the cash flow
from interest-only strips in fiscal 2003 were offset by increases in operating
expenses, mainly general and administrative expenses to service and collect the
larger managed portfolio.
The amount of cash we receive and the amount of overcollateralization
we are required to fund at the closing of our securitizations and the amount of
cash we receive as gains on whole loan sales are dependent upon a number of
factors including market factors over which we have no control. Although we
expect negative cash flow from operations to continue and fluctuate in the
foreseeable future, our goal is to reduce our negative cash flow from operations
from historical levels. We believe that if our projections based on our business
strategy prove accurate, our cash flow from operations will become positive.
However, negative cash flow from operations in fiscal 2004 may continue due to
the nature of our operations and the timing to implement our business strategy.
We generally expect the level of cash flow from operations to fluctuate.
132
As was previously discussed, during the seven quarters ended June 30,
2003, our actual prepayment experience on our managed portfolio was generally
higher than our average historical levels for prepayments. Prepayments result in
decreases in the size of our managed portfolio and decreases in the expected
future cash flows to us from our interest-only strips and servicing rights.
However, due to the favorable interest rate spreads, favorable initial
overcollateralization requirements and levels of cash received at closing on our
more recent securitizations we do not believe our recent increase in prepayment
experience will have a significant impact on our aggregate expected cash flows
from operations in the future.
Other factors could negatively affect our cash flow and liquidity such
as increases in mortgage interest rates, legislation or other economic
conditions which may make our ability to originate loans more difficult. As a
result, our costs to originate loans could increase or our volume of loan
originations could decrease.
Contractual obligations. Following is a summary of future payments
required on our contractual obligations as of June 30, 2003 (in thousands):
Payments Due by Period
---------------------------------------------------------------
Less than 1 to 3 4 to 5 More than
Contractual Obligations Total 1 year years years 5 years
- -------------------------------- ---------- --------- -------- ------- ---------
Subordinated debt.............. $ 719,540 $ 321,960 $328,440 $42,666 $26,474
Accrued interest - subordinated
debt (a) ................... 45,283 21,635 17,657 2,360 3,631
Warehouse and operating lines
of credit................... 212,109 212,109 -- -- --
Capitalized lease (b).......... 807 319 488 -- --
Operating leases (c)........... 56,123 1,420 10,415 10,755 33,533
Services and equipment (d)..... 7,331 7,331 -- -- --
---------- --------- -------- ------- -------
Total obligations.............. $1,041,193 $ 564,774 $357,000 $55,781 $63,638
========== ========= ======== ======= =======
(a) This table reflects interest payment terms elected by subordinated debt
holders as of June 30, 2003. In accordance with the terms of the
subordinated debt offering, subordinated debt holders have the right to
change the timing of the interest payment on their notes once during the
term of their investment.
(b) Amounts include principal and interest.
(c) Amounts include lease for office space.
(d) Amounts related to the relocation of our corporate headquarters. The
provisions of the lease, local and state grants will provide us with
reimbursement of a substantial amount of these payments.
Credit facilities. Borrowings against warehouse credit facilities
represent cash advanced to us for a limited duration, generally no more than 270
days, and are secured by the loans we pledge to the lender. These credit
facilities provide the primary funding source for loan originations. The
ultimate sale of the loans through securitization or whole loan sale generates
the cash proceeds necessary to repay the borrowings under the warehouse
facilities. In addition, we have the availability of revolving credit
facilities, which may be used to fund our operations. These credit facilities
are generally extended for a one-year term before the renewal of the facility
must be re-approved by the lender. We periodically review our expected future
credit needs and negotiate credit commitments for those needs as well as excess
capacity in order to allow us flexibility in the timing of the securitization of
our loans.
133
The following is a description of the warehouse and operating lines of
credit and mortgage conduit facilities, which were available to us at June 30,
2003 (in thousands):
Amount Amount
Facility Utilized On- Utilized Off-
Amount Balance Sheet Balance Sheet
-------- ------------- -------------
Revolving credit and conduit facilities:
Mortgage conduit facility, expiring July 2003 (a) $300,000 $ Na $267,488
Warehouse revolving line of credit, expiring November 2003 (b) 200,000 136,098 Na
Warehouse and operating revolving line of credit, expiring
December 2003 (c) 50,000 30,182 Na
Warehouse revolving line of credit, expiring October 2003 (d) 25,000 19,671 Na
Operating revolving line of credit, expiring January 2004 (e) 5,000 -- Na
-------- -------- --------
Total revolving credit facilities 580,000 185,951 267,488
Other facilities:
Capitalized leases, maturing January 2006 (f) 807 807 Na
-------- -------- --------
Total credit facilities $580,807 $186,758 $267,488
======== ======== ========
- -------------------------------------
Na - not applicable for facility
(a) $300.0 million mortgage conduit facility. The facility provided for the
sale of loans into an off-balance sheet facility with UBS Principal
Finance, LLC, an affiliate of UBS Warburg. This facility expired pursuant
to its terms on July 5, 2003. See "-- Application of Critical Accounting
Policies" for further discussion of the off-balance sheet features of this
facility.
(b) $200.0 million warehouse line of credit with Credit Suisse First Boston
Mortgage Capital, LLC. $100.0 million of this facility was continuously
committed for the term of the facility while the remaining $100.0 million
of the facility was available at Credit Suisse's discretion. Subsequent to
June 30, 2003, there were no new advances under the non-committed portion.
On August 20, 2003, this credit facility was amended to reduce the
committed portion to $50.0 million (from $100.0 million), eliminate the
non-committed portion and accelerate its expiration date from November 2003
to no later than September 30, 2003. The interest rate on the facility is
based on one-month LIBOR plus a margin. Advances under this facility are
collateralized by pledged loans.
(c) $50.0 million warehouse and operating credit facility with JPMorgan Chase
Bank which includes a sublimit for a letter of credit to secure lease
obligations for corporate office space. Interest rates on the advances
under this facility are based upon one-month LIBOR plus a margin. The
amount of the letter of credit was $8.0 million at June 30, 2003 and will
vary over the term of the lease. Obligations under the facility are
collateralized by pledged loans, REO, and advances to securitization
trusts. Advances on this line for general operating purposes are limited to
$5.0 million and are collateralized by our Class R Certificates of the ABFS
Mortgage Loan Trusts 1997-2, 1998-1 and 1998-3.
(d) $25.0 million warehouse line of credit facility from Residential Funding
Corporation. Under this warehouse facility, advances may be obtained,
subject to specific conditions described in the agreements. Interest rates
on the advances are based on one-month LIBOR plus a margin. The obligations
under this agreement are collateralized by pledged loans.
(e) $5.0 million revolving line of credit facility from Firstrust Savings Bank.
The obligations under this facility are collateralized by the cash flows
from our investments in the ABFS 99-A lease securitization trust and Class
R and X certificates of the ABFS Mortgage Loan Trust 2001-2. The interest
rate on the advances from this facility is one-month LIBOR plus a margin.
(f) Capitalized leases, imputed interest rate of 8.0%, collateralized by
computer equipment.
134
On September 22, 2003, we entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding our loan originations. Pursuant to the terms of this facility, we are
required to, among other things: (i) obtain a written commitment for another
credit facility of at least $200.0 million and close that additional facility by
October 3, 2003 (which condition would be satisfied by the closing of the $225.0
million facility described below); (ii) have a net worth of at least $28.0
million by September 30, 2003; with quarterly increases of $2.0 million
thereafter; (iii) apply 60% of our net cash flow from operations each quarter to
reduce the outstanding amount of subordinated debt commencing with the quarter
ending March 31, 2004; and (iv) provide a parent company guaranty of 10% of the
outstanding principal amount of loans under the facility. Prior to the closing
of the second facility, our borrowing capacity on this $200.0 million credit
facility is limited to $80.0 million. This facility has a term of 12 months
expiring in September 2004 and is secured by the mortgage loans which are funded
by advances under the facility with interest equal to LIBOR plus a margin. This
facility is subject to representations and warranties and covenants, which are
customary for a facility of this type, as well as amortization events and events
of default related to our financial condition. These provisions require, among
other things, our maintenance of a delinquency ratio for the managed portfolio
at the end of each fiscal quarter of less than 12.0%, our subordinated debt not
to exceed $705.0 million at any time, our ownership of an amount of repurchased
loans not to exceed 1.5% of the managed portfolio and our registration statement
registering $295.0 million of subordinated debt be declared effective by the SEC
no later than October 31, 2003.
On September 22, 2003, we executed a commitment letter for a mortgage
warehouse credit facility with a warehouse lender, which consists of a senior
secured revolving credit facility of up to $225.0 million to fund loan
originations and a secured last out revolver facility up to $25.0 million. The
commitment letter is subject to certain conditions, including, among other
things: (i) entering into definitive agreements, except as provided in the
commitment letter; (ii) the absence of a material adverse change in the
business, operations, property, condition (financial or otherwise) or prospects
of us or our affiliates; and (iii) our receipt of another credit facility in an
amount not less that $200.0 million, subject to terms and conditions acceptable
to this lender (which condition is satisifed by the new $200.0 million facility
described above). The commitment letter provides that these facilities will have
a term of three years with an interest rate on amounts outstanding under the
$225.0 million portion of the credit facility equal to the greater of one-month
LIBOR plus a margin or the difference between the yield maintenance fee (as
defined in the commitment letter) and the one-month LIBOR plus a margin.
Advances under this facility would be collateralized by substantially all of our
present and future assets including pledged loans and a security interest in
substantially all of our interest-only strips and residual interests which will
be contributed to a special purpose entity organized by us to facilitate this
transaction. We also agreed to pay fees of approximately $14.6 million annually
plus a nonusage fee based on the difference between the average daily
outstanding balance for the current month and the maximum credit amount under
the facility and the lender's out-of-pocket expenses.
We anticipate that these facilities will be subject to representations
and warranties, events of default and covenants which are customary for
facilities of this type, as well as our agreement to: (i) maintain sales or
renewals of our subordinated debt securities of $10.0 million per month; (ii)
restrict total principal and interest outstanding on our subordinated debt to
$750.0 million or less; (iii) make quarterly reductions commencing in April 2004
of an amount of subordinated debt outstanding to be determined; (iv) maintain
maximum interest rates payable on subordinated debt securities not to exceed 10
percentage points above comparable rates for FDIC insured products; and (v) the
lender's receipt of our audited financial statements for the period ended June
30, 2003. The definitive agreements will grant the lender an option at any time
after the first anniversary of entering into the definitive agreements to
increase the credit amount on the $250.0 million facility to $400.0 million with
additional fees payable by us plus additional interest as may be required by the
institutions or investors providing the lender with these additional funds. The
commitment letter requires that we enter into the definitive agreements not
later than October 17, 2003. While we anticipate that we will close this
transaction prior to such date, we cannot assure you that these negotiations
will result in definitive agreements or that such agreements, as negotiated,
will be on terms and conditions acceptable to us. In the event we are unable to
close these facilities or another facility within the time frame provided under
the new $200.0 million credit facility described above, the lender on that
facility would be under no obligation to make further advances under the terms
of that facility and outstanding advances would have to be repaid over a period
of time.
135
The warehouse credit agreements require that we maintain specific
financial covenants regarding net worth, leverage, net income, liquidity, total
debt and other standards. Each agreement has multiple individualized financial
covenant thresholds and ratio of limits that we must meet as a condition to
drawing on a particular line of credit. As a result of the loss experienced
during fiscal 2003, we were not in compliance with the terms of certain of the
financial covenants related to net worth, consolidated stockholders' equity and
the ratio of total liabilities to consolidated stockholders' equity under two of
our principal credit facilities (one for $50.0 million and the other for $200.0
million, of which $100.0 million was non-committed). Pursuant to the terms of
these credit facilities, the failure to comply with the financial covenants
constitutes an event of default and at the option of the lender, entitles the
lender to, among other things, terminate commitments to make future advances to
us, declare all or a portion of the loan due and payable, foreclose on the
collateral securing the loan, require servicing payments be made to the lender
or other third party or assume the servicing of the loans securing the credit
facility. An event of default under these credit facilities would result in
defaults pursuant to cross-default provisions of our other agreements, including
but not limited to, other loan agreements, lease agreements and other
agreements. The failure to comply with the terms of these credit facilities or
to obtain the necessary waivers would have a material adverse effect on our
liquidity and capital resources. We have requested and obtained waivers from
these covenant provisions from both lenders. The lender under the $50.0 million
warehouse credit facility has granted us a waiver for our non-compliance with a
financial covenant in that credit facility through September 30, 2003. This
facility was amended to reduce the available credit to $8.0 million and the
financial covenants were replaced with new covenants. We also entered into an
amendment to the $200.0 million credit facility which provides for the waiver of
our non-compliance with the financial covenants in that facility, the reduction
of the committed portion of this facility from $100.0 million to $50.0 million,
the elimination of the $100.0 million non-committed portion of this credit
facility and the acceleration of the termination date of this facility from
November 2003 to September 30, 2003. Our ability to repay this facility upon
termination is dependent on our ability to refinance the loans in one of our new
facilities or our sale of loans currently warehoused in the terminating facility
by September 30, 2003. In addition, if the anticipated loss for the first
quarter of fiscal 2004 described above results in our non-compliance with any
financial covenants, we intend to seek the appropriate waivers. There can be no
assurances that we will obtain any of these waivers.
Some of our financial covenants in other credit facilities have minimal
flexibility and we cannot say with certainty that we will continue to comply
with the terms of all debt covenants. There can be no assurance as to whether or
in what form a waiver or modification of these agreements would be granted us.
Subordinated debt securities. The issuance of subordinated debt funds
the majority of our remaining operating cash requirements. We rely significantly
on our ability to issue subordinated debt since our cash flow from operations is
not sufficient to meet these requirements. In order to expand our businesses we
have issued subordinated debt to partially fund growth and to partially fund
maturities of subordinated debt. In addition, at times we may elect to utilize
proceeds from the issuance of subordinated debt to fund loans instead of using
our warehouse credit facilities, depending on our determination of liquidity
needs. During fiscal 2003, subordinated debt increased by $63.8 million, net of
redemptions compared to an increase of $117.8 million in fiscal 2002. The
reduction in the level of subordinated debt sold was a result of our focus on
becoming cash flow positive and reducing our reliance on subordinated debt.
We registered $315.0 million of subordinated debt under a registration
statement, which was declared effective by the SEC on October 3, 2002. Of the
$315.0 million, $121.3 million of this debt was unsold as of June 30, 2003.
In June 2003, we filed a new registration statement with the SEC to
register an additional $295.0 million of subordinated debt.
136
We intend to meet our obligation to repay such debt and interest 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. Our
unrestricted cash balances are sufficient to cover approximately 8.9% of the
$343.6 million of subordinated debt and accrued interest maturities due within
one year. Unrestricted cash balances were $30.5 million at June 30, 2003,
compared to $99.6 million at June 30, 2002.
The current low interest rate environment has provided an opportunity
to reduce the interest rates offered on our subordinated debt. The
weighted-average interest rate of our subordinated debt issued in the month of
June 2003 was 7.49%, compared to debt issued in June 2002, which had a
weighted-average interest rate of 8.39%. Debt issued at our peak rate, which was
in February 2001, was at a rate of 11.85%. Our ability to further decrease the
rates offered on subordinated debt, or maintain the current rates, depends on
market interest rates and competitive factors among other circumstances. The
weighted average remaining maturity of our subordinated debt at June 2003 was
19.5 months compared to 17.2 months at June 2002.
Sales into special purpose entities and off-balance sheet facilities.
We rely significantly on access to the asset-backed securities market through
securitizations to provide permanent funding of our loan production. We also
retain the right to service the loans. Residual cash from the loans after
required principal and interest payments are made to the investors provides us
with cash flows from our interest-only strips. 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 and our
operating cash needs. See "-- Off-Balance Sheet Arrangements" for further detail
of our securitization activity and effect of securitizations on our liquidity
and capital resources.
Other liquidity considerations. In December 2002, our shareholders
approved an amendment to our Certificate of Incorporation to increase the number
of shares of authorized preferred stock from 1.0 million shares to 3.0 million
shares. The preferred shares may be used to raise equity capital, redeem
outstanding debt or acquire other companies, although no such acquisitions are
currently contemplated. The Board of Directors has discretion with respect to
designating and establishing the terms of each series of preferred stock prior
to issuance.
A further decline in economic conditions, continued instability in
financial markets or further acts of terrorism in the United States may cause
disruption in our business and operations including reductions in demand for our
loan products and our subordinated debt securities, increases in delinquencies
and credit losses in our managed loan portfolio, changes in historical
prepayment patterns and declines in real estate collateral values. To the extent
the United States experiences an economic downturn, unusual economic patterns
and unprecedented behaviors in financial markets, these developments may affect
our ability to originate loans at profitable interest rates, to price future
loan securitizations profitably and to hedge our loan portfolio effectively
against market interest rate changes which could cause reduced profitability.
Should these disruptions and unusual activities occur, our profitability and
cash flow could be reduced and our ability to make principal and interest
payments on our subordinated debt could be impaired. Additionally, under the
Soldiers' and Sailors' Civil Relief Act of 1940, members of all branches of the
military on active duty, including draftees and reservists in military service
and state national guard called to federal duty are entitled to have interest
rates reduced and capped at 6% per annum, on obligations (including mortgage
137
loans) incurred prior to the commencement of military service for the duration
of military service and may be entitled to other forms of relief from mortgage
obligations. To date, compliance with the Act has not had a material effect on
our business.
Related Party Transactions
We have a loan receivable from our Chairman and Chief Executive
Officer, Anthony J. Santilli, for $0.6 million, which was an advance for the
exercise of stock options to purchase 247,513 shares of our common stock in
1995. 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 247,513 shares of
our common stock, and is shown as a reduction of stockholders' equity in our
financial statements.
On April 2, 2001, we awarded 2,500 shares (3,025 shares after the
effect of stock dividends) of our common stock to Richard Kaufman, our director,
as a result of services rendered in connection with our stock repurchases.
In February 2003, we awarded 2,000 shares of our common stock to each
of Warren E. Palitz and Jeffrey S. Steinberg, as newly appointed members of our
Board of Directors.
We employ members of the immediate family of two of our directors and
executive officers in various executive and other positions. We believe that the
salaries we pay these individuals are competitive with salaries paid to other
employees in similar positions in our organization and in our industry.
In fiscal 2003, Lanard & Axilbund, Inc., a real estate brokerage and
management firm in which our Director, Mr. Sussman, was a partner and is now
Chairman Emeritus, acted as our agent in connection with the lease of our new
corporate office space. As a result of this transaction, Lanard & Axilbund, Inc.
has received commissions from the landlord of the new corporate office space. We
believe the amount of this commission is consistent with market and industry
standards. Additionally, as part of our agreement with Lanard & Axilbund, Inc.,
they have reimbursed us for some of our costs related to finding new office
space including some of our expenses related to legal services, feasibility
studies and space design.
Additionally, we have business relationships with other related
parties, including family members of two of our directors and executive
officers, through which we have, from time to time, purchased appraisal
services, office equipment and real estate advisory services. None of our
related party transactions, individually or collectively, are material to our
results of operations.
Reconciliation of Non-GAAP Financial Measures
This document contains non-GAAP financial measures. For purposes of the
SEC's Regulation G, a non-GAAP financial measure is a numerical measure of a
registrant's historical or future financial performance, financial position or
cash flow that excludes amounts, or is subject to adjustments that have the
effect of excluding amounts, that are included in the most directly comparable
measure calculated and presented in accordance with GAAP in our statement of
138
income, balance sheet or statement of cash flows (or equivalent statement); or
includes amounts, or is subject to adjustments that have the effect of including
amounts, that are excluded from the most directly comparable measure so
calculated and presented. In this regard, GAAP refers to accounting principles
generally accepted in the United States of America. Pursuant to the requirements
of Regulation G, following is a reconciliation of the non-GAAP financial
measures to the most directly comparable GAAP financial measure.
We present certain financial ratios to measure balance sheet leverage
relationships that include or exclude items from GAAP based financial ratios
consistent with common industry practices. Additionally, some ratios are
adjusted in order to isolate secured items such as secured debt or
overcollateralization, which is secured by loan principal in securitization
trusts, from unsecured items. Management believes these measures enhance the
users' overall understanding of our current financial performance and prospects
for the future and that these measures help in understanding the risk
characteristics of certain significant balance sheet amounts and how their
proportions to equity change over time. The following tables reconcile the
ratios presented in "Balance Sheet Information -- Balance Sheet Data" to GAAP
basis measures (dollars in thousands):
June 30,
Total liabilities to tangible ----------------------------------------
equity: 2003 2002 2001
---------- ---------- ----------
Total liabilities .............. $1,117,282 $806,997 $699,625
Equity ......................... 42,069 69,378 66,862
Less: Goodwill ................. (15,121) (15,121) (15,121)
---------- -------- --------
Tangible equity ........... $ 26,948 $ 54,257 $ 51,741
========== ======== ========
Total liabilities to tangible
equity ...................... 41.5 x 14.9 x 13.5 x
========== ======== ========
Liabilities/equity ............. 26.6 x 11.6 x 10.5 x
========== ======== ========
Adjusted debt to tangible
equity:
Total liabilities .............. $1,117,282 $806,997 $699,625
Less: Cash ..................... (47,475) (108,599) (91,092)
Less: Warehouse lines .......... (212,916) (8,486) (51,064)
Less: Loans in process ......... (35,187) (29,866) (29,130)
---------- -------- --------
821,704 660,046 528,339
Equity ......................... 42,069 69,378 66,862
Less: Goodwill ................. (15,121) (15,121) (15,121)
---------- -------- --------
Tangible equity ........... $ 26,948 $ 54,257 $ 51,741
========== ======== ========
Adjusted debt to tangible
equity ...................... 30.5 x 12.2 x 10.2 x
========== ======== ========
Liabilities/equity ............. 26.6 x 11.6 x 10.5 x
========== ======== ========
139
Subordinated debt to tangible June 30,
equity: ---------------------------------------
2003 2002 2001
---------- ---------- ----------
Subordinated debt .............. $719,540 $655,720 $537,950
Equity ......................... 42,069 69,378 66,862
Less: Goodwill ................. (15,121) (15,121) (15,121)
-------- -------- --------
Tangible equity ............. $ 26,948 $ 54,257 $ 51,741
======== ======== ========
Subordinated debt to tangible
equity ...................... 26.7 x 12.1 x 10.4 x
======== ======== ========
Liabilities/equity ............. 26.6 x 11.6 x 10.5 x
======== ======== ========
Interest-only strips to adjusted
tangible equity:
Interest-only strips ........... $598,278 $512,611 $398,519
Less: Overcollateralization .... (210,719) (160,079) (119,000)
387,559 352,532 279,519
Equity ......................... 42,069 69,378 66,862
Less: Goodwill ................. (15,121) (15,121) (15,121)
-------- -------- --------
Tangible equity ........... 26,948 54,257 51,741
Plus: Subordinated debt with
remaining maturity
>5 years .................... 26,474 27,629 28,637
-------- -------- --------
$ 53,422 $ 81,886 $ 80,378
======== ======== ========
Interest-only strips to adjusted
tangible equity ........... 7.3 x 4.3 x 3.5 x
======== ======== ========
Interest-only strips/equity .... 14.2 x 7.4 x 6.0 x
======== ======== ========
We present managed portfolio and managed real estate owned, referred to
as REO, information. Management believes these measures enhance the users'
overall understanding of our current financial performance and prospects for the
future because the volume and credit characteristics of off-balance sheet
securitized loan and lease receivables have a significant effect on our
financial performance as a result of our retained interests in the securitized
loans. Retained interests include interest-only strips and servicing rights. In
addition, because the servicing and collection of our off-balance sheet
securitized loan and lease receivables are performed in the same manner and
according to the same standards as the servicing and collection of our
on-balance sheet loan and lease receivables, certain of our resources, such as
personnel and technology, are allocated based on their pro rata relationship to
the total managed portfolio and total managed REO. The following tables
reconcile the managed portfolio measures presented in "-- Managed Portfolio
Quality" and "Selected Financial Information." (dollars in thousands):
140
June 30, 2003: Delinquencies
- -----------------------------------------------------------------------
Amount %
-------- ----
On-balance sheet loan and lease
receivables.................. $ 265,764 $ 5,412 2.04%
Securitized loan and lease
receivables..................... 3,385,310 223,658 6.61%
---------- --------
Total Managed Portfolio........... $3,651,074 $229,070 6.27%
========== ========
On-balance sheet REO.............. $ 4,776
Securitized REO................... 23,224
----------
Total Managed REO................. $ 28,000
==========
June 30, 2002: Delinquencies
- ------------------------------------------------------------------------
Amount %
-------- -----
On-balance sheet loan and
lease receivables............... $ 56,625 $ 5,918 10.45%
Securitized loan and lease
receivables..................... 3,009,564 164,855 5.48%
---------- --------
Total Managed Portfolio........... $3,066,189 $170,773 5.57%
========== ========
On-balance sheet REO.............. $ 3,784
Securitized REO................... 30,261
----------
Total Managed REO................. $ 34,045
==========
June 30, 2001: Delinquencies
- -----------------------------------------------------------------------
Amount %
-------- ----
On-balance sheet loan and
lease receivables............... $ 87,899 $ 3,382 3.85%
Securitized loan and lease
receivables..................... 2,501,496 103,631 4.14%
---------- --------
Total Managed Portfolio........... $2,589,395 $107,013 4.13%
========== ========
On-balance sheet REO.............. $ 2,323
Securitized REO................... 26,109
----------
Total Managed REO................. $ 28,432
==========
Office Facilities
We presently lease office space for our corporate headquarters in
Philadelphia, Pennsylvania. Our corporate headquarters was located in Bala
Cynwyd, Pennsylvania prior to July 7, 2003. The lease for the Bala Cynwyd
facility has expired. The current lease term for the Philadelphia facility
expires in June 2014. The terms of the rental agreement require increased
payments annually for the term of the lease with average minimum annual rental
payments of $4.2 million. We have entered into contracts, or may engage parties
in the future, related to the relocation of our corporate headquarters such as
contracts for building improvements to the leased space, office furniture and
equipment and moving services. The provisions of the lease and local and state
grants will provide us with reimbursement of a substantial amount of our costs
related to the relocation, subject to certain conditions and limitations. We do
not believe our unreimbursed expenses or unreimbursed cash outlay related to the
relocation will be material to our operations.
141
The lease requires us to maintain a letter of credit in favor of the
landlord to secure our obligations to the landlord throughout the term of the
lease. The amount of the letter of credit is $8.0 million and declines over time
to $4.0 million. The letter of credit is currently issued by JPMorgan Chase Bank
under our $8.0 million facility with JPMorgan Chase Bank.
We continue to lease some office space in Bala Cynwyd under a five-year
lease expiring in November 2004 at an annual rental of approximately $0.7
million. We perform our loan servicing and collection activities at this office,
but expect to relocate these activities to our Philadelphia office.
In May 2003, we moved our regional processing center to a different
location in Roseland, New Jersey. We also lease the office space in Roseland,
New Jersey and the nine-year lease expires in January 2012. The terms of the
rental agreement require increased payments periodically for the term of the
lease with average minimum annual rental payments of $0.8 million. The expenses
and cash outlay related to the relocation were not material to our operations.
Recent Accounting Pronouncements
The following description should be read in conjunction with the
significant accounting policies, which have been adopted and are set forth in
Note 1 of the June 30, 2003 Consolidated Financial Statements.
In November 2002, the Financial Accounting Standards Board ("FASB")
issued Financial Interpretation No. ("FIN") 45 "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 standardizes practices related to the
recognition of a liability for the fair value of a guarantor's obligation. The
rule requires companies to record a liability for the fair value of its
guarantee to provide or stand ready to provide services, cash or other assets.
The rule applies to contracts that require a guarantor to make payments based on
an underlying factor such as change in market value of an asset, collection of
the scheduled contractual cash flows from individual financial assets held by a
special purpose entity, non-performance of a third party, for
indemnification agreements, or for guarantees of the indebtedness of others
among other things. The provisions of FIN 45 are effective on a prospective
basis for guarantees that are issued or modified after December 31, 2002. The
disclosure requirements were effective for statements of annual or interim
periods ending after December 15, 2002.
Based on the requirements of this guidance for the year ended June 30,
2003, we have recorded a $0.7 million liability in conjunction with the sale of
mortgage loans to the ABFS 2003-1 securitization trust which occurred in March
2003. This liability represents the fair value of periodic interest advances
that we, as servicer of the securitized loans, are obligated to pay on behalf of
delinquent loans in the trust. The recording of this liability reduces the gain
on sale recorded for the securitization. We would expect to record a similar
liability for any subsequent securitization as it occurs. The amount of the
liability that will be recorded is dependent mainly on the volume of loans we
securitize, the expected performance of those loans and the interest rate of the
loans. In the year ended June 30, 2003, the adoption of FIN 45 reduced net
income by approximately $0.4 million and diluted earnings per share by $0.14.
See Note 14 of the Consolidated Financial Statements for further detail of this
obligation.
In December 2002, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 148 "Accounting for Stock-Based Compensation - Transition
and Disclosure." SFAS No. 148 amends SFAS No. 123 "Accounting for Stock-Based
Compensation." SFAS No. 148 provides alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based
compensation and requires pro forma disclosures of the effect on net income and
earnings per share had the fair value method been used to be included in annual
and interim reports and disclosure of the effect of the transition method used
if the accounting method was changed, among other things. SFAS No. 148 is
effective for annual reports of fiscal years beginning after December 15, 2002
142
and interim reports for periods beginning after December 15, 2002. We plan to
continue using the intrinsic value method of accounting for stock-based
compensation and therefore the new rule will have no effect on our financial
condition or results of operations. We have adopted the new standard related to
disclosure in the interim period beginning January 1, 2003. See Notes 1 and 12
of the Consolidated Financial Statements for further detail of the adoption of
this rule.
In April 2003, the FASB began reconsidering the current alternatives
available for accounting for stock-based compensation. Currently, the FASB is
continuing its deliberations on this matter. We cannot predict whether the
guidance will change our current accounting for stock-based compensation, or
what effect, if any, changes may have on our current financial condition or
results of operations.
In January 2003, the FASB issued FIN 46 "Consolidation of Variable
Interest Entities." FIN 46 provides guidance on the identification of variable
interest entities that are subject to consolidation requirements by a business
enterprise. A variable interest entity subject to consolidation requirements is
an entity that does not have sufficient equity at risk to finance its operations
without additional support from third parties and the equity investors in the
entity lack certain characteristics of a controlling financial interest as
defined in the guidance. SPEs are one type of entity, which under certain
circumstances may qualify as a variable interest entity. Although we use
unconsolidated SPEs extensively in our loan securitization activities, the
guidance will not affect our current consolidation policies for SPEs as the
guidance does not change the guidance incorporated in SFAS No. 140 "Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities" which precludes consolidation of a qualifying SPE by a transferor
of assets to that SPE. FIN 46 will therefore have no effect on our financial
condition or results of operations and would not be expected to affect it in the
future. In March 2003, the FASB announced that it is reconsidering the permitted
activities of a qualifying SPE. We cannot predict whether the guidance will
change or what effect, if any, changes may have on our current consolidation
policies for SPEs.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" to
clarify the financial accounting and reporting for derivative instruments and
hedging activities. SFAS No. 149 is intended to improve financial reporting by
requiring comparable accounting methods for similar contracts. SFAS No. 149 is
effective for contracts entered into or modified subsequent to June 30, 2003.
The requirements of SFAS No. 149 do not affect our current accounting for
derivative instruments or hedging activities, therefore, it will have no effect
on our financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No.150 requires an issuer to classify certain financial instruments having
characteristics of both liabilities and equity, such as mandatorily redeemable
shares and obligations to repurchase the issuer's equity shares, as liabilities.
The guidance is effective for financial instruments entered into or modified
subsequent to May 31, 2003, and otherwise is effective at the beginning of the
first interim period after June 15, 2003. We do not have any instruments with
such characteristics and do not expect SFAS No. 150 to have a material impact on
our financial condition or results of operations.
143
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."
144
Item 8. Financial Statements
Index to Consolidated Financial Statements Page
----
Report of Independent Certified Public Accountants..................... 131
Consolidated Balance Sheets as of June 30, 2003 and 2002............... 132
Consolidated Statements of Income for the years ended
June 30, 2003, 2002 and 2001...................................... 133
Consolidated Statements of Stockholders' Equity for the years ended
June 30, 2003, 2002 and 2001...................................... 134
Consolidated Statements of Cash Flow for the years ended
June 30, 2003, 2002 and 2001...................................... 135
Notes to Consolidated Financial Statements............................. 137
145
Report of Independent Certified Public Accountants
American Business Financial Services, Inc.
Philadelphia, Pennsylvania
We have audited the accompanying consolidated balance sheets of
American Business Financial Services, Inc. and subsidiaries as of June 30, 2003
and 2002, and the related consolidated statements of income, stockholders'
equity, and cash flow for each of the three years in the period ended June 30,
2003. 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 auditing standards generally
accepted in the United States of America. 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 consolidated 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, 2003
and 2002, and the consolidated results of their operations and their cash flow
for each of the three years in the period ended June 30, 2003 in conformity
with accounting principles generally accepted in the United States of America.
/s/ BDO Seidman LLP
BDO Seidman LLP
Philadelphia, Pennsylvania
August 29, 2003, except for Note 1, Business Conditions,
and Note 9, which are as of September 22, 2003
146
American Business Financial Services, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30,
2003 2002
-----------------------------
(dollar amounts in thousands)
Assets
Cash and cash equivalents $ 47,475 $108,599
Loan and lease receivables, net
Available for sale 271,402 57,677
Interest and fees 15,179 12,292
Other 23,761 9,028
Interest-only strips (includes the fair value of
overcollateralization related cash flows of $279,245 and
$236,629 at June 30, 2003 and 2002) 598,278 512,611
Servicing rights 119,291 125,288
Receivable for sold loans 26,734 -
Prepaid expenses 3,477 3,640
Property and equipment, net 23,302 18,446
Other assets 30,452 28,794
---------- --------
Total assets $1,159,351 $876,375
========== ========
Liabilities
Subordinated debt $ 719,540 $655,720
Warehouse lines and other notes payable 212,916 8,486
Accrued interest payable 45,448 43,069
Accounts payable and accrued expenses 30,352 13,690
Deferred income taxes 17,036 35,124
Other liabilities 91,990 50,908
---------- --------
Total liabilities 1,117,282 806,997
---------- --------
Stockholders' equity
Preferred stock, par value $.001, authorized, 3,000,000 shares
at June 30, 2003 and 1,000,000 shares at June 30, 2002;
Issued and outstanding, none - -
Common stock, par value $.001, authorized, 9,000,000 shares;
Issued: 3,653,165 shares in 2003 and 3,645,192 shares in 2002
(including Treasury shares of 706,273 in 2003 and 801,823 in
2002) 4 4
Additional paid-in capital 23,985 23,985
Accumulated other comprehensive income 14,540 11,479
Retained earnings 13,104 47,968
Treasury stock, at cost (8,964) (13,458)
---------- --------
42,669 69,978
Note receivable (600) (600)
---------- --------
Total stockholders' equity 42,069 69,378
---------- --------
Total liabilities and stockholders' equity $1,159,351 $876,375
========== ========
See accompanying notes to financial statements.
147
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Income
Year ended June 30,
2003 2002 2001
----------------------------------------------
(dollar amounts in thousands
except per share data)
Revenues
Gain on sale of loans:
Securitizations $170,950 $185,580 $128,978
Whole loan sales 655 2,448 2,742
Interest and fees 19,395 18,890 19,840
Interest accretion on interest-only strips 47,347 35,386 26,069
Servicing income 3,049 5,483 5,700
Other income 10 114 7
-------- -------- --------
Total revenues 241,406 247,901 183,336
-------- -------- --------
Expenses
Interest 68,098 68,683 56,547
Provision for credit losses 6,553 6,457 5,190
Employee related costs 41,601 36,313 28,897
Sales and marketing 27,773 25,958 24,947
General and administrative 101,219 74,887 54,570
Securitization assets valuation adjustment 45,182 22,053 -
-------- -------- --------
Total expenses 290,426 234,351 170,151
-------- -------- --------
Income (loss) before provision for income taxes (49,020) 13,550 13,185
Provision for income tax expense (benefit) (19,118) 5,691 5,274
-------- -------- --------
Income (loss) before cumulative effect of a change in
accounting principle (29,902) 7,859 7,911
Cumulative effect of a change in accounting principle - - 174
-------- -------- --------
Net income (loss) $(29,902) $ 7,859 $ 8,085
======== ======== ========
Earnings (loss) per common share
Income (loss) before cumulative effect of a
change in accounting principle:
Basic $ (10.25) $ 2.68 $ 2.08
Diluted $ (10.25) $ 2.49 $ 2.04
Net income (loss):
Basic $ (10.25) $ 2.68 $ 2.13
Diluted $ (10.25) $ 2.49 $ 2.08
Average common shares (in thousands):
Basic 2,918 2,934 3,797
Diluted 2,918 3,155 3,885
See accompanying notes to financial statements.
148
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Common Stock
-------------------- Accumulated
Number of Additional Other Total
Shares Paid-In Comprehensive Retained Treasury Note Stockholders'
(amounts in thousands) Outstanding Amount Capital Income Earnings Stock Receivable Equity
----------- ------ ---------- ------------- -------- -------- ---------- -------------
Balance, June 30, 2000 4,022 $4 $24,291 $ 5,458 $36,850 $(3,888) $(600) $62,115
Comprehensive income:
Net income - - - - 8,085 - - 8,085
Unrealized gains on
interest-only strips - - - 4,879 - - - 4,879
----- -- ------- ------- ------- ------- ----- -------
Total comprehensive income - - - 4,879 8,085 - - 12,964
Issuance of non-employee
stock options - - (333) - - - - (333)
Cash dividends ($0.26 per share) - - - - (1,013) - - (1,013)
Repurchase of treasury shares (759) - - - - (6,897) - (6,897)
Shares issued to directors 3 - 26 - - - - 26
----- -- ------- ------- ------- ------- ----- -------
Balance, June 30, 2001 3,266 4 23,984 10,337 43,922 (10,785) (600) 66,862
Comprehensive income:
Net income - - - - 7,859 - - 7,859
Unrealized gains on
interest-only strips - - - 1,142 - - - 1,142
------ -- ------- ------- ------- ------- ----- -------
Total comprehensive income - - - 1,142 7,859 - - 9,001
Stock dividend (10% of
outstanding shares) - - - (2,979) 2,979 - -
Cash dividends ($0.28 per share) - - - - (834) - - (834)
Repurchase of treasury shares (423) - - - - (5,652) - (5,652)
Exercise of stock options 1 - 1 - - - - 1
------ -- ------- ------- ------- ------- ----- -------
Balance, June 30, 2002 2,844 4 23,985 11,479 47,968 (13,458) (600) 69,378
Comprehensive income (loss):
Net loss - - - - (29,902) - - (29,902)
Unrealized gains on
interest-only strips - - - 3,061 - - - 3,061
----- -- ------- ------- ------- ------- ----- -------
Total comprehensive income (loss) - - - 3,061 (29,902) - - (26,841)
Exercise of non employee stock options 57 - - - (569) 619 - 50
Exercise of employee stock options 4 - - - (31) 51 - 20
Shares issued to employees 38 - - - (119) 492 - 373
Shares issued to directors 4 - - - (28) 51 - 23
Stock dividend (10% of
outstanding shares) - - - - (3,281) 3,281 - -
Cash dividends ($0.32 per share) - - - - (934) - - (934)
----- -- ------- ------- ------- ------- ----- -------
Balance, June 30, 2003 2,947 $4 $23,985 $14,540 $13,104 $(8,964) $(600) $42,069
===== == ======= ======= ======= ======= ===== =======
See accompanying notes to financial statements.
149
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow
Year ended June 30,
2003 2002 2001
-----------------------------------------------------
(dollar amounts in thousands)
Cash flows from operating activities
Net income (loss) $ (29,902) $ 7,859 $ 8,085
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Gain on sales of loans - Securitizations (170,950) (185,580) (128,978)
Depreciation and amortization 53,614 40,615 30,434
Interest accretion on interest-only strips (47,347) (35,386) (26,069)
Interest-only strips fair value adjustment 45,182 22,053 -
Provision for credit losses 6,553 6,457 5,190
Loans and leases originated for sale (1,732,346) (1,434,176) (1,256,090)
Proceeds from sale of loans and leases 1,458,302 1,443,898 1,218,370
Principal payments on loans and leases 19,136 12,654 7,658
(Increase) decrease in accrued interest and fees on
loan and lease receivables (2,887) 4,257 (3,547)
Purchase of initial overcollateralization on
securitized loans (10,641) - -
Required purchase of additional overcollateralization
on securitized loans (73,253) (47,271) (43,945)
Cash flow from interest-only strips 160,417 100,692 82,905
Increase (decrease) in prepaid expenses 163 (183) (1,248)
Increase in accrued interest payable 2,379 10,370 14,779
Increase (decrease) in accounts payable and accrued
expenses 17,037 5,366 (5,252)
Accrued interest payable reinvested in subordinated
debt 38,325 31,706 16,026
(Decrease) increase in deferred income taxes (22,185) 4,595 4,930
Increase (decrease) in loans in process 5,321 736 (4,012)
Other, net (2,293) (1,969) (8,841)
-----------------------------------------------------
Net cash used in operating activities (285,375) (13,307) (89,605)
-----------------------------------------------------
Cash flows from investing activities
Purchase of property and equipment, net (12,450) (4,472) (9,210)
Principal receipts and maturity of investments 36 28 751
-----------------------------------------------------
Net cash used in investing activities (12,414) (4,444) (8,459)
-----------------------------------------------------
150
American Business Financial Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flow (Continued)
Year ended June 30,
2003 2002 2001
-----------------------------------------------------
(dollar amounts in thousands)
Cash flows from financing activities
Proceeds from issuance of subordinated debt $ 181,500 $ 224,062 $ 217,694
Redemptions of subordinated debt (156,005) (137,998) (86,446)
Net borrowings (repayments) on revolving lines of
credit 179,594 (34,077) 8,095
Principal payments on lease funding facility (2,129) (3,345) (3,866)
Principal payments under capital lease obligations (213) - -
Repayments of repurchase agreement - - (3,605)
Net borrowings (repayments) of other notes payable 26,158 (5,156) (402)
Financing costs incurred (841) (1,743) (4,155)
Exercise of employee stock options 20 1 -
Exercise of non-employee stock options 50 - -
Lease incentive receipts 9,465 - -
Cash dividends paid (934) (834) (1,013)
Repurchase of treasury stock - (5,652) (6,897)
-----------------------------------------------------
Net cash provided by financing activities 236,665 35,258 119,405
-----------------------------------------------------
Net (decrease) increase in cash and cash equivalents (61,124) 17,507 21,341
Cash and cash equivalents at beginning of year 108,599 91,092 69,751
-----------------------------------------------------
Cash and cash equivalents at end of year $ 47,475 $ 108,599 $ 91,092
=====================================================
Supplemental disclosures:
Cash paid during the year for:
Interest $ 27,394 $ 26,729 $ 25,620
Income taxes $ 787 $ 1,511 $ 662
Noncash transaction recorded for capitalized
lease agreement:
Increase in property and equipment $ (1,020) $ - $ -
Increase in warehouse lines and other notes
payable $ 1,020 $ - $ -
See accompanying notes to financial statements.
151
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies
Business
American Business Financial Services, Inc. ("ABFS"), together with its
subsidiaries (the "Company"), is a diversified financial services organization
operating predominantly in the eastern and central portions of the United
States. The Company originates, sells and services business purpose loans and
home equity loans through its principal direct and indirect subsidiaries. The
Company also processes and purchases home equity loans from other financial
institutions through the Bank Alliance Services program.
The Company's loans primarily consist of fixed interest rate loans secured by
first or second mortgages on one-to-four family residences. The Company's
customers are primarily credit-impaired borrowers who are generally unable to
obtain financing from banks or savings and loan associations and who are
attracted to our products and services. The Company originates loans through a
combination of channels including a national processing center located at its
centralized operating office in Philadelphia, Pennsylvania and a regional
processing center in Roseland, New Jersey. The Company's centralized operating
office was located in Bala Cynwyd, Pennsylvania prior to July 7, 2003. Prior to
June 30, 2003 the Company also originated home equity loans through several
retail branch offices. Effective June 30, 2003, the Company no longer originates
home equity loans through retail branch offices. In addition, the Company offers
subordinated debt securities to the public, the proceeds of which are used for
repayment of existing debt, loan originations, operations (including repurchases
of delinquent assets from securitization trusts), investments in systems and
technology and for general corporate purposes.
Effective December 31, 1999, the Company de-emphasized and subsequent to that
date, discontinued the equipment leasing origination business but continues to
service the remaining portfolio of leases.
Business Conditions
For its ongoing operations, the Company depends upon frequent financings,
including the sale of unsecured subordinated debt securities, borrowings under
warehouse credit facilities or lines of credit and the sale of loans through
publicly underwritten securitizations. If the Company is unable to renew or
obtain adequate funding on acceptable terms through its sale of subordinated
debt securities or under a warehouse credit facility, or other borrowings, the
lack of adequate funds would adversely impact liquidity and reduce
profitability or result in losses. If the Company is unable to securitize or
otherwise sell its loans, its liquidity would be reduced and it may incur
losses. To the extent that the Company is not successful in maintaining or
replacing existing subordinated debt securities upon maturity, or
152
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
maintaining adequate warehouse credit facilities or lines of credit, or
securitizing and selling its loans, it may have to limit future loan
originations and further restructure its operations. Limiting loan originations
or restructuring operations could impair the Company's ability to repay
subordinated debt at maturity and may result in losses. The Company has
historically experienced negative cash flow from operations since 1996 primarily
because in general, its business strategy of selling loans through
securitization has not generated cash flow immediately. For the fiscal year
ended June 30, 2003, the Company experienced negative cash flow from operations
of $285.4 million.
In fiscal 2003, the Company recorded a net loss of $29.9 million. The loss was
primarily due to the Company's inability to complete its typical quarterly
securitization of loans during the fourth quarter of the fiscal year ended June
30, 2003 and to $45.2 million of pre-tax charges for valuation adjustments
(compared to $22.1 million of valuation adjustments in the fiscal year ended
June 30, 2002) recorded on the Company's securitization assets during the fiscal
year ended June 30, 2003. The valuation adjustments reflect the impact of higher
than anticipated prepayments on securitized loans experienced in fiscal 2003 due
to the low interest rate environment experienced during most of 2003, which has
impacted the entire mortgage industry. The valuation adjustment recorded on
securitization assets in fiscal 2003 was reduced by a $17.9 million favorable
valuation impact to the income statement as a result of reducing the discount
rates applied in valuing the securitization assets at June 30, 2003. The
discount rates were reduced at June 30, 2003 primarily to reflect the impact of
the sustained decline in market interest rates. The discount rate on the
projected residual cash flows from the Company's interest-only strips was
reduced from 13% to 11% at June 30, 2003. The discount rate used to determine
the fair value of the overcollateralization portion of the cash flows from
interest-only strips was minimally impacted by the decline in interest rates and
remained at 7% on average. As a result, the blended rate used to value
interest-only strips, including the overcollateralization cash flows, was 9% at
June 30, 2003. See Note 4 for more details on the valuation adjustments.
The Company's inability to complete its typical publicly underwritten
securitization during the fourth quarter of fiscal 2003 also adversely impacted
the Company's short-term liquidity position. In addition, further advances under
a non-committed portion of one of the Company's credit facilities were subject
to the discretion of the lender and from June 30, 2003 to August 20, 2003, there
were no new advances under the non-committed portion. On August 20, 2003, this
credit facility was amended to reduce the committed portion to $50.0 million
(from $100.0 million), eliminate the non-committed portion and accelerate its
expiration date from November 2003 to no later than September 30, 2003. The
Company also had a $300.0 million mortgage conduit facility with a financial
institution that enabled the Company to sell its loans into an off-balance sheet
facility, which expired pursuant to its terms on July 5, 2003. At June 30, 2003,
of the $516.1 million in revolving credit and conduit facilities available to
the Company, $453.4 million was drawn upon. The Company's revolving credit
facilities and mortgage conduit facility had $62.7 million of unused capacity
available at June 30, 2003, which significantly reduced its ability to fund
future loan originations until it sells existing loans, extends or expands
existing credit facilities or adds new credit facilities. The Company can
provide no assurances that it will be able to sell all of its loans, extend or
expand existing facilities or add new credit facilities.
The Company undertook specific remedial actions to address short-term liquidity
concerns including entering into an agreement on June 30, 2003 with an
investment bank
153
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
to sell up to $700.0 million of mortgage loans, subject to the satisfactory
completion of the purchaser's due diligence review and other conditions, and
soliciting bids and commitments from other participants in the whole loan sale
market. In total, through August 29, 2003, the Company sold approximately $453.2
million of loans in whole loan sales. The process of selling loans is
continuing. The Company also suspended paying quarterly dividends on its common
stock.
On September 22, 2003, the Company entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding our loan originations. Pursuant to the terms of this facility, the
Company is required to, among other things: (i) obtain a written commitment for
another credit facility of at least $200.0 million and close that additional
facility by October 3, 2003 (which condition would be satisfied by the closing
of the $225.0 million facility described below), (ii) have a net worth of at
least $28.0 million by September 30, 2003, with quarterly increases of $2.0
million thereafter; (iii) apply 60% of net cash flow from operations each
quarter to reduce the outstanding amount of subordinated debt commencing with
the quarter ending March 31, 2004; and (iv) provide a parent company guaranty of
10% of the outstanding principal amount of loans under the facility. Prior to
the closing of the second facility, borrowing capacity on this $200.0 million
credit facility is limited to $80.0 million. This facility has a term of 12
months expiring in September 2004 and is secured by the mortgage loans, which
are funded by advances under the facility with interest equal to LIBOR plus a
margin. This facility is subject to representations and warranties and
covenants, which are customary for a facility of this type, as well as
amortization events and events of default related to the Company's financial
condition. These provisions require, among other things, maintenance of a
delinquency ratio for the managed portfolio (which represents the portfolio of
securitized loans and leases serviced for others) at the end of each fiscal
quarter of less than 12.0%, the Company's subordinated debt not to exceed $705.0
million at any time, its ownership of an amount of repurchased loans not to
exceed 1.5% of the managed portfolio and its registration statement registering
$295.0 million of subordinated debt be declared effective by the SEC no later
than October 31, 2003.
On September 22, 2003, the Company executed a commitment letter for a mortgage
warehouse credit facility with a warehouse lender, which consists of a senior
secured revolving credit facility of up to $225.0 million to fund loan
originations and a secured last out revolver facility up to $25.0 million. The
commitment letter is subject to certain conditions, including, among other
things: (i) entering into definitive agreements, except as provided in the
commitment letter; (ii) the absence of a material adverse change in the
Company's business, operations, property, condition (financial or otherwise) or
prospects of it or its affiliates; and (iii) the receipt of another credit
facility in an amount not less than $200.0 million, subject to terms and
conditions acceptable to this lender (which condition is satisfied by the new
$200.0 million facility described above). The commitment letter provides that
these facilities will have a term of three years with an interest rate on
amounts outstanding under the $225.0 million portion of the credit facility
equal to the greater of one-month LIBOR plus a margin or the difference between
the yield maintenance fee (as defined in the commitment letter) and the one
month LIBOR plus a margin. Advances under this facility would be collateralized
by substantially all of the Company's present and future assets including
pledged loans and a security interest in substantially all of its interest-only
strips and residual interests which will be contributed to a special purpose
entity organized by the Company to facilitate this transaction. The Company also
agreed to pay fees of approximately $14.6 million annually plus a nonusage fee
based on the difference between the average daily outstanding balance for the
current month and the maximum credit amount under the facility and the lender's
out-of-pocket expenses.
154
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
The Company anticipates that these facilities will be subject to representations
and warranties, events of default and covenants which are customary for
facilities of this type, as well as its agreement to: (i) maintain sales or
renewals of our subordinated debt securities of $10.0 million per month; (ii)
restrict total principal and interest outstanding on its subordinated debt to
$750.0 million or less; (iii) make quarterly reductions commencing in April 2004
of an amount of subordinated debt outstanding to be determined; (iv) maintain
maximum interest rates payable on subordinated debt securities not to exceed 10
percentage points above comparable rates for FDIC insured products; and (v) the
lender's receipt of the Company's audited financial statements for the period
ended June 30, 2003. The definitive agreements will grant the lender an option
at any time after the first anniversary of entering into the definitive
agreements to increase the credit amount on the $250.0 million facility to
$400.0 million with additional fees payable by the Company plus additional
interest as may be required by the institutions or investors providing the
lender with these additional funds. The commitment letter requires that the
Company enter into definitive agreements not later than October 17, 2003. While
the Company anticipates that it will close this transaction prior to such date,
it cannot provide assurance that these negotiations will result in definitive
agreements or that such agreements, as negotiated, will be on terms and
conditions acceptable to the Company. In the event the Company is unable to
close these facilities or another facility within the time frame provided under
the new $200.0 million credit facility described above, the lender on that
facility would be under no obligation to make further advances under the terms
of that facility and outstanding advances would have to be repaid over a period
of time.
After the Company recognized its inability to securitize its loans in the fourth
quarter of fiscal 2003, it adjusted its business strategy to emphasize, among
other things, more whole loan sales. The Company intends to continue to evaluate
both public and privately placed securitization transactions, subject to market
conditions.
At June 30, 2003 there were approximately $322.0 million of subordinated
debentures maturing through June 30, 2004. The Company obtains the funds to
repay the subordinated debentures at their maturities by securitizing loans,
selling whole loans and selling additional subordinated debentures. Cash flow
from operations, the issuance of subordinated debentures and lines of credit
fund the Company's cash needs. The Company expects these sources of funds to be
sufficient to meet its cash needs. The Company could, in the future, generate
cash flows by securitizing, selling, or borrowing against its interest-only
strips and selling servicing rights generated in past securitizations.
In the event the Company was for any reason prohibited from offering additional
subordinated debentures, the Company has developed a contingent financial
restructuring plan including cash flow projections for the next twelve-month
period. Based on the Company's current cash flow projections, the Company
anticipates being able to make all scheduled subordinated debenture maturities
and vendor payments.
The contingent financial restructuring plan is based on actions that the Company
would take, in addition to those indicated in its adjusted business strategy, to
155
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Business Conditions (continued)
reduce its operating expenses and conserve cash. These actions would include
reducing capital expenditures, selling all loans originated on a whole loan
basis, eliminating or downsizing various lending, overhead and support groups,
and scaling back 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 accounting principles generally
accepted in the United States of America. 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 interest-only strips and servicing rights,
estimated servicing revenues and costs, valuation of real estate owned, the net
recoverable value of interest and fee receivables 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 shares, average common
shares, earnings per common share and stock option amounts have been
retroactively adjusted to reflect the effect of a 10% stock dividend declared
August 21, 2002 and amounts reported for June 30, 2001 and 2000 have been
retroactively adjusted to reflect the effect of a 10% stock dividend declared
October 1, 2001. See Note 10 for further description.
Cash and Cash Equivalents
Cash equivalents consist of short-term investments with an initial maturity of
three months or less. The Company held restricted cash balances of $11.0 million
and $9.0 million related to borrower escrow accounts at June 30, 2003 and June
30, 2002, respectively, and $6.0 million at June 30, 2003 related to deposits
for future settlement of interest rate swap contracts. There was no restricted
cash related to interest rate swap contracts at June 30, 2002.
156
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
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 fair
value. Fair 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 - Interest and fees are comprised mainly of accrued
interest and fees on loans and leases that are less than 90 days delinquent. Fee
receivables include, among other types of fees, forbearance and deferment
advances. Under deferment and forbearance arrangements, the Company makes
advances to a securitization trust on behalf of a borrower in amounts equal to
the delinquent loan payments and may pay taxes, insurance and other fees on
behalf of the borrower. As a result of these arrangements the Company resets the
contractual status of a loan in its managed portfolio from delinquent to current
based upon the borrower's resumption of making their loan payments. These
amounts are carried at their estimated net recoverable value.
Loan and lease receivables - Other is comprised of receivables for securitized
loans. In accordance with the Company's securitization agreements, the Company
has the right, but not the obligation, to repurchase a limited amount of
delinquent loans from securitization trusts. In accordance with the provisions
of SFAS No. 140, the Company has recorded an obligation for the repurchase of
loans subject to these removal of accounts provisions, whether or not the
Company plans to repurchase the loans. The obligation for the loans' purchase
price is recorded in Other liabilities. A corresponding receivable is recorded
at the lower of the loans' cost basis or fair 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, delinquent loans that
have been repurchased from securitization trusts and to account for estimates
for credit losses on loans and leases that are current. The allowance is
calculated based upon management's estimate of its ability to collect on
outstanding loans and leases 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. Delinquent loans are charged off when deemed fully uncollectable or
when liquidated in a payoff.
157
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
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. This asset is recognized in the Consolidated Statement of
Income, in the case of loans, as an adjustment to the gain on sale recorded at
the time the loans are securitized, or in the case of leases, as amortization
expense over the term of the leases.
Interest-Only Strips
The Company sells a majority of its originated loans through securitizations. In
connection with these securitizations, the Company receives cash and an
interest-only strip, which represents the Company's retained interest in the
securitized loans. As a holder of the interest-only strips, the Company is
entitled to receive certain excess (or residual) cash flows and
overcollateralization cash flows, which are derived from payments made to a
trust from the securitized loans after deducting payments to investors in the
securitization trust and other miscellaneous fees. These retained interests are
carried at their fair value. Fair value is based on a discounted cash flow
analysis which estimates the present value of the future expected residual cash
flows and overcollateralization cash flows utilizing assumptions made by
management at the time the loans are sold. These assumptions include the rates
used to calculate the present value of expected future residual cash flows and
overcollateralization cash flows, referred to as the discount rates, and
expected prepayment and credit loss rates on the pools of loans sold through
securitizations. Cash flows are discounted from the date the cash is expected to
be available to the Company (the "cash-out method"). Estimates of prepayment and
credit loss rates are made based on management's expectation of future
experience, which is based in part on historical experience, current and
expected economic conditions and in the case of prepayment rate assumptions,
consideration of the impact of changes in market interest rates. Excess cash
flows are retained by the trust until certain overcollateralization levels are
established. The overcollateralization is the excess of the aggregate principal
balances of loans in a securitized pool over investor interests. The
overcollateralization serves as credit enhancement for the investors.
The expected future cash flows from interest-only strips are periodically
re-evaluated. The current assumptions for prepayment and credit loss rates are
monitored against actual experience and other economic conditions and are
changed if deemed necessary.
The securitization trusts and their investors have no recourse to other assets
of the Company for failure of the securitized loans to pay when due.
158
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Servicing Rights
When loans are sold through a securitization, the servicing of the loans is
retained and the Company capitalizes the benefit associated with the rights to
service securitized loans.
Servicing rights represent the rights to receive contractual servicing fees from
securitization trusts and ancillary fees from borrowers net of adequate
compensation that would be required by a substitute servicer. Servicing rights
are carried at the lower of cost or fair value. Fair value represents the
present value of projected net cash flows from servicing. The projected cash
flows from servicing fees incorporate assumptions made by management, 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.
Amortization of the servicing rights asset for securitized loans is calculated
individually for each securitized loan pool and is recognized in proportion to
servicing income on that particular pool of loans.
The expected future cash flows from servicing rights are periodically
re-evaluated. The current assumptions for prepayment and credit loss rates are
monitored against actual experience and other economic conditions and are
changed if deemed necessary. If the Company's analysis indicates the carrying
value of servicing rights are not recoverable through future cash flows from
contractual servicing and other ancillary fees, a valuation allowance would be
required.
Receivable for Sold Loans
Receivable for sold loans represents a receivable held by the Company for loans
sold on a whole loan basis which have closed but not yet settled in cash.
159
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Prepaid Assets
Prepaid assets are comprised mainly of amounts paid for insurance coverage and
printed marketing materials and customer lists, which have not yet been
utilized. Costs for printed materials and customer lists are expensed as they
are utilized. Other marketing and advertising costs are expensed as incurred.
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 connection with public offerings of subordinated
debt securities are 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 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.
Goodwill
Goodwill is recorded in other assets and represents 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. (now American Business Mortgage Services,
Inc.). The Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets"
in July 2001. In accordance with SFAS No. 142, the amortization of goodwill was
discontinued. The Company performs periodic reviews for events or changes in
circumstances that may indicate that the carrying amount of goodwill might
exceed the fair value, which would require an adjustment to the goodwill balance
for the amount of impairment. At June 30,
160
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Goodwill (continued)
2003, no goodwill impairment existed. For segment reporting purposes, the
goodwill balance is allocated to the loan origination segment. See Note 20 for
segment reporting.
Revenue Recognition
The Company derives its revenue principally from gains on sales of loans,
interest accretion on interest-only strips, interest and fee income on loans and
leases, and servicing income. Gains on sales of loans through securitizations
represent the difference between the net proceeds to the Company, including
retained interests in the securitization and the allocated cost of loans or
leases securitized. The allocated cost of loans securitized is determined by
allocating their net carrying value between the loans, the interest-only strips
and the servicing rights retained by the Company based upon their relative fair
values. Gains 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 income represents the yield component of cash flows received
on interest-only strips. The Company uses a prospective approach to estimate
interest accretion. As previously discussed, the Company updates estimates of
residual cash flow from the securitizations. Under the prospective approach,
when it is probable that there is a favorable or unfavorable change in estimated
residual cash flow from the cash flow previously projected, the Company
recognizes a larger or smaller percentage of the cash flow as interest
accretion. Any change in value of the underlying interest-only strip could
impact the 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.
Interest and fee income consists of interest earned on loans and leases while
held in the Company's managed portfolio, and other ancillary fees collected in
connection with loan origination. Interest income is recognized based on the
simple interest or scheduled interest method depending on the original structure
of the loan. 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.
Servicing income is recognized as contractual fees and other fees for servicing
loans and leases are incurred, net of amortization of servicing rights assets.
161
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Derivative Financial Instruments
A 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 a securitization is priced or
the date the terms and pricing for a whole loan sale is fixed.
From time to time, derivative financial instruments are utilized in an attempt
to mitigate the effect of changes in interest rates between the date loans are
originated at fixed interest rates and the date the fixed interest rate
pass-through certificates to be issued by a securitization trust are priced or
the date the terms and pricing for a whole loan sale are fixed. Generally, the
period between loan origination and pricing of the pass-through interest rate or
whole loan sale is less than three months. The types of derivative financial
instruments used to hedge the effects of changes in fair value due to interest
rate changes may include interest rate swaps, futures and forward contracts. The
nature and quantity of hedging transactions are determined based on various
factors, including market conditions and the expected volume of mortgage loan
originations and purchases.
At the time the derivative contracts are executed, they are specifically
designated as hedges of mortgage loans or the Company's residual interests in
mortgage loans in its mortgage conduit facility, which the Company would expect
to be included in a term securitization or sold in whole loan sale transactions
at a future date. The mortgage loans and mortgage loans underlying the residual
interests in mortgage pools consist of essentially similar pools of fixed
interest rate loans, collateralized by real estate (primarily residential real
estate) with similar maturities and similar credit characteristics. Fixed
interest rate pass-through certificates issued by securitization trusts are
generally priced to yield an interest rate spread above interest rate swap yield
curves with maturities to match the maturities of the interest rate pass-through
certificates. The Company may hedge potential interest rate changes in interest
rate swap yield curves with forward starting interest rate swaps, Eurodollar
futures, forward treasury sales or derivative contracts of similar underlying
securities.
This practice has provided strong correlation between the Company's hedge
contracts and the ultimate pricing the Company will receive on the subsequent
securitization. The unrealized gain or loss derived from these derivative
financial instruments, which are designated as fair value hedges, is reported in
earnings as it occurs with an offsetting adjustment to the fair value of the
item hedged. The fair value of derivative financial instruments is based on
quoted market prices. The fair value of the items hedged is based on current
pricing of these assets in a securitization or whole loan sale. Cash flow
related to hedging activities is reported as it occurs. The effectiveness of the
Company's hedges is continuously monitored. If correlation did not exist, the
related gain or loss on the
162
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Derivative Financial Instruments (continued)
hedged item would no longer be recognized as an adjustment to income.
Generally, the Company does not enter into derivative financial instrument
contracts for trading purposes. However, the Company has entered into derivative
financial instrument contracts which are not designated as accounting hedges and
are therefore accounted for as trading assets or liabilities. These contracts
have been used to protect the future securitization spreads on loans in the
Company's pipeline and to reduce the exposure to changes in the fair value of
certain interest-only strips due to changes in one-month LIBOR.
Loans in the pipeline represent loan applications for which the Company is in
the process of obtaining all the documentation required for a loan approval or
approved loans, which have not been accepted by the borrower and are not
considered to be firm commitments.
The structure of certain securitization trusts includes a floating interest rate
tranche based on one-month LIBOR plus an interest rate spread. Floating interest
rate tranches in a securitization expose the Company to gains or losses due to
changes in the fair value of the interest-only strip from changes in the
floating interest rate paid to the certificate holders. In order to manage this
exposure, the Company has entered into an interest rate swap agreement to lock
in a fixed interest rate on the Company's third quarter fiscal 2002
securitization's variable rate tranche. The swap agreement requires a net cash
settlement on a monthly basis of the difference between the fixed interest rate
on the swap and the LIBOR paid on the certificates. The fair value of this swap
agreement is based on estimated market values for the sale of the contract
provided by a third party. The fair value of the contract is recorded in other
assets or other liabilities as appropriate. Net changes in the fair value during
a period are included in administrative expenses in the Statement of Income. The
interest-only strips are held as available for sale securities and therefore
changes in the fair value of the interest-only strips are recorded as a
component of equity unless the fair value of the interest-only strip falls below
its cost basis, which would require a write down through current period income.
The interest rate sensitivity for $63.0 million of floating interest rate
certificates issued from the 2003-1 securitization trust is managed by an
interest rate cap which was entered into by the trust at the inception of the
securitization. This interest rate cap limits the one-month LIBOR to a maximum
rate of 4.0% and was structured to automatically unwind as the floating interest
rate certificates pay down. See Note 18 for further discussion of the Company's
use of derivative financial instruments.
163
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Income Taxes
The Company and its subsidiaries file a consolidated 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.
Stock Options
The Company has stock option plans that provide for the periodic granting of
options to key employees and non-employee directors. The Company accounts for
stock options issued under these plans using the intrinsic value method of APB
Opinion No. 25 "Accounting for Stock Issued to Employees", and accordingly, no
expense is recognized where the exercise price equals or exceeds the fair value
of the common stock at the date of grant. Had the Company accounted for stock
options granted under these plans using the fair value method of SFAS No. 123
and SFAS No. 148, pro forma net income and earnings per share would have been as
follows (in thousands, except per share amounts):
Year Ended June 30,
2003 2002 2001
----------------------------------------------------
Net income (loss), as reported $ (29,902) $ 7,859 $ 8,085
Stock based compensation costs, net of tax
effects included in reported net income - - (174)
Stock based compensation costs, net of tax
effects determined under fair value method
for all awards (130) (170) 83
----------------------------------------------------
Pro forma $ (30,032) $ 7,689 $ 7,994
====================================================
Earnings (loss) per share - basic
As reported $ (10.25) $ 2.68 $ 2.13
Pro forma (10.29) 2.62 2.15
Earnings (loss) per share - diluted
As reported $ (10.25) $ 2.49 $ 2.08
Pro forma (10.29) 2.44 2.10
Recent Accounting Pronouncements
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Financial Interpretation No. ("FIN") 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 standardizes practices related to the recognition of a liability
for the fair value of a
164
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (continued)
guarantor's obligation. The rule requires companies to record a liability for
the fair value of its guarantee to provide or stand ready to provide services,
cash or other assets. The rule applies to contracts that require a guarantor to
make payments based on an underlying factor such as change in market value of an
asset, collection of the scheduled contractual cash flows from individual
financial assets held by a special purpose entity ("SPE"), non-performance of a
third party, for indemnification agreements, or for guarantees of the
indebtedness of others among other things. The provisions of FIN 45 are
effective on a prospective basis for guarantees that are issued or modified
after December 31, 2002. The disclosure requirements were effective for
statements of annual or interim periods ending after December 15, 2002.
Based on the requirements of this guidance for the year ended June 30, 2003, the
Company has recorded a $0.7 million liability in conjunction with the sale of
mortgage loans to the ABFS 2003-1 securitization trust which occurred in March
2003. This liability represents the fair value of periodic interest advances
that the Company, as servicer of the securitized loans, is obligated to pay on
behalf of delinquent loans in the trust. The recording of this liability reduces
the gain on sale recorded for the securitization. The Company would expect to
record a similar liability for any subsequent securitization as it occurs. The
amount of the liability that will be recorded is dependent mainly on the volume
of loans the Company securitizes, the expected performance of those loans and
the interest rates of the loans. In the year ended June 30, 2003, the adoption
of FIN 45 reduced net income by approximately $0.4 million and diluted earnings
per share by $0.14. See Note 14 for further detail of this obligation.
In December 2002, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 148 "Accounting for Stock-Based Compensation - Transition and
Disclosure." SFAS No. 148 amends SFAS No. 123 "Accounting for Stock-Based
Compensation." SFAS No. 148 provides alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based
compensation and requires pro forma disclosures of the effect on net income and
earnings per share had the fair value method been included in annual and interim
reports and disclosure of the effect of the transition method used if the
accounting method was changed. SFAS No. 148 is effective for annual reports of
fiscal years beginning after December 15, 2002 and interim reports for periods
beginning after December 15, 2002. The Company plans to continue using the
intrinsic value method of accounting for stock-based compensation and therefore
the new rule will have no effect on the Company's financial condition or results
of operations. The Company has adopted the new standard related to disclosure in
the interim period beginning January 1, 2003. See Note 12 for further detail.
165
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (continued)
In April 2003, the FASB began reconsidering the current alternatives available
for accounting for stock-based compensation. Currently, the FASB is continuing
its deliberations on this matter. The Company cannot predict whether the
guidance will change the Company's current accounting for stock-based
compensation, or what effect, if any, changes may have on the Company's current
financial condition or results of operations.
In January 2003, the FASB issued FIN 46 "Consolidation of Variable Interest
Entities." FIN 46 provides guidance on the identification of variable interest
entities that are subject to consolidation requirements by a business
enterprise. A variable interest entity subject to consolidation requirements is
an entity that does not have sufficient equity at risk to finance its operations
without additional support from third parties and the equity investors in the
entity lack certain characteristics of a controlling financial interest as
defined in the guidance. SPEs are one type of entity, which under certain
circumstances may qualify as a variable interest entity. Although the Company
uses unconsolidated SPEs extensively in its loan securitization activities, the
guidance will not affect the Company's current consolidation policies for SPEs
as the guidance does not change the guidance incorporated in SFAS No. 140
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" which precludes consolidation of a qualifying SPE by a
transferor of assets to that SPE. FIN 46 will therefore have no effect on the
Company's financial condition or results of operations and would not be expected
to affect it in the future. In March 2003, the FASB announced that it is
reconsidering the permitted activities of a qualifying SPE. The Company cannot
predict whether the guidance will change or what effect, if any, changes may
have on the Company's current consolidation policies for SPEs.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" to clarify
the financial accounting and reporting for derivative instruments and hedging
activities. SFAS No. 149 is intended to improve financial reporting by requiring
comparable accounting methods for similar contracts. SFAS No. 149 is effective
for contracts entered into or modified subsequent to June 30, 2003. The
requirements of SFAS No. 149 do not affect the Company's current accounting for
derivative instruments or hedging activities and therefore will have no effect
on the Company's financial condition or results of operations.
166
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (continued)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
requires an issuer to classify certain financial instruments, such as
mandatorily redeemable shares and obligations to repurchase the issuer's equity
shares, as liabilities. The guidance is effective for financial instruments
entered into or modified subsequent to May 31, 2003, and otherwise is effective
at the beginning of the first interim period after June 15, 2003. The Company
does not have any instruments with such characteristics and does not expect SFAS
No. 150 to have a material impact on the financial condition or results of
operations.
2. Loan and Lease Receivables
Loan and lease receivables - Available for sale were comprised of the
following (in thousands):
June 30,
2003 2002
-------- --------
Real estate secured loans (a) $270,096 $ 53,171
Leases, net of unearned income of $550 and $668 (b) 4,154 8,211
-------- --------
274,250 61,382
Less: allowance for credit losses on loan and lease
receivables available for sale 2,848 3,705
-------- --------
$271,402 $ 57,677
======== ========
(a) Includes deferred direct loan origination costs of $6.8 million and $1.4
million at June 30, 2003 and June 30, 2002, respectively.
(b) Includes deferred direct lease origination costs of $28 thousand and $0.4
million at June 30, 2003 and June 30, 2002, respectively.
Real estate secured loans have contractual maturities of up to 30 years.
At June 30, 2003 and June 30, 2002, the accrual of interest income was suspended
on real estate secured loans of $5.4 million and $7.0 million, respectively. The
allowance for loan losses includes reserves established for expected losses on
these loans in the amount of $1.4 million and $2.9 million at June 30, 2003 and
June 30, 2002, respectively. Average balances of non-accrual loans during the
years ended June 30, 2003 and 2002 were $8.6 million and $6.7 million,
respectively.
Substantially all leases are direct finance-type leases whereby the lessee has
the right to purchase the leased equipment at the lease expiration for a nominal
amount.
167
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
2. Loan and Lease Receivables (continued)
Loan and lease receivables - Interest and fees are comprised mainly of accrued
interest and fees on loans and leases that are less than 90 days delinquent. Fee
receivables include, among other types of fees, forbearance and deferment
advances. Under deferment and forbearance arrangements, the Company makes
advances to a securitization trust on behalf of a borrower in amounts equal to
the delinquent principal and interest and may pay taxes, insurance and other fee
on behalf of the borrower. As a result of these arrangements the Company resets
the contractual status of a loan in its managed portfolio from delinquent to
current based upon the borrower's resumption of making their loan payments.
These amounts are carried at their estimated net recoverable value.
Loan and lease receivables - Other is comprised of receivables for securitized
loans. In accordance with the Company's securitization agreements, the Company
has the right, but not the obligation, to repurchase a limited amount of
delinquent loans from securitization trusts. Repurchasing delinquent loans from
securitization trusts benefits the Company by allowing it to limit the level of
delinquencies and losses in the securitization trusts and as a result, the
Company can avoid exceeding specified limits on delinquencies and losses that
trigger a temporary reduction or discontinuation of cash flow from its
interest-only strips until the delinquency or loss triggers are no longer
exceeded. See Note 3 for more detail on loan repurchases. The Company's ability
to repurchase these loans does not disqualify it for sale accounting under SFAS
No. 140, which was adopted on a prospective basis in the fourth quarter of
fiscal 2001, or other relevant accounting literature because the Company is not
required to repurchase any loan and its ability to repurchase a loan is limited
by contract.
In accordance with the provisions of SFAS No. 140, the Company has recorded an
obligation for the repurchase of loans subject to these removal of accounts
provisions, whether or not the Company plans to repurchase the loans. The
obligation for the loans' purchase price is recorded in other liabilities. A
corresponding receivable is recorded at the lower of the loans' cost basis or
fair value.
168
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
3. Allowance for Credit Losses
The activity for the allowance of credit losses is summarized as follows (in
thousands):
Year ended June 30,
2003 2002 2001
--------------------------------
Balance at beginning of year $ 3,705 $ 2,480 $ 1,289
Provision for credit losses:
Business purpose loans 1,189 1,721 1,503
Home equity loans 5,000 3,417 2,600
Equipment leases 364 1,319 1,087
--------------------------------
Total provision 6,553 6,457 5,190
--------------------------------
Charge-offs, net of recoveries:
Business purpose loans (1,984) (924) (1,374)
Home equity loans (4,913) (2,892) (1,634)
Equipment leases (513) (1,416) (991)
--------------------------------
Total charge-offs, net (7,410) (5,232) (3,999)
--------------------------------
Balance at end of year $ 2,848 $ 3,705 $ 2,480
================================
Ratio of losses in the portfolio during
the period to the average managed
portfolio (a) 0.90% 0.60 % 0.53 %
Ratio of allowance to loans and leases 1.04% 6.04 % 2.49 %
available for sale
(a) The average managed portfolio includes loans and leases held as available
for sale and securitized loans and leases serviced for others. See Note 6
for detail of the total managed portfolio.
Recoveries of loans and leases previously charged-off were $402 thousand, $302
thousand and $434 thousand during the years ended June 30, 2003, 2002 and 2001,
respectively.
While the Company is under no obligation to do so, at times it elects to
repurchase delinquent loans from the securitization trusts, some of which may be
in foreclosure. The Company elects to repurchase loans in situations requiring
more flexibility for the administration and collection of these loans in order
to maximize their economic recovery and to avoid temporary discontinuations of
residual or stepdown overcollateralization cash flow from securitization trusts.
The purchase price of a delinquent loan is at the loan's outstanding contractual
balance. A foreclosed loan is one where the Company, as servicer, has initiated
formal foreclosure proceedings against the borrower and a delinquent loan is one
that is 31 days or more past due.
169
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
3. Allowance for Credit Losses (continued)
The foreclosed and delinquent loans the Company typically elects to repurchase
are usually 90 days or more delinquent and the subject of completed foreclosure
proceedings or where a completed foreclosure is imminent. The related
charge-offs on these repurchased loans are included in the provision for credit
losses in the period of charge-off.
The following table summarizes the principal balances of loans and real estate
owned (REO) repurchased from securitization trusts (dollars in thousands):
Year ended June 30,
2003 2002 2001
-------------------------------
Business purpose loans $16,252 $ 6,669 $ 4,501
Home equity loans 38,775 23,571 10,549
-------------------------------
Total $55,027 $30,240 $15,050
===============================
Number of loans repurchased 637 341 154
===============================
The Company received $37.6 million, $19.2 million and $10.9 million of proceeds
from the liquidation of repurchased loans and REO for the years ended June 30,
2003, 2002 and 2001, respectively. The Company had repurchased loans remaining
on the balance sheet in the amounts of $5.1 million, $7.3 million and $2.8
million at June 30, 2003, 2002 and 2001, respectively and REO of $4.5 million,
$2.1 million and $2.0 million at June 30, 2003, 2002 and 2001, respectively.
170
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
4. Securitizations
The following schedule details loan and lease securitizations (dollars in
millions):
Year ended June 30,
2003 2002 2001
-------------------------------------------
Loans and leases securitized:
Business purpose loans $ 112.0 $ 129.1 $ 109.9
Home equity loans 1,311.7 1,222.0 992.2
-------------------------------------------
$ 1,423.7 $ 1,351.1 $ 1,102.1
===========================================
Number of term securitizations:
Business purpose and home equity loans 3 4 4
Cash proceeds:
Business purpose and home equity loans $ 1,445.0 $ 1,374.6 $ 1,113.8
Gains:
Business purpose and home equity loans $ 171.0 $ 185.6 $ 129.0
The table below summarizes certain cash flows received from and paid to
securitization trusts (in millions):
Year ended June 30,
2003 2002
-------------- ---------------
Proceeds from new securitizations $ 1,445.0 $ 1,374.6
Contractual servicing fees received 44.9 35.3
Other cash flows received on retained interests (a) 87.2 53.4
Purchases of delinquent or foreclosed assets (55.0) (30.2)
Servicing advances (11.6) (7.5)
Reimbursement of servicing advances 10.2 7.2
(a) Amount is net of required purchases of additional overcollateralization.
The Company's securitizations involve a two-step transfer that qualified for
sale accounting under SFAS No. 125 and also qualify under SFAS No. 140. First,
the Company sells the loans to an SPE, which has been established for the
limited purpose of buying and reselling the loans and establishing a true sale
under legal standards. Next, the SPE sells the loans to a qualified SPE, which
is a trust transferring title of the loans and isolating those assets from the
Company's assets. Finally, the trust issues certificates to investors to raise
the cash purchase price for the loans being sold, collects proceeds on
171
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
4. Securitizations (continued)
behalf of the certificate holders, distributes proceeds and is a distinct legal
entity, independent from the Company.
The Company also used SPEs in the sales of loans to a $300.0 million off-balance
sheet mortgage conduit facility. Sales into the off-balance sheet facility
involved a two-step transfer that qualified for sale accounting under SFAS No.
140, similar to the process described above. This facility had a revolving
feature and could be directed by the sponsor to dispose of the loans. Typically,
the loans were disposed of by securitizing the loans in a term securitization.
The third party note purchaser also has the right to have the loans sold in
whole loan sale transactions. Under this off-balance sheet facility arrangement,
the loans had been isolated from the Company and its subsidiaries and as a
result, transfers to the facility were treated as sales for financial reporting
purposes. When loans were sold to this facility, the Company assessed the
likelihood that the sponsor would transfer the loans into a term securitization.
As the sponsor had typically transferred the loans to a term securitization
prior to the fourth quarter of fiscal 2003, the amount of gain on sale
recognized for loans sold to this facility was estimated based on the terms the
Company would obtain in a term securitization rather than the terms of this
facility. For the fourth quarter of fiscal 2003, the likelihood that the
facility sponsor would ultimately transfer the underlying loans to a term
securitization was significantly reduced and the amount of gain recognized for
loans sold to this facility was based on terms expected in a whole loan sale
transaction. The Company's ability to sell loans into this facility expired
pursuant to its terms on July 5, 2003. At June 30, 2003, the off-balance sheet
mortgage conduit facility held loans with principal balance due of $275.6
million as assets and owed $267.5 million to third parties. Through August 29,
2003, $214.7 million of the loans in the facility at June 30, 2003 were sold in
whole loan sales as directed by the facility sponsor.
Prior to March 2001, the Company had an arrangement with a warehouse lender,
which included an off-balance sheet facility. The sale into this off-balance
sheet conduit facility involved a two step transfer that also qualified for sale
accounting under SFAS No. 125. The Company terminated this facility in March
2001.
During the year ended June 30, 2003, the Company recorded total pre-tax
valuation adjustments on our securitization assets of $63.3 million, of which
$45.2 million was charged to the income statement and $18.1 million was charged
to other comprehensive income. The breakout of the total adjustments in fiscal
2003 between interest-only strips and servicing rights was as follows:
o The Company recorded total pre-tax valuation adjustments on our
interest only-strips of $58.0 million, of which, in accordance
with the provisions of SFAS No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" and Emerging Issues
Task Force guidance on issue 99-
172
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
4. Securitizations (continued)
20, "Recognition of Interest Income and Impairment on Purchased
and Retained Beneficial Interests in Securitized Financial
Assets", referred to as EITF 99-20 in this document, $39.9
million was charged to the income statement and $18.1 million was
charged to other comprehensive income. The valuation adjustment
reflects the impact of higher than anticipated prepayments on
securitized loans experienced in fiscal 2003 due to the low
interest rate environment experienced during fiscal 2003. The
valuation adjustment on interest-only strips for fiscal 2003 was
reduced by a $20.9 million favorable valuation impact as a result
of reducing the discount rates applied in valuing the
interest-only strips at June 30, 2003. The amount of the
valuation adjustment charged to the income statement was reduced
by a $10.8 million favorable valuation impact as a result of
reducing the discount rates and the charge to other comprehensive
income was reduced by $10.1 million for the favorable impact of
reducing discount rates. The discount rates were reduced at June
30, 2003 primarily to reflect the impact of the sustained decline
in market interest rates. The discount rate on the projected
residual cash flows from the Company's interest-only strips was
reduced from 13% to 11% at June 30, 2003. The discount rate used
to determine the fair value of the overcollateralization portion
of the cash flows from interest-only strips was minimally
impacted by the decline in interest rates and remained at 7% on
average. As a result, the blended rate used to value
interest-only strips, including the overcollateralization cash
flows, was 9% at June 30, 2003.
o The Company recorded total pre-tax valuation adjustments on our
servicing rights of $5.3 million, which was charged to the income
statement. The valuation adjustment reflects the impact of higher
than anticipated prepayments on securitized loans experienced in
fiscal 2003 due to the low interest rate environment experienced
during fiscal 2003. The valuation adjustment on servicing rights
for fiscal 2003 was reduced by a $7.1 million favorable valuation
impact as a result of reducing the discount rate applied in
valuing the servicing rights at June 30, 2003. The discount rate
was reduced at June 30, 2003 primarily to reflect the impact of
the sustained decline in market interest rates. The discount rate
on the Company's servicing rights was reduced from 11% to 9% at
June 30, 2003.
The write down reduced net income by $27.6 million and increased the diluted
loss per share by $9.45 in fiscal 2003.
Although beginning in the second quarter of fiscal 2002 the Company increased
its prepayment rate assumptions used to value the interest-only strips,
prepayment rates throughout the mortgage industry continued to increase and the
Company's prepayment experience continued to exceed even its revised
assumptions. Based on current economic conditions, published mortgage industry
surveys and the Company's prepayment experience, the Company believes
prepayments will continue to remain at higher than normal levels for the near
term before returning to average historical levels. Therefore the Company has
173
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
4. Securitizations (continued)
increased the prepayment rate assumptions for home equity loans for the near
term, but at a declining rate, before returning to historical levels. However,
the Company cannot predict with certainty what its prepayment experience will be
in the future. Any unfavorable difference between the assumptions used to value
interest-only strips and actual experience may have a significant adverse impact
on the value of these assets.
The following tables provide information regarding the initial and
current assumptions applied in determining the fair values of mortgage loan
related interest-only strips and servicing rights for each securitization trust.
Summary of Material Mortgage Loan Securitization
Valuation Assumptions and Actual Experience at June 30, 2003
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 2001-1 2000-4
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Interest-only strip residual discount rate:
Initial valuation......................... 13% 13% 13% 13% 13% 13% 13% 13% 13% 13%
Current valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation........................ 7% 9% 7% 7% 7% 7% 7% 7% 6% 7%
Current valuation........................ 5% 9% 7% 7% 7% 5% 6% 7% 6% 7%
Servicing rights discount rate:
Initial valuation......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Current valuation......................... 9% 9% 9% 9% 9% 9% 9% 9% 9% 9%
Prepayment rates:
Initial assumption (a):
Expected Constant Prepayment Rate (CPR):
Business loans.......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 10%
Home equity loans....................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 24%
Ramp period (months):
Business loans.......................... 27 27 27 27 27 27 24 24 24 24
Home equity loans....................... 30 30 30 30 30 30 30 30 30 24
Current assumptions (b):
Expected Constant Prepayment Rate (CPR):
Business loans ......................... 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Home equity loans ...................... 22% 22% 22% 22% 22% 22% 22% 22% 22% 22%
Ramp period (months):
Business loans.......................... 27 27 27 27 27 27 27 27 27 27
Home equity loans....................... 30 30 30 30 30 30 30 30 30 30
CPR adjusted to reflect ramp:
Business loans.......................... 5% 8% 10% 12% 15% 17% 20% 22% 22% 19%
Home equity loans....................... 15% 32% 40% 51% 42% 46% 40% 40% 37% 41%
Current prepayment experience (c):
Business loans.......................... 8% 5% 13% 12% 15% 23% 19% 9% 21% 23%
Home equity loans....................... 5% 9% 20% 28% 39% 42% 40% 37% 36% 37%
Annual credit loss rates:
Initial assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Current assumption........................ 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.50% 0.40%
Actual experience......................... -- -- 0.03% 0.03% 0.03% 0.12% 0.24% 0.17% 0.43% 0.36%
Servicing fees:
Contractual fees.......................... 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.70%
Ancillary fees............................ 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
- -----------------
(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 ramps to an expected peak rate over 27 months
then declines to the final expected CPR by month 40. The home equity loan
prepayment ramp begins at 2% in month one and ramps to an expected rate over
30 months.
(b) Current assumptions for business loans are the estimated expected
weighted-average prepayment rates over the securitization's estimated
remaining life. The majority of the home equity loan prepayment rate ramps
have been increased for the next 6 months to provide for the expected near
term continuation of higher than average prepayment. Generally, trusts for
both business and home equity loans that are out of the ramping period are
based on historical averages.
(c) Current experience is a six-month historical average.
174
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
4. Securitizations (continued)
Summary of Material Mortgage Loan Securitization
Valuation Assumptions and Actual Experience at June 30, 2003 (Continued)
2000-3 2000-2 2000-1 1999-4 1999-3 1999-2 1999-1 1998(d) 1997(d) 1996(d)
------ ------ ------ ------ ------ ------ ------ ------- ------- -------
Interest-only strip residual discount rate:
Initial valuation........................ 13% 13% 11% 11% 11% 11% 11% 11% 11% 11%
Current valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation........................ 8% 8% 8% 8% 7% 7% 7% 7% 7% 8%
Current valuation........................ 8% 8% 8% 8% 7% 7% 7% 7% 7% 8%
Servicing rights discount rate:
Initial valuation........................ 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%
Current valuation........................ 9% 9% 9% 9% 9% 9% 9% 9% 9% 9%
Prepayment rates:
Initial assumption (a):
Expected Constant Prepayment Rate (CPR):
Business loans ........................ 10% 10% 10% 10% 10% 10% 10% 13% 13% 13%
Home equity loans...................... 24% 24% 24% 24% 24% 24% 24% 24% 24% 24%
Ramp period (months):
Business loans......................... 24 24 24 24 24 24 24 24 24 24
Home equity loans...................... 24 24 18 18 18 18 18 12 12 12
Current assumptions (b):
Expected Constant Prepayment Rate (CPR):
Business loans ........................ 11% 11% 11% 11% 10% 10% 10% 10% 22% 14%
Home equity loans...................... 22% 22% 22% 22% 22% 22% 22% 23% 25% 25%
Ramp period (months):
Business loans......................... 27 Na Na Na Na Na Na Na Na Na
Home equity loans...................... 30 30 Na Na Na Na Na Na Na Na
CPR adjusted to reflect ramp:
Business loans......................... 16% 13% 23% 35% 29% 27% 30% 20% 20% 10%
Home equity loans...................... 32% 31% 37% 33% 32% 29% 26% 33% 22% 13%
Current prepayment experience (c):
Business loans......................... 23% 15% 23% 35% 29% 26% 30% 18% 19% 3%
Home equity loans...................... 32% 31% 37% 32% 32% 29% 25% 33% 21% 13%
Annual credit loss rates:
Initial assumption....................... 0.40% 0.40% 0.40% 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Current assumption....................... 0.45% 0.45% 0.65% 0.65% 0.60% 0.35% 0.55% 0.60% 0.40% 0.45%
Actual experience........................ 0.41% 0.41% 0.65% 0.63% 0.58% 0.35% 0.49% 0.57% 0.36% 0.42%
Servicing fees:
Contractual fees......................... 0.50% 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% 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 ramps to an expected peak rate over 27 months
then declines to the final expected CPR by month 40. The home equity loan
prepayment ramp begins at 2% in month one and ramps to an expected rate over
30 months.
(b) Current assumptions for business loans are the estimated expected
weighted-average prepayment rates over the securitization's estimated
remaining life. Generally, trusts for both business and home equity loans
that are out of the ramping period are based on historical averages.
(c) Current experience is a six-month historical average.
(d) Amounts represent weighted-average percentages for four 1998 securitization
pools, two 1997 securitization pools and two 1996 securitization pools.
Na = not applicable
175
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
4. Securitizations (continued)
Sensitivity analysis. The table below outlines the sensitivity of the
current fair value of the Company's interest-only strips and servicing rights to
10% and 20% adverse changes in the key assumptions used in determining the fair
value of those assets. The Company's base prepayment, loss and discount rates
are described in the table "Summary of Material Mortgage Loan Securitization
Valuation Assumptions and Actual Experience." (dollars in thousands):
Securitized collateral balance.....................................$ 3,354,071
Balance sheet carrying value of retained interests (a).............$ 717,569
Weighted-average collateral life (in years)........................ 3.9
- -------------------------
(a) Amount includes interest-only strips and servicing rights.
Sensitivity of assumptions used to determine the fair value of retained
interests (dollars in thousands):
Impact of
Adverse Change
----------------------------
10% Change 20% Change
---------- ----------
Prepayment speed.......................... $ 29,916 $ 56,656
Credit loss rate.......................... 5,247 10,495
Floating interest rate certificates (a)... 829 1,614
Discount rate............................. 20,022 38,988
- -------------------------
(a) The floating interest rate certificates are indexed to one-month LIBOR plus
a trust specific interest rate spread. The base one-month LIBOR assumption
used in this sensitivity analysis was derived from a forward yield curve
incorporating the effect of rate caps where applicable to the individual
deals.
The sensitivity analysis in the table above is hypothetical and should
be used with caution. As the figures indicate, changes in fair value based on a
10% or 20% variation in management's assumptions generally cannot easily be
extrapolated because the relationship of the change in the assumptions to the
change in fair value may not be linear. Also, in this table, the effect that a
change in a particular assumption may have on the fair value is calculated
without changing any other assumption. Changes in one assumption may result in
changes in other assumptions, which might magnify or counteract the impact of
the intended change.
These sensitivities reflect the approximate amount of the fair values
that the Company's interest-only strips and servicing rights would be reduced
for the indicated adverse changes. These reductions would result in a charge to
expense in the income statement in the period incurred and a resulting reduction
of stockholders' equity, net of income taxes.
5. Interest-Only Strips
Interest-only strips were comprised of the following (in thousands):
June 30,
2003 2002
--------------------------------
Interest-only strips
Available for sale $ 597,166 $ 510,770
Trading assets 1,112 1,841
--------------------------------
$ 598,278 $ 512,611
================================
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, 2003 and 2002, the fair value
of overcollateralization related cash flows were $279.2 million and $236.6
million, respectively.
176
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
5. Interest-Only Strips (continued)
The activity for interest-only strip receivables is summarized as follows (in
thousands):
June 30,
2003 2002
---------------------------------
Balance at beginning of period $ 512,611 $ 398,519
Initial recognition of interest-only strips,
including initial overcollateralization of
$10.6 million and $0 160,116 153,463
Cash flow from interest-only strips (160,417) (100,692)
Required purchases of additional overcollateralization 73,253 47,271
Interest accretion 47,347 35,386
Termination of lease securitization (a) (1,890) -
Net temporary adjustments to fair value (b) 7,158 717
Other than temporary fair value adjustment (b) (39,900) (22,053)
---------------------------------
Balance at end of period $ 598,278 $ 512,611
=================================
(a) Reflects release of lease collateral from two lease securitization trusts
which were terminated in accordance with the trust documents after the full
payout of trust note certificates. Net lease receivables of $1.7 million
were recorded on the balance sheet as a result of these terminations.
(b) Net temporary adjustments to fair value are recorded through other
comprehensive income, which is a component of equity. Other than temporary
adjustments to decrease the fair value of interest-only strips are recorded
through the income statement.
See Note 4 for a further description of the write downs recognized in fiscal
2003.
6. Servicing Rights
The total managed loan and lease portfolio, which includes loans and leases held
by the Company as available for sale, and securitized loans and leases serviced
for others, is as follows (in thousands):
June 30,
2003 2002
-----------------------------------
Home equity loans $ 3,249,501 $ 2,675,559
Business purpose loans 393,098 361,638
Equipment leases 8,475 28,992
----------------------------------
$ 3,651,074 $ 3,066,189
==================================
177
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
6. Servicing Rights (continued)
The activity for the loan and lease servicing rights asset is summarized as
follows (in thousands):
Year ended June 30,
2003 2002
----------------------------------
Balance at beginning of year $ 125,288 $ 102,437
Initial recognition of servicing rights 41,171 52,682
Amortization (41,886) (29,831)
Write down (5,282) -
----------------------------------
Balance at end of year $ 119,291 $ 125,288
==================================
Servicing rights are valued quarterly by the Company based on the current
estimated fair value of the servicing asset. A review for impairment is
performed by stratifying the serviced loans and leases based on loan type, which
is considered to be the predominant risk characteristic due to their different
prepayment characteristics and fee structures. During fiscal 2003, we recorded
total pre-tax valuation adjustments on our servicing rights of $5.3 million,
which was charged to the income statement. See Note 4 for more detail.
Key assumptions used in the periodic valuation of the servicing rights are
described in Note 4.
Information regarding the sensitivity of the current fair value of interest-only
strips and servicing rights to adverse changes in the key assumptions used to
value these assets is detailed in Note 4.
178
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
7. Property and Equipment
Property and equipment is comprised of the following (in thousands):
June 30,
2003 2002
-----------------------------
Computer software $ 20,282 $ 18,789
Computer hardware 3,816 4,845
Office furniture and equipment 4,680 8,038
Leasehold improvements 8,585 2,481
-----------------------------
37,363 34,153
Less accumulated depreciation and amortization 14,061 15,707
-----------------------------
$ 23,302 $ 18,446
=============================
Depreciation and amortization expense was $8.6 million, $6.8 million and $6.2
million for the years ended June 30, 2003, 2002 and 2001, respectively.
8. Other Assets and Other Liabilities
Other assets were comprised of the following (in thousands):
June 30,
2003 2002
------------ -----------
Goodwill $ 15,121 $ 15,121
Real estate owned 4,776 3,784
Financing costs, debt offerings 3,984 5,849
Due from securitization trusts for
servicing related activities - 1,616
Investments held to maturity 881 917
Other 5,690 1,507
------------ ----------
$ 30,452 $ 28,794
============ ==========
179
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
8. Other Assets and Other Liabilities (continued)
Other liabilities were comprised of the following (in thousands):
June 30,
2003 2002
------------ -----------
Commitments to fund closed loans $ 35,187 $ 29,866
Obligation for repurchase of securitized loans 27,954 10,621
Escrow deposits held 10,988 9,011
Hedging liabilities, at fair value 6,335 -
Unearned lease incentives 9,465 -
Periodic advance guarantee 650 -
Trading liabilities, at fair value 334 461
Other 1,077 949
------------ -----------
$ 91,990 $ 50,908
============ ===========
See Note 2 for an explanation of the obligation for the repurchase of
securitized loans and Note 18 for an explanation of the Company's hedging and
trading activities.
Unearned lease incentives represent reimbursements received in conjunction with
the lease agreement for the Company's new corporate office space in
Philadelphia, Pennsylvania. These funds represent reimbursement from the
landlord for leasehold improvements and furniture and equipment in the rented
space and will be recognized as an offset to rent expense over the term of the
lease or the life of the asset, whichever is shorter.
9. Subordinated Debt and Warehouse Lines and Other Notes Payable
Subordinated debt was comprised of the following (in thousands):
June 30,
2003 2002
------------ -----------
Subordinated debt (a) $ 702,423 $ 640,411
Subordinated debt - money market notes (b) 17,117 15,309
------------ -----------
Total subordinated debt $ 719,540 $ 655,720
============ ===========
180
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
Warehouse lines and other notes payable were comprised of the following (in
thousands):
June 30,
2003 2002
---------------- -------------
Warehouse and operating revolving line of credit (c) $ 30,182 $ 6,171
Warehouse revolving line of credit (d) 136,098 -
Warehouse revolving line of credit (e) 19,671 187
Bank overdraft (f) 26,158 -
Lease funding facility (g) - 2,128
Capitalized leases (h) 807 -
---------------- -------------
Total warehouse lines and other notes payable $ 212,916 $ 8,486
================ =============
(a) Subordinated debt due July 2003 through June 2013, interest rates ranging
from 3.50% to 13.00%; average rate at June 30, 2003 was 8.86%, average
remaining maturity was 19.5 months, subordinated to all of the Company's
senior indebtedness. The average rate on subordinated debt including money
market notes was 8.74% at June 30, 2003.
(b) Subordinated debt - money market notes due upon demand, interest rate at
4.0%; subordinated to all of the Company's senior indebtedness.
(c) $50.0 million warehouse and operating revolving line of credit expiring
December 2003, which includes a sublimit for a letter of credit that
expires in December 2003 to secure lease obligations for corporate office
space, collateralized by certain pledged loans, advances to securitization
trusts, real estate owned and certain interest-only strips. The amount of
the letter of credit was $8.0 million at June 30, 2003 and will vary over
the term of the office lease.
(d) $200.0 million warehouse revolving line of credit expiring November 2003,
collateralized by certain pledged loans. $100.0 million of this facility
was continuously committed for the term of the facility while the remaining
$100.0 million of the facility was available at the lender's discretion.
From June 30, 2003 to August 20, 2003, there were no new advances under the
non-committed portion. On August 20, 2003, this credit facility was amended
to reduce the committed portion to $50.0 million (from $100.0 million),
eliminate the non-committed portion and accelerate its expiration date from
November 2003 to no later than September 30, 2003.
(e) $25.0 million warehouse revolving line of credit expiring October 2003,
collateralized by certain pledged loans.
(f) Overdraft amount on bank accounts paid on the following business day.
(g) Lease funding facility matured in May 2003, collateralized by certain lease
receivables. The Company does not intend to renew this facility.
(h) Capitalized leases, maturing through January 2006, imputed interest rate of
8.0%, collateralized by computer equipment.
Principal payments on subordinated debt, warehouse lines and other notes payable
for the next five years are as follows (in thousands): year ending June 30, 2004
- - $534,388; 2005 - $170,976; 2006 - $157,952; 2007 - $27,668; and, 2008 -
$14,998.
181
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
At June 30, 2003, warehouse lines and other notes payable were collateralized by
$190.2 million of loan and lease receivables and $1.0 million of computer
equipment.
In addition to the above, the Company had available to it the following credit
facilities:
o $5.0 million operating line of credit expiring January 2004, fundings to be
collateralized by investments in the 99-A lease securitization trust and
Class R and X certificates of Mortgage Loan Trust 2001-2. This line was
unused at June 30, 2003.
o $300.0 million facility, which provided for the sale of mortgage loans into
an off-balance sheet funding facility. This facility expired pursuant to
its terms on July 5, 2003. See Note 4 for further discussion of the
off-balance sheet features of this facility. At June 30, 2003, $267.5
million of this facility was utilized.
Interest rates paid on the revolving credit facilities range from London
Inter-Bank Offered Rate ("LIBOR") plus 0.95% to LIBOR plus 1.75%. The
weighted-average interest rate paid on the revolving credit facilities was 2.24%
and 3.35% at June 30, 2003 and June 30, 2002, respectively.
The warehouse credit agreements require that the Company maintain specific
financial covenants regarding net worth, leverage, net income, liquidity, total
debt and other standards. Each agreement has multiple individualized financial
covenant thresholds and ratio limits that it must meet as a condition to drawing
on that particular line of credit. Pursuant to the terms of these credit
facilities, the failure to comply with the financial covenants constitutes an
event of default and the lender may, at its option, take certain actions
including: terminate commitments to make future advances to the Company, declare
all or a portion of the loan due and payable, foreclose on the collateral
securing the loan, require servicing payments be made to the lender, or other
third party, or assume the servicing of the loans securing the credit facility.
An event of default under these credit facilities could result in defaults
pursuant to cross-default provisions of the Company's other agreements,
including its other loan agreements and lease agreements. The failure to comply
with the terms of these credit facilities or to obtain the necessary waivers
from the lenders related to any default would have a material adverse effect on
the Company's liquidity and capital resources, could result in the Company not
having sufficient cash to repay its indebtedness, require the Company to
restructure its operations and may force the Company to sell assets on less than
optimal terms and conditions.
As a result of the loss experienced during fiscal 2003, the Company was not in
compliance with the terms of certain of the financial covenants related to net
worth, consolidated stockholders' equity and the ratio of total liabilities to
consolidated stockholders' equity under two of its principal credit facilities
(one for $50.0 million and the other for $200.0 million, of which $100.0 million
was non-committed) and the Company requested and obtained waivers of these
covenant provisions from both lenders. The lender under the $50.0 million
warehouse credit facility has granted a waiver for the Company's non-compliance
with a financial covenant in that credit facility through September 30, 2003.
This facility was amended to reduce the available credit to $8.0 million and the
financial covenants were replaced with new covenants.
The Company also entered into an amendment to the $200.0 million credit facility
which provides for the waiver of its non-compliance with the financial covenants
in that facility, the reduction of the committed portion of this facility from
$100.0 million to $50.0 million, the elimination of the $100.0 million
non-committed portion of this credit facility and the acceleration of the
termination date of this facility from November 2003 to September 30, 2003. The
Company's ability to repay this facility upon termination is dependent on its
ability to refinance the loans in one of its new facilities or the sale of loans
currently warehoused in the terminating facility by September 30, 2003.
182
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
Some of the Company's financial covenants in other credit facilities have
minimal flexibility and it cannot say with certainty that it will continue to
comply with the terms of all debt covenants. There can be no assurance as to
whether or in what form a waiver or modification of terms of these agreements
would be granted the Company.
On September 22, 2003, the Company entered into definitive agreements with a
financial institution for a new $200.0 million credit facility for the purpose
of funding its loan originations. Pursuant to the terms of this facility, the
Company is required to, among other things: (i) obtain a written commitment for
another credit facility of at least $200.0 million and close that additional
facility by October 3, 2003 (which condition would be satisfied by the closing
of the $225.0 million facility described below); (ii) have a net worth of at
least $28.0 million by September 30, 2003; with quarterly increases of $2.0
million thereafter; (iii) apply 60% of its net cash flow from operations each
quarter to reduce the outstanding amount of subordinated debt commencing with
the quarter ending March 31, 2004; and (iv) provide a parent company guaranty of
10% of the outstanding principal amount of loans under the facility. This
facility has a term of 12 months expiring in September 2004 and is secured by
the mortgage loans which are funded by advances under the facility with interest
equal to LIBOR plus a margin. This facility is subject to representations and
warranties and covenants, which are customary for a facility of this type, as
well as amortization events and events of default related to the Company's
financial condition. These provisions require, among other things, the Company's
maintenance of a delinquency ratio for the managed portfolio (which represents
the portfolio of securitized loans and leases we service for others) at the end
of each fiscal quarter of less than 12.0%, its subordinated debt not to exceed
$705.0 million at any time, its ownership of an amount of repurchased loans not
to exceed 1.5% of the managed portfolio and its registration statement
registering $295.0 million of subordinated debt be declared effective by the SEC
no later than October 31, 2003.
On September 22, 2003, the Company executed a commitment letter for a mortgage
warehouse credit facility with a warehouse lender, which consists of a senior
secured revolving credit facility of up to $225.0 million and a secured last out
revolver facility up to $25.0 million to fund loan originations. The commitment
letter is subject to certain conditions, including, among other things: (i)
entering into definitive agreements, except as provided in the commitment
letter; (ii) the absence of a material adverse change in the business,
operations, property, condition (financial or otherwise) or prospects of the
Company or its affiliates; and (iii) its receipt of another credit facility in
an amount not less than $200.0 million, subject to terms and conditions
acceptable to this lender (which condition is satisfied by the new $200.0
million facility described above). The commitment letter provides that these
facilities will have a term of three years with an interest rate on amounts
outstanding under the $225.0 million portion of the credit facility equal to the
greater of one-month LIBOR plus a margin or the difference between the yield
maintenance fee (as defined in the commitment letter) and the one-month LIBOR
plus a margin. Advances under this facility would be collateralized by
substantially all of the Company's present and future assets including pledged
loans and a security interest in substantially all of its interest-only strips
and residual interests which will be contributed to a special purpose entity
organized by the Company to facilitate this transaction. The Company also agreed
to pay fees of approximately $14.6 million annually plus a nonusage fee based on
the difference between the average daily outstanding balance for the current
month and the maximum credit amount under the facility and the lender's
out-of-pocket expenses.
183
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
The Company anticipates that these facilities will be subject to representations
and warranties, events of default and covenants which are customary for
facilities of this type, as well as its agreement to: (i) maintain sales or
renewals of our subordinated debt securities of $10.0 million per month; (ii)
restrict total principal and interest outstanding on its subordinated debt to
$750.0 million or less; (iii) make quarterly reductions commencing in April 2004
of an amount of subordinated debt outstanding to be determined; (iv) maintain
maximum interest rates payable on subordinated debt securities not to exceed 10
percentage points above comparable rates for FDIC insured products; and (v) the
lender's receipt of the Company's audited financial statements for the period
ended June 30, 2003. The definitive agreements will grant the lender an option
at any time after the first anniversary of entering into the definitive
agreements to increase the credit amount on the $250.0 million facility to
$400.0 million with additional fees payable by the Company plus additional
interest as may be required by the institutions or investors providing the
lender with these additional funds. The commitment letter requires that the
Company enter into definitive agreements not later than October 17, 2003. While
the Company anticipates that it will close this transaction prior to such date,
it cannot provide assurance that these negotiations will result in definitive
agreements or that such agreements, as negotiated, will be on terms and
conditions acceptable to the Company. In the event the Company is unable to
close these facilities or another facility within the time frame provided under
the new $200.0 million credit facility described above, the lender on that
facility would be under no obligation to make further advances under the terms
of that facility and outstanding advances would have to be repaid over a period
of time.
Under a registration statement declared effective by the SEC on October 3, 2002,
the Company registered $315.0 million of subordinated debt. Of the $315.0
million, $121.3 million of debt from this registration statement was available
for future issuance as of June 30, 2003. In June 2003, the Company filed a new
registration statement with the SEC to register an additional $295.0 million of
subordinated debt.
The Company's subordinated debt securities are subordinated in right of payment
to, or subordinate to, the 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. 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.
184
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
9. Subordinated Debt and Warehouse Lines and Other Notes Payable (continued)
In September 2002, the Company entered into a series of leases for computer
equipment which qualify as capital leases. The total principal amount of debt to
be recorded under these leases is $1.0 million. The leases have an imputed
interest rate of 8.0% and mature through January 2006.
The Company paid commitment fees and non-usage fees on warehouse lines and
operating lines of credit of $0.4 million, $0.7 million and $0.4 million in the
years ended June 30, 2003, 2002 and 2001, respectively.
10. Stockholders' Equity
In fiscal 1999, the Board of Directors initiated a stock repurchase program in
view of the price level of the Company's common stock, which at the time traded
and has continued to trade at below book value. In addition, the Company's
consistent earnings growth over the past several years through fiscal 2002 did
not result in a corresponding increase in the market value of its common stock.
The repurchase program was extended in fiscal 2000, 2001 and 2002. The fiscal
2002 extension authorized the purchase of up to 10% of the then outstanding
shares, which totaled approximately 2,661,000 shares on the date of the
extension. The Company repurchased 43,000 shares under the most current
repurchase program, which terminated in November 2002. The Company did not
extend the repurchase program beyond this date and currently has no plans to
repurchase additional shares.
The total number of shares repurchased under the stock repurchase program was:
117,000 in fiscal 1999; 327,000 in fiscal 2000; 627,000 in fiscal 2001; and
352,000 in fiscal 2002. The cumulative effect of the stock repurchase program
was an increase in diluted earnings per share of $0.41 and $0.32 for the years
ended June 30, 2002 and 2001, respectively.
On August 21, 2002, the Board of Directors declared a 10% stock dividend payable
September 13, 2002 to shareholders of record on September 3, 2002. In
conjunction with the Board's resolution, all outstanding stock options and
related exercise prices were adjusted. Accordingly, all outstanding common
shares, earnings per common share, average common share and stock option amounts
presented have been adjusted to reflect the effect of this stock dividend.
Amounts presented for fiscal 2001 have been similarly adjusted for the effect of
a 10% stock dividend declared October 1, 2001, which was paid on November 5,
2001 to shareholders of record on October 22, 2001. The Company increased its
quarterly cash dividend to $0.08 per share in fiscal 2003. Cash dividends of
$0.32, $0.28 and $0.26 were paid in the years ended June 30, 2003, 2002 and
2001, respectively.
185
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
10. Stockholders' Equity (continued)
In May 2002 the Company registered 440,000 shares of its common stock for use in
a dividend reinvestment plan. The dividend reinvestment plan is intended to
allow shareholders to purchase the Company's common stock with dividend payments
from their existing common stock holdings. This option continues to be offered
to the shareholders. As of June 30, 2003, 431,566 shares are available for use
in the plan.
In December 2002, the Company's shareholders approved an increase in the number
of shares of authorized preferred stock from 1.0 million shares to 3.0 million
shares. The preferred shares may be used to raise equity capital, redeem
outstanding debt or acquire other companies, although no such acquisitions are
currently contemplated. The Board of Directors has discretion with respect to
designating and establishing the terms of each series of preferred stock prior
to issuance.
11. Employee Benefit Plan
The Company has a 401(k) defined contribution plan, which was established in
1995, available to all employees who have been with the Company for one month
and have reached the age of 21. Employees may generally contribute up to 15% of
their earnings each year, subject to IRS imposed limitations. For participants
with one or more years of service, the Company, at its discretion, may match up
to 25% of the first 5% of earnings contributed by the employee, and may match an
additional 25% of the first 5% of earnings contributed by the employee in
Company stock. The Company's contribution was $417 thousand, $350 thousand and
$307 thousand for the years ended June 30, 2003, 2002 and 2001, respectively.
186
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
12. Stock Option and Stock Incentive Plans
The Company has stock option plans that provide for the periodic granting of
options to key employees and non-employee directors. These plans have been
approved by the Company's shareholders. Options are generally granted to key
employees 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, 2003, 230,024 shares
were available for future grant under the Company's stock option plans.
A summary of key employee stock option activity for the years ended June 30,
2003, 2002 and 2001 follows. Stock option activity has been retroactively
adjusted for the effect of the stock dividends described in Note 10.
Weighted-Average
Number of Shares Exercise Price
--------------------------------------------------
Options outstanding, June 30, 2000 563,981 $ 13.23
Options granted 81,675 5.32
Options canceled (91,052) 15.82
--------------------------------------------------
Options outstanding, June 30, 2001 554,604 11.64
Options granted 110,311 12.81
Options exercised (121) 10.75
Options canceled (61,336) 7.32
--------------------------------------------------
Options outstanding, June 30, 2002 603,458 11.95
Options granted 6,000 13.50
Options exercised (4,000) 5.06
Options canceled (41,466) 14.41
--------------------------------------------------
Options outstanding, June 30, 2003 563,992 $ 11.79
==================================================
The Company also issues stock options to non-employee directors. Options
generally are granted to non-employee directors 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.
A summary of non-employee director stock option activity for the three years
ended June 30, 2003, 2002 and 2001 follows. Stock option activity has been
retroactively adjusted for the effect of the stock dividends described in Note
10.
187
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
12. Stock Option and Stock Incentive Plans (continued)
Weighted-Average
Number of Shares Exercise Price
--------------------------------------------------
Options outstanding, June 30, 2000 211,750 $ 9.45
Options granted 48,400 5.27
Options canceled (25,410) 18.30
--------------------------------------------------
Options outstanding, June 30, 2001 234,740 7.63
Options granted 59,400 13.97
Options canceled (25,410) 11.81
--------------------------------------------------
Options outstanding, June 30, 2002 268,730 8.64
Options exercised (87,985) 7.37
Options canceled (12,100) 10.74
--------------------------------------------------
Options outstanding, June 30, 2003 168,645 $ 9.25
==================================================
The Company accounts for stock options issued under these plans using the
intrinsic value method. See Note 1 for more detail.
The weighted-average fair value of options granted during the fiscal years ended
June 30, 2003, 2002 and 2001 were $7.00, $5.85 and $2.15, respectively. 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,
2003 2002 2001
------------------------------------------------------------
Expected volatility 65% 50% 40%
Expected life 8 yrs. 8 yrs. 8 yrs.
Risk-free interest rate 3.3% - 3.8% 3.4% - 5.3% 5.0% - 5.9%
188
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
12. Stock Option and Stock Incentive Plans (continued)
The following tables summarize information about stock options outstanding under
these plans at June 30, 2003:
Options Outstanding
- ------------------------------------------------------------------------------------------
Weighted
Remaining Weighted-
Range of Exercise Number of Contractual Life Average
Prices of Options Shares in Years Exercise Price
- ------------------------------------------------------------------------------------------
$ 3.94 to 5.63 174,971 3.7 $ 4.62
10.74 to 12.59 312,549 6.7 11.27
13.49 to 15.74 186,671 3.0 14.94
17.22 to 20.46 58,446 4.6 18.70
---------------------------------------------------------------
732,637 4.9 $ 11.21
===============================================================
Options Exercisable
- ------------------------------------------------------------------------------------------
Weighted
Remaining Weighted-
Range of Exercise Number of Contractual Life Average
Prices of Options Shares in Years Exercise Price
- ------------------------------------------------------------------------------------------
$ 3.94 to 5.63 144,701 2.9 $ 4.52
10.74 to 12.59 161,019 5.9 11.02
13.49 to 15.74 139,531 3.1 15.14
17.22 to 20.46 58,446 4.6 18.70
---------------------------------------------------------------
503,697 4.1 $ 11.18
===============================================================
The FASB released interpretation No. 44 "Accounting for Certain Transactions
Involving Stock Compensation" allows options granted to directors to be
accounted for consistently with those granted to employees if certain conditions
are met, and therefore, no expense is recognized where the exercise price equals
or exceeds the fair value of the shares at the date of grant. In accordance with
the guidance, in fiscal 2001, the Company recorded $174 thousand as a cumulative
effect of a change in accounting principle, which represents the cumulative
amount of expense recognized in prior years for stock options issued to
non-employee directors.
In fiscal 2002 the Board of Directors adopted, and the shareholders approved, a
stock incentive plan. The stock incentive plan provides for awards to officers
and other employees of the Company in the form of the Company's common stock.
Awards made pursuant to this plan are under the direction of the Compensation
Committee of the Board of Directors and are dependent on the Company, and
individuals receiving the grant, achieving certain goals developed by the
Compensation Committee. The vesting schedule for awards under this plan, if any,
189
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
12. Stock Option and Stock Incentive Plans (continued)
are set by the Compensation Committee at time of grant. The total number of
shares authorized to be granted under the Stock Incentive Plan are 165,000
shares. The number of shares issuable can be adjusted, however, in the event of
a reorganization, recapitalization, stock split, stock dividend, merger,
consolidation or other change in the corporate structure of the Company. On
October 15, 2002, 27,899 shares were granted at a price of $10.05 per share and
10,876 shares were granted on October 17, 2002 at $10.43 per share to officers
and employees under this plan.
13. Income Taxes
The provision for income taxes consists of the following (in thousands):
Year ended June 30,
2003 2002 2001
-----------------------------------------------------
Current
Federal $ 9 $ 1,455 $ 383
State 400 250 76
-----------------------------------------------------
409 1,705 459
-----------------------------------------------------
Deferred
Federal (19,377) 3,986 4,641
State (150) - 174
-----------------------------------------------------
(19,527) 3,986 4,815
-----------------------------------------------------
Total provision for income taxes $ (19,118) $ 5,691 $ 5,274
=====================================================
There were $4.1 million in federal tax benefits from the utilization of net
operating loss carryforwards in the year ended June 30, 2003 while there were no
tax benefits from the utilization of net operating loss carryforwards in the
year ended June 30, 2002.
190
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
13. Income Taxes (continued)
The cumulative temporary differences resulted in net deferred income tax assets
or liabilities consisting primarily of the following (in thousands):
Year ended June 30,
2003 2002
---------------------------------------
Deferred income tax assets:
Allowance for credit losses $ 997 $ 1,297
Net operating loss carryforwards 72,581 60,720
Other 14,544 6,303
---------------------------------------
88,122 68,320
Less valuation allowance 36,830 29,326
---------------------------------------
51,292 38,994
---------------------------------------
Deferred income tax liabilities:
Interest-only strips and other
receivables 68,328 74,118
---------------------------------------
68,328 74,118
---------------------------------------
Net deferred income tax liability $ 17,036 $ 35,124
=======================================
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. The utilization of net operating loss carryforwards for federal tax
purposes is not dependent on future taxable income from operations, but on the
reversal of timing differences principally related to existing securitization
assets. These timing differences are expected to absorb the available net
operating loss carryforwards during the carryforward period.
A reconciliation of income taxes at federal statutory rates to the Company's tax
provision is as follows (in thousands):
Year ended June 30,
2003 2002 2001
-------------------------------------
Federal income tax at statutory rates $ (17,157) $ 4,742 $ 4,615
Nondeductible items 85 65 534
Other, net (2,046) 884 125
-------------------------------------
$ (19,118) $ 5,691 $ 5,274
=====================================
For income tax reporting, the Company has net operating loss carryforwards
aggregating approximately $460.4 million available to reduce future state income
taxes for various states as of June 30, 2003. If not used, substantially all of
the carryforwards will expire at various dates from June 30, 2003 to June 30,
2005. The $2.0 million benefit in the other, net category is the result of the
reversal of state and federal reserves which are no longer deemed necessary.
191
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
14. Commitments and Contingencies
Operating Leases
As of June 30, 2003, the Company leases property under noncancelable operating
leases requiring minimum annual rentals as follows (in thousands):
Year ending June 30,
2004 $ 1,422
2005 5,283
2006 5,131
2007 5,312
2008 5,442
Thereafter 33,533
-------------
$ 56,123
=============
Rent expense for leased property was $5.1 million, $4.9 million and $5.2
million, respectively, for the years ended June 30, 2003, 2002, and 2001.
Employment Agreements
In January 1997, the Company entered into employment agreements, as amended,
with three executives under which they are entitled to an initial annual base
compensation of $625 thousand, collectively, automatically adjusted for
increases in the Consumer Price Index and may be adjusted for merit increases.
The agreements with two of the executives also provide for bonus payments up to
225% of the executive's annual salary under a cash bonus plan established by the
Company's Board of Directors. The third executive is entitled to a bonus payment
of up to 50% of the executive's annual salary. The agreements terminate upon the
earlier of: (a) the executive's death, permanent disability, termination of
employment for cause, voluntary resignation or 70th birthday; (b) the later of
five years from any anniversary date of the agreements for two executives and
three years for one executive; or (c) five years from the date of notice to the
executive of the Company's intention to terminate the agreement for two
executives and three years for one executive. In addition, two of the 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 remaining executive is entitled to a similar payment but only if
he is terminated in connection with a change in control.
The Company has also entered into an employment agreement with another executive
under which the executive is entitled to receive an initial annual base
compensation of $335 thousand which shall be reviewed annually and may be
adjusted for merit increases. The executive is eligible for a cash bonus payment
192
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
14. Commitments and Contingencies (continued)
Employment Agreements (continued)
of up to 50% of the executive's annual base compensation based upon the Company
achieving specific goals and objectives. This agreement terminates upon: (a) the
earlier of the executive's death, permanent disability, termination of
employment for cause, voluntary resignation 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. In the event of a change in
control, this executive will receive his highest annual salary for the
twelve-month period preceding the termination of his employment and his highest
annual bonus paid in any of the three fiscal years preceding termination. In
addition, this executive is eligible for a cash bonus payment of up to 50% of
the executive's annual base compensation at the time of award based upon the
executive achieving specific goals and objectives.
The Company has also entered into an employment arrangement with another
executive under which the executive is entitled to receive an initial annual
base compensation of $275 thousand. In addition, this executive is eligible for
a cash bonus payment of up to 50% of the executive's annual base compensation
based upon the Company achieving specific goals and objectives. This executive
is entitled to receive one year's base salary if terminated for any reason,
except for cause as defined in the agreement. This executive is also entitled to
a severance payment equal to two times the executive's highest annual base
salary and bonus earned within a specified period if terminated due to a change
in control of the Company or within twenty-four months of a change in control of
the Company the executive resigns due to circumstances specified in the
agreement.
Periodic Advance Guarantees
As the servicer of securitized loans, the Company is obligated to advance
interest payments for delinquent loans if we deem that the advances will
ultimately be recoverable. These advances can first be made out of funds
available in a trust's collection account. If the funds available from the
trust's collection account are insufficient to make the required interest
advances, then the Company is required to make the advance from its operating
cash. The advances made from a trust's collection account, if not recovered from
the borrower or proceeds from the liquidation of the loan, require reimbursement
from the Company. However, the Company can recover any advances the Company
makes from its operating cash from the subsequent month's mortgage loan payments
to the applicable trust prior to any distributions to the certificate holders.
193
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
14. Commitments and Contingencies (continued)
Periodic Advance Guarantees (continued)
The Company adopted FIN 45 on a prospective basis for guarantees that are issued
or modified after December 31, 2002. Based on the requirements of this guidance
for the fiscal year ended June 30, 2003, the Company has recorded a $0.7 million
liability in conjunction with the sale of mortgage loans to the ABFS 2003-1
securitization trust which occurred in March 2003. This liability represents its
estimate of the fair value of periodic interest advances that the Company as
servicer of the securitized loans, is obligated to pay to the trust on behalf of
delinquent loans. The fair value of the liability was estimated based on an
analysis of historical periodic interest advances and recoveries from
securitization trusts.
Other
State and federal banking regulatory agencies, state attorneys general offices,
the Federal Trade Commission, the U.S. Department of Justice, the U.S.
Department of Housing and Urban Development and state and local governmental
authorities have increased their focus on lending practices by some companies in
the subprime industry, more commonly referred to as "predatory lending"
practices. State, local and federal governmental agencies have imposed sanctions
for practices including, but not limited to, charging borrowers excessive fees,
imposing higher interest rates than the borrower's credit risk warrants and
failing to adequately disclose the material terms of loans to the borrowers. As
a result of these initiatives, the Company is unable to predict whether state,
local or federal authorities will require changes in the Company's lending
practices in the future, including the reimbursement of borrowers as a result of
fees charged or the imposition of fines, or the impact of those changes on the
Company's profitability. The Pennsylvania Attorney General reviewed certain fees
charged to Pennsylvania customers by the Company's subsidiary, HomeAmerican
Credit, Inc., which does business as Upland Mortgage. Although the Company
believes that these fees were fair and in compliance with applicable federal and
state laws, in April 2002 the Company agreed to reimburse borrowers
approximately $221,000 with respect to a particular fee paid by borrowers from
January 1, 1999 to mid-February 2001 and to reimburse the Commonwealth of
Pennsylvania $50,000 for their costs of investigation and for future public
protection purposes. The Company discontinued charging this particular fee in
mid-February 2001. The Company has satisfied the monetary commitments and
obligations to the Pennsylvania Attorney General. The reserve, which the Company
previously established, was adequate to cover the resolution of this matter.
15. Legal Proceedings
On February 26, 2002, a purported class action titled Calvin Hale v.
HomeAmerican Credit, Inc., No. 02 C 1606, United States District Court for the
Northern District of Illinois, was filed in the Circuit Court of Cook County,
Illinois (subsequently removed by Upland Mortgage to the captioned federal
194
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
15. Legal Proceedings (continued)
court) against the Company's subsidiary, HomeAmerican Credit, Inc., which does
business as Upland Mortgage, on behalf of borrowers in Illinois, Indiana,
Michigan and Wisconsin who paid a document preparation fee on loans originated
since February 4, 1997. The case consisted of three purported class action
counts and two individual counts. The plaintiff alleged that the charging of,
and the failure to properly disclose the nature of, a document preparation fee
were improper under applicable state law. In November 2002, the Illinois Federal
District Court dismissed the three class action counts and an agreement in
principle was reached in August 2003 to settle the matter. The terms of the
settlement have been finalized and did not have a material effect on the
Company's consolidated financial position or results of operations.
The Company's lending subsidiaries, including HomeAmerican Credit, Inc. which
does business as Upland Mortgage, are involved, from time to time, in class
action lawsuits, other litigation, claims, investigations by governmental
authorities, and legal proceedings arising out of their lending and servicing
activities, including the purported class action entitled, Calvin Hale v.
HomeAmerican Credit, Inc., d/b/a Upland Mortgage, described above. Due to the
Company's current expectation regarding the ultimate resolution of these
actions, management believes that the liabilities resulting from these actions
will not have a material adverse effect on its consolidated financial position
or results of operations. However, due to the inherent uncertainty in litigation
and because the ultimate resolution of these proceedings are influenced by
factors outside of the Company's control, the Company's estimated liability
under these proceedings may change or actual results may differ from its
estimates.
Additionally, court decisions in litigation to which the Company is not a party
may also affect its lending activities and could subject it to litigation in the
future. For example, in Glukowsky v. Equity One, Inc., (Docket No. A-3202 -
01T3), dated April 24, 2003, to which the Company is not a party, the Appellate
Division of the Superior Court of New Jersey determined that the Parity Act's
preemption of state law was invalid and that the state laws precluding some
lenders from imposing prepayment fees are applicable to loans made in New
Jersey. The Company expects that, as a result of the publicity surrounding
predatory lending practices and this recent New Jersey court decision regarding
the Parity Act, it may be subject to other class action suits in the future.
In addition, from time to time, the Company is involved as plaintiff or
defendant in various other legal proceedings arising in the normal course of its
business. While the Company cannot predict the ultimate outcome of these various
legal proceedings, management believes that the resolution of these legal
actions should not have a material effect on the Company's financial position,
results of operations or liquidity.
195
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
16. Related Party Transactions
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
247,513 shares of the Company's common stock in 1995. 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 247,513 shares of the Company's stock,
and is shown as a reduction of stockholders' equity on the accompanying balance
sheet.
On April 2, 2001, the Company awarded 2,500 shares (3,025 shares after the
effect of stock dividends) of its common stock to a director of the Company as a
result of services rendered in connection with its stock repurchases.
In February 2003, the Company awarded 2,000 shares of its common stock to each
of two newly appointed members of its Board of Directors.
The Company employs members of the immediate family of one of its directors and
one of its non-director executive officers in various executive and other
positions. The Company believes that the salaries paid to these individuals are
competitive with salaries paid to other employees in similar positions within
the Company and in its industry.
Additionally, the Company has business relationships with other related parties
including family members of one of its directors and one of its non-director
executive officers through which the Company has, from time to time, purchased
appraisal services, office equipment and real estate advisory services. None of
these related party transactions, individually or collectively, are material to
the Company's results of operations.
196
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
17. Fair Value of Financial Instruments
No active market exists for certain of the Company's 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.
The following table summarizes the carrying amounts and fair value estimates of
financial instruments recorded on the Company's financial statements at June 30,
2003 and 2002 (in thousands):
June 30, 2003 June 30, 2002
------------------------ -------------------------
Carrying Carrying
Value Fair Value Value Fair Value
--------- ---------- ---------- ----------
Assets
Cash and cash equivalents $ 47,475 $ 47,475 $ 108,599 $ 108,599
Loans and leases available for sale 271,402 272,991 57,677 67,145
Interest-only strips 598,278 598,278 512,611 512,611
Servicing rights 119,291 119,291 125,288 125,951
Investments held to maturity 881 946 917 989
Liabilities
Subordinated debt and warehouse
lines and notes payable $ 932,456 $ 931,302 $ 664,206 $ 663,212
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.
Servicing rights - 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.
Investments held to maturity - Represent mortgage loan backed securities
retained in securitizations. Fair value is determined using estimated
197
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
17. Fair Value of Financial Instruments (continued)
discounted future cash flows taking into consideration anticipated
prepayment rates and credit loss rates of the underlying loans and pass
through investment certificate interest rates of current securitizations.
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 mortgage backed securities retained in securitizations,
which were held-to-maturity investment securities were as follows (in
thousands):
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
------------------------------------------------------
June 30, 2003 $ 881 $ 65 $ -- $ 946
June 30, 2002 $ 917 $ 72 $ -- $ 989
Mortgage backed securities mature through November 2005.
18. Derivative Financial Instruments
SFAS No. 133 was effective on a prospective basis for all fiscal quarters of
fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 on July
1, 2000 resulted in the cumulative effect of a change in accounting principle of
$15 thousand pre-tax being recognized as expense in the Consolidated Statement
of Income for the year ended June 30, 2001. Due to the immateriality of the
cumulative effect of adopting SFAS No. 133, the $15 thousand pre-tax expense is
included in general and administrative expense in the Consolidated Statement of
Income. The tax effects and earnings per share amounts related to the cumulative
effect of adopting SFAS No. 133 are not material.
Hedging activity
Related to Loans Expected to Be Sold Through Securitizations. At the time the
derivative contracts are executed, they are specifically designated as hedges of
mortgage loans or the Company's residual interests in mortgage loans in its
mortgage conduit facility, which the Company would expect to be included in a
term securitization at a future date. The mortgage loans and mortgage loans
underlying residual interests in mortgage pools consist of essentially similar
pools of fixed interest rate loans, collateralized by real estate (primarily
residential real estate) with similar maturities and similar credit
characteristics. Fixed interest rate pass-through certificates issued by
198
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
18. Derivative Financial Instruments (continued)
Hedging activity (continued)
securitization trusts are generally priced to yield an interest rate spread
above interest rate swap yield curves with maturities to match the maturities of
the interest rate pass-through certificates. The Company may hedge potential
interest rate changes in interest rate swap yield curves with forward starting
interest rate swaps, Eurodollar futures, forward treasury sales or derivative
contracts of similar underlying securities. This practice has provided strong
correlation between the hedge contracts and the ultimate pricing that the
Company will receive on the subsequent securitization.
Related to Loans Expected to Be Sold Through Whole Loan Sale Transactions. The
Company may also utilize derivative financial instruments in an attempt to
mitigate the effect of changes in market interest rates between the date loans
are originated at fixed interest rates and the date that the loans will be sold
in a whole loan sale. At the time the derivative contracts are executed, they
are specifically designated as hedges of mortgage loans or the Company's
residual interests in mortgage loans in its mortgage conduit facility, which the
Company would expect to be included in a whole loan sale transaction at a future
date. The Company may hedge the effect of changes in market interest rates with
forward sale commitments, forward starting interest rate swaps, Eurodollar
futures, forward treasury sales or derivative contracts of similar underlying
securities. On June 30, 2003, the Company entered into a forward sale agreement
providing for the sale of $275 million of home equity mortgage loans at a price
of 105.0%.
Disqualified Hedging Relationship. The securitization market was not available
to the Company in the fourth quarter of fiscal 2003. As a result, the Company
realized that the expected high correlation between the changes in the fair
values of the derivatives and the mortgage loans would not be achieved and
discontinued hedge accounting. During the quarter ending June 30, 2003, $4.0
million of losses on $170.0 million of forward starting interest rate swaps
previously designated as a hedge of mortgage loans expected to be securitized
was charged to earnings. An offsetting increase of $3.7 million in the value of
the hedged mortgage loans was recorded in earnings, representing the changes in
value of the loans until the date that the Company learned that the
securitization market was not available.
The Company recorded the following gains and losses on the fair value of
derivative financial instruments accounted for as hedging transactions or on
disqualified hedging relationships for the years ended June 30, 2003, 2002 and
2001. Ineffectiveness related to qualified hedging relationships during the
period was immaterial. Ineffectiveness is a measure of the difference in the
change in fair value of the derivative financial instrument as compared to the
change in the fair value of the item hedged (in thousands):
199
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
18. Derivative Financial Instruments (continued)
Hedging activity (continued)
Year Ended June 30,
---------------------------------------
2003 2002 2001
------------- ----------- -----------
Offset by gains and losses recorded on
securitizations:
Losses on derivative financial
instruments $ (3,806) $ (9,401) $ (4,343)
Offset by gains and losses recorded on
the fair value of hedged items:
Losses on derivative financial
instruments $ (7,037) $ -- $ --
Amount settled in cash - paid $ (5,041) $ (9,401) $ (4,343)
At June 30, 2003, forward sale agreements and outstanding forward starting
interest rate swap contracts accounted for as hedges and unrealized losses
recorded as liabilities on the balance sheet were as follows (in thousands):
Notional Unrealized
Amount Loss
--------- ------------
Forward sale agreement $ 275,000 $ --
Forward starting interest rate
swaps $ -- $ (6,776)(a)
(a) Represents the liability carried on the balance sheet at June 30,
2003 for previously recorded losses not yet settled in cash.
There were no outstanding derivatives contracts accounted for as hedges at June
30, 2002 or 2001.
Trading activity
Generally, the Company does not enter into derivative financial instrument
contracts for trading purposes. However, the Company has entered into derivative
financial instrument contracts which have not been designated as hedges in
accordance with SFAS No. 133 and were therefore accounted for as trading assets
or liabilities.
Related to Loans Expected to Be Sold Through Securitizations. During fiscal
2003, the Company used interest rate swap contracts to protect the future
securitization spreads on loans in its pipeline. Loans in the pipeline represent
loan applications for which the Company is in the process of obtaining all the
documentation required for a loan approval or approved loans, which have not
been accepted by the borrower and are not considered to be firm commitments. The
200
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
18. Derivative Financial Instruments (continued)
Trading activity (continued)
Company believed there was a greater chance that market interest rates that
would be obtained on the subsequent securitization of these loans would increase
rather than decline, and chose to protect the spread that could be earned in the
event of rising rates.
However due to a decline in market interest rates during the period the
derivative contracts were used to manage interest rate risk on loans in the
pipeline, the Company recorded losses on forward starting interest rate swap
contracts during the fiscal year ended June 30, 2003. The losses are summarized
in the table below.
Related to Loans Expected to Be Sold Through Whole Loan Sale Transactions. The
$170.0 million notional amount of forward starting interest rate swap contracts
carrying over from the disqualified hedging relationship discussed above are
currently being utilized to manage the effect of changes in market interest
rates on the fair value of fixed-rate mortgage loans that were previously
expected to be sold in a fourth quarter of fiscal 2003 securitization, but are
now expected to be sold in whole loan sale transactions. The Company has elected
not to designate these derivative contracts as an accounting hedge.
The following gains and losses were recorded on the fair value of derivative
financial instruments classified as trading for the year ended June 30, 2003.
There were no derivative contracts classified as trading for the years ended
June 30, 2002 and 2001 except those noted below to manage the exposure to
changes in the fair value of certain interest-only strips due to changes in
one-month LIBOR. (in thousands):
Trading gains(losses) on forward
starting interest rate swaps:
Related to loan pipeline $ (3,796)
Related to whole loan sales $ 441
Amount settled in cash - paid $ (2,671)
At June 30, 2003, outstanding forward starting interest rate swap contracts used
to manage interest rate risk on loans expected to be sold in whole loan sale
transactions and the associated unrealized gains recorded as assets on the
balance sheet are summarized in the table below. There were no open derivative
contracts classified as trading for the years ended June 30, 2002 and 2001
except those noted below to manage the exposure to changes in the fair value of
certain interest-only strips due to changes in one-month LIBOR. (in thousands):
201
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
18. Derivative Financial Instruments (continued)
Trading activity (continued)
Notional Unrealized
Amount Gain
--------- -----------
Forward starting interest rate $170,000 $ 441
swaps
The sensitivity of the forward starting interest rate swap contracts held as
trading as of June 30, 2003 to a 0.1% change in market interest rates is $0.1
million.
Related to Interest-only Strips. For fiscal years ended June 30, 2003 and 2002,
respectively, the Company recorded net losses of $0.9 million and $0.7 million
on an interest rate swap contract which was not designated as an accounting
hedge. This contract was designed to reduce the exposure to changes in the fair
value of certain interest-only strips due to changes in one-month LIBOR. The
loss on the swap contract was due to decreases in the interest rate swap yield
curve during the periods the contract was in place. Included in the $0.9 million
net loss recorded in the fiscal year ended June 30, 2003, were unrealized gains
of $0.1 million representing the net change in the fair value of the contract
during the fiscal year and $1.0 million of cash losses paid during the fiscal
year. Included in the $0.7 million net loss recorded in the fiscal year ended
June 30, 2002, were unrealized losses of $0.5 million representing the net
change in the fair value of the contract during the fiscal year and $0.2 million
of cash losses paid during the fiscal year. The cumulative net unrealized loss
of $0.3 million is included as a trading liability in Other liabilities.
Terms of the interest rate swap contract at June 30, 2003 were as follows
(dollars in thousands):
Notional amount $ 44,535
Rate received - Floating (a) 1.18%
Rate paid - Fixed 2.89%
Maturity date April 2004
Unrealized loss $ 334
Sensitivity to 0.1% change in interest rates $ 17
- ----------
(a) Rate represents the spot rate for one-month LIBOR paid on the securitized
floating interest rate certificate at the end of the period.
202
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
19. Reconciliation of Basic and Diluted Earnings Per Common Share
Year ended June 30,
2003 2002 2001
-----------------------------------------------------
(in thousands except per share data)
(Numerator)
Income (loss) before cumulative effect of a
change in accounting principle $ (29,902) $ 7,859 $ 7,911
Cumulative effect of a change in accounting
principle - - 174
-----------------------------------------------------
Net income (loss) $ (29,902) $ 7,859 $ 8,085
=====================================================
(Denominator) Average Common Shares:
Average common shares outstanding 2,918 2,934 3,797
Average potentially dilutive shares (a) 221 88
-----------------------------------------------------
Average common and potentially dilutive
shares 2,918 3,155 3,885
=====================================================
Earnings (loss) per common share:
Basic:
Income (loss) before cumulative effect of a
change in accounting principle $ (10.25) $ 2.68 $ 2.08
Cumulative effect of a change in accounting
principle - - 0.05
-----------------------------------------------------
Net income (loss) $ (10.25) $ 2.68 $ 2.13
=====================================================
Diluted:
Income (loss) before cumulative effect of a
change in accounting principle $ (10.25) $ 2.49 $ 2.04
Cumulative effect of a change in accounting
principle - - 0.04
-----------------------------------------------------
Net income (loss) $ (10.25) $ 2.49 $ 2.08
=====================================================
- ----------
(a) Anti-dilutive in fiscal year 2003.
203
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
20. 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 and loans secured by one to four family residential real estate.
The Servicing segment services the loans originated by the Company 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 securitization trust 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.
The All Other caption on the following tables mainly represents segments that do
not meet the SFAS No. 131 "Disclosures about Segments of an Enterprise and
Related Information" defined thresholds for determining reportable segments,
financial assets not related to operating segments and is mainly comprised of
interest-only strips, 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.
204
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
20. Segment Information (continued)
Year ended June 30, 2003
------------------------------------------------------------------------------------
Loan Treasury and Reconciling
Origination Funding Servicing All Other Items Consolidated
------------------------------------------------------------------------------------
(in thousands)
External revenues:
Gain on sale of loans:
Securitizations $ 170,950 $ - $ - $ - $ - $ 170,950
Whole loan sales 655 - - - - 655
Interest income 9,311 422 762 47,347 - 57,842
Non-interest income 8,295 4 45,480 - (41,820) 11,959
Inter-segment revenues - 75,422 - 74,752 (150,174) -
Operating expenses:
Interest expense 20,970 66,526 2,467 53,557 (75,422) 68,098
Non-interest expense 52,471 9,079 42,542 64,406 - 168,498
Depreciation and amortization 3,236 108 1,168 4,136 - 8,648
Interest-only strips valuation adjustment - - - 45,182 - 45,182
Inter-segment expense 116,572 - - - (116,572) -
Income tax expense (benefit) (1,575) 53 25 (17,621) - (19,118)
------------------------------------------------------------------------------------
Net income (loss) $ (2,463) $ 82 $ 40 $ (27,561) $ - $ (29,902)
====================================================================================
Segment assets $ 349,207 $ 156,082 $ 111,254 $ 639,377 $ (96,569) $ 1,159,351
====================================================================================
205
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
20. Segment Information (continued)
Year ended June 30, 2002
------------------------------------------------------------------------------------
Loan Treasury and Reconciling
Origination Funding Servicing All Other Items Consolidated
------------------------------------------------------------------------------------
(in thousands)
External revenues:
Gain on sale of loans and leases
Securitizations $ 185,580 $ - $ - $ - $ - $ 185,580
Whole loan sales 2,448 - - - - 2,448
Interest income 7,199 998 1,309 35,386 - 44,892
Non-interest income 9,198 1 35,387 102 (29,707) 14,981
Inter-segment revenues - 70,586 - 68,335 (138,921) -
Operating expenses:
Interest expense 22,387 67,256 298 49,328 (70,586) 68,683
Non-interest expense 41,547 11,613 31,375 52,163 - 136,698
Depreciation and amortization 3,348 142 1,095 2,332 - 6,917
Interest-only strips valuation adjustment - - - 22,053 - 22,053
Inter-segment expense 98,042 - - - (98,042) -
Income tax expense (benefit) 16,423 (3,119) 1,650 (9,263) - 5,691
------------------------------------------------------------------------------------
Net income (loss) $ 22,678 $ (4,307) $ 2,278 $ (12,790) $ - $ 7,859
====================================================================================
Segment assets $ 95,017 $ 202,621 $ 124,914 $ 541,950 $ (88,127) $ 876,375
====================================================================================
206
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
21. Quarterly Data Statement (unaudited)
The interim financial statements below contain all adjustments (consisting of
normal recurring accruals and the elimination of intercompany balances)
necessary in management's opinion for a fair presentation of financial position
and results of operations. The following tables summarize financial data by
quarters (in thousands, except per share amounts):
Fiscal 2003 Quarters Ended
------------------------------------------------------------------------------
June 30, March 31, December 31, September 30,
------------------------------------------------------------------------------
Revenues
Gain on sale of loans and leases
Securitizations $ 556 $ 54,504 $ 57,879 $ 58,011
Whole sale loans 626 (4) (2) 35
Interest and fees 6,002 4,665 4,595 4,133
Interest accretion on interest-only
strips 12,986 12,114 11,500 10,747
Servicing income 382 486 644 1,537
Other income 3 1 2 4
------------------------------------------------------------------------------
Total revenues 20,555 71,766 74,618 74,467
Total expenses (a) 76,383 71,737 70,979 71,327
------------------------------------------------------------------------------
Income (loss) before provision for
income tax expense (55,828) 29 3,639 3,140
Provision for income tax expense
(benefit) (21,773) (192) 1,528 1,319
------------------------------------------------------------------------------
Net income (loss) $ (34,055) $ 221 $ 2,111 $ 1,821
==============================================================================
Earnings (loss) per common share:
Basic $ (11.68) $ 0.07 $ 0.72 $ 0.64
Diluted $ (11.68) $ 0.06 $ 0.69 $ 0.61
(a) Includes pre-tax adjustments to the fair value of securitization assets of
$11.8 million, $10.7 million, $10.6 and $12.1 million for the quarters ended
June 30, March 31, December 31 and September 30, respectively.
207
American Business Financial Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
June 30, 2003
21. Quarterly Data Statement (unaudited) (continued)
Fiscal 2002 Quarters Ended
-----------------------------------------------------------------------------
June 30, March 31, December 31, September 30,
-----------------------------------------------------------------------------
Revenues
Gain on sale of loans and leases
Securitizations $ 56,441 $ 49,220 $ 44,563 $ 35,356
Whole sale loans 74 540 641 1,193
Interest and fees 4,505 4,752 4,885 4,748
Interest accretion on interest-only
strips 9,466 9,538 8,646 7,736
Servicing income 1,267 1,282 1,298 1,636
Other income 7 103 1 3
-----------------------------------------------------------------------------
Total revenues 71,760 65,435 60,034 50,672
Total expenses (a) 67,818 62,399 55,810 48,324
-----------------------------------------------------------------------------
Income before provision for income tax
expense 3,942 3,036 4,224 2,348
Provision for income tax expense 1,656 1,275 1,774 986
-----------------------------------------------------------------------------
Net Income $ 2,286 $ 1,761 $ 2,450 $ 1,362
=============================================================================
Earnings per common share:
Basic $ 0.80 $ 0.58 $ 0.87 $ 0.43
Diluted $ 0.75 $ 0.55 $ 0.79 $ 0.40
(a) Includes pre-tax adjustments to the fair value of securitization assets of
$8.9 million, $8.7 million and $4.5 million for the quarters ended June 30,
March 31 and December 31, respectively.
208
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
---------------------------------------------------------------
On August 2, 2001, Ernst & Young LLP resigned as our independent
accountants. Ernst & Young LLP had been engaged as our auditor on May 17, 2001,
replacing BDO Seidman, LLP. During the period of engagement through August 2,
2001, Ernst & Young LLP did not issue any reports on our financial statements.
During fiscal 2001 and the subsequent interim period through August 2,
2001, we did not have any disagreements with Ernst & Young LLP, on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements, if not resolved to the satisfaction of
Ernst & Young LLP, would have caused it to make a reference to the subject
matter of the disagreements in connection with its report. During fiscal 2001
and the subsequent interim period through August 2, 2001, none of the events
described in Regulation S-K Item 304 (a)(1)(v) occurred.
Our Board of Directors approved the reengagement of BDO Seidman, LLP as
the Company's independent accountants effective August 8, 2001. BDO Seidman, LLP
acted as our independent accountants during the two-year period ended June 30,
2000 through May 17, 2001. During the two years ended June 30, 2000 and the
subsequent interim period through May 17, 2001, we consulted with BDO Seidman,
LLP regarding the application of accounting principles in the normal course of
BDO Seidman, LLP's engagement as our independent auditors. BDO Seidman, LLP
issued reports on our financial statements during the two-year period ended June
30, 2000. The reports of BDO Seidman, LLP on our financial statements during the
two-year period ended June 30, 2000 did not contain an adverse opinion, or a
disclaimer of opinion, and were not qualified or modified as to uncertainty,
audit scope or accounting principles.
During the two-year period ended June 30, 2000, and interim period from
July 1, 2000 through May 17, 2001, we did not have any disagreements with BDO
Seidman, LLP, on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of BDO Seidman, LLP, would have caused it to
make a reference to the subject matter of the disagreements in connection with
its report.
Item 9A. Controls and Procedures
-----------------------
The Company, under the supervision and with the participation of its
management, including its principal executive officer and principal financial
officer, evaluated the effectiveness of the design and operation of its
disclosure controls and procedures as of the end of the period covered by this
report. Based on this evaluation, the principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures are effective in reaching a reasonable level of assurance that
information required to be disclosed by the Company in the reports that it files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time period specified in the Securities and
Exchange Commission's rules and forms.
209
The principal executive officer and principal financial officer also
conducted an evaluation of internal control over financial reporting ("Internal
Control") to determine whether any changes in Internal Controls occurred during
the quarter that have materially affected or which are reasonably likely to
materially affect Internal Controls. Based on that evaluation, there has been no
such change during the quarter covered by this report.
A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected. The
Company conducts periodic evaluations to enhance, where necessary its procedures
and controls.
210
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 2003 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.
For information regarding our executive officers, See "Item 1. Business
- -- Executive Officers Who Are Not Also Directors."
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.
To 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, 2003, our officers, directors
and greater than 10% beneficial owners have complied with all Section 16(a)
filing requirements.
Item 11. Executive Compensation
-----------------------
The information required to be included in Item 11 of Part III of this
Form 10-K incorporates by reference certain information from our definitive
proxy statement, for our 2003 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 and
Related Stockholder Matters
-------------------------------------------------------------------
The information required to be included in Item 12 of Part III of this
Form 10-K incorporates by reference certain information from our definitive
proxy statement, for our 2003 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.
For information, including a tabular presentation, regarding our
securities authorized for issuance under equity compensation plans, see "Item 5.
Market for Registrant's Common Stock and Related Stockholder Matters."
211
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 2003 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 14. Principal Accounting Fees and Services
--------------------------------------
The information required to be included in Item 14 of Part III of this
Form 10-K incorporates by reference certain information from our definitive
proxy statement for our 2003 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.
PART IV
Item 15. Exhibits and Reports on Form 8-K
--------------------------------
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation (Incorporated by reference from Exhibit 3.1 to the
Quarterly Report on Form 10-Q filed February 14, 2003).
3.2 Amended and Restated Bylaws (Incorporated by reference from Exhibit 3.2 to the Quarterly Report on Form
10-Q filed February 14, 2003).
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")).
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).
212
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
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 Registrant's Registration Statement on Form
S-2, No. 333-63859, filed September 21, 1998).
4.9 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.9 of Registrant's
Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998).
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. (Incorporated by
reference from Exhibit 4.11 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed
June 27, 2000).
4.12 Form of Investment Note. (Incorporated by reference from Exhibit 4.12 of Registrant's Registration
Statement on Form S-2, No. 333-40248, filed June 27, 2000).
4.13 Form of Indenture by and between ABFS and U.S. Bank Trust National Association. (Incorporated by
reference from Exhibit 4.13 of Registrant's Registration Statement on Form S-2, No. 333-63014, filed on
June 14, 2001).
4.14 Form of Investment Note. (Incorporated by reference from Exhibit 4.14 of Registrant's Registration
Statement on Form S-2, No. 333-63014, filed on June 14, 2001).
4.15 Form of Indenture by and between ABFS and U.S. Bank National Association. (Incorporated by reference
from Exhibit 4.15 of Registrant's Registration Statement on Form S-2, No. 333-90366, filed on June 12,
2002).
4.16 Form of Investment Note. (Incorporated by reference from Exhibit 4.16 of Registrant's Registration
Statement on Form S-2, No. 333-90366, filed on June 12, 2002).
4.17 Form of Indenture by and between ABFS and U.S. Bank National Association (Incorporated by reference
from Exhibit 4.17 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25,
2003).
4.18 Form of Investment Note (Incorporated by reference from Exhibit 4.18 of Registrant's Registration
Statement on Form S-2, No. 333-106476, filed on June 25, 2003).
213
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.1 Amended and Restated Stock Option Plan (Incorporated by reference from Exhibit 10.2 of ABFS' Quarterly
Report on Form 10-QSB from the quarter ended September 30, 1997, File No. 0-22474).**
10.2 Stock Option Award Agreement (Incorporated by reference from Exhibit 10.1 of the Registration Statement
on Form S-11 filed on February 26, 1993, Registration No. 33-59042 (the "Form S-11")).**
10.3 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 1996 Form SB-2")).**
10.4 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).**
10.5 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).**
10.6 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).
10.7 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")).
10.8 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).
10.9 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).
10.10 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).
10.11 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).**
214
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.12 Amendment One to Anthony J. Santilli's Employment Agreement (Incorporated by reference from Exhibit
10.3 of the September 30, 1997 Form 10-QSB).**
10.13 Amendment One to Beverly Santilli's Employment Agreement (Incorporated by reference from Exhibit 10.4
of the September 30, 1997 Form 10-QSB).**
10.14 Management Incentive Plan (Incorporated by reference from Exhibit 10.16 of the 1996 Form SB-2).**
10.15 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).**
10.16 Form of Pooling and Servicing Agreement related to the Company's loan securitizations dated May 1,
1996, August 31, 1996, February 28, 1997, September 1, 1997, February 1, 1998, June 1, 1998, and
September 1, 1998 (Incorporated by reference from Exhibit 4.1 of ABFS' Quarterly Report on Form 10-QSB
for the quarter ended March 31, 1995 (the "March 31, 1995 Form 10-QSB")).
10.17 Form of Sales and Contribution Agreement related to the Company's loan securitizations dated May 1,
1996 and September 27, 1996 (Incorporated by reference from Exhibit 4.1 of the March 31, 1995 Form
10-QSB).
10.18 Form of Indenture related to the Company's loan securitizations dated December 1, 1998, March 1, 1999,
June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000, September 1, 2000,
December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference from Exhibit 10.18
to the Registration Statement on Form S-2 filed June 14, 2001, Registration No. 333-63014 (the "2001
Form S-2")).
10.19 Form of Unaffiliated Seller's Agreement related to the Company's loan securitizations dated December 1,
1998, March 1, 1999, June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000,
September 1, 2000, December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference
from Exhibit 10.19 to the 2001 Form S-2).
10.20 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).
10.21 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).
215
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.22 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).
10.23 Agreement for Purchase and Sale of Stock between Stanley L. Furst, Joel E. Furst and ABFS dated October
27, 1997 (Incorporated by reference from ABFS' Current Report on Form 8-K dated October 27, 1997, File
No. 0-22747).
10.24 Standard Form of Office Lease and Rider to Lease dated April 2, 1993 by and between 5 Becker Farm
Associates and NJMIC (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).
10.25 First Amendment of Lease by and between 5 Becker Farm Associates and NJMIC 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).
10.26 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).
10.27 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).
10.28 Form of Standard Terms and Conditions of Lease Acquisition Agreement related to NJMIC'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).
10.29 Amended and Restated Specific Terms and Conditions of Servicing Agreement related to NJMIC'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).
216
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.30 Amended and Restated Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC'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).
10.31 Specific Terms and Conditions of Servicing Agreement related to NJMIC'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).
10.32 Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC'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).
10.33 Form of Indenture related to the lease-backed securitizations among ABFS Equipment Contract Trust
1998-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated June 1, 1998 and among ABFS
Equipment Contract Trust 1999-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated
June 1, 1999. (Incorporated by reference from Exhibit 10.39 of Registrant's Registration Statement on
Form S-2, No. 333-63859, filed September 21, 1998).
10.34 Form of Receivables Sale Agreement related to the lease-backed securitizations ABFS Equipment Contract
Trust 1998-A, dated June 1, 1998, and ABFS Equipment Contract Trust 1999-A, dated June 1, 1999.
(Incorporated by reference from Exhibit 10.34 of the 2001 Form S-2).
10.35 Form of Unaffiliated Seller's Agreement related to the Company's home equity loan securitizations dated
March 27, 1997, September 29, 1997, February 1, 1998, June 1, 1998, and September 1, 1998 (Incorporated
by reference from Exhibit 10.40 of Registrant's Registration Statement on Form S-2, No. 333-63859,
filed September 21, 1998).
10.36 $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).
10.37 Lease Agreement dated August 30, 1999 related to One Presidential Boulevard, Bala Cynwyd, Pennsylvania
(Incorporated by reference to Exhibit 10.1 of the Registrant's September 30, 1999 Form 10-Q).
217
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.38 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).**
10.39 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).**
10.40 American Business Financial Services, Inc. Amended and Restated 1999 Stock Option Plan (Incorporated by
reference from Exhibit 10.4 of the Registrant's Quarterly Report on Form 10-Q from the quarter ended
September 30, 2001 filed on November 14, 2001).**
10.41 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).
10.42 Amendment No. 4, dated as of November 12, 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 10.4 of the Registrant's December 31, 1999 Form 10-Q).
10.43 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).
10.44 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).
10.45 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).
218
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.46 Eight 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).
10.47 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).
10.48 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 Registrant's
Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000).
10.49 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 (Incorporated by reference from
Exhibit 10.64 of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 2000
(the "2000 Form 10-K")).
10.50 Indenture dated as of July 6, 2000 between ABFS Mortgage Loan Warehouse Trust 2000-2 and The Chase
Manhattan Bank. (Incorporated by reference from Exhibit 10.65 of the 2000 Form 10-K).
10.51 Employment Agreement by and between American Business Financial Services, Inc. and Milton Riseman
(Incorporated by reference from Exhibit 10.66 of the 2000 Form 10-K).**
10.52 Letter Employment Agreement by and between American Business Financial Services, Inc. and Ralph Hall
(Incorporated by reference from Exhibit 10.67 of the 2000 Form 10-K).**
219
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.53 Master Loan and Security Agreement, dated as of January 22, 2001, between American Business Credit,
Inc., HomeAmerican Credit, Inc., d/b/a Upland Mortgage, and American Business Mortgage Services, Inc.,
f/k/a New Jersey Mortgage and Investment Corp., as Borrowers, American Business Financial Services,
Inc., as Guarantor, and Morgan Stanley Dean Witter Mortgage Capital Inc., as Lender (Incorporated by
reference from Exhibit 10.1 of Registrant's December 31, 2000 Form 10-Q).
10.54 Senior Secured Credit Agreement, among: American Business Credit, Inc. ("ABC"), a Pennsylvania
corporation, HomeAmerican Credit, Inc. ("HAC"), a Pennsylvania corporation doing business under the
assumed or fictitious name Upland Mortgage, and New Jersey Mortgage and Investment Corp., a New Jersey
corporation whose name will be changed in January 2001 to American Business Mortgage, American Business
Financial Services, Inc. (the "Parent"), and The Chase Manhattan Bank (Incorporated by reference from
Exhibit 10.2 of Registrant's December 31, 2000 Form 10-Q).
10.55 Sale and Servicing Agreement, dated as of March 1, 2001, by and among ABFS OSO, Inc., a Delaware
corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican
Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage
Services, Inc., a New Jersey corporation, as the Originators, American Business Financial Services
Inc., a Delaware corporation, as the Guarantor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware
business trust, as the Trust, American Business Credit, Inc., a Pennsylvania corporation, as the
Servicer, EMC Mortgage Corporation, a Delaware corporation, as the Back-up Servicer, and The Chase
Manhattan Bank, a New York banking corporation, as the Indenture Trustee and the Collateral Agent.
(Incorporated by reference from Exhibit 10.72 of Registrant's Post-Effective Amendment No. One to the
Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001).
10.56 Indenture, dated as of March 1, 2001, by and among Triple-A One Funding Corporation, a Delaware
corporation, as the Initial Purchaser, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware statutory
business trust, and its successors and assigns, as the Trust or the Issuer, The Chase Manhattan Bank, a
New York banking corporation, and its successors, as the Indenture Trustee, and American Business
Financial Services, Inc., as the Guarantor. (Incorporated by reference from Exhibit 10.73 of
Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248,
filed April 5, 2001).
10.57 Insurance and Reimbursement Agreement, dated as of March 28, 2001, among MBIA Insurance Corporation, a
New York stock insurance company, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust,
as the Trust, ABFS OSO, Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc.,
a Pennsylvania corporation, as the Originator and the Servicer, HomeAmerican Credit, Inc., a
Pennsylvania corporation, d/b/a Upland Mortgage, as the Originator, American Business Mortgage
Services, Inc., a New Jersey corporation, as the Originator, American Business Financial Services,
Inc., a Delaware corporation, as the Guarantor, The Chase Manhattan Bank, as the Indenture Trustee, and
Triple-A One Funding Corporation, a Delaware corporation, as the Initial Purchaser. (Incorporated by
reference from Exhibit 10.74 of Registrant's Post-Effective Amendment No. One to the Registration
Statement on Form S-2, No. 333-40248, filed April 5, 2001).
220
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.58 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-1, dated as of March 1,
2001, by and among Morgan Stanley ABS Capital I Inc., a Delaware corporation, as the Depositor,
American Business Credit, Inc., a Pennsylvania corporation, as the Servicer, and The Chase Manhattan
Bank, a New York banking corporation, as the Trustee. (Incorporated by reference from Exhibit 10.75 of
Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248,
filed April 5, 2001).
10.59 Unaffiliated Seller's Agreement, dated as of March 1, 2001, by and among Morgan Stanley ABS Capital I,
Inc., a Delaware corporation, and its successors and assigns, as the Depositor, ABFS 2001-1, Inc., a
Delaware corporation, and its successors, as the Unaffiliated Seller, American Business Credit, Inc., a
Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation,
and American Business Mortgage Services Inc., a New Jersey corporation, as the Originators.
(Incorporated by reference from Exhibit 10.76 of Registrant's Post-Effective Amendment No. One to the
Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001).
10.60 Amended and Restated Sale and Servicing Agreement dated as of June 28, 2001 by and among ABFS
Greenmont, Inc., as Depositor, HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business
Mortgage Services, Inc. f/k/a 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. (Incorporated by reference from Exhibit
10.60 to the Form 10-K for the fiscal year ended June 30, 2001 filed on September 28, 2001).
10.61 Letter Agreement dated July 1, 2000 between ABFS and Albert W. Mandia. (Incorporated by reference to
Exhibit 10.61 of Amendment No. 1 to the 2001 Form S-2 filed on October 5, 2001).**
10.62 American Business Financial Services, Inc. 2001 Stock Incentive Plan. (Incorporated by reference from
Exhibit 10.1 to the Form 10-Q for the quarter ended September 30, 2001 filed on November 14, 2001 (the
"September 2001 Form 10-Q")).**
221
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.63 American Business Financial Services, Inc. 2001 Stock Incentive Plan Restricted Stock Agreement.
(Incorporated by reference from Exhibit 10.2 of the September 2001 Form 10-Q).**
10.64 American Business Financial Services, Inc. 2001 Executive Management Incentive Plan. (Incorporated by
reference from Exhibit 10.3 of the September 2001 Form 10-Q).**
10.65 December 2001 Amendment to Senior Secured Credit Agreement dated December 2001, among American Business
Financial Services, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania
corporation doing business under the assumed or fictitious name Upland Mortgage, and American Business
Mortgage Services, Inc. and JPMorgan Chase Bank. (Incorporated by reference from Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2001 filed on February
14, 2002 (the "December 2001 Form 10-Q")).
10.66 Master Repurchase Agreement between Credit Suisse First Boston Mortgage Capital LLC and ABFS Repo 2001,
Inc. (Incorporated by reference to Exhibit 10.2 from the December 2001 Form 10-Q).
10.67 Master Contribution Agreement, dated as of November 16, 2001 by and between American Business Financial
Services, Inc. and ABFS Repo 2001, Inc. (Incorporated by reference from Exhibit 10.3 to the December
2001 Form 10-Q).
10.68 Custodial Agreement dated as of November 16, 2001, by and among ABFS Repo 2001, Inc., a Delaware
corporation; American Business Credit, Inc., a Pennsylvania corporation; JPMorgan Chase Bank, a New
York banking corporation; and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by
reference from Exhibit 10.4 to the December 2001 Form 10-Q).
10.69 Guaranty, dated as of November 16, 2001, by and among American Business Financial Services, Inc.,
American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage, American Business
Mortgage Services, Inc. and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by reference
from Exhibit 10.5 to the December 2001 Form 10-Q).
10.70 Amendment No. 1 to the Indenture dated March 1, 2001 among Triple-A One Funding Corporation, ABFS
Mortgage Loan Warehouse Trust 2001-1 and JPMorgan Chase Bank. (Incorporated by reference from Exhibit
10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 filed on
May 15, 2002 (the "March 2002 Form 10-Q").
222
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.71 Amendment No. 2 to the Sale and Servicing Agreement dated as of March 1, 2001 by and among ABFS OSO
Inc., a Delaware corporation, as Depositor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware
business trust, as the Trust, American Business Financial Services, Inc., a Delaware corporation, as
Guarantor, American Business Credit, Inc., a Pennsylvania corporation, as Servicer, JPMorgan Chase Bank
f/k/a The Chase Manhattan Bank, a New York banking corporation, as Indenture Trustee and as Collateral
Agent and MBIA Insurance Corporation, a New York stock insurance company, as Note Insurer.
(Incorporated by reference from Exhibit 10.2 to the March 2002 Form 10-Q).
10.72 3/02 Amended and Restated Senior Secured Credit Agreement dated as of March 15, 2002 among: American
Business Credit, Inc. and certain affiliates and JPMorgan Chase Bank, as Agent and as a Lender.
(Incorporated by reference from Exhibit 10.3 to the March 2002 Form 10-Q).
10.73 $1.2 million Committed Line of Credit Note between American Business Financial Services, Inc. and
Firstrust Savings Bank dated January 18, 2002. (Incorporated by reference from Exhibit 10.4 to the
March 2002 Form 10-Q).
10.74 American Business Financial Services, Inc. Dividend Reinvestment and Stock Purchase Plan. (Incorporated
by reference from Exhibit 10.1 of the Registrant's Registration Statement on Form S-3, No. 333-87574,
filed on May 3, 2002).
10.75 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-2, dated as of June 1, 2001,
by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, and The Chase Manhattan Bank, a New York banking corporation.
(Incorporated by reference from Exhibit 10.75 of Registrant's Registration Statement on Form S-2, No.
33-90366, filed on June 12, 2002 (the "2002 Form S-2).
10.76 Unaffiliated Seller's Agreement, dated June 1, 2001 by and among Bear Stearns Asset Backed Securities,
Inc., a Delaware corporation, ABFS 2001-2, Inc., a Delaware corporation, American Business Credit,
Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania
corporation, and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by
reference from Exhibit 10.76 of the 2002 Form S-2).
10.77 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2002-1, dated as of March 1,
2002, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation and JPMorgan Chase Bank, a New York banking
corporation. (Incorporated by reference from Exhibit 10.77 of the 2002 Form S-2).
223
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.78 Unaffiliated Seller's Agreement, dated as of March 1, 2002 by and among Bear Stearns Asset Backed
Securities, Inc., a Delaware corporation, ABFS 2002-1, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation and American Business Mortgage Services, Inc., a New Jersey corporation.
(Incorporated by reference from Exhibit 10.78 of the 2002 Form S-2).
10.79 Pooling and Services Agreement relating to ABFS Mortgage Loan Trust 2002-2, dated as of June 1, 2002,
by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, and JP Morgan Chase Bank, a New York corporation.
(Incorporated by reference from Exhibit 10.79 to Registrant's Annual Report on Form 10-K for the year
ended June 30, 2002 filed on September 20, 2002 (the "2002 Form 10-K")).
10.80 Unaffiliated Seller's Agreement, dated as of June 1, 2002, by and among Credit Suisse First Boston
Mortgage Securities Corp., a Delaware corporation, ABFS 2002-2, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, and HomeAmerican Credit Inc., d/b/a Upland Mortgage,
a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation.
(Incorporated by reference from Exhibit 10.80 to 2002 Form 10-K).
10.81 Indemnification Agreement dated June 21, 2002, by ABFS 2002-2, Inc., American Business Credit, Inc.,
HomeAmerican Credit, Inc. and American Business Mortgage Services, Inc. in favor of Credit Suisse First
Boston Mortgage Securities Corp. and Credit Suisse First Boston Corp. (Incorporated by reference from
Exhibit 10.81 to 2002 Form 10-K).
10.82 First Amended and Restated Warehousing Credit and Security Agreement between American Business Credit,
Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation,
HomeAmerican Credit, Inc., a Pennsylvania corporation, and Residential Funding Corporation, a Delaware
corporation dated as of July 1, 2002. (Incorporated by reference from Exhibit 10.82 to 2002 Form 10-K).
10.83 Promissory Note between American Business Credit, Inc., a Pennsylvania corporation, American Business
Mortgage Services, Inc., a New Jersey corporation, HomeAmerican Credit, Inc., a Pennsylvania
corporation, and Residential Funding Corporation, a Delaware corporation dated July 1, 2002.
(Incorporated by reference from Exhibit 10.83 to 2002 Form 10-K).
10.84 Guaranty dated July 1, 2002 given by American Business Financial Services, Inc., a Delaware
corporation, to Residential Funding Corporation, a Delaware corporation. (Incorporated by reference
from Exhibit 10.84 to 2002 Form 10-K).
224
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.85 Office Lease Agreement, dated November 27, 2002 and Addendum to Office Lease, dated November 27, 2002
between the Registrant and Wanamaker, LLC. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002).
10.86 Letter Agreement dated May 20, 2002 between the Registrant and the Commonwealth of Pennsylvania.
(Incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, dated
December 9, 2002 and filed December 27, 2002).
10.87 Letter of Intent with PIDC Local Development Corporation dated December 3, 2002. (Incorporated by
reference to Exhibit 10.3 to the Registrant's Report on Form 8-K, dated December 9, 2002 and filed
December 27, 2002).
10.88 Letter of Credit from JPMorgan Chase Bank for $6,000,000 provided as security for a lease for office
space. (Incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for
the period ended December 31, 2002).
10.89 12/02 Amendment to Senior Secured Credit Agreement for $50.0 million warehouse line, operating line and
letter of credit with JPMorgan Chase. (Incorporated by reference to Exhibit 10.5 to the Registrant's
Quarterly Report on Form 10-Q for the period ended December 31, 2002).
10.90 Lease between CWLT Roseland Exchange L.L.C., and American Business Financial Services, Inc. for 105
Eisenhower Parkway, Roseland, N.J. (the "Roseland Lease") (Incorporated by reference to Exhibit 10.2 to
the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2003 (the "March 31, 2003
Form 10-Q")).
10.91 Amendment No. 3 to Letter of Credit Agreement with JP Morgan Chase (Incorporated by reference to
Exhibit 10.1 to the March 31, 2003 Form 10-Q).
10.92 First Amendment to the Roseland Lease (Incorporated by reference to Exhibit 10.3 of the March 31, 2003
Form 10-Q).
10.93 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-3, dated as of September 1,
2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation,
American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking
corporation (Incorporated by reference from Exhibit 10.93 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
225
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.94 Unaffiliated Seller's Agreement, dated as of September 1, 2002, by and among Credit Suisse First Boston
Mortgage Securities Corp., a Delaware corporation, ABFS 2002-3, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation
(Incorporated by reference from Exhibit 10.94 of Registrant's Registration Statement on Form S-2, No.
333-106476, filed on June 25, 2003).
10.95 Indemnification Agreement, dated September 23, 2002, by ABFS 2002-3, Inc., American Business Credit,
Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in
favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston
Corporation (Incorporated by reference from Exhibit 10.95 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
10.96 Unaffiliated Seller's Agreement, dated as of December 1, 2002, by and among Credit Suisse First Boston
Mortgage Securities Corp., a Delaware corporation, ABFS 2002-4, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation
(Incorporated by reference from Exhibit 10.96 of Registrant's Registration Statement on Form S-2, No.
333-106476, filed on June 25, 2003).
10.97 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-4, dated as of December 1,
2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation,
American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking
corporation (Incorporated by reference from Exhibit 10.97 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
10.98 Indemnification Agreement, dated December 18, 2002, by ABFS 2002-4, Inc., American Business Credit,
Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in
favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston
Corporation (Incorporated by reference from Exhibit 10.98 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
10.99 Unaffiliated Seller's Agreement, dated as of March 1, 2003, by and among Bear Stearns Asset Backed
Securities, Inc., a Delaware corporation, ABFS 2003-1, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation.
226
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.100 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2003-1, dated as of March 1, 2003,
by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation.
10.101 Insurance and Indemnity Agreement, dated March 31, 2003, by Radian Asset Assurance Inc., a New York
stock insurance company, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican
Credit, Inc. d/b/a Upland Mortgage, American Business Mortgage Services, Inc., ABFS 2003-1, Inc., Bear
Stearns Asset Backed Securities, Inc. and JPMorgan Chase Bank.
10.102 Amended and Restated Committed Line of Credit Note, dated June 2, 2003, between American Business
Financial Services, Inc. and Firstrust Savings Bank.
10.103 Amendment Number One to the Master Repurchase Agreement, dated November 13, 2002, between Credit Suisse
First Boston Mortgage Capital LLC and ABFS REPO 2001, Inc.
10.104 3/31/03 Amendment to Senior Secured Credit Agreement, dated March 31, 2003, among American Business
Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation,
American Business Mortgage Services, Inc., a New Jersey corporation, ABFS Residual 2002, Inc., American
Business Financial Services, Inc., a Delaware corporation, and JPMorgan Chase Bank and certain other
lenders.
10.105 12/02 Amendment to 3/02 Security Agreement - Residual Interest Certificates, dated December 18, 2002,
made by ABFS Residual 2002, Inc., a Delaware corporation in favor of JPMorgan Chase Bank.
10.106 Letter, dated August 21, 2003 from JPMorgan Chase Bank to American Business Credit, Inc.,
HomeAmerican Credit, Inc., American Business Mortgage Services, Tiger Relocation Company, ABFS
Residual 2002, Inc. and American Business Financial Services, Inc. regarding waiver of
financial covenant in 3/02 Senior Secured Credit Agreement dated as of March 15, 2002.
(Incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K, File
No. 0-22474, filed on September 25, 2003 (the "9/25/03 8-K")).
10.107 Mortgage Loan Purchase and Interim Servicing Agreement, dated July 22, 2003, among DLJ Mortgage
Capital, Inc., American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage and
American Business Mortgage Services, Inc.
10.108 Mortgage Loan Purchase and Interim Servicing Agreement, dated as of June 30, 2003, among EMC Mortgage
Corporation, American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage, and
American Business Mortgage Services, Inc.
10.109 Waiver and Amendment Number Two to the Master Repurchase Agreement between Credit Suisse First Boston
Mortgage Capital LLC and ABFS Repo 2001, Inc. dated August 20, 2003 and Letter dated as of August 20,
2003 from Credit Suisse First Boston Mortgage Capital LLC to ABFS Repo 2001, Inc. (Incorporated by
reference to Exhibit 10.2 of the Registrant's 9/25/03 8-K).
10.110 Sale and Servicing Agreement, dated September 22, 2003, among ABFS Balapointe, Inc.,
HomeAmerican Credit, Inc., ABFS Mortgage Loan Warehouse Trust 2003-1, American Business Credit,
Inc., American Business Financial Services, Inc. and JPMorgan Chase Bank. (Incorporated by
reference to Exhibit 10.3 of the 9/25/03 8-K).
10.111 Indenture, dated September 22, 2003 between ABFS Mortgage Loan Warehouse Trust 2003-1 and
JPMorgan Chase Bank, as Indenture Trustee, with Appendix I, Defined Terms. (Incorporated by
reference to Exhibit 10.4 of the Registrant's 9/25/03 8-K).
10.112 Trust Agreement, dated as of September 22, 2003, by and between ABFS Bala Pointe, Inc., as
Depositor and Wilmington Trust Company, as Owner Trustee. (Incorporated by reference to Exhibit
10.5 of the Registrant's 9/25/03 8-K).
10.113 ABFS Mortgage Loan Warehouse Trust 2003-1 Secured Notes Series 2003-1 Purchase Agreement.
(Incorporated by reference to Exhibit 10.6 of the Registrant's 9/25/03 8-K).
10.114 Commitment letter dated September 22, 2003 addressed to American Business Financial Services
Inc. from Chrysalis Warehouse Funding, LLC. (Incorporated by reference to Exhibit 10.7 of the
Registrant's 9/25/03 8-K).
10.115 Fee letter dated September 22, 2003 addressed to American Business Financial Services, Inc. and
Chrysalis Warehouse Funding, LLC from Clearwing Capital, LLC. (Incorporated by reference to
Exhibit 10.8 of the Registrant's 9/25/03 8-K).
10.116 Amendment to Senior Secured Credit Agreement dated as of September 22,2003 among American Business
Credit, Inc. and certain affiliates and JPMorgan Chase Bank and other parties thereto. (Incorporated
by reference to Exhibit 10.9 of the Registrant's 9/25/03 8-K)
227
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
11.1 Statement of Computation of Per Share Earnings (Included in Note 19 of the Notes to June 30, 2003
Consolidated Financial Statements).
12.1 Computation of Ratio of Earnings to Fixed Charges.
16.1 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.1 of the
Registrant's Current Report on Form 8-K dated May 17, 2001.)
16.2 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.2 of the
Registrant's Current Report on Form 8-K dated August 2, 2001.)
21.1 Subsidiaries of the Registrant.
23.1 Consent of BDO Seidman, LLP.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
32.1 Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
- ----------------------
** Indicates management contract or compensatory plan or arrangement.
Reports on Form 8-K:
May 8, 2003 - (Items 7, 9 and 12) related to the press release dated May 1,
2003 regarding results of operations for the quarter ended March
31, 2003.
June 13, 2003 - (Item 5) related to receipt of a civil subpoena from the U.S.
Department of Justice.
228
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AMERICAN BUSINESS FINANCIAL SERVICES, INC.
Date: September 29, 2003 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.
Signature Capacity Date
- ---------------------------------- ------------------------------------- ----------------
/s/ Anthony J. Santilli Chairman, President, Chief Executive September 29, 2003
- ---------------------------------- Officer, Chief Operating Officer and
Anthony J. Santilli Director (Principal Executive and
Operating Officer)
/s/ Albert W. Mandia Executive Vice President and Chief September 29, 2003
- ---------------------------------- Financial Officer (Principal Financial
Albert W. Mandia and Accounting Officer)
/s/ Leonard Becker Director September 29, 2003
- ----------------------------------
Leonard Becker
/s/ Michael DeLuca Director September 29, 2003
- ----------------------------------
Michael DeLuca
/s/ Richard Kaufman Director September 29, 2003
- ----------------------------------
Richard Kaufman
/s/ Jerome Miller Director September 29, 2003
- ----------------------------------
Jerome Miller
/s/ Warren Palitz Director September 29, 2003
- ----------------------------------
Warren Palitz
Director September 29, 2003
- ----------------------------------
Jeffrey Steinberg
/s/ Harold Sussman Director September 29, 2003
- ----------------------------------
Harold Sussman
229
EXHIBIT INDEX
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation (Incorporated by reference from Exhibit 3.1 to the
Quarterly Report on Form 10-Q filed February 14, 2003).
3.2 Amended and Restated Bylaws (Incorporated by reference from Exhibit 3.2 to the Quarterly Report on Form
10-Q filed February 14, 2003).
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")).
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).
230
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
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 Registrant's Registration Statement on Form
S-2, No. 333-63859, filed September 21, 1998).
4.9 Form of Unsecured Investment Note (Incorporated by reference from Exhibit 4.9 of Registrant's
Registration Statement on Form S-2, No. 333-63859, filed September 21, 1998).
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. (Incorporated by
reference from Exhibit 4.11 of Registrant's Registration Statement on Form S-2, No. 333-40248, filed
June 27, 2000).
4.12 Form of Investment Note. (Incorporated by reference from Exhibit 4.12 of Registrant's Registration
Statement on Form S-2, No. 333-40248, filed June 27, 2000).
4.13 Form of Indenture by and between ABFS and U.S. Bank Trust National Association. (Incorporated by
reference from Exhibit 4.13 of Registrant's Registration Statement on Form S-2, No. 333-63014, filed on
June 14, 2001).
4.14 Form of Investment Note. (Incorporated by reference from Exhibit 4.14 of Registrant's Registration
Statement on Form S-2, No. 333-63014, filed on June 14, 2001).
4.15 Form of Indenture by and between ABFS and U.S. Bank National Association. (Incorporated by reference
from Exhibit 4.15 of Registrant's Registration Statement on Form S-2, No. 333-90366, filed on June 12,
2002).
4.16 Form of Investment Note. (Incorporated by reference from Exhibit 4.16 of Registrant's Registration
Statement on Form S-2, No. 333-90366, filed on June 12, 2002).
4.17 Form of Indenture by and between ABFS and U.S. Bank National Association (Incorporated by reference
from Exhibit 4.17 of Registrant's Registration Statement on Form S-2, No. 333-106476, filed on June 25,
2003).
4.18 Form of Investment Note (Incorporated by reference from Exhibit 4.18 of Registrant's Registration
Statement on Form S-2, No. 333-106476, filed on June 25, 2003).
231
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.1 Amended and Restated Stock Option Plan (Incorporated by reference from Exhibit 10.2 of ABFS' Quarterly
Report on Form 10-QSB from the quarter ended September 30, 1997, File No. 0-22474).**
10.2 Stock Option Award Agreement (Incorporated by reference from Exhibit 10.1 of the Registration Statement
on Form S-11 filed on February 26, 1993, Registration No. 33-59042 (the "Form S-11")).**
10.3 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 1996 Form SB-2")).**
10.4 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).**
10.5 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).**
10.6 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).
10.7 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")).
10.8 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).
10.9 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).
10.10 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).
10.11 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).**
232
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.12 Amendment One to Anthony J. Santilli's Employment Agreement (Incorporated by reference from Exhibit
10.3 of the September 30, 1997 Form 10-QSB).**
10.13 Amendment One to Beverly Santilli's Employment Agreement (Incorporated by reference from Exhibit 10.4
of the September 30, 1997 Form 10-QSB).**
10.14 Management Incentive Plan (Incorporated by reference from Exhibit 10.16 of the 1996 Form SB-2).**
10.15 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).**
10.16 Form of Pooling and Servicing Agreement related to the Company's loan securitizations dated May 1,
1996, August 31, 1996, February 28, 1997, September 1, 1997, February 1, 1998, June 1, 1998, and
September 1, 1998 (Incorporated by reference from Exhibit 4.1 of ABFS' Quarterly Report on Form 10-QSB
for the quarter ended March 31, 1995 (the "March 31, 1995 Form 10-QSB")).
10.17 Form of Sales and Contribution Agreement related to the Company's loan securitizations dated May 1,
1996 and September 27, 1996 (Incorporated by reference from Exhibit 4.1 of the March 31, 1995 Form
10-QSB).
10.18 Form of Indenture related to the Company's loan securitizations dated December 1, 1998, March 1, 1999,
June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000, September 1, 2000,
December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference from Exhibit 10.18
to the Registration Statement on Form S-2 filed June 14, 2001, Registration No. 333-63014 (the "2001
Form S-2")).
10.19 Form of Unaffiliated Seller's Agreement related to the Company's loan securitizations dated December 1,
1998, March 1, 1999, June 1, 1999, September 1, 1999, December 1, 1999, March 1, 2000, June 1, 2000,
September 1, 2000, December 1, 2000, September 1, 2001 and December 1, 2001. (Incorporated by reference
from Exhibit 10.19 to the 2001 Form S-2).
10.20 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).
10.21 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).
233
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.22 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).
10.23 Agreement for Purchase and Sale of Stock between Stanley L. Furst, Joel E. Furst and ABFS dated October
27, 1997 (Incorporated by reference from ABFS' Current Report on Form 8-K dated October 27, 1997, File
No. 0-22747).
10.24 Standard Form of Office Lease and Rider to Lease dated April 2, 1993 by and between 5 Becker Farm
Associates and NJMIC (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).
10.25 First Amendment of Lease by and between 5 Becker Farm Associates and NJMIC 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).
10.26 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).
10.27 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).
10.28 Form of Standard Terms and Conditions of Lease Acquisition Agreement related to NJMIC'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).
10.29 Amended and Restated Specific Terms and Conditions of Servicing Agreement related to NJMIC'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).
234
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.30 Amended and Restated Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC'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).
10.31 Specific Terms and Conditions of Servicing Agreement related to NJMIC'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).
10.32 Specific Terms and Conditions of Lease Acquisition Agreement related to NJMIC'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).
10.33 Form of Indenture related to the lease-backed securitizations among ABFS Equipment Contract Trust
1998-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated June 1, 1998 and among ABFS
Equipment Contract Trust 1999-A, American Business Leasing, Inc. and The Chase Manhattan Bank dated
June 1, 1999. (Incorporated by reference from Exhibit 10.39 of Registrant's Registration Statement on
Form S-2, No. 333-63859, filed September 21, 1998).
10.34 Form of Receivables Sale Agreement related to the lease-backed securitizations ABFS Equipment Contract
Trust 1998-A, dated June 1, 1998, and ABFS Equipment Contract Trust 1999-A, dated June 1, 1999.
(Incorporated by reference from Exhibit 10.34 of the 2001 Form S-2).
10.35 Form of Unaffiliated Seller's Agreement related to the Company's home equity loan securitizations dated
March 27, 1997, September 29, 1997, February 1, 1998, June 1, 1998, and September 1, 1998 (Incorporated
by reference from Exhibit 10.40 of Registrant's Registration Statement on Form S-2, No. 333-63859,
filed September 21, 1998).
10.36 $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).
10.37 Lease Agreement dated August 30, 1999 related to One Presidential Boulevard, Bala Cynwyd, Pennsylvania
(Incorporated by reference to Exhibit 10.1 of the Registrant's September 30, 1999 Form 10-Q).
235
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.38 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).**
10.39 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).**
10.40 American Business Financial Services, Inc. Amended and Restated 1999 Stock Option Plan (Incorporated by
reference from Exhibit 10.4 of the Registrant's Quarterly Report on Form 10-Q from the quarter ended
September 30, 2001 filed on November 14, 2001).**
10.41 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).
10.42 Amendment No. 4, dated as of November 12, 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 10.4 of the Registrant's December 31, 1999 Form 10-Q).
10.43 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).
10.44 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).
10.45 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).
236
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.46 Eight 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).
10.47 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).
10.48 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 Registrant's
Registration Statement on Form S-2, No. 333-40248, filed June 27, 2000).
10.49 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 (Incorporated by reference from
Exhibit 10.64 of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 2000
(the "2000 Form 10-K")).
10.50 Indenture dated as of July 6, 2000 between ABFS Mortgage Loan Warehouse Trust 2000-2 and The Chase
Manhattan Bank. (Incorporated by reference from Exhibit 10.65 of the 2000 Form 10-K).
10.51 Employment Agreement by and between American Business Financial Services, Inc. and Milton Riseman
(Incorporated by reference from Exhibit 10.66 of the 2000 Form 10-K).**
10.52 Letter Employment Agreement by and between American Business Financial Services, Inc. and Ralph Hall
(Incorporated by reference from Exhibit 10.67 of the 2000 Form 10-K).**
237
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.53 Master Loan and Security Agreement, dated as of January 22, 2001, between American Business Credit,
Inc., HomeAmerican Credit, Inc., d/b/a Upland Mortgage, and American Business Mortgage Services, Inc.,
f/k/a New Jersey Mortgage and Investment Corp., as Borrowers, American Business Financial Services,
Inc., as Guarantor, and Morgan Stanley Dean Witter Mortgage Capital Inc., as Lender (Incorporated by
reference from Exhibit 10.1 of Registrant's December 31, 2000 Form 10-Q).
10.54 Senior Secured Credit Agreement, among: American Business Credit, Inc. ("ABC"), a Pennsylvania
corporation, HomeAmerican Credit, Inc. ("HAC"), a Pennsylvania corporation doing business under the
assumed or fictitious name Upland Mortgage, and New Jersey Mortgage and Investment Corp., a New Jersey
corporation whose name will be changed in January 2001 to American Business Mortgage, American Business
Financial Services, Inc. (the "Parent"), and The Chase Manhattan Bank (Incorporated by reference from
Exhibit 10.2 of Registrant's December 31, 2000 Form 10-Q).
10.55 Sale and Servicing Agreement, dated as of March 1, 2001, by and among ABFS OSO, Inc., a Delaware
corporation, as the Depositor, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican
Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation, and American Business Mortgage
Services, Inc., a New Jersey corporation, as the Originators, American Business Financial Services
Inc., a Delaware corporation, as the Guarantor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware
business trust, as the Trust, American Business Credit, Inc., a Pennsylvania corporation, as the
Servicer, EMC Mortgage Corporation, a Delaware corporation, as the Back-up Servicer, and The Chase
Manhattan Bank, a New York banking corporation, as the Indenture Trustee and the Collateral Agent.
(Incorporated by reference from Exhibit 10.72 of Registrant's Post-Effective Amendment No. One to the
Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001).
10.56 Indenture, dated as of March 1, 2001, by and among Triple-A One Funding Corporation, a Delaware
corporation, as the Initial Purchaser, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware statutory
business trust, and its successors and assigns, as the Trust or the Issuer, The Chase Manhattan Bank, a
New York banking corporation, and its successors, as the Indenture Trustee, and American Business
Financial Services, Inc., as the Guarantor. (Incorporated by reference from Exhibit 10.73 of
Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248,
filed April 5, 2001).
10.57 Insurance and Reimbursement Agreement, dated as of March 28, 2001, among MBIA Insurance Corporation, a
New York stock insurance company, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware business trust,
as the Trust, ABFS OSO, Inc., a Delaware corporation, as the Depositor, American Business Credit, Inc.,
a Pennsylvania corporation, as the Originator and the Servicer, HomeAmerican Credit, Inc., a
Pennsylvania corporation, d/b/a Upland Mortgage, as the Originator, American Business Mortgage
Services, Inc., a New Jersey corporation, as the Originator, American Business Financial Services,
Inc., a Delaware corporation, as the Guarantor, The Chase Manhattan Bank, as the Indenture Trustee, and
Triple-A One Funding Corporation, a Delaware corporation, as the Initial Purchaser. (Incorporated by
reference from Exhibit 10.74 of Registrant's Post-Effective Amendment No. One to the Registration
Statement on Form S-2, No. 333-40248, filed April 5, 2001).
238
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.58 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-1, dated as of March 1,
2001, by and among Morgan Stanley ABS Capital I Inc., a Delaware corporation, as the Depositor,
American Business Credit, Inc., a Pennsylvania corporation, as the Servicer, and The Chase Manhattan
Bank, a New York banking corporation, as the Trustee. (Incorporated by reference from Exhibit 10.75 of
Registrant's Post-Effective Amendment No. One to the Registration Statement on Form S-2, No. 333-40248,
filed April 5, 2001).
10.59 Unaffiliated Seller's Agreement, dated as of March 1, 2001, by and among Morgan Stanley ABS Capital I,
Inc., a Delaware corporation, and its successors and assigns, as the Depositor, ABFS 2001-1, Inc., a
Delaware corporation, and its successors, as the Unaffiliated Seller, American Business Credit, Inc., a
Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania corporation,
and American Business Mortgage Services Inc., a New Jersey corporation, as the Originators.
(Incorporated by reference from Exhibit 10.76 of Registrant's Post-Effective Amendment No. One to the
Registration Statement on Form S-2, No. 333-40248, filed April 5, 2001).
10.60 Amended and Restated Sale and Servicing Agreement dated as of June 28, 2001 by and among ABFS
Greenmont, Inc., as Depositor, HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business
Mortgage Services, Inc. f/k/a 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. (Incorporated by reference from Exhibit
10.60 to the Form 10-K for the fiscal year ended June 30, 2001 filed on September 28, 2001).
10.61 Letter Agreement dated July 1, 2000 between ABFS and Albert W. Mandia. (Incorporated by reference to
Exhibit 10.61 of Amendment No. 1 to the 2001 Form S-2 filed on October 5, 2001).**
10.62 American Business Financial Services, Inc. 2001 Stock Incentive Plan. (Incorporated by reference from
Exhibit 10.1 to the Form 10-Q for the quarter ended September 30, 2001 filed on November 14, 2001 (the
"September 2001 Form 10-Q")).**
239
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.63 American Business Financial Services, Inc. 2001 Stock Incentive Plan Restricted Stock Agreement.
(Incorporated by reference from Exhibit 10.2 of the September 2001 Form 10-Q).**
10.64 American Business Financial Services, Inc. 2001 Executive Management Incentive Plan. (Incorporated by
reference from Exhibit 10.3 of the September 2001 Form 10-Q).**
10.65 December 2001 Amendment to Senior Secured Credit Agreement dated December 2001, among American Business
Financial Services, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania
corporation doing business under the assumed or fictitious name Upland Mortgage, and American Business
Mortgage Services, Inc. and JPMorgan Chase Bank. (Incorporated by reference from Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2001 filed on February
14, 2002 (the "December 2001 Form 10-Q")).
10.66 Master Repurchase Agreement between Credit Suisse First Boston Mortgage Capital LLC and ABFS Repo 2001,
Inc. (Incorporated by reference to Exhibit 10.2 from the December 2001 Form 10-Q).
10.67 Master Contribution Agreement, dated as of November 16, 2001 by and between American Business Financial
Services, Inc. and ABFS Repo 2001, Inc. (Incorporated by reference from Exhibit 10.3 to the December
2001 Form 10-Q).
10.68 Custodial Agreement dated as of November 16, 2001, by and among ABFS Repo 2001, Inc., a Delaware
corporation; American Business Credit, Inc., a Pennsylvania corporation; JPMorgan Chase Bank, a New
York banking corporation; and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by
reference from Exhibit 10.4 to the December 2001 Form 10-Q).
10.69 Guaranty, dated as of November 16, 2001, by and among American Business Financial Services, Inc.,
American Business Credit, Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage, American Business
Mortgage Services, Inc. and Credit Suisse First Boston Mortgage Capital LLC. (Incorporated by reference
from Exhibit 10.5 to the December 2001 Form 10-Q).
10.70 Amendment No. 1 to the Indenture dated March 1, 2001 among Triple-A One Funding Corporation, ABFS
Mortgage Loan Warehouse Trust 2001-1 and JPMorgan Chase Bank. (Incorporated by reference from Exhibit
10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 filed on
May 15, 2002 (the "March 2002 Form 10-Q").
240
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.71 Amendment No. 2 to the Sale and Servicing Agreement dated as of March 1, 2001 by and among ABFS OSO
Inc., a Delaware corporation, as Depositor, ABFS Mortgage Loan Warehouse Trust 2001-1, a Delaware
business trust, as the Trust, American Business Financial Services, Inc., a Delaware corporation, as
Guarantor, American Business Credit, Inc., a Pennsylvania corporation, as Servicer, JPMorgan Chase Bank
f/k/a The Chase Manhattan Bank, a New York banking corporation, as Indenture Trustee and as Collateral
Agent and MBIA Insurance Corporation, a New York stock insurance company, as Note Insurer.
(Incorporated by reference from Exhibit 10.2 to the March 2002 Form 10-Q).
10.72 3/02 Amended and Restated Senior Secured Credit Agreement dated as of March 15, 2002 among: American
Business Credit, Inc. and certain affiliates and JPMorgan Chase Bank, as Agent and as a Lender.
(Incorporated by reference from Exhibit 10.3 to the March 2002 Form 10-Q).
10.73 $1.2 million Committed Line of Credit Note between American Business Financial Services, Inc. and
Firstrust Savings Bank dated January 18, 2002. (Incorporated by reference from Exhibit 10.4 to the
March 2002 Form 10-Q).
10.74 American Business Financial Services, Inc. Dividend Reinvestment and Stock Purchase Plan. (Incorporated
by reference from Exhibit 10.1 of the Registrant's Registration Statement on Form S-3, No. 333-87574,
filed on May 3, 2002).
10.75 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2001-2, dated as of June 1, 2001,
by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, and The Chase Manhattan Bank, a New York banking corporation.
(Incorporated by reference from Exhibit 10.75 of Registrant's Registration Statement on Form S-2, No.
33-90366, filed on June 12, 2002 (the "2002 Form S-2).
10.76 Unaffiliated Seller's Agreement, dated June 1, 2001 by and among Bear Stearns Asset Backed Securities,
Inc., a Delaware corporation, ABFS 2001-2, Inc., a Delaware corporation, American Business Credit,
Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., d/b/a Upland Mortgage, a Pennsylvania
corporation, and American Business Mortgage Services, Inc., a New Jersey corporation. (Incorporated by
reference from Exhibit 10.76 of the 2002 Form S-2).
10.77 Pooling and Servicing Agreement, relating to ABFS Mortgage Loan Trust 2002-1, dated as of March 1,
2002, by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation and JPMorgan Chase Bank, a New York banking
corporation. (Incorporated by reference from Exhibit 10.77 of the 2002 Form S-2).
241
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.78 Unaffiliated Seller's Agreement, dated as of March 1, 2002 by and among Bear Stearns Asset Backed
Securities, Inc., a Delaware corporation, ABFS 2002-1, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation and American Business Mortgage Services, Inc., a New Jersey corporation.
(Incorporated by reference from Exhibit 10.78 of the 2002 Form S-2).
10.79 Pooling and Services Agreement relating to ABFS Mortgage Loan Trust 2002-2, dated as of June 1, 2002,
by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, and JP Morgan Chase Bank, a New York corporation.
(Incorporated by reference from Exhibit 10.79 to Registrant's Annual Report on Form 10-K for the year
ended June 30, 2002 filed on September 20, 2002 (the "2002 Form 10-K")).
10.80 Unaffiliated Seller's Agreement, dated as of June 1, 2002, by and among Credit Suisse First Boston
Mortgage Securities Corp., a Delaware corporation, ABFS 2002-2, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, and HomeAmerican Credit Inc., d/b/a Upland Mortgage,
a Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation.
(Incorporated by reference from Exhibit 10.80 to 2002 Form 10-K).
10.81 Indemnification Agreement dated June 21, 2002, by ABFS 2002-2, Inc., American Business Credit, Inc.,
HomeAmerican Credit, Inc. and American Business Mortgage Services, Inc. in favor of Credit Suisse First
Boston Mortgage Securities Corp. and Credit Suisse First Boston Corp. (Incorporated by reference from
Exhibit 10.81 to 2002 Form 10-K).
10.82 First Amended and Restated Warehousing Credit and Security Agreement between American Business Credit,
Inc., a Pennsylvania corporation, American Business Mortgage Services, Inc., a New Jersey corporation,
HomeAmerican Credit, Inc., a Pennsylvania corporation, and Residential Funding Corporation, a Delaware
corporation dated as of July 1, 2002. (Incorporated by reference from Exhibit 10.82 to 2002 Form 10-K).
10.83 Promissory Note between American Business Credit, Inc., a Pennsylvania corporation, American Business
Mortgage Services, Inc., a New Jersey corporation, HomeAmerican Credit, Inc., a Pennsylvania
corporation, and Residential Funding Corporation, a Delaware corporation dated July 1, 2002.
(Incorporated by reference from Exhibit 10.83 to 2002 Form 10-K).
10.84 Guaranty dated July 1, 2002 given by American Business Financial Services, Inc., a Delaware
corporation, to Residential Funding Corporation, a Delaware corporation. (Incorporated by reference
from Exhibit 10.84 to 2002 Form 10-K).
242
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.85 Office Lease Agreement, dated November 27, 2002 and Addendum to Office Lease, dated November 27, 2002
between the Registrant and Wanamaker, LLC. (Incorporated by reference to Exhibit 10.1 to the
Registrant's Report on Form 8-K, dated December 9, 2002 and filed December 27, 2002).
10.86 Letter Agreement dated May 20, 2002 between the Registrant and the Commonwealth of Pennsylvania.
(Incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, dated
December 9, 2002 and filed December 27, 2002).
10.87 Letter of Intent with PIDC Local Development Corporation dated December 3, 2002. (Incorporated by
reference to Exhibit 10.3 to the Registrant's Report on Form 8-K, dated December 9, 2002 and filed
December 27, 2002).
10.88 Letter of Credit from JPMorgan Chase Bank for $6,000,000 provided as security for a lease for office
space. (Incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for
the period ended December 31, 2002).
10.89 12/02 Amendment to Senior Secured Credit Agreement for $50.0 million warehouse line, operating line and
letter of credit with JPMorgan Chase. (Incorporated by reference to Exhibit 10.5 to the Registrant's
Quarterly Report on Form 10-Q for the period ended December 31, 2002).
10.90 Lease between CWLT Roseland Exchange L.L.C., and American Business Financial Services, Inc. for 105
Eisenhower Parkway, Roseland, N.J. (the "Roseland Lease") (Incorporated by reference to Exhibit 10.2 to
the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2003 (the "March 31, 2003
Form 10-Q")).
10.91 Amendment No. 3 to Letter of Credit Agreement with JP Morgan Chase (Incorporated by reference to
Exhibit 10.1 to the March 31, 2003 Form 10-Q).
10.92 First Amendment to the Roseland Lease (Incorporated by reference to Exhibit 10.3 of the March 31, 2003
Form 10-Q).
10.93 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-3, dated as of September 1,
2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation,
American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking
corporation (Incorporated by reference from Exhibit 10.93 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
243
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.94 Unaffiliated Seller's Agreement, dated as of September 1, 2002, by and among Credit Suisse First Boston
Mortgage Securities Corp., a Delaware corporation, ABFS 2002-3, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation
(Incorporated by reference from Exhibit 10.94 of Registrant's Registration Statement on Form S-2, No.
333-106476, filed on June 25, 2003).
10.95 Indemnification Agreement, dated September 23, 2002, by ABFS 2002-3, Inc., American Business Credit,
Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in
favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston
Corporation (Incorporated by reference from Exhibit 10.95 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
10.96 Unaffiliated Seller's Agreement, dated as of December 1, 2002, by and among Credit Suisse First Boston
Mortgage Securities Corp., a Delaware corporation, ABFS 2002-4, Inc., a Delaware corporation, American
Business Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation
(Incorporated by reference from Exhibit 10.96 of Registrant's Registration Statement on Form S-2, No.
333-106476, filed on June 25, 2003).
10.97 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2002-4, dated as of December 1,
2002, by and among Credit Suisse First Boston Mortgage Securities Corp., a Delaware corporation,
American Business Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking
corporation (Incorporated by reference from Exhibit 10.97 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
10.98 Indemnification Agreement, dated December 18, 2002, by ABFS 2002-4, Inc., American Business Credit,
Inc., HomeAmerican Credit, Inc. d/b/a Upland Mortgage and American Business Mortgage Services, Inc. in
favor of Credit Suisse First Boston Mortgage Securities Corp. and Credit Suisse First Boston
Corporation (Incorporated by reference from Exhibit 10.98 of Registrant's Registration Statement on
Form S-2, No. 333-106476, filed on June 25, 2003).
10.99 Unaffiliated Seller's Agreement, dated as of March 1, 2003, by and among Bear Stearns Asset Backed
Securities, Inc., a Delaware corporation, ABFS 2003-1, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc. d/b/a Upland Mortgage, a
Pennsylvania corporation, and American Business Mortgage Services, Inc., a New Jersey corporation.
244
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
10.100 Pooling and Servicing Agreement relating to ABFS Mortgage Loan Trust 2003-1, dated as of March 1, 2003,
by and among Bear Stearns Asset Backed Securities, Inc., a Delaware corporation, American Business
Credit, Inc., a Pennsylvania corporation, and JPMorgan Chase Bank, a New York banking corporation.
10.101 Insurance and Indemnity Agreement, dated March 31, 2003, by Radian Asset Assurance Inc., a New York
stock insurance company, American Business Credit, Inc., a Pennsylvania corporation, HomeAmerican
Credit, Inc. d/b/a Upland Mortgage, American Business Mortgage Services, Inc., ABFS 2003-1, Inc., Bear
Stearns Asset Backed Securities, Inc. and JPMorgan Chase Bank.
10.102 Amended and Restated Committed Line of Credit Note, dated June 2, 2003, between American Business
Financial Services, Inc. and Firstrust Savings Bank.
10.103 Amendment Number One to the Master Repurchase Agreement, dated November 13, 2002, between Credit Suisse
First Boston Mortgage Capital LLC and ABFS REPO 2001, Inc.
10.104 3/31/03 Amendment to Senior Secured Credit Agreement, dated March 31, 2003, among American Business
Credit, Inc., a Pennsylvania corporation, HomeAmerican Credit, Inc., a Pennsylvania corporation,
American Business Mortgage Services, Inc., a New Jersey corporation, ABFS Residual 2002, Inc., American
Business Financial Services, Inc., a Delaware corporation, and JPMorgan Chase Bank and certain other
lenders.
10.105 12/02 Amendment to 3/02 Security Agreement - Residual Interest Certificates, dated December 18, 2002,
made by ABFS Residual 2002, Inc., a Delaware corporation in favor of JPMorgan Chase Bank.
10.106 Letter, dated August 21, 2003 from JPMorgan Chase Bank to American Business Credit, Inc.,
HomeAmerican Credit, Inc., American Business Mortgage Services, Tiger Relocation Company, ABFS
Residual 2002, Inc. and American Business Financial Services, Inc. regarding waiver of
financial covenant in 3/02 Senior Secured Credit Agreement dated as of March 15, 2002.
(Incorporated by reference to Exhibit 10.1 of the Registrant's Current Report on Form 8-K, File
No. 0-22474, filed on September 25, 2003 (the "9/25/03 8-K")).
10.107 Mortgage Loan Purchase and Interim Servicing Agreement, dated July 22, 2003, among DLJ Mortgage
Capital, Inc., American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage and
American Business Mortgage Services, Inc.
10.108 Mortgage Loan Purchase and Interim Servicing Agreement, dated as of June 30, 2003, among EMC Mortgage
Corporation, American Business Credit, Inc., Homeamerican Credit, Inc. d/b/a Upland Mortgage, and
American Business Mortgage Services, Inc.
10.109 Waiver and Amendment Number Two to the Master Repurchase Agreement between Credit Suisse First Boston
Mortgage Capital LLC and ABFS Repo 2001, Inc. dated August 20, 2003 and Letter dated as of August 20, 2003
from Credit Suisse First Boston Mortgage Capital LLC to ABFS Repo 2001, Inc. (Incorporated by reference to
Exhibit 10.2 of the Registrant's 9/25/03 8-K).
10.110 Sale and Servicing Agreement, dated September 22, 2003, among ABFS Balapointe, Inc.,
HomeAmerican Credit, Inc., ABFS Mortgage Loan Warehouse Trust 2003-1, American Business Credit,
Inc., American Business Financial Services, Inc. and JPMorgan Chase Bank. (Incorporated by
reference to Exhibit 10.3 of the 9/25/03 8-K).
10.111 Indenture, dated September 22, 2003 between ABFS Mortgage Loan Warehouse Trust 2003-1 and
JPMorgan Chase Bank, as Indenture Trustee, with Appendix I, Defined Terms. (Incorporated by
reference to Exhibit 10.4 of the Registrant's 9/25/03 8-K).
10.112 Trust Agreement, dated as of September 22, 2003, by and between ABFS Bala Pointe, Inc., as
Depositor and Wilmington Trust Company, as Owner Trustee. (Incorporated by reference to Exhibit
10.5 of the Registrant's 9/25/03 8-K).
10.113 ABFS Mortgage Loan Warehouse Trust 2003-1 Secured Notes Series 2003-1 Purchase Agreement.
(Incorporated by reference to Exhibit 10.6 of the Registrant's 9/25/03 8-K).
10.114 Commitment letter dated September 22, 2003 addressed to American Business Financial Services
Inc. from Chrysalis Warehouse Funding, LLC. (Incorporated by reference to Exhibit 10.7 of the
Registrant's 9/25/03 8-K).
10.115 Fee letter dated September 22, 2003 addressed to American Business Financial Services, Inc. and
Chrysalis Warehouse Funding, LLC from Clearwing Capital, LLC. (Incorporated by reference to
Exhibit 10.8 of the Registrant's 9/25/03 8-K).
10.116 Amendment to Senior Secured Credit Agreement dated as of September 22, 2003 among American
Business Credit, Inc. and certain affiliates and JPMorgan Chase Bank and other parties thereto.
(Incorporated by reference to Exhibit 10.9 of the Registrant's 9/25/03 8-K).
245
Exhibit
Number Description
- ------ --------------------------------------------------------------------------------------------------------
11.1 Statement of Computation of Per Share Earnings (Included in Note 19 of the Notes to June 30, 2003
Consolidated Financial Statements).
12.1 Computation of Ratio of Earnings to Fixed Charges.
16.1 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.1 of the
Registrant's Current Report on Form 8-K dated May 17, 2001.)
16.2 Letter regarding change in certifying accountants. (Incorporated by reference from Exhibit 16.2 of the
Registrant's Current Report on Form 8-K dated August 2, 2001.)
21.1 Subsidiaries of the Registrant.
23.1 Consent of BDO Seidman, LLP.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
32.1 Certification pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
- ----------------------
** Indicates management contract or compensatory plan or arrangement.
246