Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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, 2004
-------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to ________________
Commission file number 000-22474
AMERICAN BUSINESS FINANCIAL SERVICES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 87-0418807
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Penn Square East, Philadelphia, PA 19107
--------------------------------------------
(Address of principal executive offices) (Zip Code)
(215) 940-4000
--------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
---------------------------------------
(Title of class)
Series A Convertible Preferred Stock, par value $.001 per share
---------------------------------------------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] YES [ ] NO
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). [ ] YES [X] NO
The aggregate market value of the registrant's common stock, par value
$.001 per share, held by non-affiliates of the registrant based on the price at
which the common stock was last sold as of the last business day of the
registrant's most recently completed second fiscal quarter was $5.8 million.
The number of shares outstanding of the registrant's sole class of
common stock as of September 30, 2004, the latest practicable date before the
filing of this Form 10-K, was 3,598,342 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement, in
connection with its 2004 Annual Meeting of Stockholders, to be filed with the
Securities and Exchange Commission within 120 days after June 30, 2004, are
incorporated by reference into Part III of this Annual Report on Form 10-K.
2
PART I
ITEM 1. BUSINESS
FORWARD LOOKING STATEMENTS
Some of the information in this Annual Report on Form 10-K may contain
forward-looking statements. You can identify these statements by words or
phrases such as "will likely result," "may," "are expected to," "will continue
to," "is anticipated," "estimate," "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 INFORMATION REGARDING OUR BUSINESS
American Business Financial Services, Inc. is a financial services
organization operating mainly in the eastern and central portions of the United
States. Recent expansion has positioned us to increase our operations in the
western portion of the United States, especially California. Through our
principal direct and indirect subsidiaries, we currently originate, sell and
service home equity and purchase money mortgage loans, to which we refer as home
mortgage loans, secured by first or 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
mortgage loans. During fiscal 2004, 89.9% of loans originated by us were secured
by first mortgages and 10.1% of loans originated by us were secured by second
mortgages. See "-- Lending Activities -- Home Mortgage Loans" for a description
of our home mortgage loan lending activities.
Additionally, we service loans to businesses secured by real estate and
other business assets that we had originated and sold in prior periods, which we
refer to in this document as business purpose loans. To the extent we obtain a
credit facility to fund business purpose loans, we may originate and sell
business purpose loans in future periods.
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. This type of borrower is commonly
referred to as a subprime borrower. Loans made to subprime borrowers are
frequently referred to as subprime loans. Financial institutions utilize a
credit rating system referred to as a FICO score to evaluate the
creditworthiness of borrowers and as a means to establish their risk associated
with lending to a particular borrower. The higher the FICO score, which can
range from 300 to 850, the more creditworthy the borrower is. Generally,
borrowers with FICO scores of 720 to 850 would receive the most favorable
interest rates. During fiscal 2004, the average FICO score of our subprime home
mortgage borrowers was 623. According to Standard & Poor's, subprime lenders
issued securitized transactions with mixed collateral (fixed and adjustable rate
mortgage loans) with a range of average FICO scores between 584 and 642 during
the second quarter of calendar 2004.
3
We originate loans through a combination of channels including a
national processing center located at our centralized operating office in
Philadelphia, Pennsylvania, and a network of mortgage brokers. During fiscal
2004, we acquired broker operations in West Hills, California and Austin, Texas,
and opened new offices in Edgewater, Maryland and Irvine, California to support
our broker operations. We also process and purchase home mortgage loans through
our Bank Alliance Services program. Through this program, we purchase home
mortgage loans from other financial institutions and hold these loans as
available for sale until they are sold in a whole loan sale or in connection
with a future securitization. Our loan servicing and collection activities were
performed at our Bala Cynwyd, Pennsylvania office, and were relocated to our
Philadelphia office on July 12, 2004. See "-- Lending Activities."
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 otherwise
qualified to offer our home mortgage loan products in 46 states.
Our business strategy has generally involved the sale of substantially
all of the loans we originate through a combination of loan sales with servicing
released, which we refer to as whole loan sales, and securitizations. 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 through the fourth quarter
of fiscal 2003, we have elected to utilize securitization transactions
extensively due to the favorable conditions we experienced in the securitization
markets. We generally realized higher gain on sale in our securitization
transactions than on whole loan sales for cash. 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. Due to our
inability to securitize our loans in the fourth quarter of fiscal 2003, we
adjusted our business strategy to emphasize more whole loan sales. The use of
whole loan sales enables us to more rapidly generate cash flow, protect against
volatility in the securitization markets and reduce risks inherent in retaining
an interest in the securitized loans. However, unlike securitizations, where we
may retain the right to service the loans we sell for a fee, which we refer to
as servicing rights, 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. Of the $982.7 million of loans originated by us
in fiscal 2004, at June 30, 2004, approximately 10% of these loans were
securitized, approximately 60% of these loans were sold in whole loan sales with
servicing released and the remainder were on our balance sheet at June 30, 2004
as available for sale pending future sale. We do not intend to hold any of these
loans on our balance sheet permanently. See "-- Recent Developments,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Whole Loan Sales" and "-- Whole Loan Sales."
When we securitize loans originated by our subsidiaries, we may retain
interests in the securitized loans in the form of interest-only strips and
servicing rights, which we refer to as our securitization assets. A
securitization is a financing technique often used by originators of financial
assets to raise capital. A securitization involves the transfer of a pool of
financial assets, in our case, loans, to a trust in exchange for certificates,
notes or other securities issued by the trust and representing an undivided
interest in the trust assets. The transfer to the trust involves a sale and
pledge of the financial assets, as well as providing representations and
warranties regarding these transferred assets, depending on the particular
transaction. Next, the trust sells a portion of the certificates, notes or other
securities to investors for cash. Often the originator of the loans retains the
servicing rights and may also retain an interest in the cash flows generated by
the securitized loans which is subordinate to the interest represented by the
notes or certificates sold to investors in the securitizations. This interest in
the cash flows generated by the securitized loans is called an interest-only
strip. See "-- Securitizations" and "-- Loan Servicing and Administrative
Procedures" for further information.
4
Loans and leases in which we have interests, either because the loans
and leases are on our balance sheet or sold into securitizations in which we
have retained interests, are referred to as our total portfolio. The managed
portfolio includes loans held as available for sale on our balance sheet and
loans serviced for others.
In addition to other sources, we fund our operations with subordinated
debentures that we offer from our principal operating office located in
Philadelphia, Pennsylvania. We offer these debentures without the assistance of
an underwriter or dealer. At June 30, 2004, we had $522.6 million in
subordinated debentures outstanding which included investment notes and
uninsured money market notes. These debentures had a weighted-average interest
rate of 9.91% and a weighted-average remaining maturity of 13.5 months. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Our principal corporate office is located at 103 Springer Building,
3411 Silverside Road, Wilmington, Delaware 19810. The telephone number at that
address is (302) 478-6160. Our principal operating office is located at The
Wanamaker Building, 100 Penn Square East, Philadelphia, Pennsylvania 19107. The
telephone number at the Philadelphia office is (215) 940-4000. We maintain a web
site on the World Wide Web at www.abfsonline.com. The information on our web
site is not and should not be considered part of this document and is not
incorporated into this prospectus by reference. This web site is only intended
to be an inactive textual reference.
RECENT DEVELOPMENTS
EXCHANGE OFFERS. On December 1, 2003, we mailed the Offer to Exchange,
referred to as the first exchange offer in this document, to holders of our
subordinated debentures issued prior to April 1, 2003. On May 14, 2004, we
mailed a second exchange offer, referred to as the second exchange offer in this
document, to holders of our subordinated debentures issued prior to November 1,
2003. The first exchange offer and the second exchange offer are collectively
referred to as the exchange offers in this document. Pursuant to the terms of
the exchange offers, eligible holders of subordinated debentures had the ability
to exchange their debentures for (i) equal amounts of senior collateralized
subordinated notes and shares of 10.0% Series A convertible preferred stock
referred to as Series A preferred stock in this document; and/or (ii)
dollar-for-dollar for shares of Series A preferred stock. Pursuant to the terms
of the first exchange offer, we exchanged $117.2 million of subordinated
debentures for 61.8 million shares of Series A preferred stock and $55.4 million
of senior collateralized subordinated notes. As a result of the second exchange
offer, we exchanged $91.4 million of subordinated debentures for 47.6 million
shares of Series A preferred stock and $43.8 million of senior collateralized
subordinated notes. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview -- Exchange Offers" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources -- Subordinated Debentures" for a
more detailed discussion of the exchange offers.
Depending on market conditions and our financial condition, we may
engage in additional exchange offers in the future and we are considering
another exchange offer in our second quarter of fiscal 2005. See "Risk Factors
- -- We may issue additional preferred stock which could be entitled to dividends,
liquidation preferences and other special rights and preferences not shared by
holders of our common stock or which could have anti-takeover effects."
OUR RECENT FINANCIAL DIFFICULTIES AND LIQUIDITY CONCERNS. Several
events and issues, which occurred beginning in the fourth quarter of fiscal
2003, have negatively impacted our short-term liquidity and contributed to our
losses for fiscal 2003 and fiscal 2004. These events included our inability to
complete publicly underwritten securitizations during the fourth quarter of
fiscal 2003 and all of fiscal 2004 (we completed a privately-placed
securitization in the second quarter of fiscal 2004), our inability to draw down
upon and the expiration of several of our credit facilities, and our temporary
discontinuation of sales of new subordinated debentures for approximately a
six-week period during the first quarter of fiscal 2004. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Overview" for information regarding our continued inability to complete
publicly underwritten securitizations.
5
As a result of these liquidity issues our loan origination volume
during fiscal 2004 was substantially reduced. From July 1, 2003 through June 30,
2004, we originated $982.7 million of loans, as compared to originations of
$1.67 billion of loans for the same period in fiscal 2003. We anticipate that
depending upon the size of our future quarterly securitizations, if any, we will
need to increase our loan originations to approximately $400.0 million to $500.0
million per month to return to profitable operations. If we are unable to
complete quarterly securitizations, we will need to increase our loan
originations to approximately $550.0 million to $650.0 million per month to
return to profitability. Our ability to achieve the levels of loan originations
necessary to achieve profitable operations could be hampered by our failure to
continue to successfully implement our adjusted business strategy, funding
limitations under existing credit facilities and our ability to obtain new
credit facilities and renew existing facilities. Our plan is to increase loan
originations through the continued application of our business strategy
adjustments, particularly as related to building our expanded broker channel and
offering adjustable rate mortgages, purchase money mortgages and more
competitively priced fixed rate mortgages. See "-- Business Strategy" for a
discussion of our plans to achieve this level of originations. For a detailed
discussion of our losses, capital resources and commitments, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."
On June 30, 2004, we had unrestricted cash of approximately $0.9
million and up to $210.4 million available under our warehouse credit
facilities. We can only use advances under these credit facilities to fund loan
originations and not for any other purposes. The combination of our current cash
position and expected sources of operating cash may not be sufficient to cover
our operating cash requirements.
6
For the next six to twelve months, we intend to augment our sources of
operating cash with proceeds from the issuance of subordinated debentures. In
addition to repaying maturing subordinated debentures, proceeds from the
issuance of subordinated debentures may be used to fund overcollateralization
requirements, as defined below, in connection with our loan originations and to
fund our operating losses. Under the terms of our credit facilities, our credit
facilities will advance us 75% to 97% of the value of loans we originate. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" for a discussion of the terms of
our credit facilities. As a result of this limitation, we must fund the
difference between the loan value and the advances, which we refer to as the
overcollateralization requirement, from our operating cash. We can provide no
assurances that we will be able to continue issuing subordinated debentures.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources -- Remedial Steps Taken
to Address Liquidity Issues" for a discussion of the specific actions we
undertook to address liquidity concerns.
RECENT OPERATING LOSSES AND SALE OF ASSETS. We incurred a net loss
attributable to common stock of $115.1 million and $29.9 million for the fiscal
years ended June 30, 2004 and 2003, respectively. In addition, depending on our
ability to recognize gains on our future securitizations, we anticipate
incurring operating losses at least through the first quarter of fiscal 2005.
The loss for fiscal 2004 primarily resulted from liquidity issues we
have experienced since the fourth quarter of fiscal 2003, including the absence
of credit facilities until the second quarter of fiscal 2004, which
substantially reduced our loan origination volume and our ability to generate
revenues, our inability to complete a publicly underwritten securitization
during fiscal 2004, our shift in business strategy to focus on whole loan sales,
and charges to the income statement of $46.4 million for pre-tax valuation
adjustments on our securitization assets. Additionally, operating expense levels
that would support greater loan origination volume also contributed to the loss
for fiscal 2004.
During fiscal 2004, we recorded total pre-tax valuation adjustments on
our interest-only strips and servicing rights of $63.8 million, of which $46.4
million was charged as expense to the income statement and $17.4 million was
charged to other comprehensive income, a component of stockholders' equity. The
fiscal 2004 adjustments primarily reflect the impact of higher than anticipated
prepayments on securitized loans experienced in fiscal 2004 due to the low
interest rate environment experienced during fiscal 2004. Additionally, the
fiscal 2004 valuation adjustment also includes a write down of $5.4 million of
the carrying value of our interest-only strips and servicing rights related to
five of our mortgage securitization trusts to reflect their values under the
terms of a September 27, 2004 sale agreement. The sale of these assets was
undertaken to raise cash to pay fees on new warehouse credit facilities and as a
result, we did not realize their full value as reflected on our books. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Application of Critical Accounting Estimates - Interest-Only
Strips" for a discussion of how valuation adjustments are recorded.
AMOUNT OF OUR INDEBTEDNESS. At June 30, 2004, we had total
indebtedness of approximately $847.4 million, comprised of amounts outstanding
under our credit facilities, senior collateralized subordinated notes issued in
the exchange offers, capitalized leases and subordinated debentures. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" for a comparison at June 30, 2004
of our secured and unsecured obligations to assets which were available to repay
those obligations.
7
BUSINESS STRATEGY ADJUSTMENTS. In response to our inability to
securitize and liquidity issues described above, we adjusted our business
strategy at the beginning of fiscal 2004 to 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. See "-- Business Strategy."
If we fail to generate sufficient liquidity through the sales of our
loans, the sale of our subordinated debentures, the maintenance of credit
facilities or a combination of the foregoing, we will have to restrict loan
originations and make additional changes to our business strategy, including
restricting or restructuring our operations which could result in losses and
impair our ability to repay our subordinated debentures and other outstanding
debt. While we currently believe that we will 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 debentures
when due. If we fail to successfully implement our adjusted business strategy,
we will be required to consider other alternatives, including raising additional
equity, seeking to convert an additional portion of our subordinated debentures
to equity, seeking protection under federal bankruptcy laws, seeking a strategic
investor, or exploring a sale of the company or some or all of its assets. 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, restrict our ability to repay our outstanding
debt, and negatively impact the value of our capital stock" and "-- If we are
unable to obtain additional financing, we may not be able to restructure our
business to permit profitable operations or repay our outstanding debt and the
value of our capital stock will be negatively impacted."
In addition to these restrictions and changes to our business strategy
in the event we are unable to offer additional subordinated debentures for any
reason, we have developed a contingent financial restructuring plan including
cash flow projections for the next twelve-month period. Based on our current
cash flow projections, we anticipate being able to make all scheduled
subordinated debenture maturities and vendor payments.
The contingent financial restructuring plan is based on actions that we
would take, in addition to those indicated in our adjusted business strategy, to
reduce our 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 obtaining working capital funding. No assurance can be given that we will be
able to successfully implement the contingent financial restructuring plan, if
necessary, and repay the outstanding debt when due. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources -- Remedial Steps Taken to Address Liquidity Issues."
CREDIT FACILITIES, SERVICING AGREEMENTS AND WAIVERS RELATED TO
FINANCIAL COVENANTS. At various times since June 30, 2003, we have been out of
compliance with one or more financial covenants contained in our $200.0 million
credit facility (reduced to $100.0 million on September 30, 2004). We have
continued to operate on the basis of waivers granted by the lender under this
facility. We currently anticipate that we will be out of compliance with one or
more of these financial covenants at October 31, 2004 and will need a waiver
from this lender for this noncompliance to continue to operate. The expiration
date of this facility was originally September 21, 2004, but the lender agreed
to extend the expiration date until November 5, 2004 in consideration for, among
other things, a reduction in the amount that could be borrowed under this
facility to $100.0 million.
8
At various times since June 30, 2003 we have also been out of
compliance with the net worth requirement in several of our pooling and
servicing agreements and sale and servicing agreements (collectively referred to
in this document as the servicing agreements) and have been required to obtain
waivers from and amendments to these agreements. As a result of the amendments
to our servicing agreements, all of our servicing agreements associated with
bond insurers now provide for term-to-term servicing and, in the case of our
servicing agreements with two bond insurers, our rights as servicer may be
terminated at the expiration of a servicing term in the sole discretion of the
bond insurer.
We cannot assure you that we will continue to receive the waivers and
servicing agreement extensions that we need to operate or that they will not
contain conditions that are unacceptable to us. Because we anticipate incurring
losses through at least the first quarter of fiscal 2005, we anticipate that we
will need to obtain additional waivers from our lenders and bond insurers as a
result of our non-compliance with financial covenants contained in our credit
facilities and servicing agreements. To the extent we are not able to obtain
waivers under our credit facilities, we may be unable to pay dividends on the
Series A preferred stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" for
additional information regarding the waivers obtained. See also "Risk Factors --
Restrictive covenants in the agreements governing our indebtedness may reduce
our operating flexibility and limit our ability to operate profitability, and
our ability to repay our outstanding debt may be impaired and the value of our
capital stock could be negatively impacted" and " -- 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, impair our ability to repay our
outstanding debt and negatively impact the value of our capital stock."
9
SECURITIES CLASS ACTION LAWSUITS AND SHAREHOLDER DERIVATIVE ACTION. In
January and February of 2004, four class action lawsuits were filed against us
and certain of our officers and directors. A consolidated amended class action
complaint that supersedes these four complaints was filed on August 19, 2004 in
the United States District Court for the Eastern District of Pennsylvania. The
consolidated complaint alleges that, during the applicable class period, our
forbearance and deferment practices enabled us to, among other things, lower our
delinquency rates to facilitate the securitization of our loans which
purportedly allowed us to collect interest income from our securitized loans and
inflate our financial results and market price of our common stock. The
consolidated amended class action complaint seeks unspecified compensatory
damages, costs and expenses related to bringing the action, and other
unspecified relief.
On March 15, 2004, a shareholder derivative action was filed against
us, as a nominal defendant, and our director and Chief Executive Officer,
Anthony Santilli, our Chief Financial Officer, Albert Mandia, our directors,
Messrs. Becker, DeLuca and Sussman, and our former director Mr. Kaufman, as
defendants, in the United States District Court for the Eastern District of
Pennsylvania and alleges that the named directors and officers breached their
fiduciary duties to the Company, engaged in the abuse of control, gross
mismanagement and other violations of law. The lawsuit seeks unspecified
compensatory damages, equitable or injunctive relief and costs and expenses
related to bringing the action, and other unspecified relief. The parties have
agreed to stay this case pending disposition of any motion to dismiss the
consolidated amended complaint filed in the putative consolidated securities
class action. See "Legal Proceedings" and "Risk Factors -- We are subject to
private litigation, including lawsuits resulting from the alleged "predatory"
lending practices, as well as securities class action and derivative lawsuits,
the impact of which on our financial position is uncertain. The inherent
uncertainty related to litigation of this type and the preliminary stage of
these suits makes it difficult to predict the ultimate outcome or potential
liability that we may incur as a result of these matters."
WHERE YOU CAN GET ADDITIONAL INFORMATION
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:
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.
10
BUSINESS STRATEGY
Our adjusted business strategy 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 adjusted business strategy involves significantly increasing the
use of loan brokers to increase loan origination volume and retaining and hiring
senior officers to manage the broker program. In December 2003, we hired an
experienced industry professional who manages our wholesale business and
acquired a broker operation with 35 employees (67 employees at June 30, 2004)
located in California. In March 2004, we opened a mortgage broker office in
Maryland and hired three experienced senior managers and a loan origination
staff of 40 (56 employees at June 30, 2004). In June 2004, we acquired a broker
operation with 35 employees in Texas. In addition, we hired 25 account
executives to develop relationships with mortgage brokers and to expand our
broker presence in the eastern, southern and mid-western areas of the United
States and retained 67 employees in our Upland Broker Services Philadelphia
headquarters to support our growing broker network. In total at June 30, 2004,
we had 285 employees in our broker operations, including 136 account executives.
Our business strategy includes the following:
o Selling substantially all of the loans we originate through a
combination of whole loan sales and securitizations. Whole loan
sales are generally completed on a weekly 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. When securitization opportunities are available to us,
the size of our quarterly loan securitizations will be reduced from
previous levels. We expect to execute our securitizations, if any,
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.
o Broadening our mortgage loan product line and increasing loan
originations. Historically we have originated primarily fixed-rate
home equity loans. Under our business strategy, we originate
adjustable-rate, alt-A and alt-B mortgage loans which have higher
credit scores as well as a wide array of fixed-rate and adjustable
rate mortgage loans in order to appeal to a broader base of
prospective customers and increase loan originations. During the
three months ended June 30, 2004, 46.7% of the loans which we
originated were adjustable-rate mortgage loans. We have also begun
to originate purchase money mortgage loans primarily through our
broker channel. In fiscal 2004, we originated $176.9 million of
purchase money mortgages, or 18.0% of total home mortgage loans
originated.
11
o Offering more competitive interest rates charged to borrowers on new
products. By offering more competitive interest rates charged on new
products, we originate loans to borrowers with higher credit
quality. In addition, by offering more competitive interest rates
our loans appeal to a wider customer base which we expect will
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. During
fiscal 2004, we originated only $587,000 of business purpose loans.
In the future, we may originate business purpose loans to meet
demand in the whole loan sale and securitization markets to the
extent we obtain a credit facility to fund business purpose loans.
We can utilize our current credit facilities only to fund home
mortgage loans.
o Expanding the use of e-commerce in our retail and broker channels.
This is expected to increase loan applications and reduce the cost
to originate loans.
o Reducing the cost of loan originations. We have implemented plans
to:
o reduce the cost to originate in our Upland Mortgage
direct retail channel by broadening the product line and
offering more competitive interest rates in order to
increase origination volume, and reducing marketing
costs;
o reduce the cost to originate in our broker channel by:
a) increasing volume by broadening the mortgage loan
product line, b) consolidating some of the broker
channel's operating functions to our centralized
operating office in Philadelphia, and c) developing and
expanding broker relationships; we also introduced Easy
Loan Advisor on our Internet-based website for our
offices supporting our broker operations. Easy Loan
Advisor offers significant efficiencies by automating
the origination and underwriting of loans; and
o reduce the cost to originate in the Bank Alliance
Services program by broadening our product line and
increasing the amount of fees we would charge to any new
participating financial institutions.
o Reducing the amount of outstanding subordinated debentures. The
increase in cash flow expected under our business strategy is
expected to accelerate a reduction in our reliance on issuing
subordinated debentures to meet our liquidity needs and allow us to
begin to pay down existing subordinated debentures.
o Reducing operating costs. From June 30, 2003 to June 30, 2004, our
workforce has experienced a net reduction of 150 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. However, we expect to
increase our sales, servicing and support positions as necessary in
the future to handle higher levels of loan originations. Since June
30, 2003 we reduced our workforce by approximately 255 employees and
experienced a net loss of approximately 90 additional employees who
resigned. Partially offsetting this workforce reduction, we have
added 195 loan origination employees in our broker channel as part
of our business strategy's focus on expanding our broker operations.
12
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 reasonable 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 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 outstanding
debt and could negatively impact the value of our capital stock."
SUBSIDIARIES
As a holding company, our activities have been limited to:
o providing management oversight over subsidiary operations;
13
o holding the shares of our subsidiaries; and
o 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, currently services business purpose loans
and home mortgage loans. In the past, this subsidiary also originated and sold
business purpose loans.
HomeAmerican Credit, Inc., a Pennsylvania corporation incorporated in
1991, originates, purchases, sells and services home mortgage loans.
HomeAmerican Credit, Inc. acquired Upland Mortgage Corp. in 1996 and since that
time has conducted business as "Upland Mortgage." HomeAmerican Credit, Inc. also
administers the Bank Alliance Services program. See "-- Lending Activities --
Home Mortgage Loans."
American Business Mortgage Services, Inc., a New Jersey corporation
organized in 1938 and acquired by us in October 1997, originates, purchases,
sells and services home mortgage loans.
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 facilities. 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 entities in connection with our financing activities, including credit
facilities. We also have several additional subsidiaries that are inactive or
not significant to our operations.
14
The following chart sets forth our basic organizational structure and
our primary subsidiaries.(a)
---------------------------------------------
AMERICAN BUSINESS FINANCIAL
SERVICES, INC.
==============================================
Holding Company
Management oversight over subsidiary
operations and raising capital for lending
and servicing operations
---------------------------------------------
|
|
---------------------------------------------
AMERICAN BUSINESS CREDIT, INC.
==============================================
Services business purpose loans and
home mortgage loans
---------------------------------------------
|
-------------------------------------------------------
| | |
| | |
---------------- ---------------------- ---------------------
AMERICAN HOMEAMERICAN TIGER
BUSINESS CREDIT, INC. D/B/A RELOCATION
MORTGAGE UPLAND COMPANY
SERVICES, INC. MORTGAGE
---------------- ---------------------- ---------------------
---------------- ---------------------- ---------------------
Originates, Originates, purchases, Holds, maintains
purchases, sells sells and services and sells foreclosed
and home mortgage loans real estate
services home and administers the
mortgage Bank Alliance
loans 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.
15
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,
-------------------------------------
2004 2003 2002
--------- ------ ---------
(DOLLARS IN THOUSANDS)
Loans Originated/Purchased
Business purpose loans.................... $ 587 $ 122,790 $ 133,352
Home mortgage loans....................... $ 982,093 $ 1,543,730 $ 1,246,505
Number of Loans Originated/Purchased
Business purpose loans.................... 2 1,340 1,372
Home mortgage loans....................... 8,281 17,003 14,015
Average Loan Size
Business purpose loans.................... $ 293 $ 92 $ 97
Home mortgage loans....................... $ 119 $ 91 $ 89
Weighted-Average Interest Rate on Loans
Originated/Purchased
Business purpose loans.................. 14.62% 15.76% 15.75%
Home mortgage loans..................... 7.86% 9.99% 10.91%
Combined................................ 7.86% 10.42% 11.38%
Weighted-Average Term (in months)
Business purpose loans.................... 150 160 161
Home mortgage loans....................... 294 272 260
Loans Securitized or Sold
Business purpose loans.................... $ 18,931 $ 112,025 $ 129,074
Home mortgage loans....................... $ 930,853 $ 1,339,752 $ 1,279,740
Number of Loans Securitized or Sold
Business purpose loans.................... 198 1,195 1,331
Home mortgage loans....................... 9,932 14,952 14,379
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 2004 2003 2002
--------- ---- ---- ----
Business purpose loans........................ 70.1% 62.2% 62.6%
Home mortgage loans........................... 81.3 78.2 77.8
16
The following table shows the geographic distribution of our loan
originations and purchases during the periods indicated.
YEAR ENDED JUNE 30,
-------------------------------------------------------------------------------------
2004 2003 2002
-------------------------- ---------------------------- -------------------------
Amount % Amount % Amount %
---------- ------- ------------- -------- -------------- --------
(dollars in thousands)
California $230,665 23.47% $ -- --% $ -- --%
New York 99,631 10.14 376,425 22.59 341,205 24.73
Pennsylvania 83,594 8.51 118,915 7.14 103,865 7.53
Massachusetts 64,254 6.54 134,342 8.06 101,383 7.35
Florida 57,092 5.81 135,164 8.11 97,686 7.08
Maryland 48,777 4.96 36,542 2.19 25,307 1.83
Virginia 41,294 4.20 46,508 2.79 33,169 2.40
Michigan 40,975 4.17 92,009 5.52 89,224 6.47
Ohio 39,949 4.07 70,957 4.26 65,884 4.77
New Jersey 38,108 3.88 212,035 12.72 159,117 11.53
Illinois 37,617 3.83 90,111 5.41 73,152 5.30
Georgia 26,127 2.66 21,022 1.26 49,956 3.62
Indiana 17,583 1.79 33,671 2.02 27,833 2.02
Texas 17,155 1.75 9,746 0.58 304 0.02
Connecticut 16,841 1.71 42,525 2.55 30,461 2.21
Other (a) 123,018 12.51 246,548 14.80 181,311 13.14
-------- ------ ---------- ------ ---------- -------
Total $982,680 100.00% $1,666,520 100.00% $1,379,857 100.00%
======== ====== ========== ====== ========== =======
- ----------
(a) No individual state included in "Other" constitutes more than 1.5% of
total loan originations for the fiscal year ended June 30, 2004.
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. This type of borrower is commonly referred to as a subprime borrower.
Loans made to subprime borrowers are frequently referred to as subprime loans.
See "-- Business Strategy."
HOME MORTGAGE LOANS. We originate home mortgage loans, consisting of
home equity loans and purchase money mortgage loans, through Upland Mortgage and
American Business Mortgage Services, Inc. We also process and purchase loans
through the Bank Alliance Services program. We originate home mortgage loans
primarily to credit-impaired borrowers through various channels including retail
marketing and broker operations. Our retail channel includes direct mail and our
subsidiaries' interactive web sites, and have included radio and television
advertisements.
In total at June 30, 2004, we had 285 employees in our broker
operations including 136 account executives. Our broker operations originate
loans using a broker network that after recent expansion is spread
geographically throughout the continental United States. During fiscal 2004, we
added four offices with 192 employees at June 30, 2004 to support our broker
operations and hired 25 account executives to expand our broker presence and
increase loan originations. We also introduced Easy Loan Advisor on our
Internet-based broker website for our offices supporting our broker operations.
Easy Loan Advisor offers significant efficiencies by automating the origination
and underwriting of these loans.
17
We entered the home equity loan market in 1991. With the recent
expansion of our broker operations, we added purchase money mortgage loans in
2004. Currently, we are licensed or otherwise qualified to originate home
mortgage loans in 46 states. We also hired 25 account executives to develop
relationships with mortgage brokers and to expand our broker presence in the
eastern, southern and mid-western areas of the United States. We generally sell
on a whole loan basis with servicing released, or securitize the loans
originated and funded by our subsidiaries.
The business strategy that we are emphasizing beginning in fiscal 2004
has impacted our origination of home mortgage loans. Our business strategy is
designed to appeal to a broader prospective customer base and increase the
amount of loan originations. We have broadened our mortgage loan product line to
include adjustable-rate, alt-A and alt-B and purchase money mortgage loans. Our
strategy also emphasizes reducing the cost to originate loans by expanding our
broker network and reducing retail 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 mortgage loan
business, see "-- Business Strategy."
Our retail operations receive home mortgage loan applications from
potential borrowers over the phone, in writing, in person or through our
subsidiaries' interactive web sites, and most recently through third-party
lending-related web sites with whom we have working agreements. The loan request
is then evaluated for possible loan approval. The loan processing staff
generally provides its home mortgage applicants who qualify for loans with a
conditional loan approval within 24 hours and closes its home mortgage loans
within approximately fifteen to twenty days of obtaining a conditional loan
approval.
Our broker operations receive home mortgage loan applications from
third-party unrelated brokers both in writing and increasingly through our newly
introduced broker Internet web site. The loan request is then evaluated for
possible loan approval. The loan processing staff generally provides the brokers
with a conditional loan approval within 24 hours and closes its home mortgage
loans within approximately fifteen to twenty days of obtaining a conditional
loan approval.
18
The following table presents the amounts of loans we originated in 2004
in our retail and broker operations channels (in thousands):
Bank
Retail Broker Alliance
Channel Channel Services Total
-------------- ------------- -------------- ------------
Purchase Money Mortgage Loans:
Fixed rate $ 2,177 $ 45,617 $ 634 $ 48,428
Adjustable rate 836 127,607 - 128,443
-------- -------- -------- --------
Total $ 3,013 $173,224 $ 634 $176,871
======== ======== ======== ========
Home Equity Loans:
Fixed rate $424,619 $ 94,051 $127,770 $646,440
Adjustable rate 40,423 104,503 13,856 158,782
-------- -------- -------- --------
Total $465,042 $198,554 $141,626 $805,222
======== ======== ======== ========
Total Home Mortgage Loans:
Fixed rate $426,796 $139,668 $128,404 $694,868
Adjustable rate 41,259 232,110 13,856 287,225
-------- -------- -------- --------
Total $468,055 $371,778 $142,260 $982,093
======== ======== ======== ========
Home mortgage loans ranged from $7,700 to $658,500 with an average loan
size of approximately $119,000 during 2004 and $91,000 during 2003. We
originated $982.1 million of home mortgage loans during fiscal 2004 and $1.5
billion during fiscal 2003. These loans were made both at fixed rates of
interest and adjustable rates of interest, which were tied to 6 month LIBOR, 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 mortgage loans during fiscal 2004 was 7.86% and
during fiscal 2003 was 9.99%. The average loan-to-value ratios for the loans
originated by us during fiscal 2004 and fiscal 2003 were 81.3% and 78.2%,
respectively.
We attempt to maintain our interest rates and other charges on home
mortgage loans to be competitive with the lending rates of other sub-prime
mortgage finance companies. 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 mortgage loan with us.
We have business arrangements with several financial institutions,
which provide for our purchase of home mortgage 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 mortgage 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.
Pursuant to the program, a financial institution adopts our
underwriting criteria for home mortgage 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 a whole loan sale or securitization.
19
During fiscal 2004, we received referrals from approximately ten
financial institutions participating in this program. As of June 30, 2004, seven
financial institutions located in the eastern portion of the United States were
actively 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 consists of approximately 575 branches.
These seven financial institutions accounted for approximately 20.5% of the
referrals received by us under the Bank Alliance Services program during fiscal
2004. Pursuant to this program, our subsidiaries purchased approximately $142.3
million of loans during the year ended June 30, 2004 and $201.9 million of loans
during the fiscal year ended June 30, 2003. During the year ended June 30, 2004,
our top three financial institutions under the Bank Alliance Services program
accounted for approximately 96.1% of our loan volume from this program. Only one
of the seven remaining active participants was in our top three volume providers
in fiscal 2004. We intend to expand the Bank Alliance Services program with
financial institutions across the United States. See "-- Business Strategy."
During fiscal 1999, we launched a retail 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.
During fiscal 2004, using our Easy Loan Advisor (referred to as ELA in
this document) proprietary software, we launched a broker Internet loan
distribution channel. We have added functionality to service the brokerage
community and sales channels through its automated underwriting engine thereby
providing access to the brokerage communities 7 days a week, 24 hours a day as
well as loan structuring options to provide the various loan solutions to
borrowers. The ELA software is a state of the art loan restructuring system
which provides brokers almost instantaneous loan structure options. This
technology is key to our forecasted loan growth.
BUSINESS PURPOSE LOANS. Through our subsidiary, American Business
Credit, Inc., we service business purpose loans that we originated and sold in
prior periods 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.
During prior periods, we originated 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 did not target any particular industries or trade groups and, in fact, took
precautions against a concentration of loans in any one industry group. All
business purpose loans originated generally were 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 were
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. We originated less than $1.0 million of business purpose loans in
fiscal 2004. We are currently not originating these loans; however, in the
future, we may originate business purpose loans to meet demand in the whole loan
sale and securitization markets to the extent we obtain a credit facility to
fund business purpose loans. If we originate business purpose loans in the
future, we will 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. See
"-- Business Strategy."
20
We originated $587,000 in business purpose loans during the year ended
June 30, 2004, and originated $122.8 million during fiscal 2003. When we
originated larger volumes of business purpose loans, these loans generally
ranged from $14,000 to $685,000 and had an average loan size of approximately
$92,000 for the loans originated during the fiscal year ended June 30, 2003.
Generally, our business purpose loans are made at fixed interest rates and for
terms ranging from five to fifteen years. We generally charged origination fees
for these loans of 4.75% to 5.75% of the outstanding principal balance. The
weighted-average interest rate charged on the business purpose loans originated
by us during the year ended June 30, 2004 was 14.62% and during fiscal year 2003
was 15.76%. Business purpose loans we originated during fiscal 2004 and fiscal
2003 had a loan-to-value ratio, based solely upon the real estate collateral
securing the loans, of 70.1% and 62.2%, respectively.
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, Inc. 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. Approximately 80% to 85% of our home mortgage loans
serviced had prepayment fees at the time of their origination. On home mortgage
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
mortgage loans range from 1% to 5% of the outstanding principal balance and
remain in effect for one to five years. At the time of their origination,
approximately 90% to 95% of our business purpose loans had prepayment fees. 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, 2004, approximately 50%
to 55% of securitized home mortgage loans in our total portfolio had prepayment
fees and approximately 50% to 55% of securitized business purpose loans in our
total portfolio had prepayment fees.
State law sometimes restricts our ability to charge a prepayment fee
for both home mortgage and business purpose loans. Prior to its preclusion, we
used the Parity Act to preempt these state laws for home mortgage loans which
meet the definition of alternative mortgage transactions under the Parity Act.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Legal and Regulatory Considerations" for a discussion of how the
adoption by the Office of Thrift Supervision in July 2003 of a rule which
precludes us from using the Parity Act to preempt state prepayment penalty and
late fees laws may impact our new loan originations.
In states which have overridden the Parity Act and in the case of some
fully amortizing home mortgage 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.
21
MARKETING STRATEGY
RETAIL LOAN ORIGINATION CHANNEL. Historically, we concentrated our
marketing efforts for home mortgage 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 current business
strategy, we have broadened our mortgage loan product line to include
adjustable-rate, alt-A and alt-B and purchase money 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 total portfolio, which could hinder
our ability to operate profitably, impair our ability to repay our outstanding
debt and negatively impact the value of our capital stock."
We market home mortgage loans through direct mail campaigns and our
interactive web sites, and have in the past used telemarketing, radio and
television advertising. Recently, we have begun to accept applications forwarded
to us by third-party lending-related web sites with whom we have working
agreements. 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 the
Bank Alliance Services program as additional sources of loans.
Our marketing efforts for home mortgage loans in our retail channel are
focused on the eastern and central portions of the United States and continuing
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.
BROKER OPERATIONS CHANNEL. We also use a network of loan brokers as a
source of home mortgage loans. We continue 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. During fiscal 2004, we acquired
broker operations in West Hills, California and Austin, Texas, and opened new
offices in Edgewater, Maryland and Irvine, California to support our broker
operations.
We market our broker operations though various sources including direct
broker solicitation, trade shows and trade advertising. We also introduced Easy
Loan Advisor on our Internet-based website for our offices supporting our broker
operations. Additionally, we market our programs and rates through e-mail.
BUSINESS PURPOSE LOANS. In prior fiscal years, our marketing efforts
for business purpose loans focused on our niche market of selected small
businesses located in our market area, which generally included the eastern and
central portions of the United States. We targeted businesses, which might
qualify for loans from traditional lending sources, but elected to use our
products and services. Our experience had indicated that these borrowers were
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 had been willing to pay our
origination fees and interest rates, which were generally higher than those
charged by traditional lending sources.
We had marketed 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 had in the past used newspaper
and radio advertising. Although we originated only $587,000 of business purpose
loans during the year ended June 30, 2004, we may originate and sell business
purpose loans in future periods to the extent we obtain a credit facility to
fund business purpose loans. Certain business purpose loans originated by us in
prior periods are held for sale. See "-- Business Strategy" and "-- Lending
Activities -- Business Purpose Loans."
22
UNDERWRITING PROCEDURES AND PRACTICES
Summarized below are some of the policies and practices which are
followed in connection with the origination of home mortgage loans and business
purpose 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
verify 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.
The following table outlines the key parameters of the major credit
grades of our current home mortgage loan underwriting guidelines. During fiscal
2004, we adjusted our credit grade and underwriting guidelines. We believe these
adjustments provide more consistency with the guidelines used by institutional
purchasers in the whole loan sale secondary market. As a result, we have
broadened our home mortgage loan products to include loan programs allowing
higher overall loan-to-value ratios, which are offset by compensating credit
characteristics. These loans are originated with the primary intent of being
sold as whole loans on the secondary market. The implementation of the new
credit and underwriting guidelines allows us to be more competitive in the whole
loan sale secondary market and enhances our ability to execute our adjusted
business strategy. We will continue to monitor our credit and underwriting
guidelines to maintain consistency with demand by institutional purchasers of
whole loans. During the year ended June 30, 2004, home mortgage loans
represented 99.9% of the loans we originated.
23
"A" CREDIT GRADE "B" CREDIT GRADE "C" CREDIT GRADE HOPE
- -------------------- ------------------------- ------------------------- ------------------------- -------------------------
General Repayment Has good credit but might Pays the majority of Marginal credit history Designed to provide a
have some minor accounts on time but has which is offset by other borrower with poor credit
delinquency some 30 and/or 60 day positive attributes. history an opportunity to
delinquency correct past credit
problems through lower
monthly payment.
Existing Mortgage Cannot exceed a maximum Cannot exceed a maximum Cannot exceed two 60 day Cannot exceed a maximum
Loans of three 30 day of four 30 day delinquencies and/or one of one 120 day
delinquencies in the past delinquencies/ one 60 day 90 day delinquency in the delinquency in the past
12 months. delinquency in the past past 12 months. 12 months.
12 months.
Non-Mortgage Credit Major credit and Major credit and Major credit and Major and minor credit
installment debt should installment debt can installment debt can delinquency is
be current but may exhibit some minor 30 exhibit some minor 30 acceptable, but must
exhibit some minor 30 day and/or 60 day and/or 90 day demonstrate some payment
delinquency. Minor credit delinquency. Minor credit delinquency. Minor credit regularity.
may exhibit some minor may exhibit up to 90 day may exhibit more serious
delinquency. delinquency. delinquency.
Bankruptcy Filings Discharged more than 2 Discharged more than 18 Discharged more than 1 Discharged more than 2
Chapter 7 years with reestablished months with reestablished year with reestablished years with reestablished
credit. credit. credit. credit.
Chapter 13 Filed more than 2 years, Filed more than 18 Filed more than 1 year, Filed more than 1 year,
satisfactory payment plan months, satisfactory satisfactory payment plan satisfactory payment plan
performance payment plan performance performance performance
Debt Service-to- Generally not to exceed Generally not to exceed Generally not to exceed Generally not to exceed
Income 50%. 50%. 55%. 55%.
Owner Occupied: Generally 80% to 100% for Generally 80% to 85% for Generally 70% to 80% for Generally 65% to 70% for
Loan-to-value ratio a 1-4 family dwelling a 1-4 family dwelling a 1-4 family dwelling a 1-4 family dwelling
residence; 90% for a residence; 85% for a residence; 70% for a residence.
condominium. condominium. condominium.
Non-Owner Occupied: Generally 85% for a 1-4 Generally 75% for a 1-4 Generally 70% for a 1-4 N/A
Loan-to-value ratio family dwelling or family dwelling or family dwelling or
condominium. condominium. condominium.
24
In addition to the home mortgage loans we originate under the standard
home mortgage loan underwriting guidelines outlined in the preceding table, we
also originate a limited number of second mortgage home equity loans 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 24 months.
Pursuant to our current 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."
If originated, business purpose loans generally are secured by
residential real estate and at times commercial real estate. Loan amounts
generally ranged 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 has 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 included
confirmation of income or cash flow through tax returns, bank statements and
other forms of proof of income and business cash flow. Generally, we made loans
to businesses whose bankruptcy was discharged at least two years prior to
closing, but we had made exceptions to allow for the bankruptcy to be discharged
just prior to or at closing. In addition, we generally received 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 fiscal 2004 and 2003 were 70.1% and 62.2%,
respectively.
Generally, the maximum acceptable loan-to-value ratio for home mortgage
loans to be securitized is 100%. The average loan-to-value ratios of home
mortgage loans we originated during the years ended June 30, 2004 and 2003 were
81.3% and 78.2%, respectively. 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.
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 outstanding debt and negatively impact the value
of our capital stock."
25
LOAN SERVICING AND ADMINISTRATIVE PROCEDURES
We service the loans in accordance with our established servicing
procedures. The loans we service include loans we hold as available for sale and
most of the loans we have securitized. 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. On July 12, 2004, our servicing and collections
activities, which were previously located at our operating office in Bala
Cynwyd, Pennsylvania, were relocated to our Philadelphia, Pennsylvania office.
At June 30, 2004, the portfolio we serviced consisted of 27,165 loans with an
aggregate outstanding balance of $2.1 billion.
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, 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.
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 may 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
ratio. We may take these conditions into account when we evaluate a borrower's
request for assistance for relief from the borrower's financial hardship.
26
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.
In a deferment arrangement, we make advances 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
payment plan. Borrowers must provide a written explanation of their hardship,
which generally requests relief from their delinquent 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 ranging from approximately 12 to 42 months, depending on
the period for which deferment is requested, 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 at least two
senior vice presidents.
Principal guidelines currently applicable to the deferment process
include: (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 two senior
vice presidents. If the deferment arrangement is approved, a collector contacts
the borrower regarding the approval and the revised payment terms.
For borrowers who are three or more payments delinquent, we will
consider using a forbearance arrangement. In a forbearance arrangement, we make
advances 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 will create a
payment plan for the borrower which 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 on behalf of the borrower.
Principal guidelines currently applicable to the forbearance process
include the following: (i) the borrower must have first and/or second mortgages
with us; (ii) the borrower's account was originated at least six months prior to
the request for forbearance; (iii) the borrower's account must be at least three
payments delinquent to qualify for a forbearance agreement; (iv) the borrower
must submit a written request for forbearance containing an explanation for his
or her previous delinquency and setting forth the reasons that the borrower now
believes he or she is able to meet his or her loan obligations; and (v) the
borrower must make a down payment of at least one month's past due payments of
principal and interest in order to enter into a forbearance agreement, and the
borrower who is six or more payments delinquent must make a down payment of at
least two past due payments. No request for forbearance may be denied without
review by our senior vice president of collections or his designee.
27
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 also depends upon one or more of the
following factors: our assessment of the individual borrower's current financial
situation, reasons for the delinquency 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 principal and interest loan payments. 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, we will declare the account in default, reflect it as a
delinquent loan in our delinquency statistics and resume collection actions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Total Portfolio Quality -- Deferment and Forbearance Arrangements"
for information regarding the impact of these arrangements on our operations.
Based on information learned by our in-house legal staff while
participating in industry forums and conferences and statements made by outside
attorneys to us in the course of their legal representation of us, we believe we
are among a small number of non-conforming 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. For example, if in the course of the
collection of a loan or fee the servicing department or collections department
becomes aware of problems with a loan, such as title issues, department
personnel will immediately notify an in-house attorney who will review the file
and immediately initiate any necessary corrective action, including referral to
outside counsel if appropriate. Also as an example, every notice of default and
bankruptcy proof of claim is signed by an in-house attorney. Frequently, when
reviewing the file relevant to a particular notice of default or proof of claim,
the reviewing attorney will become aware of inconsistencies or issues and
immediately initiate any necessary corrective action, including referral to
outside counsel if appropriate. This frequent day-to-day contact between our
servicing and collections departments, our in-house legal staff and outside
counsel, and the early involvement of an in-house attorney in emerging legal
issues that this facilitates, enables our in-house attorneys to resolve issues
before they become costly disputes and to negotiate alternatives to foreclosure
for problem loans.
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. After
acquisition, all costs incurred in maintaining the property are accounted for as
expenses. When carried on our balance sheet, we record real estate owned at the
lower of cost or estimated fair value.
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.
28
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, limit the funds available to repay our
outstanding debt and negatively impact the value of our capital 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 -- Securitizations." 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 our
outstanding debt and could negatively impact the value of our capital stock."
Beginning in the fourth quarter of fiscal 2002, we offered customer
retention incentives to borrowers who were exploring loan refinancing
opportunities for the purpose of lowering their monthly loan payments. In an
attempt to retain the loans we were servicing for these borrowers, we offered
the borrowers the opportunity to receive a monthly cash rebate equal to a
percentage of their scheduled monthly loan payments for periods of six to twelve
months. When we were successful in retaining these loans, we reduced the level
of loan prepayments in our managed portfolio of securitized loans. To initially
qualify for this program, a borrower has to be current on their loan principal
and interest payments and to continue to qualify and receive each month's cash
rebate, a borrower has to remain current. The percentage of rebates on scheduled
monthly loan payments offered to participants ranged from 15% to 20%. At June
30, 2004, $344.8 million in principal amount outstanding on loans were
participating in this program on which we expect to pay rebates of approximately
$1.3 million.
SECURITIZATIONS
We were unable to complete quarterly publicly underwritten
securitizations during the fourth quarter of fiscal 2003 and all of fiscal 2004.
We completed a privately-placed securitization in the second quarter of fiscal
2004. Our inability to complete a 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 Civil Division of the
U.S. Attorney's Office in Philadelphia regarding our forbearance practices, an
anonymous letter regarding us received by our investment bankers, the SEC's
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.
29
During the year ended June 30, 2004, we completed a securitization of
$135.9 million of loans in the second quarter and sold $5.5 million of loans
into an off-balance sheet mortgage conduit facility. 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. The securitization of loans
and sale into the mortgage conduit facility generated gains on sale of loans of
$15.1 million during the year ended June 30, 2004, $171.0 million during fiscal
2003 and $185.6 million during fiscal 2002. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- 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 may 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,
2004, 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 our outstanding debt and could negatively impact the
value of our capital stock."
30
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 our outstanding debt and could negatively impact the
value of our capital stock." See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Securitizations -- Trigger
Management" for a description of the impact of these repurchases on our
business.
In the past, certain of our securitizations included 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, 2004.
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. Due to our
inability to complete a 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 "Managements Discussion and Analysis
of Financial Condition and Results of Operations -- Whole Loan Sales" for more
detail.
COMPETITION
We have significant competition for home mortgage loans. We concentrate
our marketing efforts for home mortgage 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. Many large financial institutions have gradually expanded their
sub-prime lending capabilities. Many of these companies have name recognition
and greater access to capital at a cost lower than our cost of capital.
Additionally, federally chartered banks and thrifts can preempt some of the
state and local lending laws to which we are subject, thereby giving them a
competitive advantage.
Competition among industry participants can take many forms, including
convenience in obtaining a loan, customer service, marketing and distribution
channels, amount and term of the loan, loan origination fees and interest rates.
Additional competition may lower the interest rates we can charge borrowers,
thereby potentially lowering gain on future whole loan sales and
securitizations.
31
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 "-- Marketing
Strategy" for information regarding the markets in which we compete. See "--
Business Strategy" for discussion of our emphasis on broadening our mortgage
loan product line and offering competitive interest rates. See "Risk Factors --
Competition from other lenders could adversely affect our ability to attain
profitable operations and our ability to repay our outstanding debt may be
impaired and the value of our capital stock could be negatively impacted."
REGULATION
GENERAL. Our business is regulated by federal, state and, in certain
cases, local laws. All home mortgage loans must meet the requirements of, among
other statutes and regulations, the Truth in Lending Act, the Real Estate
Settlement Procedures Act, the Equal Credit Opportunity Act of 1974, 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 ACT, 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.
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, impose limits on the amount of
funds a borrower can be required to deposit with us in any escrow account for
the payment of taxes, insurance premiums or other charges; limits the fees which
may be paid to third parties; and imposes various disclosure 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.
32
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 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, on December 22, 2003, we entered into a joint agreement
with the Civil Division of the U.S. Attorney's Office for the Eastern District
of Pennsylvania, which ended the inquiry by the U.S. Attorney focused on our
forbearance policy initiated pursuant to the civil subpoena dated May 14, 2003.
See "Legal Proceedings."
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. 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, which may hinder our ability to operate profitably, negatively
impair our ability to repay our outstanding debt and negatively impact the value
of our capital stock."
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
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 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, which may hinder our ability
to operate profitably, negatively impair our ability to repay our outstanding
debt and negatively impact the value of our capital stock."
33
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 13, 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.
State law sometimes restricts our ability to charge a prepayment fee
for both home equity and business purpose loans. Prior to its preclusion, we
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. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Legal and Regulatory Considerations" for a discussion of how the
adoption by the Office of Thrift Supervision in July 2003 of a rule which
precludes us from using the Parity Act to preempt state prepayment penalty and
late fees laws may impact our new loan originations.
SERVICEMEMBERS CIVIL RELIEF ACT. Under the Servicemembers Civil Relief
Act (formerly known as the Soldiers' and Sailors' Civil Relief Act of 1940),
referred to as the Relief Act in this document, 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 stayed and may have
obligations adjusted in a manner to preserve the interests of
all parties.
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.
34
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 Servicemembers Civil Relief Act, our cash
flows and interest income may be adversely affected which would negatively
impair our ability to repay our outstanding debt and would negatively impact the
value of our capital stock."
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.
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER RISK FACTORS SET FORTH BELOW TOGETHER
WITH ALL OF THE OTHER INFORMATION INCLUDED IN THIS FORM 10-K AND INCORPORATED BY
REFERENCE INTO THIS FORM 10-K WHICH COULD IMPACT THE VALUE OF OUR CAPITAL STOCK
AND OUR ABILITY TO REPAY OUR OUTSTANDING DEBT.
BECAUSE WE HAVE HISTORICALLY EXPERIENCED NEGATIVE CASH FLOWS FROM OPERATIONS, WE
WILL BE REQUIRED TO RELY, IN PART, ON SALES OF ADDITIONAL SUBORDINATED
DEBENTURES TO FUND OUR CONTINUING OPERATIONS AND TO REPAY OUR OUTSTANDING DEBT.
TO THE EXTENT THAT WE ARE UNABLE TO SELL ADDITIONAL SUBORDINATED DEBENTURES OR
OTHER SECURITIES, OUR ABILITY TO REPAY OUR OUTSTANDING DEBT COULD BE IMPAIRED
AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.
We have historically experienced negative cash flows from operations
since 1996 primarily because our previous business strategy of selling loans
primarily through securitization required 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 or a whole loan sale, 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 flows
immediately. Our cash flow from operations for the fiscal year ended June 30,
2003, was a negative of $285.4 million compared to a negative $13.3 million for
fiscal 2002. Negative cash flow from operations increased $272.1 million for the
fiscal year ended June 30, 2003 mainly due to our inability to complete a
securitization or otherwise sell our loans in the fourth quarter of fiscal 2003.
If our adjusted business strategy changes to include a sale of loans through
securitizations, then, depending on the size and frequency of our future
securitizations, we may experience negative cash flow from operations in the
future. We anticipate that we will be required to rely, in part, on the offering
of additional securities, including subordinated debentures, to fund both our
operations and repay our outstanding debt for at least the next two years.
35
During the fiscal year ended June 30, 2004, we experienced positive
cash flow from operations of $6.8 million primarily due to whole loan sales of
loans we originated. However, the combination of our current cash position and
expected sources of operating cash may not be sufficient to cover our operating
cash requirements. Should we experience negative cash flows from operations in
the future, and if we are unable to sell subordinated debentures to fund our
operations, our ability to repay our outstanding debt could be impaired and the
value of our capital stock could be negatively impacted. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."
BECAUSE WE HAD NEGATIVE RETAINED EARNINGS IN FISCAL 2004, WE HAVE NOT GENERATED
SUFFICIENT EARNINGS TO COVER OUR FIXED CHARGES, WHICH MAY NEGATIVELY IMPAIR OUR
ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR
CAPITAL STOCK.
At June 30, 2004, we had negative retained earnings of $98.3 million
on our balance sheet as a result of our losses for fiscal 2004 and fiscal 2003.
Our earnings before income taxes and fixed charges were insufficient to cover
fixed charges by $183.4 million for the fiscal year ended June 30, 2004. To the
extent that we are unable to generate earnings sufficient to cover our fixed
charges, we may have insufficient funds to repay our outstanding debt, which
would have a negative impact on the value of our capital stock.
SINCE WE DO NOT SET ASIDE FUNDS TO REPAY OUR OUTSTANDING DEBT AND TO THE EXTENT
THE COLLATERAL SECURING SENIOR COLLATERALIZED SUBORDINATED NOTES IS NOT
SUFFICIENT FOR THE REPAYMENT OF THE NOTES, HOLDERS OF OUR OUTSTANDING DEBT MUST
RELY ON OUR CASH FLOW FROM OPERATIONS AND OTHER SOURCES FOR REPAYMENT. IF OUR
SOURCES OF REPAYMENT ARE NOT ADEQUATE, WE MAY BE UNABLE TO REPAY OUR OUTSTANDING
DEBT, WHICH WOULD HAVE A NEGATIVE IMPACT ON THE VALUE OF OUR CAPITAL STOCK.
We do not contribute funds on a regular basis to a separate account,
commonly known as a sinking fund, to repay our outstanding debt upon maturity.
Because funds are not set aside periodically for the repayment of the
outstanding debt over its term, holders of the subordinated debentures and
senior collateralized subordinated notes, to the extent that the cash flow from
interest-only strips securing the senior collateralized subordinated notes is
not sufficient for the repayment of the senior collateralized subordinated notes
over their terms, must rely on our cash flow from operations and other sources
for repayment, such as funds from the sale of additional subordinated debentures
and proceeds from whole loan sales. We anticipate that during fiscal 2005 we
will incur significant contractual obligations that will negatively impact our
cash flow from operations, including, but not limited to: (i) the payment of
maturing subordinated debentures and the accrued interest on outstanding
subordinated debentures of $326.2 million and $20.0 million, respectively; (ii)
the payment of maturing senior collateralized subordinated notes and the accrued
interest on senior collateralized subordinated notes of $28.1 million and $1.0
million, respectively; (iii) the payment of dividends on Series A preferred
stock of $ 10.9 million; and (iv) the repayment of the warehouse lines of credit
of $239.6 million. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources --
Contractual Obligations" for a discussion of our contractual obligations. To the
extent revenues from operations and other sources are not sufficient to repay
the outstanding debt, holders of outstanding debt may lose all or a part of
their investment. Our ability to repay the outstanding debt at maturity and our
ability to meet other financial obligations may depend, in part, on our ability
to raise new funds through the sale of additional subordinated debentures. At
June 30, 2004, $522.6 million of subordinated debentures were outstanding. We
estimate that during fiscal 2005 we will not generate sufficient after-tax
earnings to pay the principal and interest on maturing subordinated debentures
and we will need to sell approximately $260.0 million to $275.0 million of
additional subordinated debentures to pay the principal and interest on our
outstanding subordinated debentures and to pay our other obligations, including
the principal and interest on the senior collateralized subordinated notes and
dividends on our Series A preferred stock. In addition, we use the proceeds from
sales of additional subordinated debentures to pay maturities on existing
subordinated debentures because we have been unable to issue subordinated
debentures with maturities long enough to fund our business. In essence, we
replace maturing short-term subordinated debentures with new short-term
subordinated debentures to achieve the longer term funding effect we need in
order to implement our business strategy. Once cash flows from after tax
earnings become available, as anticipated under our adjusted business strategy,
we anticipate having cash available to begin paying down maturing subordinated
debentures and reducing the amount of maturing short-term subordinated
debentures we replace with new subordinated debentures. See "-- Because we have
historically experienced negative cash flows from operations, we will be
required to rely, in part, on sales of additional subordinated debentures to
fund our continuing operations and to repay our outstanding debt. To the extent
that we are unable to sell additional subordinated debentures or other
securities, our ability to repay our outstanding debt could be impaired and the
value of our capital stock could be negatively impacted," "-- 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, restrict
our ability to repay our outstanding debt and negatively impact the value of our
capital stock," and "-- 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, impair our ability to repay our outstanding debt and negatively impact
the value of our capital stock."
36
SINCE WE DO NOT SET ASIDE FUNDS TO REPAY HOLDERS OF OUR MONEY MARKET NOTES UPON
DEMAND, HOLDERS OF MONEY MARKET NOTES MUST RELY ON OUR CASH FLOW FROM OPERATIONS
AND OTHER SOURCES FOR REPAYMENT OF THEIR UNINSURED MONEY MARKET NOTES. IF OUR
SOURCES OF REPAYMENT ARE NOT ADEQUATE, WE MAY BE UNABLE TO SATISFY THE HOLDERS'
REDEMPTION REQUESTS ON A TIMELY BASIS.
Holders of our uninsured money market notes may request a full or
partial repayment of their notes at any time by delivering a written notice to
us specifying the amount of the redemption. Redemption requests by written
notice may be for any amount and we may take up to 10 business days after the
receipt of the notice to mail the proceeds of the redemption to the holder. In
fiscal 2004, we repaid $26.9 million of money market notes pursuant to
redemption requests. At June 30, 2004, we had $12.7 million of money market
notes outstanding and $0.9 million of cash and cash equivalents available to
repay these money market notes. Since we do not set aside funds to repay money
market notes upon the holder's demand, holders must rely on our available cash
and cash equivalents when a request is made for repayment. If holders of all of
our money market notes requested repayment as of June 30, 2004, we did not have
sufficient cash or cash equivalents to repay all money market notes outstanding
as of such date. If we do not have sufficient cash to repay all holders
requesting redemption, we may take up to 10 business days to mail the proceeds
to the holders. To the extent that we continue to experience liquidity issues,
are unable to sell additional subordinated debentures or other sources for
repayment are not available, we may be unable to satisfy the holders' redemption
requests when made. In the event we are unable to mail proceeds to redeeming
holders within 10 business days, we would be in default under the terms of our
indenture governing the money market notes.
Absent a waiver, our failure to repay the money market notes within a
10 business day period provided for pursuant to the terms of the indenture would
result in an event of default which could accelerate debt repayment terms under
our credit facilities and indentures due to various cross default provisions
contained in the agreements evidencing our outstanding debt, which would have a
material adverse effect on our liquidity and capital resources.
Subject to the consent of the trustee under the indenture governing the
rights of holders of uninsured money market notes, we have the ability to change
the redemption procedures without the approval of holders of money market notes,
provided that no changes can be made that will adversely affect the rights of
holders of outstanding money market notes. If we experience a significant
increase in requests for the redemption of money market notes, we may request
that the trustee approve an extension of the 10 business day period provided for
the redemption of money market notes. In such event, this modification would
only be effective with respect to money market notes issued subsequent to the
date of the trustee's consent and our notice regarding the extension to
prospective investors. See "-- Since we do not set aside funds to repay our
outstanding debt and to the extent the collateral securing senior collateralized
subordinated notes is not sufficient for the repayment of the notes, holders of
our outstanding debt must rely on our cash flow from operations and other
sources for repayment. If our sources of repayment are not adequate, we may be
unable to repay our outstanding debt, which would have a negative impact on the
value of our capital stock."
37
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, RESTRICT OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY
IMPACT THE VALUE OF OUR CAPITAL STOCK.
For our ongoing operations, we depend upon frequent financings,
including the sale of our unsecured subordinated debentures 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 additional subordinated debentures, the lack of adequate
funds would hinder our ability to operate profitably, restrict our ability to
repay our outstanding debt and negatively impact the value of our capital stock.
On September 22, 2003, we entered into definitive agreements with a
financial institution for a $200.0 million credit facility. In addition, on
October 14, 2003, we entered into definitive agreements with a warehouse lender
for a $250.0 million credit facility to fund loan originations. This $200.0
million credit facility was extended to November 5, 2004 and reduced to $100.0
million. We have entered into a commitment letter and anticipate entering into
a definitive agreement regarding a $100.0 million credit facility to replace our
expiring credit facility. However, there can be no assurances as to whether we
will enter into the definitive agreement prior to November 5, 2004 or that this
agreement will contain terms and conditions acceptable to us.
If we are unable to comply with the terms of our credit facilities,
these lenders have the option to accelerate payment on these facilities and
would have no further obligation to make additional advances under these
facilities. In addition, absent a waiver, our inability to comply with the
financial and other terms of this debt could accelerate debt repayment terms
under our other outstanding debt due to the various cross default provisions
contained in the agreements evidencing our outstanding debt. Additionally, our
ability to obtain alternative financing sources may be limited to the extent we
have agreed to pledge our interest-only strips and residual interests, which
represent a significant amount of our assets, to secure our obligations in an
amount not to exceed 10% of the outstanding principal balance of, and the
payment of fees on, the $250.0 million credit facility and a portion of the cash
flows from our interest-only strips to secure the senior collateralized
subordinated notes outstanding, and by our current financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" for further discussion of these
facilities.
38
Although we obtained two warehouse credit facilities totaling $450.0
million in fiscal 2004, and after November 5, 2004 we expect to have at least
two warehouse credit facilities totaling at a minimum $500.0 million, the
proceeds of these credit facilities could only be used to fund loan originations
and could not be used for any other purpose. Consequently, we need to generate
cash to fund the balance of our business operations from other sources, such as
whole loan sales, additional financings and sales of subordinated debentures.
Additionally, our warehouse credit facilities have been obtained at high costs,
which have a significant impact on our liquidity.
We are currently negotiating additional credit facilities to provide
additional borrowing capacity to fund the increased level of loan originations
expected under our adjusted business strategy, however, no assurances can be
given that we will succeed in obtaining new credit facilities or that these
facilities will contain terms and conditions acceptable to us.
While we currently believe we will continue to have credit facilities
available to finance new loan obligations, we cannot assure you that we will be
successful in maintaining or replacing existing credit facilities 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. Limiting our
originations or earlier sales of loans would hinder our ability to operate
profitably or result in losses, restrict our ability to repay our outstanding
debt and negatively impact the value of our capital stock. Our ability to repay
our outstanding debt at maturity may depend, in part, on our ability to raise
new funds through the sale of additional subordinated debentures. 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
our outstanding debt as it comes 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 our
outstanding debt and could negatively impact the value of our capital stock" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
In the event we are unable to offer subordinated debentures for any
reason, we have developed a contingent financial restructuring plan including
cash flow projections for the next twelve-month period. Based on our current
cash flow projections, we anticipate being able to make all scheduled debt
maturities and vendor payments.
The contingent financial restructuring plan is based on actions that we
would take, in addition to those indicated in our adjusted business strategy, to
reduce our 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 obtaining working capital funding. No assurance can be given that we will be
able to successfully implement the contingent financial restructuring plan, if
necessary, and repay our outstanding debt which would negatively impact the
value of our capital stock.
39
IF WE ARE UNABLE TO OBTAIN ADDITIONAL FINANCING, WE MAY NOT BE ABLE TO
RESTRUCTURE OUR BUSINESS TO PERMIT PROFITABLE OPERATIONS OR REPAY OUR
OUTSTANDING DEBT AND THE VALUE OF OUR CAPITAL STOCK WILL BE NEGATIVELY IMPACTED.
Our inability to complete publicly underwritten securitizations during
the fourth quarter of fiscal 2003 and all of fiscal 2004 (we completed a
privately-placed securitization in the second quarter of fiscal 2004), our
inability to draw down upon and the expiration of several of our credit
facilities, and our temporary discontinuation of sales of new subordinated
debentures for approximately a six-week period during the first quarter of
fiscal 2004 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 in
July 2003 and the temporary discontinuation of the sale of new subordinated
debentures for approximately a six-week period during the first quarter of
fiscal 2004 also adversely impacted our short-term liquidity position.
We have entered into a commitment letter and anticipate entering into
definitive agreements for a $100.0 million credit facility to replace our
expiring $200.0 million (now $100.0 million) credit facility. However, we cannot
give any assurances that we will execute definitive agreements for this facility
on or before November 5, 2004 or that the definitive agreements offered to us
will contain terms acceptable to us, although preliminary discussions indicate
the replacement facility will be structured similarly to our $250.0 million
credit facility.
Although we obtained two warehouse credit facilities totaling $450.0
million in fiscal 2004, and after November 5, 2004 we expect to have at least
two warehouse credit facilities totaling at a minimum $500.0 million, the
proceeds of these credit facilities could only be used to fund loan originations
and could not be used for any other purpose. Consequently, we need to generate
cash to fund the balance of our business operations from other sources, such as
whole loan sales, additional financings and sales of subordinated debentures.
Additionally, our warehouse credit facilities have been obtained at high costs,
which have a significant impact on our liquidity. We are currently negotiating
additional credit facilities to provide additional borrowing capacity to fund
the increased level of loan originations expected under our adjusted business
strategy, however, no assurances can be given that we will succeed in obtaining
new credit facilities or that these facilities will contain terms and conditions
acceptable to us.
Our ability to obtain alternative sources of financing may be limited
to the extent we have pledged our interest-only strips and residual interests,
which represent a significant amount of our assets, to secure our obligations in
an amount not to exceed 10% of the outstanding principal balance of, and the
payment of fees on, the $250.0 million credit facility and a portion of the cash
flows from our interest-only strips to secure the senior collateralized
subordinated notes, and by our current financial situation. 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 under our adjusted business strategy. Limiting our originations or
earlier sales of our loans would prevent us from operating profitably and
restrict our ability to repay our outstanding debt and could negatively impact
the value of our capital stock. Likewise, there can be no assurance that we can
successfully implement our adjusted business strategy, if necessary, or that the
assumptions underlying the adjusted business strategy can be achieved. Our
failure to successfully implement our adjusted business strategy, if necessary,
would impair our ability to operate profitably and repay our outstanding debt
and would negatively impact the value of our capital stock. If we fail to
successfully implement our adjusted business strategy, we will be required to
consider other alternatives, including raising equity, seeking to convert a
portion of our subordinated debentures to equity, seeking protection under
federal bankruptcy laws, seeking a strategic investor, or exploring a sale of
the company or some or all of its assets.
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 OUTSTANDING DEBT WHICH COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL
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 during fiscal
2004 and the significant net pre-tax valuation adjustments to our securitization
assets resulted in a net loss attributable to common stock of $29.9 million for
fiscal 2003 and $115.1 million for fiscal 2004, and contributed to our shift in
focus to less profitable whole loan sales. The losses resulted in our inability
to comply with certain financial covenants contained in our credit facilities.
The losses and the expiration of our mortgage conduit facility adversely
impacted our short-term liquidity position. The temporary discontinuation of
sales of subordinated debentures further impaired our liquidity.
40
Depending on our ability to recognize gains on our future
securitizations, we anticipate incurring losses at least through the first
quarter of fiscal 2005 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 whole loan sale or
securitization markets would hinder our ability to operate profitably and repay
our outstanding debt which would negatively impact the value of our capital
stock."
BASED UPON OUR LOSS FOR THE QUARTER ENDED JUNE 30, 2004 AND OUR ANTICIPATED LOSS
FOR THE QUARTER ENDED SEPTEMBER 30, 2004, WE WILL BE OUT OF COMPLIANCE WITH
FINANCIAL COVENANTS CONTAINED IN ONE OF OUR CREDIT FACILITIES AND WE WILL
CONTINUE TO NEED WAIVERS FROM OUR LENDER.
At various times since June 30, 2003, including at June 30, 2004, July
31, 2004, August 31, 2004 and September 30, 2004, we have been out of compliance
with one or more financial covenants contained in our $200.0 million credit
facility. We have continued to operate on the basis of waivers granted by the
lender under this facility. We currently anticipate that we will be out of
compliance with one or more of these financial covenants at October 31, 2004 and
will need a waiver from this lender for this noncompliance to continue to
operate. The expiration date of this facility was originally September 21, 2004,
but the lender agreed to extend the expiration date until November 5, 2004 in
consideration for, among other things, a reduction in the amount that could be
borrowed under this facility to $100.0 million.
A provision in our $250.0 million credit facility required us to
maintain another credit facility for $200.0 million with a $40.0 million
sublimit of such facility available for funding loans between the time they are
closed by a title agency or closing attorney and the time documentation for the
loans is received by the collateral agent. As a result of the reduction of our
$200.0 million facility to $100.0 million, as described above, we entered into
an amendment to the master loan and security agreement governing our $250.0
million facility which reduced the required amount for another facility to
$100.0 million. In the event we do not extend the $200.0 million (now $100.0
million) facility beyond its November 5, 2004 expiration date, or in the event
we do not otherwise enter into definitive agreements with other lenders by
November 5, 2004 which satisfy the above-described requirements in our $250.0
million facility for $100.0 million in additional credit facilities and a $40.0
million sublimit, we will need an additional amendment to the $250.0 million
facility or a waiver from the lender to continue to operate.
We cannot assure you that we will continue to receive the waivers that
we need to operate or that they will not contain conditions that are
unacceptable to us. Because we anticipate incurring losses through at least the
first quarter of fiscal 2005, we anticipate that we will need to obtain
additional waivers from our lenders and bond insurers as a result of our
non-compliance with financial covenants contained in our credit facilities and
servicing agreements. See "-- We depend upon the availability of financing to
fund our operations. Any failure to obtain adequate funding could hurt our
ability to operate profitably, restrict our ability to repay our outstanding
debt and negatively impact the value of our capital stock," and "-- Restrictive
covenants in the agreements governing our indebtedness may reduce our operating
flexibility and limit our ability to operate profitably, and our ability to
repay our outstanding debt may be impaired and the value of our capital stock
could be negatively impacted."
41
IN THE EVENT OUR COMMON STOCK IS DELISTED FROM TRADING ON THE NASDAQ NATIONAL
MARKET SYSTEM, THE VALUE OF OUR CAPITAL STOCK AND OUR ABILITY TO CONTINUE TO
SELL SUBORDINATED DEBENTURES WOULD BE NEGATIVELY IMPACTED.
Since our common stock is listed on the NASDAQ National Market System,
we are required to meet certain requirements established by the NASDAQ Stock
Market in order to maintain this listing. These requirements include, among
other things, maintenance of stockholders' equity of $10.0 million, a minimum
bid price of $1.00 and a market value of publicly held shares of $5.0 million.
On April 1, 2004, we received a notice from the NASDAQ Stock Market
that we were not in compliance with the requirement for continued listing of our
common stock on the NASDAQ National Market System on the basis that we have not
met the requirement that the minimum market value of our publicly held shares
equal at least $5.0 million. Under NASDAQ Marketplace Rules, we had 90 days, or
until June 28, 2004, to become compliant with this requirement for a period of
10 consecutive trading days. On June 15, 2004, we advised the NASDAQ Stock
Market that we had been in compliance with this requirement for 10 consecutive
trading days and we withdrew our application to list our common stock on the
American Stock Exchange, referred to as AMEX in this document, which application
we filed with AMEX upon our receipt of the letter from the NASDAQ Stock Market
described above. On June 24, 2004, we received a letter from the staff of the
NASDAQ Stock Market confirming that we had regained compliance with the NASDAQ
continued listing requirement related to the market value of our publicly held
shares and were not subject to delisting.
There can be no assurance that we will be in compliance with the
$10.0 million stockholders' equity requirement on September 30, 2004. We are
considering a new exchange offer in order to maintain compliance with this
listing requirement.
If we are unable to maintain our listing on the NASDAQ National Market
System, the value of our capital stock and our ability to continue to sell
subordinated debentures would be negatively impacted by making the process of
complying with the state securities laws more difficult, costly and time
consuming. As a result, we may be unable to continue to sell subordinated
debentures in certain states, which would have a material adverse effect on our
liquidity and our ability to repay maturing debt when due.
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, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND
NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
We generally retain interest-only strips and may retain 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 $459.1 million and
the value of our servicing rights totaled $73.7 million at June 30, 2004.
Together, these two assets represented 51.1% of our total assets at June 30,
2004. 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 outstanding debt and negatively
impact the value of our capital stock.
42
During fiscal 2004, we recorded a write down of $63.8 million on our
securitization assets. The write down consisted of a $46.4 million reduction of
pre-tax income and a $17.4 million pre-tax reduction of other comprehensive
income, a component of stockholders' equity. The write down was mainly due to
actual prepayment experience that was higher than anticipated. During fiscal
2003, we recorded a write down of $63.3 million on 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. 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 -- Impact of Changes in Critical Accounting Estimates
in Prior Fiscal Years" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- 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. See "-- 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, impair our ability to repay our
outstanding debt and negatively impact the value of our capital stock."
LENDING TO CREDIT-IMPAIRED BORROWERS MAY RESULT IN HIGHER DELINQUENCIES IN OUR
TOTAL PORTFOLIO, WHICH COULD HINDER OUR ABILITY TO OPERATE PROFITABLY, IMPAIR
OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR
CAPITAL 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 subprime borrowers, which are commonly referred to as
subprime loans, may entail a higher risk of delinquency and loss than loans made
to borrowers who use traditional financing sources. Financial institutions
utilize a credit rating system referred to as a FICO score to evaluate the
creditworthiness of borrowers and as a means to establish the risk associated
with lending to a particular borrower. The higher the FICO score, which can
range from 300 to 850, the more creditworthy the borrower is. Generally,
borrowers with FICO scores of 720 to 850 would receive the most favorable
interest rates. During fiscal 2004, the average FICO score of our subprime home
mortgage borrowers was 623. According to Standard & Poor's, subprime lenders
issued securitized transactions with mixed collateral (fixed and adjustable rate
mortgage loans) with a range of average FICO scores between 584 and 642 during
the second quarter of calendar 2004. Historically, we have experienced higher
rates of delinquency on these subprime loans 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 subprime loans, our standards and procedures
may not offer adequate protection against risks of default. When we securitize
loans we continue to bear some exposure to delinquencies and losses through our
securitization assets, which are accounted for through our credit loss
assumptions. Higher than anticipated delinquencies, foreclosures or losses in
our total portfolio could reduce the cash flow we receive from our
securitization assets which would hinder our ability to operate profitably,
restrict our ability to repay our outstanding debt and negatively impact the
value of our capital stock. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Total Portfolio Quality" and
"Business -- Lending Activities."
43
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, IMPAIR OUR ABILITY TO REPAY
OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
We re-acquire the risks of delinquency and default for non-performing
loans that we determine to repurchase from the securitization trusts. 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, could impair our ability to repay our outstanding debt and
negatively impact the value of our capital stock. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Securitizations
- -- 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, our ability to repay our outstanding debt
could be impaired and the value of our capital stock could be negatively
impacted. Lack of liquidity in these circumstances could result in more pools
reaching trigger levels, which, in turn, would further tighten liquidity.
At June 30, 2004, four of our twenty-six mortgage securitization trusts
were under a triggering event as a result of delinquencies exceeding specified
levels. There were no securitization trusts exceeding specified loss levels at
June 30, 2004. At June 30, 2003, none of our mortgage securitization trusts were
under a triggering event. Approximately $8.0 million of excess
overcollateralization is being held by the four trusts as of June 30, 2004. For
the fiscal years ended June 30, 2004 and 2003, we repurchased delinquent loans
and real estate owned with an aggregate unpaid principal balance of $54.0
million and $55.0 million, respectively, from securitization trusts primarily
for trigger management. We cannot predict when the four trusts currently
exceeding triggers will be below trigger limits and release the excess
overcollateralization. In order for these trusts to release the excess
overcollateralization, delinquent loans would need to decline, or we would need
to repurchase delinquent loans of up to $10.4 million as of June 30, 2004. We
received $40.9 million and $37.6 million of proceeds from the liquidation of
repurchased loans and real estate owned in fiscal 2004 and fiscal 2003,
respectively.
44
While our managed portfolio has significantly decreased and we
anticipate that the amount of loans repurchased from securitization trust will
decline, 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 debentures to fund these repurchases.
Prepayments by borrowers also make it more difficult for us to maintain
delinquencies below trigger limits set in securitization agreements. During
fiscal 2004 and fiscal 2003, $1.3 billion and $1.0 billion, respectively, of our
loans were prepaid by the borrowers prior to maturity. 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 our outstanding debt and
negatively impact the value of our capital stock. We currently anticipate that
the level of prepayments and prepayment speeds will decline 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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Securitizations -- Trigger
Management," "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Total Portfolio Quality," "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Securitizations"
and "Business -- Lending Activities."
AN INTERRUPTION OR REDUCTION IN THE WHOLE LOAN SALE OR SECURITIZATION MARKETS
WOULD HINDER OUR ABILITY TO OPERATE PROFITABLY AND REPAY OUR OUTSTANDING DEBT
WHICH WOULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL 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 whole loan sales or
securitizations. If we do not close whole loan sales or securitizations 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 our financial condition;
o the performance of our previously securitized loans;
o the credit quality of our total portfolio; and
o changes in federal tax laws.
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, repay our outstanding debt which would have a
material adverse effect on our results of operations, financial condition and
business prospects and would negatively impact the value of our capital stock.
If it is not possible or economical for us to complete a whole loan sale or
securitization 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
additional subordinated debentures, 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."
45
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 OUTSTANDING DEBT AND COULD
NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
Our adjusted business strategy seeks to increase our loan volume by
broadening our loan product line, offering more 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 broaden our mortgage loan product line and increase
originations of loans;
o obtain additional financing to fund our operations;
o manage the mix of loans originated in order to maximize the
timing and levels of advances under our credit facilities and
to appeal to a broader group of borrowers;
o expand in markets with a sufficient concentration of borrowers
who meet our underwriting criteria;
o maintain adequate financing on reasonable terms to fund our
loan origination;
o profitably sell our loans through whole loan sales 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 adjusted 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
outstanding debt and could negatively impact the value of our capital stock. If
we fail to successfully implement our adjusted business strategy, we will be
required to consider other alternatives, including raising equity, seeking to
convert a portion of our subordinated debentures to equity, seeking protection
under federal bankruptcy laws, seeking a strategic investor, or exploring a sale
of the company or some or all of its assets.
CHANGES IN INTEREST RATES COULD NEGATIVELY IMPACT OUR ABILITY TO OPERATE
PROFITABLY, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND COULD
NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL 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;
46
o increasing the interest rates we must pay on our subordinated
debentures 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 debentures, 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 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 outstanding debt and could negatively
impact the value of our capital stock); and
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, 2004, floating
interest rate certificates represented 12.6% 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 debentures with terms of one year or more which
are not redeemable at our option represent an unfavorable
source of borrowing in an environment where market rates fall
below those paid on the subordinated debentures (At June 30,
2004, $15.3 million in non-redeemable subordinated debentures
with maturities of greater than one year was outstanding.);
and
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, could impair our ability to repay our
outstanding debt and could negatively impact the value of our
capital stock (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, impair our ability to repay our
outstanding debt and negatively impact the value of our
capital stock.").
47
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."
OUR SECURITIZATION AGREEMENTS IMPOSE OBLIGATIONS ON US TO MAKE CASH OUTLAYS
WHICH COULD IMPAIR OUR ABILITY TO OPERATE PROFITABLY AND OUR ABILITY TO REPAY
OUR OUTSTANDING DEBT AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL 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 our outstanding
debt and could negatively impact the value of our capital
stock. See "Business -- Securitizations."
In fiscal 2004, our cash expenditures related to our securitization
agreements constituted less than $100,000. We do not anticipate that these cash
outlays will increase significantly in the foreseeable future.
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, IMPAIR
OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR
CAPITAL STOCK.
As part of the securitization of our loans, we may retain the servicing
rights, which is the right to service the loans for a fee. At June 30, 2004,
85.5% of the total portfolio we serviced was owned by third parties. The value
of servicing rights related to our total portfolio is an asset on our balance
sheet called servicing rights. We enter into agreements in connection with the
securitizations that allow bond insurers 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. Since October 2003 we have been out of compliance with the net worth
covenant in the servicing agreements associated with one bond insurer and we
have obtained a waiver from this bond insurer for this noncompliance on a
monthly basis in order to continue as servicer under these servicing agreements.
We anticipate having to obtain this waiver on a monthly basis for the
foreseeable future. There can be no assurances that we will continue to receive
the waivers necessary to operate or that such waivers will not contain
conditions that are unacceptable to us.
48
As a result of recent amendments to our servicing agreements, all of
our servicing agreements associated with the bond insurers now provide for
term-to-term servicing and, in the case of our servicing agreements with two
bond insurers, our rights as a servicer may be terminated at the expiration of a
servicing term in the sole discretion of the bond insurer. During fiscal 2004,
we did not experience any termination of servicing rights pursuant to existing
term-to-term servicing agreements. There can be no assurances that we will
continue to receive the servicing agreement extensions we need to operate or
that they will not contain conditions that are unacceptable to us. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
If we lose the right to service some or all of the loans in our total
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 our outstanding debt and
negatively impact the value of our capital 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 EXCEED 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 OUTSTANDING DEBT MAY BE IMPAIRED AND THE VALUE OF OUR CAPITAL STOCK
WOULD BE NEGATIVELY IMPACTED.
During fiscal 2003 and 2002, we experienced record levels of loan
originations. As a result of our liquidity issues, our loan volume for fiscal
2004 decreased substantially. During fiscal 2004, we originated $982.7 million
of loans as compared to originations of $1.67 billion of loans in fiscal 2003.
We anticipate that depending upon the size of our future quarterly
securitizations, if any, we will need to increase our loan originations to
approximately $400.0 million to $500.0 million per month to return to profitable
operations. If we are unable to complete quarterly securitizations, we will need
to increase our loan originations to approximately $500.0 million to $600.0
million per month to return to profitability. Our ability to achieve the level
of loan originations necessary to obtain profitable operations depends upon a
variety of factors, some of which are outside our control, including:
o interest rates;
o our ability to manage the mix of loans originated in order to
maximize the timing and levels of advances under our credit
facilities and to appeal to a broader group of borrowers;
o our ability to broaden our mortgage loan product line;
o our ability to originate loans, which have the characteristics
that qualify for us to obtain advances under our new credit
facilities (including higher loan-to-value ratios than those
originated in the past);
o our ability to obtain additional financing on reasonable
terms;
o conditions in the asset-backed securities markets;
o our ability to attract and retain qualified personnel;
o economic conditions in our primary market area;
o competition; and
o regulatory restrictions.
49
To the extent that we are not successful in maintaining or replacing
outstanding debt upon maturity, increasing and maintaining adequate warehouse
credit facilities or lines of credit to fund increasing loan originations, or
securitizing and selling our loans, we may have to limit future loan
originations and further restructure our operations. If we are unable to attain
the level of loan originations of approximately $400.0 to $500.0 million per
month with a securitization or approximately $500.0 million to $600.0 million
per month without a securitization, we may be unable to attain profitable
operations, our ability to repay our outstanding debt may be impaired and the
value of our capital stock would be negatively impacted. See "-- Changes in
interest rates could negatively impact our ability to operate profitably, impair
our ability to repay our outstanding debt and could negatively impact the value
of our capital stock."
THE LOANS WE RECENTLY ORIGINATED ARE UNSEASONED AND MAY HAVE HIGHER DELINQUENCY
AND DEFAULT RATES THAN MORE SEASONED LOAN PORTFOLIOS, WHICH COULD RESULT IN
LOSSES ON LOANS THAT ARE REQUIRED TO BE REPURCHASED BY US UNDER RECOURSE
PROVISIONS AND WHICH MAY IMPACT OUR ABILITY TO SELL LOANS IN THE SECONDARY
MARKET WHICH WOULD NEGATIVELY IMPAIR OUR ABILITY TO REPAY OUTSTANDING DEBT AND
IMPACT THE VALUE OF OUR CAPITAL STOCK.
The mortgage loans which we recently originated are unseasoned and may
have higher delinquency and default rates than seasoned mortgage loans.
Delinquency interrupts the flow of projected interest income from a mortgage
loan, and default can ultimately lead to a loss if the net realizable value of
the real property securing the mortgage loan is insufficient to cover the
principal and interest due on the loan. We start bearing the risk of delinquency
and default on loans when we originate them. Some whole loan sale agreements we
enter into with purchasers may include limited recourse provisions obligating us
to repurchase loans at the sale price in the event of unfavorable delinquency
performance of the loans sold or to refund premiums if a sold loan prepays
within a specified period. The duration of these obligations typically ranges
from 60 days to one year from the date of the loan sale. We reserve for these
premium obligations at the time of sale through an expense charge against the
gain on sale. In fiscal 2004, we had sold approximately $803.7 million of loans
under agreements containing recourse provisions, of which $624.0 million of
loans were still subject to recourse provisions at June 30, 2004. The remaining
$4.7 million of whole loan sales during fiscal 2004 were without recourse.
We attempt to manage these risks with risk-based loan pricing and
appropriate underwriting policies and loan collection methods. However, if such
policies and methods are insufficient to control our delinquency and default
risks and do not result in appropriate loan pricing and appropriate loss
reserves, our ability to repay our outstanding debt will be negatively impaired
and the value of our capital stock will be negatively impacted.
A DECLINE IN REAL ESTATE VALUES COULD RESULT IN A REDUCTION IN OUR LOAN
ORIGINATIONS, WHICH COULD HINDER OUR ABILITY TO ATTAIN PROFITABLE OPERATIONS,
IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE
OF OUR CAPITAL 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, limit our ability to
repay our outstanding debt and negatively impact the value of our capital stock.
See "Business -- Lending Activities."
50
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 OUTSTANDING DEBT AND
NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
Declining real estate values will 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, limit our ability to repay
our outstanding debt and negatively impact the value of our capital stock. In
addition, 89.9% of our loans originated during fiscal 2004 were secured by first
mortgages and 10.1% of our loans originated during fiscal 2004 were secured by
second mortgages. Our loans secured by second mortgages are more frequently
subject to delinquencies and losses on foreclosure than the loans secured by
first mortgages. 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."
THE AMOUNT OF OUR OUTSTANDING DEBT COULD IMPAIR OUR FINANCIAL CONDITION, OUR
ABILITY TO FULFILL OUR DEBT AND DIVIDEND OBLIGATIONS AND COULD NEGATIVELY IMPACT
THE VALUE OF OUR CAPITAL STOCK.
As of June 30, 2004, we had total indebtedness of approximately $847.4
million, comprised of amounts outstanding under our warehouse lines,
subordinated debentures, senior collateralized subordinated notes issued in the
exchange offers through June 30, 2004, convertible promissory notes and
capitalized lease obligations. At June 30, 2004, our ratio of total debt and
liabilities to equity was approximately 86.5 to 1. At June 30, 2004, we also had
availability to incur additional indebtedness of approximately $210.4 million
under our revolving warehouse and credit facilities. In fiscal 2005, we will be
obligated to pay $615.9 million of interest and principal on maturing debt
outstanding at June 30, 2004 and $10.9 million of dividends on Series A
preferred stock outstanding at June 30, 2004. If we issue $275.0 million of
additional subordinated debentures during fiscal 2005, we would expect to
increase the amount of interest payable in the next twelve months by
approximately $14.0 million. In addition, during fiscal 2004, we were required
to pay fees and expenses of lenders of $23.3 million in order to maintain
existing and obtain new credit facilities. During fiscal 2005, these fees and
expenses are estimated to be approximately $30.0 million.
The amount of our outstanding indebtedness could:
o require us to dedicate a substantial portion of our cash flow
to the payment of interest, principal and fees on our
indebtedness, thereby reducing the availability of our cash
flow to fund working capital, capital expenditures and other
general corporate requirements, including the payment of
dividends on our capital stock;
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.
51
In addition, the interest expense resulting from additional outstanding
debt and fees and expenses of lenders payable in order to maintain our credit
facilities would reduce our profitability and could impair our ability to repay
our outstanding debt as it matures. 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 our
obligation in an amount not to exceed 10% of the outstanding principal balance
of, and the payment of fees on, our $250.0 million credit facility and a portion
of the cash flows from our interest-only strips is pledged to secure the senior
collateralized subordinated notes issued in the exchange offers. Our inability
to obtain financing or sell assets on satisfactory terms could impair our
ability to operate profitably and our ability to repay our outstanding debt and
could negatively impact the value of our capital 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, restrict
our ability to repay our outstanding debt and negatively impact the value of our
capital stock."
WE DO NOT CURRENTLY PAY CASH DIVIDENDS ON OUR COMMON STOCK AND DO NOT ANTICIPATE
DOING SO IN THE FORESEEABLE FUTURE.
During the first quarter of fiscal 2004, we suspended paying cash
dividends on our common stock and we do not anticipate paying any cash dividends
on the common stock in the foreseeable future. As a Delaware corporation, we may
not declare and pay dividends on our capital stock if the amount paid exceeds an
amount equal to the surplus which represents the excess of our net assets over
paid-in-capital or, if there is no surplus, our net profits for the current
and/or immediately preceding fiscal year. Under applicable Delaware case law,
dividends may not be paid on our common stock if we become insolvent or the
payment of dividends will render us insolvent. As a result, to the extent that
we continue to experience losses, we may be prohibited from paying dividends on
our common stock under applicable Delaware law. In addition, the terms of Series
A preferred stock issued by us in the exchange offers may restrict the payment
of dividends on our common stock. See "-- We have issued 109.4 million shares of
the Series A preferred stock in the exchange offers, which have dividend rights
and rights upon liquidation which rank senior to our common stock."
WE HAVE ISSUED 109.4 MILLION SHARES OF THE SERIES A PREFERRED STOCK IN THE
EXCHANGE OFFERS, WHICH HAVE DIVIDEND RIGHTS AND RIGHTS UPON LIQUIDATION WHICH
RANK SENIOR TO OUR COMMON STOCK.
Our board of directors has designated 200,000,000 shares of preferred
stock as Series A preferred stock. As of August 23, 2004, 109.4 million shares
of the Series A preferred stock were outstanding as a result of the exchange
offers. Upon any voluntary or involuntary liquidation, dissolution or winding up
of our affairs, before any payment to holders of common stock, the holders of
the Series A preferred stock will be entitled to receive a liquidation
preference of $1.00 per share, plus accrued and unpaid dividends, if any, to the
date of final distribution to such holders.
We pay monthly cash dividend payments to the Series A preferred
stockholders of $0.008334 per share of the Series A preferred stock, subject to
compliance with applicable Delaware law. We are required to pay the cumulative
amount of any unpaid dividends upon liquidation of the Series A preferred stock,
or the appropriate adjustment, which takes into account unpaid dividends, will
be made upon the redemption or conversion of the Series A preferred stock. As
long as shares of the Series A preferred stock are outstanding, no dividends
will be declared or paid on our common stock unless all monthly dividends
accrued and unpaid on outstanding shares of the Series A preferred stock have
been paid in full.
52
ISSUANCE OF SHARES OF OUR COMMON STOCK UPON THE CONVERSION OF THE SERIES A
PREFERRED STOCK WILL RESULT IN SIGNIFICANT DILUTION OF EQUITY INTERESTS OF
EXISTING HOLDERS OF OUR COMMON STOCK, REDUCE THE PROPORTIONATE VOTING POWER OF
EXISTING HOLDERS OF OUR COMMON STOCK AND MAY DECREASE THE MARKET VALUE PER SHARE
OF OUR COMMON STOCK.
On or after the second anniversary of the issuance date (or on or after
the one year anniversary of the issuance date if no dividends are paid on the
Series A preferred stock outstanding on such date), the holder of shares of the
Series A preferred stock has an option to convert each share of the Series A
preferred stock into a number of shares of common stock determined by dividing:
(A) $1.00 plus an amount equal to accrued but unpaid dividends (if the
conversion date is prior to the second anniversary of the issuance date because
the Series A preferred stock has become convertible due to failure to pay
dividends), $1.20 plus an amount equal to accrued but unpaid dividends (if the
conversion date is prior to the third anniversary of the issuance date but on or
after the second anniversary of the issuance date) or $1.30 plus an amount equal
to accrued but unpaid dividends (if the conversion date is on or after the third
anniversary of the issuance date) by (B) the market price of a share of our
common stock (which figure shall not be less than $5.00 per share regardless of
the actual market price, such $5.00 minimum figure to be subject to adjustments
for stock splits, including reverse stock splits) on the conversion date.
To the extent that holders of the Series A preferred stock issued in
the exchange offers exercise their conversion rights described above, the
maximum number of shares into which 109.4 million shares of the Series A
preferred stock issued in the exchange offers may be converted is 28.5 million
shares of common stock based upon the conversion price of $1.30 per share, a
market price of $5.00 per share and assuming the payment of all dividends on the
shares of the Series A preferred stock currently outstanding. The issuance of
28.5 million shares of common stock will result in significant dilution of
equity interests of existing holders of our common stock, reduce the
proportionate voting power of existing holders of our common stock and may
decrease the market value per share of our common stock.
If we are unable to continue paying dividends on the Series A preferred
stock outstanding, this could result in the Series A preferred stock outstanding
being converted into shares of our common stock prior to the second anniversary
of the issuance date of the Series A preferred stock.
WE MAY ISSUE ADDITIONAL PREFERRED STOCK WHICH COULD BE ENTITLED TO DIVIDENDS,
LIQUIDATION PREFERENCES AND OTHER SPECIAL RIGHTS AND PREFERENCES NOT SHARED BY
HOLDERS OF OUR COMMON STOCK OR WHICH COULD HAVE ANTI-TAKEOVER EFFECTS.
We are authorized to issue up to 3,000,000 shares of blank check
preferred stock, in addition to 200,000,000 shares of preferred stock designated
as Series A preferred stock. See "-- We have issued 109.4 million shares of the
Series A preferred stock in the exchange offers, which have dividend rights and
rights upon liquidation which rank senior to our common stock." We may issue
shares of preferred stock in one or more series as our board of directors may
from time to time determine without stockholder approval. The voting powers,
preferences and other special rights and the qualifications, limitations or
restrictions of each such series of preferred stock may differ from those of the
Series A preferred stock and all other series of preferred stock at any time
outstanding. The issuance of any such preferred stock could materially adversely
affect the rights of holders of our common stock and could reduce the value of
our capital stock.
Depending on market conditions and our financial condition, we may
engage in additional exchange offers in the future and we are considering
another exchange offer in the fall of 2004, as a result of which we may issue
additional shares of preferred stock.
In addition, specific rights granted to future holders of preferred
stock could be used to restrict our ability to merge with, or sell our assets
to, a third party. The ability of the board of directors to issue preferred
stock could discourage, delay or prevent a takeover of our company, thereby
preserving control of our company by the current stockholders. See "--
Beneficial ownership of 49.7% of our common stock (excluding options) by our
executive officers and directors may limit or preclude a change in control of
our company."
53
THE VALUE OF OUR COMMON STOCK COULD BE ADVERSELY IMPACTED BY THE MARKET
PERCEPTION OF OUR COMPANY.
The market value of our common stock has decreased and may continue to
decrease based on our performance and market perception and conditions. The
market value of our common stock may be based primarily upon the market's
perception of the future viability of our company, our ability to implement our
adjusted business strategy and our ability to reduce our outstanding debt, and
may be secondarily based upon the perceived value of our interest-only strips
which constitute a substantial portion of our assets.
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 OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
IN A DECLINING INTEREST RATE ENVIRONMENT, EVEN AN EFFECTIVE HEDGING STRATEGY
COULD RESULT IN LOSSES IN THE CURRENT PERIOD WHICH COULD IMPAIR OUR ABILITY TO
REPAY OUR OUTSTANDING DEBT AND NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
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. During fiscal 2004, we recorded gains on the fair value of derivative
financial instruments of $2.5 million and paid $0.8 million of cash in
settlement of derivative financial instruments. We recorded losses on the fair
value of derivative financial instruments of $14.2 million during fiscal 2003
and $9.4 million in fiscal 2002. The amount of losses settled in cash was $7.7
million in fiscal 2003 and $9.4 million in fiscal 2002. 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 OUTSTANDING DEBT MAY BE
IMPAIRED AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.
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 outstanding
debt may be impaired and the value of our capital stock could be negatively
impacted. 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.
54
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.
The need to increase our loan volume to implement our adjusted business
strategy 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 A SMALL NUMBER OF STATES COULD HINDER OUR
ABILITY TO OPERATE PROFITABLY AND REDUCE THE FUNDS AVAILABLE TO REPAY OUR
OUTSTANDING DEBT WHICH COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
In fiscal 2004, we originated 54.5% of our mortgage loans in
California, New York, Pennsylvania, Massachusetts and Florida. The concentration
of loans in these states subjects us to the risk that a downturn in the economy
or recession in these states would more greatly affect us than if our lending
business were more geographically diversified. As a result, an economic downturn
or recession in these states could result in decreases in loan originations and
increases in delinquencies and foreclosures in our total portfolio which could
negatively impair our ability to sell or securitize loans, hinder our ability to
operate profitably, limit the funds available to repay our outstanding debt and
could negatively impact the value of our capital stock. See "Business -- Lending
Activities."
55
OUR OPERATIONS IN A SMALL NUMBER OF STATES COULD BE IMPACTED BY THE OCCURRENCE
OF A NATURAL DISASTER, WHICH COULD HINDER OUR ABILITY TO OBTAIN PROFITABLE
OPERATIONS, IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY
IMPACT THE VALUE OF OUR CAPITAL STOCK.
In fiscal 2004, we originated approximately 37.6% of our mortgage loans
in California, Florida, New Jersey, Texas, and Georgia. The occurrence of a
natural disaster, such as an earthquake or hurricane, in one or more of these
states could result in a decline in loan originations, the declining value or
destruction of the mortgaged properties in these states and an increase in the
risk of delinquency, foreclosure or loss for the loans originated by us, which
could have a material adverse effect on our business, financial conditions and
results of operations. See "Business -- Lending Activities" and "-- 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 outstanding debt and negatively impact the value
of our capital stock."
OUR RESIDENTIAL LENDING BUSINESS IS SUBJECT TO GOVERNMENT REGULATION AND
LICENSING REQUIREMENTS, WHICH MAY HINDER OUR ABILITY TO OPERATE PROFITABLY,
NEGATIVELY IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND NEGATIVELY
IMPACT THE VALUE OF OUR CAPITAL 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 46 states where we are licensed or otherwise qualified
with respect to originating, processing, underwriting, selling and servicing
home mortgage 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 entered into a joint agreement with the Civil
Division of the U.S. Attorney's Office for the Eastern District of Pennsylvania
which ended the inquiry by the U.S. Attorney focused on our forbearance policy
initiated pursuant to the civil subpoena dated May 14, 2003. See "Legal
Proceedings."
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
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.
56
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 13, 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. Prior to its
preclusion in July 2003, we had 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 on new loans in some of the states where we originate loans.
Prior to this rule becoming effective, 80% to 85% of the home mortgage loans we
originated contained prepayment fees. The origination of a high percentage of
loans with prepayment fees impacts our securitization gains and securitization
assets by helping to reduce the likelihood of a borrower prepaying their loan,
thereby prolonging the life of a securitization, and increasing the amounts of
residual cash flow, servicing fees and prepayment fees we can expect to collect
over the life of a securitization. We currently expect that the percentage of
loans that we will originate in the future containing prepayment fees will
decrease to approximately 65% to 70%. During fiscal 2004, approximately 72% of
the loans we originated contained prepayment fees. This decrease in prepayment
fee penetration will potentially reduce the amount of gains and securitization
assets we will record on any future securitizations. Because there are many
other variables including market conditions, which will also impact
securitizations, we are unable to quantify the impact of this rule on any future
securitization assets and related gains until we complete a publicly-placed
securitization of loans which we originated since this rule became effective.
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 governmental reviews of our lending practices which could
hinder our ability to operate profitably and repay our debt which could
negatively impact the value of our capital stock. See "Business -- Regulation."
57
WE ARE SUBJECT TO PRIVATE LITIGATION, INCLUDING LAWSUITS RESULTING FROM THE
ALLEGED "PREDATORY" LENDING PRACTICES, AS WELL AS SECURITIES CLASS ACTION AND
DERIVATIVE LAWSUITS, THE IMPACT OF WHICH ON OUR FINANCIAL POSITION IS UNCERTAIN.
THE INHERENT UNCERTAINTY RELATED TO LITIGATION OF THIS TYPE AND THE PRELIMINARY
STAGE OF THESE SUITS MAKES IT DIFFICULT TO PREDICT THE ULTIMATE OUTCOME OR
POTENTIAL LIABILITY THAT WE MAY INCUR AS A RESULT OF THESE MATTERS.
We are subject, from time to time, to private litigation 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 authorities, and legal proceedings arising out of their lending and
servicing activities. For example, in the purported class action entitled,
Calvin Hale v. HomeAmerican Credit, Inc., d/b/a Upland Mortgage, borrowers in
several states alleged that the charging of, and failure to properly disclose
the nature of, a document preparation fee were improper under applicable state
law. The case was ultimately settled without class certification. In addition,
on May 20, 2004, the purported consumer class action lawsuit captioned Moore v.
American Business Financial Services, Inc. et al, No. 003237 was filed against
us, our lending subsidiaries and an unrelated party in the Philadelphia Court of
Common Pleas. The lawsuit was brought on behalf of residential mortgage
consumers and challenges the validity of our deed in lieu of foreclosure and
force-placed insurance practices as well as certain mortgage service fees
charged by us. This lawsuit appears to relate, in part, to the same subject
matter as the U.S. Attorney's inquiry concluded in December 2003 with no
findings of wrongdoing as discussed in "Legal Proceedings." The lawsuit seeks
actual and treble damages, statutory damages, punitive damages, costs and
expenses of the litigation and injunctive relief. We believe the complaint
contains fundamental factual inaccuracies and that we have numerous defenses to
these allegations. 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 "Legal Proceedings."
In January and February of 2004, four class action lawsuits were filed
against us and certain of our officers and directors in the United States
District Court for the Eastern District of Pennsylvania. The consolidated
amended class action complaint that supersedes complaints filed in those four
lawsuits brings claims on behalf of a class of all purchasers of our common
stock for a proposed class period of January 27, 2000 through June 26, 2003. The
consolidated complaint alleges that, among other things, we and the named
directors and officers violated Sections 10(b) and 20(a) of the Exchange Act.
The consolidated complaint alleges that, during the applicable class period, our
forbearance and deferment practices enabled us to, among other things, lower our
delinquency rates to facilitate the securitization of our loans which
purportedly allowed us to collect interest income from our securitized loans and
inflate our financial results and market price of our common stock. The
consolidated amended class action complaint seeks unspecified compensatory
damages, costs and expenses related to bringing the action, and other
unspecified relief.
In addition, a shareholder derivative action was filed against us, as a
nominal defendant, and our directors and certain officers in the United States
District Court for the Eastern District of Pennsylvania, alleging that the named
directors and officers breached their fiduciary duties to us, engaged in the
abuse of control, gross mismanagement and other violations of law during the
period from January 27, 2000 through June 25, 2003.
Procedurally, these lawsuits are in a very preliminary stage. We
believe that we have several defenses to the claims raised by these lawsuits and
intend to vigorously defend the lawsuits. Due to the inherent uncertainties in
litigation and because the ultimate resolution of these proceedings is
influenced by factors outside of our control, we are currently unable to predict
the ultimate outcome of this litigation or its impact on our financial position
or results of operations. However, to the extent that our management will be
required to participate in or otherwise devote substantial amounts of time to
the defense of these lawsuits, such activities would result in the diversion of
our management resources from our business operations and the implementation of
our adjusted business strategy, which may negatively impact our results of
operations. See "Legal Proceedings."
58
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
OUTSTANDING DEBT AND WOULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL 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
outstanding debt and negatively impact the value of our capital stock. See
"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
OUR OUTSTANDING DEBT COULD BE ADVERSELY AFFECTED AND THE VALUE OF OUR CAPITAL
STOCK COULD BE NEGATIVELY IMPACTED.
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 our outstanding debt could be adversely affected
and the value of our capital stock could be negatively impacted.
RESTRICTIVE COVENANTS IN THE AGREEMENTS GOVERNING OUR INDEBTEDNESS MAY REDUCE
OUR OPERATING FLEXIBILITY AND LIMIT OUR ABILITY TO OPERATE PROFITABLY, AND OUR
ABILITY TO REPAY OUR OUTSTANDING DEBT MAY BE IMPAIRED AND THE VALUE OF OUR
CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.
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.
59
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. In the past, we did not meet certain
financial covenants contained in our credit facilities and we requested and
obtained waivers or amendments to our credit facilities to address our
non-compliance with these financial covenants.
The terms of our $200.0 million credit facility, as amended, required,
among other things, that we have a minimum net worth of $25.0 million at October
31, 2003 and November 30, 2003, $30.0 million at December 31, 2003, $32.0
million at March 31, 2004 and $34.0 million at June 30, 2004. An identical
minimum net worth requirement applied to an $8.0 million letter of credit
facility with the same lender through December 22, 2003, the date this facility
expired according to its terms. We obtained waivers from these net worth
requirements from the lender under these two facilities. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources -- Credit Facilities." As a result of our future
anticipated losses, we anticipate that we will also need to obtain additional
waivers in future periods from our lenders for our non-compliance with any
financial covenants 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.
WE DEPENDED ON MORTGAGE BROKERS FOR APPROXIMATELY 39% OF OUR LOAN PRODUCTION IN
FISCAL 2004 AND, IF WE ARE UNABLE TO MAINTAIN RELATIONSHIPS WITH THESE BROKERS,
IT COULD NEGATIVELY IMPACT THE VOLUME AND PRICING OF OUR LOANS, ADVERSELY AFFECT
OUR RESULTS OF OPERATIONS AND ABILITY TO REPAY OUR OUTSTANDING DEBT AND COULD
NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL STOCK.
We depended on brokers for approximately 39% of our loan originations
in fiscal 2004. In addition, our adjusted business strategy to increase loan
originations requires creating an expanded broker network, which will increase
the percentage of our loan production that will be dependent on broker
relationships. Further, our competitors also have relationships with our brokers
and other lenders, and actively compete with us in our efforts to expand our
broker network. Accordingly, we cannot assure you that we will be successful in
maintaining our existing relationships or expanding our broker network which
could negatively impact the volume and pricing of our loans, which could have a
material adverse effect on our results of operations and our ability to repay
our outstanding debt and could negatively impact the value of our capital stock.
60
SOME OF OUR WAREHOUSE FINANCING AGREEMENTS INCLUDE PROVISION FOR 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, OUR
ABILITY TO REPAY OUR OUTSTANDING DEBT AND THE VALUE OF OUR CAPITAL 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. We
have not experienced margin calls on these agreements related to the value of
loan collateral. However, during the first four months of fiscal 2004, we did
have one previous warehouse lender and the sponsor of a previous mortgage
conduit facility request that we use up to 100% of the proceeds received from
the sale of loans funded by their facilities to pay down their facilities from
their scheduled 97% advance rates to advance rates of 83% and 92%, respectively.
The requests from these facility providers were made primarily in response to
our liquidity issues and in exchange for waivers and amendments to the credit
facility. See "Management's Discussion and Analysis of Financial Position and
Results of Operations -- Liquidity and Capital Resources." These facilities were
fully paid off in October 2003.
We are unable to predict whether we will be subject to margin calls in
the foreseeable future. Any such margin call could have a material adverse
effect on our results of operations, financial condition and business prospects,
our ability to repay our outstanding debt and the value of our capital stock.
PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND DELAWARE LAW MAY HAVE THE
EFFECT OF IMPEDING A CHANGE OF CONTROL WHICH COULD NEGATIVELY IMPACT THE VALUE
OF OUR CAPITAL STOCK.
We are subject to restrictions that may impede our ability to effect a
change in control. Certain provisions contained in our certificate of
incorporation and bylaws and certain provisions of Delaware law may have the
effect of discouraging a third party from making an acquisition proposal for us
and thereby inhibit a change in control, which could negatively impact the value
of our capital stock.
BENEFICIAL OWNERSHIP OF 49.7% OF OUR COMMON STOCK (EXCLUDING OPTIONS) BY OUR
EXECUTIVE OFFICERS AND DIRECTORS MAY LIMIT OR PRECLUDE A CHANGE IN CONTROL OF
OUR COMPANY.
As of September 30, 2004, our executive officers and directors, in the
aggregate, beneficially owned approximately 49.7% of our outstanding common
stock (excluding options to purchase shares of our common stock). As a result,
these stockholders acting together are able to control most matters requiring
approval by our stockholders, including the election of directors. Such
concentration of ownership may have the effect of delaying or preventing a
change in control of our company, including transactions in which stockholders
might otherwise receive a premium for their shares over then current market
prices.
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, LIMIT THE FUNDS AVAILABLE TO REPAY OUR OUTSTANDING DEBT AND
NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL 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.
61
Since the commencement of our operations, there have been approximately
ten instances where we have determined not to foreclose on the real estate
collateralizing a delinquent loan because of environmental considerations. Two
are currently under administration. Any losses we sustained on these loans did
not have a material adverse effect on our profitability and we believe any
losses we may sustain in the future will not be material. We may face
environmental clean up costs with respect to one of the loans under
administration which we do not believe will have a material adverse effect on
our financial results.
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 OUTSTANDING DEBT MAY BE IMPAIRED
AND THE VALUE OF OUR CAPITAL STOCK COULD BE NEGATIVELY IMPACTED.
Terrorists' attacks in the United States in September 2001 caused major
instability in the United States 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 debentures, 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. 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 outstanding debt could be
impaired and the value of our capital stock could be negatively impacted.
IF MANY OF OUR BORROWERS BECOME SUBJECT TO THE SERVICEMEMBERS CIVIL RELIEF ACT,
OUR CASH FLOWS AND INTEREST INCOME MAY BE ADVERSELY AFFECTED WHICH WOULD
NEGATIVELY IMPAIR OUR ABILITY TO REPAY OUR OUTSTANDING DEBT AND WOULD NEGATIVELY
IMPACT THE VALUE OF OUR CAPITAL STOCK.
Under the Servicemembers Civil Relief Act (formerly known as 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.
62
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 AND IMPAIR OUR ABILITY TO REPAY OUR
OUTSTANDING DEBT AND COULD NEGATIVELY IMPACT THE VALUE OF OUR CAPITAL 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, 2004, we employed 931 people on a full-time basis and 38
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.
63
EXECUTIVE OFFICERS WHO ARE NOT ALSO DIRECTORS(1)
BARRY EPSTEIN, age 65, is our Managing Director of the National
Wholesale Residential Mortgage Division, a position he has held since December
2003. Mr. Epstein is responsible for the sales, marketing and day-to-day
management of our broker origination channel. From October 2003 to December
2003, Mr. Epstein was Chief Operating Officer of Rekaren, Incorporated, a
mortgage loan broker. Mr. Epstein was Managing Director and a director of
Approved FSB, a federally chartered savings bank, from 2000 to 2002. From 1998
through 2000, he was a consultant with Lincolnshire Management, Inc., an equity
fund manager. Mr. Epstein was Senior Vice President of Ocwen Financial Services,
a subsidiary of Ocwen Federal Bank of West Palm Beach, Florida, from 1996 to
1998.
STEPHEN M. GIROUX, age 56, is our Executive Vice President, General
Counsel and Secretary. Mr. Giroux is also an Executive Vice President and the
General Counsel and Secretary of all of our subsidiaries. Mr. Giroux was
promoted to Executive Vice President and Secretary in November 2003. Mr. Giroux
was our Senior Vice President and General Counsel from April 2001 to November
2003. Mr. Giroux joined us in September 1999 as Senior Vice President and Deputy
General Counsel. Prior to such time, he was a partner with the law firm of Weir
& Partners, LLC, Philadelphia, Pennsylvania from 1998 to 1999. From 1977 to
1998, Mr. Giroux was Senior Vice President and Lead Counsel for CoreStates
Financial Corp., Philadelphia, Pennsylvania, and its predecessors.
ALBERT W. MANDIA, age 57, is our Executive Vice President and Chief
Financial Officer, 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 is an
Executive Vice President and the Chief Financial Officer of all of our
subsidiaries. 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 68, is our Chairman of our Consumer Mortgage Group.
Mr. Riseman has held that position from the time he joined us in June 1999. Mr.
Riseman resigned and served as our consultant from July 2, 2003 until November
24, 2003. On November 24, 2003, Mr. Riseman rejoined us as Chairman of our
Consumer Mortgage Group. As Chairman of the Consumer Mortgage Group, Mr. Riseman
is 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 October 1998, 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.
JEFFREY M. RUBEN, age 41, is our Executive Vice President, a position
he has held since September 1998. Mr. Ruben was our 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.
BEVERLY SANTILLI, age 45, is the President of American Business Credit,
Inc. and an Executive Vice President of HomeAmerican Credit, Inc., a position
she was appointed to on June 1, 2004. Mrs. Santilli is also responsible for our
human resources and those of our subsidiaries. Mrs. Santilli was our First
Executive Vice President, from September 1998 through May 2004. Prior to
September 1998 Mrs. Santilli held a variety of positions including Executive
Vice President, Vice President and Secretary. Prior to joining American Business
Credit, Inc. 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.
____________________
(1) Ages are as of October 1, 2004.
64
ITEM 2. PROPERTIES
Except for real estate acquired in foreclosure in the normal course of
our business, we do not presently hold title to any real estate for operating
purposes. The interests which we presently hold in real estate are in the form
of mortgages against parcels of real estate owned by our borrowers or their
affiliates and real estate acquired through foreclosure.
We presently lease office space for our corporate headquarters in
Philadelphia, Pennsylvania. 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 provided 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 currently $8.0 million. The letter
of credit is currently issued by 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 performed loan servicing and collection activities at this office,
but these activities were relocated to our Philadelphia office on July 12, 2004.
The expenses and cash outlay related to the relocation were not material to our
operations.
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.
In connection with the acquisition of the California mortgage broker
operation in December 2003, we assumed the obligations under a lease for
approximately 3,700 square feet of space in West Hills, California. The
remaining term of the lease is 2 years, expiring September 30, 2006 at an annual
rental of approximately $0.1 million.
65
In connection with the opening of the Irvine, California mortgage
broker operation, we entered into a sublease on March 4, 2004 for approximately
6,400 square feet of space. The term of the sublease is 1 2/3 years and expires
November 30, 2005. The terms of the sublease require average minimum annual
rental payments of $0.1 million.
In connection with the opening of the Maryland mortgage broker
operation, we entered into a sublease on March 15, 2004 for approximately 10,300
square feet of space in Edgewater, Maryland. The term of the sublease is 3 years
and expires March 15, 2007. The terms of the sublease require increased payments
annually for the term of the lease with average minimum annual rental payments
of $0.2 million.
In connection with the acquisition of the Texas broker operation, we
entered into a sublease on June 11, 2004 for approximately 6,000 square feet of
space in Austin, Texas. The term of the sublease is 10 1/2 months, expiring
April 28, 2005 at an annual rental of approximately $0.1 million.
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 were
finalized and the action was dismissed on September 23, 2003. The matter did not
have a material effect on our consolidated financial position or results of
operations.
On May 20, 2004, the purported consumer class action lawsuit captioned
Moore v. American Business Financial Services, Inc. et al, No. 003237 was filed
against us, our lending subsidiaries and an unrelated party in the Philadelphia
Court of Common Pleas. The lawsuit was brought on behalf of residential mortgage
consumers and challenges the validity of our deed in lieu of foreclosure and
force-placed insurance practices as well as certain mortgage service fees
charged by us. This lawsuit relates, in part, to the same subject matter as the
U.S. Attorney's inquiry concluded in December 2003 with no findings of
wrongdoing as discussed below. The lawsuit seeks actual and treble damages,
statutory damages, punitive damages, costs and expenses of the litigation and
injunctive relief. Procedurally, this lawsuit is in a very preliminary stage. We
believe the complaint contains fundamental factual inaccuracies and that we have
numerous defenses to these allegations. We intend to vigorously defend this
lawsuit. Due to the inherent uncertainties in litigation and because the
ultimate resolution of this proceeding is influenced by factors outside of our
control, we are currently unable to predict the ultimate outcome of this
litigation or its impact on our financial position or results of operations.
In addition, our lending subsidiaries, including HomeAmerican Credit,
Inc., which does business as Upland Mortgage, and American Business Mortgage
Services, Inc., 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. For example,
in July 2004, we received a document request in the form of an administrative
subpoena from the New Jersey Attorney General's Office, acting as counsel for
the Office of Consumer Protection, in connection with American Business Mortgage
Services, Inc. It seeks the loan files of two borrowers and includes a broader
request for a list of loans solicited or closed by a former loan officer from
January 1, 1999 to the present. The loan officer's employment was terminated in
2001. While it would appear that the request does not raise material issues,
since this matter is in the preliminary stages, communications from the Attorney
General's Office have not been sufficient to confirm the extent of their
interest. 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 is
influenced by factors outside of our control, our estimated liability under
these proceedings may change or actual results may differ from our estimates.
66
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. On May 26,
2004, the New Jersey Supreme Court reversed the decision of the Appellate
Division of the Superior Court of New Jersey and held that the Parity Act had
preempted the New Jersey Prepayment Law, which prohibited housing lenders from
imposing prepayment penalties. However, the plaintiff has petitioned the United
States Supreme Court for certiorari in this matter.
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.
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.
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 requested 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, including: (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 we sold or transferred mortgage loans, any
instance in which we did not service or 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. On December 22, 2003, we entered into a
Joint Agreement with the Civil Division of the U. S. Attorney's Office for the
Eastern District of Pennsylvania which ends this inquiry. We do not believe that
the Joint Agreement with the U.S. Attorney's Office has had a significant impact
on our operations.
In response to the inquiry and as part of the Joint Agreement, we have
adopted a revised forbearance policy, which became effective on November 19,
2003. Under this policy, we no longer require a borrower to execute a deed in
lieu of foreclosure as a condition to entering into a forbearance agreement with
us where the real estate securing the loan is the borrower's primary residence.
Under the Joint Agreement, we also agreed to return to existing borrowers any
executed but unrecorded deeds in lieu of foreclosure obtained under our former
forbearance policy.
We also agreed to contribute a total of $80 thousand, and made this
contribution as required, to a U.S. Department of Housing and Urban Development
(HUD) approved housing counseling organization providing housing counseling in
states in which we originate mortgage loans. Under our revised forbearance
policy, eligible borrowers are sent a letter, along with our standard form
forbearance agreement encouraging them to: read the forbearance agreement; seek
the advice of an attorney or other advisor prior to signing the forbearance
agreement; and contact our consumer advocate by calling a toll-free number with
questions. The Joint Agreement requires that for 18 months following its
execution, we will notify the U.S. Attorney's Office of any material changes we
propose to make to our forbearance policy and form of forbearance agreement (or
cover letter) and that no changes to these documents shall be effective until at
least 30 days after this notification. The U.S. Attorney reserves the right to
reinstitute its inquiry if we do not comply with our revised forbearance policy,
fail to provide the 30 days notice described above, or disregard the concerns of
the U.S. Attorney's Office after providing such notice. The Joint Agreement also
requires that we provide the U.S. Attorney with two independently prepared
reports confirming our compliance with our revised forbearance policy (including
the standard form of forbearance agreement and cover letter) and internal
company training for collections department employees described below. These
reports are to be submitted to the U.S. Attorney's Office at 9 and 18 months
after the execution of the Joint Agreement. KPMG LLP, which we engaged to
perform an independent compliance audit required at the end of the 9-month
period, determined that we had complied with our policy requirements entered
into as a result of the Joint Agreement with the U.S. Attorney's Office.
67
We also agreed to implement a formal training session regarding our
revised forbearance policy for all of our collections department employees, at
which such employees are directed to inform borrowers that they can obtain
assistance from housing and credit counseling organizations and how to find such
organizations in their area. We agreed to monitor compliance with our
forbearance policy and take appropriate disciplinary action against those
employees who do not comply with this policy.
In January and February of 2004, four class action lawsuits were filed
against us and certain of our officers and directors. Lead plaintiffs and
counsel were appointed on June 3, 2004. A consolidated amended class action
complaint that supersedes these four complaints was filed on August 19, 2004 in
the United States District Court for the Eastern District of Pennsylvania. The
consolidated class action case is American Business Financial Services, Inc.
Securities Litigation, Civil Action No. 04-0265.
The consolidated amended class action complaint brings claims on behalf
of a class of all purchasers of our common stock for a proposed class period of
January 27, 2000 through June 26, 2003. The consolidated complaint names us, our
director and Chief Executive Officer, Anthony Santilli, our Chief Financial
Officer, Albert Mandia, and former director, Richard Kaufman, as defendants and
alleges that, among other things, we and the named directors and officers
violated Sections 10(b) and 20(a) of the Exchange Act. The consolidated
complaint alleges that, during the applicable class period, our forbearance and
deferment practices enabled us to, among other things, lower our delinquency
rates to facilitate the securitization of our loans which purportedly allowed us
to collect interest income from our securitized loans and inflate our financial
results and market price of our common stock. The consolidated amended class
action complaint seeks unspecified compensatory damages, costs and expenses
related to bringing the action, and other unspecified relief.
On March 15, 2004, a shareholder derivative action was filed against
us, as a nominal defendant, and our director and Chief Executive Officer,
Anthony Santilli, our Chief Financial Officer, Albert Mandia, our directors,
Messrs. Becker, DeLuca and Sussman, and our former director Mr. Kaufman, as
defendants, in the United States District Court for the Eastern District of
Pennsylvania. The complaint is captioned: Osterbauer v. Santilli, Kaufman,
Mandia, Becker, DeLuca and Sussman, Civil Action No. 04-1105. The lawsuit was
brought nominally on behalf of the Company, as a shareholder derivative action,
alleging that the named directors and officers breached their fiduciary duties
to the Company, engaged in the abuse of control, gross mismanagement and other
violations of law during the period from January 27, 2000 through June 25, 2003.
The lawsuit seeks unspecified compensatory damages, equitable or injunctive
relief and costs and expenses related to bringing the action, and other
unspecified relief. The parties have agreed to stay this case pending
disposition of any motion to dismiss the consolidated amended complaint filed in
the putative consolidated securities class action.
Procedurally, these lawsuits are in a very preliminary stage. We
believe that we have several defenses to the claims raised by these lawsuits and
intend to vigorously defend the lawsuits. Due to the inherent uncertainties in
litigation and because the ultimate resolution of these proceedings is
influenced by factors outside of our control, we are currently unable to predict
the ultimate outcome of this litigation or its impact on our financial position
or results of operations. See "Risk Factors -- We are subject to private
litigation, including lawsuits resulting from the alleged "predatory" lending
practices, as well as securities class action and derivative lawsuits, the
impact of which on our financial position is uncertain. The inherent uncertainty
related to litigation of this type and the preliminary stage of these suits
makes it difficult to predict the ultimate outcome or potential liability that
we may incur as a result of these matters."
68
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Special Meeting of Stockholders of the Company was held on June 29,
2004. The following proposal was presented to stockholders and voted on at the
Special Meeting:
To approve a proposal to issue shares of the Series A preferred stock
in connection with the second exchange offer and shares of common stock issuable
upon the conversion of Series A Preferred Stock (the "Proposal").
The results of the voting on the Proposal at the Special Meeting were
as follows:
Shares For Shares Against Shares Abstaining Broker Non-votes
2,102,819 27,877 3,372 0
69
PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASE OF SECURITIES
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, 2002............................ 14.42 5.78
December 31, 2002............................. 11.52 8.81
March 31, 2003................................ 13.56 9.14
June 30, 2003................................. 11.55 5.77
September 30, 2003............................ 7.25 4.00
December 31, 2003............................. 6.62 2.83
March 31, 2004................................ 4.09 2.73
June 30, 2004................................. 5.60 2.97
September 30, 2004............................ 5.75 3.54
On September 30, 2004, the closing price of the common stock on the
NASDAQ National Market System was $4.00.
On April 1, 2004, we received a notice from the NASDAQ Stock Market
that we were not in compliance with the requirement for continued listing of our
common stock on the NASDAQ National Market System on the basis that we have not
met the requirement that the minimum market value of our publicly held shares
equals at least $5.0 million. Under NASDAQ Marketplace Rules, we had 90 days, or
until June 28, 2004, to become compliant with this requirement for a period of
10 consecutive trading days. On June 15, 2004, we advised the NASDAQ Stock
Market that we had been in compliance with this requirement for 10 consecutive
trading days and we withdrew our application to list our common stock on the
American Stock Exchange, referred to as AMEX in this document, which application
we filed with AMEX upon our receipt of the letter from the NASDAQ Stock Market
described above. On June 24, 2004, we received a letter from the staff of the
NASDAQ Stock Market confirming that we had regained compliance with the NASDAQ
continued listing requirement related to the market value of our publicly held
shares and were not subject to delisting. There can be no assurance that we will
be in compliance with the $10.0 million stockholders' equity requirement on
September 30, 2004. We are considering a new exchange offer in order to maintain
compliance with this listing requirement. If we are unable to maintain our
listing on the NASDAQ National Market System, the value of our capital stock and
our ability to continue to sell subordinated debentures would be negatively
impacted by making the process of complying with the state securities laws more
difficult, costly and time consuming. As a result, we may be unable to continue
to sell subordinated debentures in certain states, which would have a material
adverse effect on our liquidity and our ability to repay maturing debt when due.
As of October 5, 2004, there were 1,131 record holders and
approximately 1,470 beneficial holders of our common stock.
On May 13, 2004, our board of directors declared a 10% common stock
dividend, which was paid on June 8, 2004 to common stockholders of record as of
May 25, 2004. Stock price and related information contained in this document
have been adjusted to reflect this stock dividend.
70
During the first quarter of fiscal 2004, we suspended paying quarterly
cash dividends on our common stock. During the fiscal year ended June 30, 2003,
we paid dividends of $0.291 per share on our common stock for an aggregate
dividend payment of $0.9 million.
On August 21, 2002, the Board of Directors declared a 10% stock
dividend on our common stock which was paid on September 13, 2002 to
shareholders of record as of September 3, 2002. All cash dividends on our common
stock reported above have been adjusted to reflect all stock dividends.
The payment of dividends on our common stock 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.
During fiscal 2004, we declared the following dividends on our Series A
preferred stock (in thousands, except per share):
PREFERRED TOTAL
DIVIDEND PER PREFERRED
FOR THE MONTH ENDED SHARE DIVIDENDS
- -------------------------------------------- ------------ ---------
January 31, 2004............................ $ 0.008334 $ 323
February 29, 2004........................... 0.008334 514
March 31, 2004.............................. 0.008334 515
April 30, 2004.............................. 0.008334 515
May 31, 2004................................ 0.008334 515
June 30, 2004............................... 0.008334 515
---------
$2,897
=========
As a Delaware corporation, we may not declare and pay dividends on
capital stock if the amount paid exceeds an amount equal to the surplus which
represents the excess of our net assets over paid-in-capital or, if there is no
surplus, our net profits for the current and/or immediately preceding fiscal
year. Dividends cannot be paid from our net profits unless the paid-in-capital
represented by the issued and outstanding stock having a preference upon the
distribution of our assets at the market value is intact. Under applicable
Delaware case law, dividends may not be paid on our Series A preferred stock or
common stock if we become insolvent or the payment of the dividend will render
us insolvent. To the extent we pay dividends and we are deemed to be insolvent
or inadequately capitalized, a bankruptcy court could direct the return of any
dividends. In addition, pursuant to the terms of the Series A preferred stock,
no dividends may be paid on shares of Series A preferred stock or set apart for
payment by us if the terms of any of our agreements prohibit such declaration,
payment or setting apart for payment or provide that such declaration, payment
or setting apart for payment would constitute a breach thereof or a default
thereunder, or if such declaration or payment shall be restricted by agreement
or law, would be unlawful, or would cause us to become insolvent as contemplated
by the Delaware law.
See "Part III - Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters" for the information
regarding our equity compensation plans.
On February 11, 2003, the Board of Directors issued 2,000 shares (2,200
shares after the effect of subsequent stock dividends) of common stock to each
of Warren E. Palitz, a current director, and Jeffrey S. Steinberg, a former
director, in consideration for their board service. This issuance was exempt
from registration under Section 4(2) of the Securities Act of 1933, as amended,
referred to as the Securities Act, based upon a determination that the investors
were sophisticated, had access to, and were provided with, information that
would otherwise be contained in a registration statement and there was no
general solicitation.
71
As of December 24, 2003, we issued a convertible non-negotiable
promissory note; referred to as the note in this document, in the principal
amount of $475,000 to Rekaren, Incorporated, a California corporation referred
to as Rekaren, as partial consideration for the purchase of certain assets of
Rekaren. At any time on or after December 24, 2004 and before January 31, 2005,
the outstanding principal balance of, and accrued interest under, the note is
convertible, at the holder's option, into the number of shares of our common
stock determined by dividing the aggregate principal amount of the note by the
conversion price of $5.00 per share (the conversion price is subject to
adjustments in case of a stock split, combination, reclassification or other
similar event effected by us with respect to the common stock). We issued the
note in reliance on the exemption from registration under Section 4(2) of the
Securities Act based upon a determination that the investor was sophisticated,
had access to, and was provided with, information that would otherwise be
contained in a registration statement and there was no general solicitation.
As of December 24, 2003, we issued 200,000 shares (220,000 after the
effect of subsequent stock dividends) of common stock to Barry Epstein, the
newly hired experienced industry professional to head the National Wholesale
Residential Mortgage Division, as an inducement material to his employment with
us pursuant to the employment agreement and restricted stock agreement by and
between us and Mr. Epstein, dated December 24, 2003. We issued the foregoing
shares in reliance on the exemption from registration under Section 4(2) of the
Securities Act based upon a determination that the security was issued to a
sophisticated investor who had access to, and was provided with, information
that would otherwise be contained in a registration statement and there was no
general solicitation.
As of February 6, 2004, in connection with the first exchange offer, we
issued $55.4 million in the aggregate principal amount of senior collateralized
subordinated notes and 61.8 million shares of Series A preferred stock in
exchange for $117.2 million in the aggregate principal amount of subordinated
debentures issued prior to April 1, 2003. As of June 30, 2004, in connection
with the second exchange offer, we issued $28.6 million in the aggregate
principal amount of senior collateralized subordinated notes and 32.0 million
shares of Series A preferred stock in exchange for $60.6 million in the
aggregate principal amount of subordinated debentures. We issued the foregoing
senior collateralized subordinated notes and shares of the Series A preferred
stock in reliance on the exemption from the registration under Section 3(a)(9)
of the Securities Act.
We believe that the exchange offers met all of the requirements of the
exemption provided by Section 3(a)(9) of the Securities Act because (i) we were
the issuer of both (a) the senior collateralized subordinated notes and the
Series A preferred stock issued in the exchange offers and (b) the subordinated
debentures exchanged; (ii) the exchange offers involved an exchange exclusively
with our existing security holders and did not involve any new consideration
being paid by security holders; and (iii) we did not pay, and do not intend to
pay, any compensation for soliciting holders of subordinated debentures to
participate in the exchange offers.
As of June 11, 2004, we issued a convertible non-negotiable promissory
note, referred to as the ESI note in this document, in the principal amount of
$650,000 to ESI Mortgage, LP, a Texas limited partnership referred to as ESI, as
partial consideration for the purchase of certain assets of ESI. At any
principal payment date (based on an installment schedule), the principal balance
due under the ESI note is convertible, at the holder's option, into the number
of shares of our common stock determined by dividing the aggregate principal
amount then due under the ESI note by the closing sales price per share of our
common stock on the immediately preceding principal due date, except for the
principal amount due on December 31, 2004, which is based on the closing sales
price per share of our common stock on June 11, 2004. However, the ESI note may
not be converted by the holder as of the December 31, 2004 principal payment
date if such conversion would negatively impact the securities law exemptions
available with respect to our unregistered securities offerings occurring during
the period from June 11, 2004 through the first principal payment date, in which
case the principal amount which would have been convertible as of such date will
be convertible on March 31, 2005, at the same exchange ratio that would have
applied to a December 31, 2004 conversion. We issued the ESI note in reliance on
the exemption from registration under Section 4(2) of the Securities Act based
upon a determination that the investor was sophisticated, had access to, and was
provided with, information that would otherwise be contained in a registration
statement and there was no general solicitation.
72
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.
YEAR ENDED JUNE 30,
-----------------------------------------------------
2004 2003 2002 2001 2000
--------- -------- --------- --------- --------
STATEMENT OF INCOME DATA: (In thousands, except per share data)
Revenues:
Gain on sale of loans and leases:
Securitizations.................... $ 15,107 $170,950 $185,580 $128,978 $ 90,380
Whole loan sales................... 18,725 655 2,448 2,742 1,717
Interest and fees.................... 17,732 19,395 18,890 19,840 17,683
Interest accretion on interest-only
strips............................. 40,176 47,347 35,386 26,069 16,616
Other................................ 5,332 3,059 5,597 5,707 4,250
--------- -------- -------- -------- --------
Total revenues.......................... 97,072 241,406 247,901 183,336 130,646
Total expenses(a)....................... 276,794 290,426 234,351 170,151 120,284
--------- -------- -------- -------- --------
Income (loss) before provision for income
taxes (benefit)...................... (179,722) (49,020) 13,550 13,185 10,362
Provision for income taxes (benefit).... (68,294) (19,118) 5,691 5,274 3,938
--------- -------- -------- -------- --------
Income (loss) before cumulative effect of
a change in accounting principle..... (111,428) (29,902) 7,859 7,911 6,424
Cumulative effect of a change in
accounting principle................. -- -- -- 174 --
--------- -------- -------- -------- --------
Income (loss) before dividends on
preferred stock....................... (111,428) (29,902) 7,859 8,085 6,424
Dividends on preferred stock............ 3,718 -- -- -- --
--------- -------- -------- -------- --------
Net income (loss) attributable to common
stock................................ $(115,146) $(29,902) $ 7,859 $ 8,085 $ 6,424
========= ======== ======== ======== ========
Per Common Share Data:
Income (loss) before cumulative effect of
a change in accounting principle (b):
Basic earnings (loss) per common share $ (34.07) $ (9.32) $ 2.44 $ 1.89 $ 1.41
Diluted earnings (loss) per common share (34.07) (9.32) 2.26 1.85 1.37
Net income (loss):
Basic earnings (loss) per common share $ (34.07) $ (9.32) $ 2.44 $ 1.94 $ 1.41
Diluted earnings (loss) per common share (34.07) (9.32) 2.26 1.89 1.37
Cash dividends declared per common share. -- 0.291 0.255 0.236 0.227
_____________________________
(a) Includes securitization assets fair value adjustments of $41.2 million
for the fiscal year ended June 30, 2004, $45.2 million for the fiscal
year ended June 30, 2003, $22.1 million for the fiscal year ended June
30, 2002 and $12.6 million for the fiscal year ended June 30, 2000.
(b) Amounts for the years ended June 30, 2003 and prior have been
retroactively adjusted to reflect the effect of a 10% common stock
dividend declared May 13, 2004 as if the additional shares had been
outstanding for each period presented. Amounts for the years ended June
30, 2002 and prior have been retroactively adjusted to reflect the
effect of a 10% stock dividend declared August 21, 2002. Amounts for
the years ended June 30, 2001 and prior have been retroactively
adjusted to reflect the effect of a 10% stock dividend declared October
1, 2001.
73
JUNE 30,
--------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents ... $ 910 $ 36,590 $ 99,599 $ 84,667 $ 66,507
Restricted cash ............. 13,307 10,885 9,000 6,425 3,244
Loan and lease receivables:
Loans available for sale . 304,275 263,419 45,919 78,060 29,699
Non-accrual loans ........ 1,993 3,999 3,868 2,831 3,474
Lease receivables ........ -- 3,984 7,891 14,030 18,629
Interest and fees receivable 18,089 10,838 9,595 14,582 11,071
Deferment and forbearance
advances receivable ....... 6,249 4,341 2,697 1,967 1,931
Loans subject to repurchase
rights..................... 38,984 23,761 9,028 2,428 --
Interest-only strips ........ 459,086 598,278 512,611 398,519 277,872
Servicing rights ............ 73,738 119,291 125,288 102,437 74,919
Receivable for sold loans and
leases..................... -- 26,734 -- -- 46,333
Total assets ................ 1,042,870 1,159,351 876,375 766,487 594,282
Subordinated debentures ..... 522,609 719,540 655,720 537,950 390,676
Senior collateralized
subordinated notes......... 83,639 -- -- -- --
Total liabilities ........... 1,030,955 1,117,282 806,997 699,625 532,167
Stockholders' equity ........ 11,915 42,069 69,378 66,862 62,115
YEAR ENDED JUNE 30,
--------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
OTHER DATA:
Total loans and leases on
balance sheet................. $ 303,603 $ 267,325 $ 59,386 $ 91,615 $ 48,580
Originations(a):
Business purpose loans........ 587 122,790 133,352 120,537 106,187
Home mortgage loans........... 982,093 1,543,730 1,246,505 1,096,440 949,014
Average loan size of loans
originated(a):
Business purpose loans........ 293 92 97 91 89
Home mortgage loans........... 119 91 89 82 70
Weighted average interest rate
of loans originated(a):
Business purpose loans........ 14.62% 15.76% 15.75% 15.99% 15.99%
Home mortgage loans........... 7.86 9.99 10.91 11.46 11.28
Combined...................... 7.86 10.42 11.38 11.91 11.64
Loans and leases sold:
Securitizations............... $ 141,407 $1,423,764 $1,351,135 $1,102,066 $1,001,702
Whole loan sales.............. 808,378 28,013 57,679 76,333 102,670
_________________
(a) Conventional first mortgages and leases originated in fiscal 2000 have
been excluded because we no longer originate these types of loans and
leases.
74
YEAR ENDED JUNE 30,
-------------------------------------------------------------
FINANCIAL RATIOS: 2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
Return on average assets....... (11.60)% (3.07)% 0.94% 1.22% 1.31%
Return on average equity....... (566.80) (44.20) 11.75 12.22 10.29
Total delinquencies as a
percentage of total on
balance sheet portfolio at
end of period(a)............ 1.19 1.97 11.72 3.87 6.08
Real estate owned as a
percentage of total on
balance sheet portfolio at
end of period............... 0.63 1.79 6.37 2.53 3.41
Loan and lease losses as a
percentage of the average
total on balance sheet
portfolio during the
period (b).................. 8.93 5.17 4.23 3.31 1.09
Pre-tax income (loss) as a
percentage of total
revenues.................... (1.11) (20.00) 5.47 7.19 7.93
Ratio of earnings to fixed
charges(c).................. (1.42)x 0.31x 1.19x 1.23x 1.26x
_________________
(a) Includes loans delinquent 31 days or more and excludes real estate
owned 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
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).
(b) Percentage based on annualized losses and average total portfolio.
(c) Earnings (loss) before income taxes and fixed charges were insufficient
to cover fixed charges by $183.4 million and $49.0 million for the
years ended June 30, 2004 and 2003, respectively.
The following table presents financial ratios and measures for our
total portfolio and total real estate owned, referred to as REO. The total
portfolio measure includes loans and leases recorded on our balance sheet and
securitized loans and leases both managed by us and serviced by others.
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 portfolio and total
REO. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Reconciliation of Non-GAAP Financial Measures" for a
reconciliation of total portfolio and managed real estate owned to our balance
sheet.
YEAR ENDED JUNE 30,
---------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Total Portfolio - Loans and
Leases..................... $2,231,689 $3,651,074 $3,066,189 $2,589,395 $1,918,540
FINANCIAL RATIOS:
Total delinquencies as a
percentage of total
portfolio at end of period.. 10.67% 6.27% 5.59% 4.13% 2.91%
Real estate owned as a
percentage of total
portfolio at end of period.. 1.54 0.77 1.11 1.10 0.68
Loan and lease losses as a
percentage of the average
total portfolio during the
period...................... 1.02 0.36 0.28 0.53 0.31
75
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, 2004, 2003 and
2002 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.
OVERVIEW
GENERAL. We are a financial services organization operating mainly in
the eastern and central portions of the United States. Recent expansion has
positioned us to increase our operations in the western portion of the United
States, especially California. See "-- Business Strategy Adjustments" for
details of our acquisition of a broker operation located in California. Through
our principal direct and indirect subsidiaries, we originate, sell and service
home mortgage loans. We also process and purchase home mortgage loans through
our Bank Alliance Services program. See "Business -- Lending Activities -- Home
Mortgage Loans" for a description of this program and the amount of loans we
purchased under this program. Additionally, we service business purpose loans,
which we had originated and sold in prior periods. To the extent we obtain a
credit facility to fund business purpose loans, we may originate and sell
business purpose loans in future periods.
In addition, we offer subordinated debentures 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 and funding our loan overcollateralization requirements under our credit
facilities), investments in systems and technology and for general corporate
purposes.
Historically, our loans primarily consisted of fixed interest rate
loans secured by first or second mortgages on one-to-four family residences. Our
business strategy adjustments include increasing loan originations by offering
adjustable rate loans and purchase money mortgage loans. During the fourth
quarter of fiscal 2004, 46.7% of loans we originated were adjustable rate and
53.3% were fixed rate. During fiscal 2004, 18.0% of the loans we originated were
purchase money mortgage loans. During fiscal 2004, 89.9% of the loans we
originated were secured by first mortgages and 10.1% were secured by second
mortgages.
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. This type of borrower is commonly
referred to as a subprime borrower. Loans made to subprime borrowers are
frequently referred to as subprime loans.
We originate loans through a combination of channels including a
national processing center located at our centralized operating office in
Philadelphia, Pennsylvania and a network of mortgage brokers. Our loan servicing
and collection activities are performed at our Philadelphia office.
76
Our loan origination volumes, and accordingly our financial results,
are affected by the economic environment, including interest rates, consumer
spending and debt levels, real estate values and employment rates. Additionally,
our loan originations are affected by competitive conditions and regulatory
influences.
Our principal revenues are derived from gains on the sale of loans in
either whole loan sales or securitizations, interest accretion on our
interest-only strips, interest income earned on loans while they are carried on
our balance sheet and income from servicing loans.
Our principal expenses include interest expense incurred on our
subordinated debentures and senior collateralized subordinated notes, interest
expense incurred to fund loans while they are carried on our balance sheet, the
provision for credit losses recognized on loans carried on our balance sheet and
loans repurchased from securitization trusts, employee related costs, marketing
costs, costs to service and collect loans and other administrative expenses.
Our critical success factors include our ability to originate loans,
our ability to sell loans in whole loan sales or into securitizations, our
ability to maintain credit and warehouse facilities to fund loan originations,
and our ability to raise capital through the sale of subordinated debentures.
OUR RECENT FINANCIAL DIFFICULTIES AND LIQUIDITY CONCERNS. Several
events and issues, which occurred beginning in the fourth quarter of fiscal
2003, have negatively impacted our short-term liquidity and contributed to our
losses for fiscal 2003 and fiscal 2004. These events included our inability to
complete publicly underwritten securitizations during the fourth quarter of
fiscal 2003 and all of fiscal 2004 (we completed a privately-placed
securitization in the second quarter of fiscal 2004), our inability to draw down
upon and the expiration of several of our credit facilities, and our temporary
discontinuation of sales of new subordinated debentures for approximately a
six-week period during the first quarter of fiscal 2004.
77
Our inability to complete a 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 securitizations of loans for
another unaffiliated subprime leader, an inquiry by the Civil Division of the
U.S. Attorney's Office in Philadelphia regarding our forbearance practices, an
anonymous letter regarding us received by our investment bankers, the SEC's
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 securitizations transactions with non-affiliated
originators.
We were unable to complete a publicly underwritten securitization
during fiscal 2004 due to our diminished capacity to originate loans, our
commitment to whole loan sales under our adjusted business strategy, our
financial condition and liquidity issues, and an absence of market demand for
our securitizations. We completed a privately-placed securitization during the
second quarter of fiscal 2004.
As a result of these liquidity issues our loan origination volume
during fiscal 2004 was substantially reduced. From July 1, 2003 through June 30,
2004, we originated $982.7 million of loans, as compared to originations of
$1.67 billion of loans for the same period in fiscal 2003. We anticipate that
depending upon the size of our future quarterly securitizations, if any, we will
need to increase our loan originations to approximately $400.0 million to $500.0
million per month to return to profitable operations. If we are unable to
complete quarterly securitizations, we will need to increase our loan
originations to approximately $500.0 million to $600.0 million per month to
return to profitability. Our ability to achieve the levels of loan originations
necessary to achieve profitable operations could be hampered by our failure to
continue to successfully implement our adjusted business strategy, funding
limitations under existing credit facilities and our ability to obtain new
credit facilities and renew existing facilities. Our plan is to increase loan
originations through the continued application of our business strategy
adjustments, particularly as related to building our expanded broker channel and
offering adjustable rate mortgages and more competitively priced fixed rate
mortgages. See "Business -- Business Strategy" for a discussion of our plans to
achieve this level of originations. For a detailed discussion of our losses,
capital resources and commitments, see "-- Liquidity and Capital Resources."
We have entered into a commitment letter and anticipate entering into a
definitive agreement regarding a $100.0 million credit facility to replace our
$200.0 million facility (reduced to $100.0 million on September 30, 2004) that
expires on November 5, 2004. However, we cannot assure you that we will enter
into a definitive agreement regarding the $100.0 million credit facility or that
this agreement will contain terms and conditions acceptable to us.
78
We are currently negotiating additional credit facilities to provide
additional borrowing capacity to fund the increased level of loan originations
expected under our adjusted business strategy, however, no assurances can be
given that we will succeed in obtaining new credit facilities or that these
facilities will contain terms and conditions acceptable to us. See "-- Liquidity
and Capital Resources" for a discussion of these facilities.
On June 30, 2004, we had unrestricted cash of approximately $0.9
million and up to $210.4 million available under our warehouse credit
facilities. We can only use advances under these credit facilities to fund loan
originations and not for any other purposes. The combination of our current cash
position and expected sources of operating cash may not be sufficient to cover
our operating cash requirements.
For the next six to twelve months, we intend to augment our sources of
operating cash with proceeds from the issuance of subordinated debentures. In
addition to repaying maturing subordinated debentures, proceeds from the
issuance of subordinated debentures may be used to fund overcollateralization
requirements, as defined below, in connection with our loan originations and to
fund our operating losses. Under the terms of our credit facilities, our credit
facilities will advance us 75% to 97% of the value of loans we originate. See
"-- Liquidity and Capital Resources" for a discussion of advance rates under the
terms of our credit facilities." As a result of this limitation, we must fund
the difference between the loan value and the advances, which we refer to as the
overcollateralization requirement, from our operating cash. We can provide no
assurances that we will be able to continue issuing subordinated debentures.
See "-- Liquidity and Capital Resources -- Remedial Steps Taken to
Address Liquidity Issues" for a discussion of the specific actions we undertook
to address liquidity concerns.
RECENT OPERATING LOSSES AND SALE OF ASSETS. We incurred a net loss
attributable to common stock of $115.1 million and $29.9 million for the fiscal
years ended June 30, 2004 and 2003, respectively. In addition, depending on our
ability to recognize gains on our future securitizations, we anticipate
incurring operating losses at least through the first quarter of fiscal 2005.
The loss for fiscal 2004 primarily resulted from liquidity issues we
have experienced since the fourth quarter of fiscal 2003, including the absence
of credit facilities until the second quarter of fiscal 2004, which
substantially reduced our loan origination volume and our ability to generate
revenues, our inability to complete a publicly underwritten securitization
during fiscal 2004, our shift in business strategy to focus on whole loan sales,
and charges to the income statement of $46.4 million for pre-tax valuation
adjustments on our securitization assets. Additionally, operating expense levels
that would support greater loan origination volume also contributed to the loss
for fiscal 2004.
During fiscal 2004, we recorded total pre-tax valuation adjustments on
our interest-only strips and servicing rights of $63.8 million, of which $46.4
million was charged as expense to the income statement and $17.4 million was
charged to other comprehensive income, a component of stockholders' equity.
These adjustments primarily reflect the impact of higher than anticipated
prepayments on securitized loans experienced in fiscal 2004 due to the low
interest rate environment experienced during fiscal 2004. Additionally, the
fiscal 2004 valuation adjustment also includes a write down of $5.4 million of
the carrying value of our interest-only strips and servicing rights related to
five of our mortgage securitization trusts to reflect their values under the
terms of a September 27, 2004 sale agreement. The sale of these assets was
undertaken as part of our negotiations to obtain the new $100.0 million
warehouse credit facility described in "-- Liquidity and Capital Resources" and
to raise cash to pay fees on new warehouse credit facilities and as a result, we
did not realize their full value as reflected on our books. This compares to
total pre-tax valuation adjustments on our securitization assets of $63.3
million during the year ended June 30, 2003, of which $45.2 million was charged
as expense to the income statement and $18.1 million was reflected as an
adjustment to other comprehensive income. See "- Application of Critical
Accounting Estimates - Interest-Only Strips" for a discussion of how valuation
adjustments are recorded.
EXCHANGE OFFERS. On December 1, 2003, we mailed an offer to exchange,
which we refer to as the first exchange offer, to holders of our subordinated
debentures issued prior to April 1, 2003. On May 14, 2004, we mailed a second
offer to exchange, which we refer to as the second exchange offer, to holders of
our subordinated debentures issued prior to November 1, 2003. See "-- Liquidity
and Capital Resources -- Subordinated Debentures" for more detail on the terms
of the exchange offers, senior collateralized subordinated notes and Series A
preferred stock issued and the results of the exchange offers.
Depending on market conditions and our financial condition, we may
engage in additional exchange offers in the future and we are considering
another exchange offer in our second quarter of fiscal 2005.
79
AMOUNT OF OUR INDEBTEDNESS. At June 30, 2004, we had total
indebtedness of approximately $847.4 million, comprised of amounts outstanding
under our credit facilities, senior collateralized subordinated notes issued in
the exchange offers, capitalized leases and subordinated debentures. See "--
Liquidity and Capital Resources -- Secured and Unsecured Indebtedness " for a
comparison at June 30, 2004 of our secured and senior debt obligations and
unsecured subordinated debenture obligations to assets which are available to
repay those obligations.
BUSINESS STRATEGY ADJUSTMENTS. In response to our inability to
securitize our loans and the liquidity concerns described above, we adjusted our
business strategy at the beginning of fiscal 2004. Our adjusted business
strategy focuses on shifting 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. See "Business -- Business Strategy" for information regarding our
adjusted business strategy.
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 reasonable terms and to profitably sell or
securitize 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 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 outstanding
debt and could negatively impact the value of our capital stock."
If we fail to generate sufficient liquidity through the sales of our
loans, the sale of our subordinated debentures, the maintenance of credit
facilities or a combination of the foregoing, we will have to restrict loan
originations and make additional changes to our business strategy, including
restricting or restructuring our operations which could result in losses and
impair our ability to repay our subordinated debentures and other outstanding
debt. While we currently believe that we will 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 debentures
when due. If we fail to successfully implement our adjusted business strategy,
we will be required to consider other alternatives, including raising additional
equity, seeking to convert an additional portion of our subordinated debentures
to equity, seeking protection under federal bankruptcy laws, seeking a strategic
investor, or exploring a sale of the company or some or all of its assets. 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, restrict our ability to repay our outstanding
debt and negatively impact the value of our capital stock" and "-- If we are
unable to obtain additional financing, we may be not be able to restructure our
business to permit profitable operations or repay our outstanding debt and the
value of our capital stock will be negatively impacted."
In addition to the above potential restrictions and changes to our
business strategy, in the event we are unable to offer additional subordinated
debentures for any reason, we have developed a contingent financial
restructuring plan including cash flow projections for the next twelve-month
period. Based on our current cash flow projections, we anticipate being able to
make all scheduled subordinated debenture maturities and vendor payments.
80
The contingent financial restructuring plan is based on actions that we
would take, in addition to those indicated in our adjusted business strategy, to
reduce our 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 obtaining working capital funding. No assurance can be given that we will be
able to successfully implement the contingent financial restructuring plan, if
necessary, and repay the subordinated debentures when due.
CREDIT FACILITIES, SERVICING AGREEMENTS AND WAIVERS RELATED TO
FINANCIAL COVENANTS. At various times since June 30, 2003, including at June 30,
2004, July 31, 2004, August 31, 2004 and September 30, 2004, we have been out of
compliance with one or more financial covenants contained in our $200.0 million
credit facility (reduced to $100.0 million). We have continued to operate on the
basis of waivers granted by the lender under this facility. We currently
anticipate that we will be out of compliance with one or more of these financial
covenants at October 31, 2004 and will need a waiver from this lender for this
noncompliance to continue to operate. The expiration date of this facility was
originally September 21, 2004, but the lender agreed to extend the expiration
date until November 5, 2004 in consideration for, among other things, a
reduction in the amount that could be borrowed under this facility to $100.0
million.
A provision in our $250.0 million credit facility required us to
maintain another credit facility for $200.0 million with a $40.0 million
sublimit of such facility available for funding loans between the time they are
closed by a title agency or closing attorney and the time documentation for the
loans is received by the collateral agent. As a result of the reduction of our
$200.0 million facility to $100.0 million, as described above, we entered into
an amendment to the master loan and security agreement governing our $250.0
million facility which reduced the required amount for another facility to
$100.0 million. In the event we do not extend the $200.0 million (now $100.0
million) facility beyond its November 5, 2004 expiration date, or in the event
we do not otherwise enter into definitive agreements with other lenders by
November 5, 2004 which satisfy the above-described requirements in our $250.0
million facility for $100.0 million in additional credit facilities and a $40.0
million sublimit, we will need an additional amendment to the $250.0 million
facility or a waiver from the lender to continue to operate.
At various times since June 30, 2003 we have also been out of
compliance with the net worth requirement in several of our pooling and
servicing agreements and sale and servicing agreements (collectively referred to
in this document as the servicing agreements). Two of the financial insurers who
provide financial guaranty insurance to certain bond holders and certificate
holders under these servicing agreements (collectively referred to in this
document as bond insurers) required us to amend the servicing agreements in
consideration for granting us waivers from this noncompliance. One bond insurer
granted us a permanent waiver from this noncompliance in consideration for a
term-to-term servicing arrangement. The other bond insurer granted us a one-time
waiver in consideration for a term-to-term servicing arrangement. Since then, we
have had to obtain a waiver of net worth requirements from this bond insurer on
a monthly basis and we currently anticipate that we will need to do so for the
foreseeable future.
Due to our financial results during fiscal 2004, two other bond
insurers required us to amend the servicing agreements related to the
securitizations these bond insurers insured. As a result of the amendments to
our servicing agreements, all of our servicing agreements associated with bond
insurers now provide for term-to-term servicing and, in the case of our
servicing agreements with two bond insurers, our rights as servicer may be
terminated at the expiration of a servicing term in the sole discretion of the
bond insurer.
81
We cannot assure you that we will continue to receive the waivers and
servicing agreement extensions that we need to operate or that they will not
contain conditions that are unacceptable to us. Because we anticipate incurring
losses through at least the first quarter of fiscal 2005, we anticipate that we
will need to obtain additional waivers from our lenders and bond insurers as a
result of our non-compliance with financial covenants contained in our credit
facilities and servicing agreements. To the extent we are not able to obtain
waivers under our credit facilities, we may be unable to pay dividends on the
Series A preferred stock. See "-- Liquidity and Capital Resources" for
additional information regarding the waivers obtained. See also "Risk Factors --
Restrictive covenants in the agreements governing our indebtedness may reduce
our operating flexibility and limit our ability to operate profitability, and
our ability to repay our outstanding debt may be impaired and the value of our
capital stock could be negatively impacted" and " -- 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, impair our ability to repay our
outstanding debt and negatively impact the value of our capital stock."
DELINQUENCIES; FORBEARANCE AND DEFERMENT ARRANGEMENTS. We had total
delinquencies in our managed portfolio of $219.4 million at June 30, 2004,
$228.9 million at June 30, 2003 and $171.6 million at June 30, 2002. The managed
total portfolio includes loans on our balance sheet and loans serviced for
others. At June 30, 2004, the total managed portfolio was $2.1 billion, compared
to $3.7 billion at June 30, 2003 and $3.1 billion at June 30, 2002. 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
10.49% at June 30, 2004 compared to 6.27% at June 30, 2003 and 5.59% at June 30,
2002.
As the managed portfolio continues to season and if the economy does
not continue to improve, 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 debentures. As
the portfolio seasons, or ages, the likelihood that borrowers will incur credit
problems increases. Additionally, 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.
Delinquencies in our total managed portfolio do not include $216.3
million of previously delinquent loans at June 30, 2004, 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 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, we will generally declare the account in default, reflect it as a
delinquent loan in our delinquency statistics and resume collection actions.
During the final six months of fiscal 2003 and the first six months of
fiscal 2004, we experienced a pronounced increase in the number of borrowers
under deferment arrangements and in light of the weakened economic environment
during that twelve-month period we made use of deferment arrangements to a
greater degree than in prior periods. Since December 2003, we have experienced a
reduction in new deferment arrangements and if the improving economic
environment continues, we expect to continue to experience a reduction in new
deferment arrangements.
82
There was approximately $216.3 million of cumulative unpaid principal
balance of loans under deferment and forbearance arrangements at June 30, 2004,
as compared to approximately $197.7 million and $138.7 million of cumulative
unpaid principal balance at June 30, 2003 and 2002, respectively. Total
cumulative unpaid principal balances under deferment or forbearance arrangements
as a percentage of the total managed portfolio were 10.34% at June 30, 2004,
compared to 5.41% and 4.52% at June 30, 2003 and 2002, respectively.
Additionally, there are loans under deferment and forbearance arrangements which
have returned to delinquent status. At June 30, 2004, there was $29.9 million of
cumulative unpaid principal balance under deferment arrangements and $31.8
million of cumulative unpaid principal balance under forbearance arrangements
that are now reported as delinquent 31 days or more. See "-- On Balance Sheet
Portfolio Quality -- Deferment and Forbearance Arrangements," "-- Total
Portfolio Quality -- Deferment and Forbearance Arrangements" and "Risk Factors
- -- Restrictive covenants in the agreements governing our indebtedness may reduce
our operating flexibility and limit our ability to operate profitably, and our
ability to repay our outstanding debt may be impaired and the value of our
capital stock could be negatively impacted."
LISTING ON THE NASDAQ NATIONAL MARKET SYSTEM. Since our common stock is
listed on the NASDAQ National Market System, we are required to meet certain
requirements established by the NASDAQ Stock Market in order to maintain this
listing. These requirements include, among other things, maintenance of
stockholders' equity of $10.0 million, a minimum bid price of $1.00 and a market
value of publicly held shares of $5.0 million. If we are unable to maintain our
listing on the NASDAQ National Market System, the value of our capital stock and
our ability to continue to sell subordinated debentures would be negatively
impacted by making the process of complying with the state securities laws more
difficult, costly and time consuming. As a result, we may be unable to continue
to sell subordinated debentures in certain states, which would have a material
adverse effect on our liquidity and our ability to repay maturing debt when due.
There can be no assurance that we will be in compliance with the $10.0 million
stockholders' equity requirement on September 30, 2004. We are considering a new
exchange offer in order to maintain compliance with this listing requirement.
See "Risk Factors -- In the event our common stock is delisted from trading on
the NASDAQ National Market System, the value of our capital stock and our
ability to continue to sell subordinated debentures would be negatively
impacted."
LIQUIDITY AND CAPITAL RESOURCES
GENERAL. 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 serviced
portfolio and investments in securitization assets with the expectation that
they will generate sufficient cash flows in the future to cover our operating
requirements, including repayment of maturing subordinated debentures and senior
collateralized subordinated notes outstanding. Our cash needs change as the mix
of loan sales through securitization shifts to more whole loan sales, as the
serviced portfolio changes, as our interest-only strips mature and release cash,
as subordinated debentures and senior collateralized subordinated notes
outstanding mature, as operating expenses change and as revenues change. Because
we have historically experienced negative cash flows from operations under our
prior business strategy and, more recently, have been impacted by short-term
liquidity issues, our business requires continual access to short and long-term
sources of debt to generate the cash required to fund our operations.
83
Our cash requirements include funding loan originations, repaying
existing subordinated debentures and senior collateralized subordinated notes
outstanding, paying interest expense, preferred dividends and operating
expenses, funding capital expenditures, and in connection with our
securitizations, funding overcollateralization requirements, costs of
repurchasing delinquent loans for trigger management and servicer obligations.
When loans are sold through a securitization, we may 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 "--
Securitizations" and "-- Securitizations -- Trigger Management" and "--
Securitizations -- Repurchase Rights" for more information on how the servicing
of securitized loans affects requirements on our capital resources and cash
flow. 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).
Under our business strategy, we initially finance our loans under
secured credit facilities. These credit facilities are generally revolving lines
of credit that enable us to borrow on a short-term basis against our loans. We
then sell our loans to unrelated third parties on a whole loan basis or
securitize our loans to generate the cash to pay off these revolving credit
facilities.
LIQUIDITY CONCERNS. Several events and issues have negatively impacted
our short-term liquidity. First, our inability to complete a publicly
underwritten securitization during the fourth quarter of fiscal 2003 adversely
impacted our short-term liquidity position and contributed to our loss for
fiscal 2003. Because there was no securitization, $453.4 million of the $516.1
million in revolving credit and conduit facilities available to us at June 30,
2003 was drawn upon. Our revolving credit facilities and mortgage conduit
facility had only $62.7 million of unused capacity available at June 30, 2003,
which significantly reduced our ability to fund loan originations in fiscal 2004
until we sold existing loans, extended existing credit facilities, or added new
credit facilities.
Second, our ability to borrow under credit facilities to fund new loan
originations in the first three months of fiscal 2004 using borrowings under
certain of our credit facilities which carried over into fiscal 2004 was
limited, terminated or expired by October 31, 2003. Further advances under a
non-committed portion of one of these 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 to, among other things, eliminate the non-committed
portion, reduce the amount available to $50.0 million and accelerate the
expiration date from November 2003 to September 30, 2003. We entered into a
subsequent amendment to this facility, which extended its maturity date to
October 17, 2003. 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. In
addition, we were unable to borrow under a $25.0 million warehouse facility
after September 30, 2003, and this $25.0 million facility expired on October 31,
2003.
Third, even though we were successful in obtaining one new credit
facility in September 2003 and a second new credit facility in October 2003, our
ability to finance new loan originations in the second and third quarters of
fiscal 2004 with borrowings under these new facilities was limited. The
limitations resulted from requirements to fund overcollateralization, which is
discussed below, in connection with new loan originations.
Fourth, our temporary discontinuation of sales of new subordinated
debentures for approximately a six-week period during the first quarter of
fiscal 2004 further impaired our liquidity.
As a result of these liquidity issues, our loan origination volume was
substantially reduced. In fiscal 2004, we originated $982.7 million of loans,
compared to originations of $1.67 billion of loans in fiscal 2003. As a result
of the decrease in loan originations and liquidity issues described above, we
incurred losses in fiscal 2003 and 2004 and depending on our ability to complete
securitizations and recognize gains in the future, we anticipate incurring
losses at least through the first quarter of fiscal 2005.
84
For the next six to twelve months, we intend to augment our sources of
operating cash with proceeds from the issuance of subordinated debentures. In
addition to repaying maturing subordinated debentures, proceeds from the
issuance of subordinated debentures may be used to fund overcollateralization
requirements in connection with our loan originations and fund our operating
losses. Under the terms of our credit facilities, our credit facilities will
advance us 75% to 97% of the value of loans we originate. As a result of this
limitation, we must fund the difference between the loan value and the advances,
which we refer to as the overcollateralization requirement, from our operating
cash. We can provide no assurances that we will be able to continue issuing
subordinated debentures.
There can be no assurance that we will be in compliance with the
$10.0 million stockholders' equity requirement on September 30, 2004. We are
considering a new exchange offer in order to maintain compliance with this
listing requirement. If we are unable to maintain our listing on the NASDAQ
National Market System, our ability to continue to sell subordinated debentures
would be negatively impacted by making the process of complying with the state
securities laws more difficult, costly and time consuming. As a result, we may
be unable to continue to sell subordinated debentures in certain states, which
would have a material adverse effect on our liquidity and our ability to repay
maturing debt when due.
SECURED AND UNSECURED INDEBTEDNESS. At June 30, 2004, we had total
indebtedness of approximately $847.4 million, comprised of amounts outstanding
under our credit facilities, senior collateralized subordinated notes issued in
the exchange offers, capitalized leases and subordinated debentures. The
following table compares our secured and senior debt obligations and unsecured
subordinated debenture obligations at June 30, 2004 to assets which were
available to repay those obligations. We anticipate that any shortfall in assets
available to repay obligations will be funded through cash received on the sale
of future loan originations:
85
SECURED AND UNSECURED
SENIOR DEBT SUBORDINATED TOTAL
(in thousands) OBLIGATIONS DEBENTURES DEBT/ASSETS
----------- ------------ -----------
Outstanding debt obligations (a)(f)........ $ 324,839 (b) $ 522,609 $ 847,448
=========== ============ ===========
Assets available to repay debt:
Cash and cash equivalents ............. $ -- $ 910 $ 910
Loans.................................. 252,326 (c) 51,949 304,275
Interest-only strips (e)............... 179,207 (a)(b) 279,879 459,086 (d)
Servicing rights....................... -- 73,738 73,738 (d)
----------- ------------ ------------
Total assets available................. $ 431,533 $ 406,476 $ 838,009
=========== ============ ============
- -------------
(a) Includes the impact of the exchange of $177.8 million of subordinated
debentures (unsecured subordinated debentures) for $84.0 million of senior
collateralized subordinated notes (secured and senior debt obligations) and
93.8 million shares of Series A preferred stock in the first exchange offer
and first closing of the second exchange offer. At June 30, 2004, our
interest in the cash flows from the interest-only strips held in the trust,
which secure the senior collateralized subordinated notes totaled $411.9
million, of which approximately $125.5 million represents 150% of the
principal balance of the senior collateralized subordinated notes
outstanding at June 30, 2004. For presentation purposes, $125.5 million is
included in the column entitled "secured and senior debt obligations" in the
table above.
(b) Security interests under the terms of the $250.0 million credit facility are
included in this table. This $250.0 million credit facility is secured by
loans when funded under this facility. In addition, interest-only strips
secure, as a first priority, obligations in an amount not to exceed 10% of
the outstanding principal balance under this facility and the obligations
due under the fee letter related to this facility. Assuming the entire
$250.0 million available under this credit facility were utilized, the
maximum amount secured by the interest-only strips would be approximately
$53.7 million. This amount is included as an allocation of our interest-only
strips to the secured and senior debt obligations column.
(c) Reflects the amount of loans specifically pledged as collateral against our
advances under our credit facilities.
(d) Reflects the fair value of our interest-only strips and servicing rights at
June 30, 2004.
(e) The grant of a lien on the collateral to secure the senior collateralized
subordinated notes issued upon the completion of the first exchange offer
and the senior collateralized subordinated notes to be issued in this
exchange offer is not a direct lien on any interest-only strips, but is,
rather, a lien on the right of certain of our subsidiaries to receive
certain cash flows from ABFS Warehouse Trust 2003-1 which is a special
purpose entity which holds the majority of, but not all of, the
interest-only strips directly or indirectly held by us. The interest-only
strips in this trust also secure, as a first priority, obligations in an
amount not to exceed 10% of the outstanding principal balance under our
$250.0 million credit facility and the obligations due under the fee letter
related to this facility. Assuming the entire $250.0 million available under
this credit facility were utilized, the maximum amount secured by the
interest-only strips would be approximately $53.7 million.
86
(f) The second exchange offer was extended through August 23, 2004 with closings
on July 31, 2004 and August 23, 2004. The pro forma effects on the above
table of the two closings of an additional $30.8 million of subordinated
debentures (unsecured subordinated debentures) for $15.2 million of senior
collateralized subordinated notes (secured obligations) and 15.6 million
shares of Series A Preferred Stock are summarized below. At August 23, 2004,
$22.8 million of our interest-only strips were collateralizing these new
senior collateralized subordinated notes. Including the senior
collateralized subordinated notes issued as of June 30, 2004, $148.2 million
of our interest-only strips are collateralizing senior collateralized
subordinated notes. The table below summarizes the pro forma impact of the
two closings of our second exchange offer subsequent to June 30, 2004 on the
historical comparison of our secured and senior debt obligations and
unsecured subordinated debenture obligations at June 30, 2004 to assets
which are available to repay those obligations (in thousands):
SECURED AND UNSECURED
SENIOR DEBT SUBORDINATED TOTAL
(in thousands) OBLIGATIONS DEBENTURES DEBT/ASSETS
----------- ------------ -----------
Outstanding debt obligations -
historical............................... $ 324,839 $ 522,609 $ 847,448
Pro forma effect of the second exchange
offer extension to August 23, 2004....... 15,173 (30,811) (15,638)
----------- ------------ -----------
Pro forma outstanding debt
obligations.............................. $ 340,012 $ 491,798 $ 831,810
=========== ============ ===========
Total assets available to repay debt -
historical............................... $ 431,533 $ 406,476 $ 838,009
Pro forma effect of the second exchange
offer extension to August 23, 2004....... 22,760 (22,760) --
----------- ------------ -----------
Pro forma assets available................... $ 454,293 $ 383,716 $ 838,009
=========== ============ ===========
87
REMEDIAL STEPS TAKEN TO ADDRESS LIQUIDITY ISSUES. Since June 30, 2003,
we undertook specific remedial actions to address liquidity concerns including:
o We adjusted our business strategy beginning in early fiscal 2004.
Our adjusted business strategy focuses on shifting 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. See "-- Overview -- Business Strategy Adjustments" and
"Business -- Business Strategy" for more information.
o We solicited bids and commitments from participants in the whole
loan sale market and entered into forward sale agreements and
individual sale transactions. In total, from June 30, 2003 through
June 30, 2004, we sold approximately $1.1 billion (which includes
$222.3 million of loans sold by the expired mortgage conduit
facility described under "-- Credit Facilities") of loans through
whole loan sales. From July 1, 2004 through September 30, 2004, we
sold an additional $586.5 million of loans through whole loan sales.
88
o We have entered into an informal arrangement with one recurring
purchaser of our loans whereby the purchaser maintains members of
its loan underwriting staff on our premises to facilitate its
purchase of our loans promptly after we originate them. This
arrangement accelerates our receipt of cash proceeds from the sale
of loans, accelerates the pay down of our advances under our
warehouse credit facilities and adds to our liquidity. This quicker
turnaround time is expected to enable us to operate with smaller
committed warehouse credit facilities than would otherwise be
necessary.
o On October 31, 2003, we completed a privately-placed securitization,
with servicing released, of $173.5 million of loans.
o We entered into two definitive loan agreements during fiscal 2004
for the purpose of funding our loan originations. These two
agreements replaced those credit facilities, which carried over into
fiscal 2004 but were limited, terminated or expired by October 31,
2003. We entered into the first agreement on September 22, 2003 with
a financial institution for a one-year $200.0 million credit
facility. We entered into the second agreement on October 14, 2003
with a warehouse lender for a three-year revolving mortgage loan
warehouse credit facility of up to $250.0 million. The $200.0
million facility was extended to November 5, 2004 and reduced to
$100.0 million. The three-year $250.0 million warehouse credit
facility continues to be available. See "-- Credit Facilities" for
information regarding the terms of these facilities.
o We have recently entered into a commitment letter and anticipate
entering into a definitive agreement with a warehouse lender for a
one-year $100.0 million credit facility to replace the maturing
$200.0 million credit facility (reduced to $100.0 million). However,
we cannot assure you that we will enter into a definitive agreement
regarding the $100.0 million credit facility or that this agreement
will contain the terms and conditions acceptable to us. We also sold
the interest-only strips and servicing rights related to five of our
mortgage securitization trusts to an affiliate of this facility
provider under the terms of a September 27, 2004 sale agreement. The
sale of these assets was undertaken as part of our negotiations to
obtain the new $100.0 million warehouse credit facility and to raise
cash to pay fees on new warehouse credit facilities and as a result,
we did not realize their full value as reflected on our books. We
wrote down the carrying value of these interest-only strips and
servicing rights by $5.4 million at June 30, 2004 to reflect their
values under the terms of the sale agreement.
89
o We are currently negotiating additional credit facilities to provide
additional borrowing capacity to fund the increased level of loan
originations expected under our adjusted business strategy, however,
no assurances can be given that we will succeed in obtaining new
credit facilities or that these facilities will contain terms and
conditions acceptable to us. See "-- Credit Facilities" for
information regarding the terms of these facilities and "Risk
Factors -- If we are unable to obtain additional financing, we may
not be able to restructure our business to permit profitable
operations or repay our outstanding debt and the value of our
capital stock will be negatively impacted."
o We mailed exchange offers on December 1, 2003 and May 14, 2004 to
holders of our subordinated debentures in order to increase our
stockholders' equity and reduce the amount of our outstanding debt.
These exchange offers resulted in the exchange of $208.6 million of
our subordinated debentures for 109.4 million shares of Series A
preferred stock and $99.2 million of senior collateralized
subordinated notes. The issuance of 109.4 million shares of Series A
preferred stock results in an annual cash preferred dividend
obligation of $10.9 million. See "-- Subordinated Debentures" for
more detail on the terms of the exchange offers, senior
collateralized subordinated notes and preferred stock issued.
o On January 22, 2004, we executed an agreement to sell our interests
in the remaining leases in our portfolio. The terms of the agreement
included a cash sale price of approximately $4.8 million in exchange
for our lease portfolio balance as of December 31, 2003. We received
the cash from this sale in January 2004 and recognized a net gain of
$0.5 million.
o We suspended the payment of quarterly dividends on our common stock
beginning in the first quarter of fiscal 2004.
Although we obtained two warehouse credit facilities totaling $450.0
million in fiscal 2004, and after November 5, 2004 we expect to have at least
two warehouse credit facilities totaling at a minimum $500.0 million, the
proceeds of these credit facilities could only be used to fund loan originations
and could not be used for any other purpose. Consequently, we need to generate
cash to fund the balance of our business operations from other sources, such as
whole loan sales, additional financings and sales of subordinated debentures.
Additionally, our warehouse credit facilities have been obtained at high costs,
which have a significant impact on our liquidity. See "-- Credit Facilities" for
detail on the amount of fees we are required to pay under these facilities.
We can provide no assurances that we will be able to sell our loans,
maintain existing credit facilities or expand or obtain new credit facilities,
if necessary. If we are unable to maintain existing financing, we may not be
able to restructure our business to permit profitable operations or repay our
subordinated debentures and senior collateralized subordinated notes when due.
Even if we are able to maintain adequate financing, our inability to originate
and sell our loans could hinder our ability to operate profitably in the future
and repay our subordinated debentures and senior collateralized subordinated
notes when due.
SHORT AND LONG TERM CAPITAL RESOURCES AND CONTRACTUAL OBLIGATIONS. The
following table summarizes our short and long-term capital resources and
contractual obligations as of June 30, 2004. For capital resources, the table
presents projected and scheduled principal cash flows expected to be available
to meet our contractual obligations. For those timeframes where a shortfall in
capital resources exists, we anticipate that these shortfalls will be funded
through a combination of cash from whole loan sales of future loan originations
and the issuance of subordinated debentures. We can provide no assurances that
we will be able to continue issuing subordinated debentures. In the event that
we are unable to offer additional subordinated debentures for any reason, we
have developed a contingent financial restructuring plan. See "-- Overview --
Business Strategy Adjustments" for a discussion of this plan. The terms of our
credit facilities provide that we may only use the funds available under the
credit facilities to originate home mortgage loans.
90
---------------------------------------------------------------
LESS THAN 1 TO 3 3 TO 5 MORE THAN
1 YEAR YEARS YEARS 5 YEARS TOTAL
---------------------------------------------------------------
(IN THOUSANDS)
Capital Resources from:
Unrestricted cash...................... $ 910 $ -- $ -- $ -- $ 910
Cash pledged as collateral against
contractual obligation............... 1,000 2,000 1,000 4,000 8,000
Loans available for sale............... 301,040 73 84 3,078 304,275
Interest-only strips (a).............. 112,168 174,518 113,000 270,626 670,312
Servicing rights (a)................... 20,897 30,421 22,578 49,474 123,370
Investments............................ 839 -- -- -- 839
---------- --------- --------- --------- ---------
436,854 207,012 136,662 327,178 1,107,706
---------- --------- --------- --------- ---------
Contractual Obligations (b)
Subordinated debentures................ 326,152 170,452 14,036 11,969 522,609
Accrued interest-subordinated
debentures (c)....................... 20,033 11,332 1,312 1,650 34,327
Senior collateralized subordinated notes 28,094 50,701 2,516 2,328 83,639
Accrued interest-senior collateralized
subordinated notes (d).............. 1,002 1,738 126 109 2,975
Warehouse lines of credit (e).......... 239,587 -- -- -- 239,587
Convertible promissory note (f)........ 697 433 -- -- 1,130
Capitalized lease (g)................. 377 142 -- -- 519
Operating leases (h)................... 5,940 11,217 11,561 27,883 56,601
Services and equipment................. 1,464 -- -- -- 1,464
---------- --------- --------- --------- ---------
623,346 246,015 29,551 43,939 942,851
---------- --------- --------- --------- ---------
Excess (Shortfall)..................... $ (186,492) $ (39,003) $ 107,111 $ 283,239 $ 164,855
========== ========= ========= ========= =========
- -------------
(a) Reflects projected cash flows utilizing assumptions including prepayment and
credit loss rates. See "-- Application of Critical Accounting Estimates --
Interest-Only Strips" and "Application of Critical Accounting Estimates -
Servicing Rights."
(b) See "-- Contractual Obligations."
(c) This table reflects interest payment terms elected by subordinated debenture
holders as of June 30, 2004. In accordance with the terms of the
subordinated debenture offering, subordinated debenture holders have the
right to change the timing of the interest payment on their notes once
during the term of their investment.
(d) This table reflects interest payment terms elected by senior collateralized
subordinated note holders as of June 30, 2004.
(e) See the table provided under "-- Credit Facilities" for additional
information about our credit facilities.
(f) Amount includes principal and accrued interest at June 30, 2004.
(g) Amounts include principal and interest.
(h) Amounts include lease for office space.
Cash flow from operations, the issuance of subordinated debentures 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. Each funding source is described
in more detail below.
CASH FLOW FROM OPERATIONS. One of our corporate goals is to achieve
sustainable positive cash flow from operations. However, we cannot be certain
that we will achieve our projections regarding positive cash flow from
operations. Our achieving 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;
91
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 had been negative because
we incur the cash expenses as we originate loans, 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. However, during the year ended June 30, 2004, we experienced
positive cash flow from operations, primarily due to whole loan sales of loans
we originated in prior periods that were carried on our balance sheet at June
30, 2003.
Additionally, increasing market interest rates could negatively impact
our cash flows. 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. Increasing market interest rates would also
result in higher interest expense incurred on future issuances of subordinated
debentures and interest expense incurred to fund loans while they are carried on
our balance sheet.
Cash flow from operations for the year ended June 30, 2004 was a
positive $6.8 million compared to a negative $285.4 million for the year ended
June 30, 2003. The positive cash flow from operations for the year ended June
30, 2004 was due to our sales during fiscal 2004 of loans originated in the
prior fiscal year that were carried on our balance sheet at June 30, 2003.
During the year ended June 30, 2004, we received cash on whole loan sales of
$835.5 million and $26.7 million during the year ended June 30, 2003 from a
whole loan sale transaction, which closed on June 30, 2003, but settled in cash
on July 1, 2003. Additionally, cash flow from our interest-only strips in fiscal
2004 increased $18.0 million, compared to fiscal 2003. The following table
compares the principal amount of loans sold in whole loan sales during the year
ended June 30, 2004, to the amount of loans originated during the same period
(in thousands).
Whole Loan Loans
Quarter Ended Sales Originated
- --------------------------------------------- ----------- ----------
September 30, 2003........................... $ 245,203 $ 124,052
December 31, 2003............................ 7,975 (a) 103,084
March 31, 2004............................... 228,629 241,449
June 30, 2004................................ 326,571 514,095
---------- ----------
Total for the year ended June 30, 2004....... $ 808,378 $ 982,680
========== ==========
(a) During the quarter ended December 31, 2003, we completed a securitization of
$173.5 million of mortgage loans.
The amount of cash we receive as gains on whole loan sales, and the
amount of cash we receive and the amount of overcollateralization we are
required to fund at the closing of our securitizations are dependent upon a
number of factors including market factors over which we have no control.
Although we expect cash flow from operations to continue to fluctuate in the
foreseeable future, our goal is to improve upon our historical levels of
negative cash flow from operations. We believe that if our projections based on
our business strategy prove accurate, our cash flow from operations will
continue to be positive. However, negative cash flow from operations may occur
in any future quarter depending on the size and frequency of our whole loan
sales, the size and frequency of our future securitizations and due to the
nature of our operations and the time required to implement our business
strategy adjustments. We generally expect the level of cash flow from operations
to fluctuate.
92
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, 2004 (in thousands):
PAYMENTS DUE BY PERIOD
----------------------------------------------------------------------
LESS THAN 1 TO 3 3 TO 5 MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
- ----------------------------------------- ----------- ----------- ----------- ---------- ----------
Subordinated debentures................. $ 522,609 $ 326,152 $ 170,452 $ 14,036 $ 11,969
Accrued interest - subordinated
debentures (a)........................ 34,327 20,033 11,332 1,312 1,650
Senior collateralized subordinated notes 83,639 28,094 50,701 2,516 2,328
Accrued interest - senior
collateralized subordinated notes (b) 2,975 1,002 1,738 126 109
Warehouse lines of credit (c)........... 239,587 239,587 -- -- --
Convertible promissory notes (d)........ 1,130 697 433 -- --
Capitalized lease (e)................... 519 377 142 -- --
Operating leases (f).................... 56,601 5,940 11,217 11,561 27,883
Services and equipment.................. 1,464 1,464 -- -- --
--------- ---------- ---------- --------- ---------
Total obligations....................... $ 942,851 $ 623,346 $ 246,015 $ 29,551 $ 43,939
========= ========== ========== ========= =========
- ----------
(a) This table reflects interest payment terms elected by subordinated debenture
holders as of June 30, 2004. In accordance with the terms of the
subordinated debenture offering, subordinated debenture holders have the
right to change the timing of the interest payment on their notes once
during the term of their investment.
(b) This table reflects interest payment terms elected by senior collateralized
subordinated note holders as of June 30, 2004.
(c) See the table provided under "-- Credit Facilities" for additional
information about our credit facilities.
(d) Amount includes principal and accrued interest at June 30, 2004.
(e) Amounts include principal and interest.
(f) Amounts include lease for office space.
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. Under the
terms of these facilities, approximately 75% to 97% of our loan originations may
be funded with borrowings under the credit facilities and the remaining amounts,
our overcollateralization requirements, must come from our operating capital.
The ultimate sale of the loans through whole loan sale or securitization
generates the cash proceeds necessary to repay the borrowings under the
warehouse facilities. We periodically review our expected future credit needs
and attempt to negotiate credit commitments for those needs as well as excess
capacity in order to allow us flexibility in implementing our adjusted business
strategy.
93
The following is a description of the warehouse and operating lines of
credit facilities, which were available to us at June 30, 2004 (in thousands):
FACILITY AMOUNT AMOUNT
AMOUNT UTILIZED AVAILABLE
-------- -------- ---------
REVOLVING CREDIT FACILITIES:
Warehouse revolving line of credit, expiring September 2004 (a)...... $ 200,000 $ 53,223 $ 146,777
Warehouse revolving line of credit, expiring October 2006 (b)........ 250,000 186,364 63,636
---------- --------- ---------
Total revolving credit facilities.................................... 450,000 239,587 210,413
OTHER FACILITIES:
Capitalized leases, maturing January 2006 (c)..................... 488 488 --
---------- --------- ---------
Total credit facilities.............................................. $ 450,488 $ 240,075 $ 210,413
========== ========= =========
- -------------
(a) $200.0 million warehouse revolving line of credit with JP Morgan Chase Bank
entered into on September 22, 2003 and expiring September 2004. The maturity
date of this facility was extended to November 5, 2004 and the facility was
reduced to $100.0 million. Interest rates on the advances under this
facility are based upon one-month LIBOR plus a margin. Obligations under the
facility are collateralized by pledged loans. Further detail and provisions
of this facility are described below.
Additionally, we have a stand alone letter of credit with JP Morgan Chase
Bank to secure lease obligations for corporate office space. The amount of
the letter of credit was $8.0 million at June 30, 2004. The letter of credit
was collateralized by cash.
(b) $250.0 million warehouse revolving line of credit with Chrysalis Warehouse
Funding, LLC, entered into on October 14, 2003 and expiring October 2006.
Interest rates on the advances under this facility are based upon one-month
LIBOR plus a margin. Obligations under the facility are collateralized by
pledged loans. Further detail and provisions of this facility are described
below.
(c) Capitalized leases, imputed interest rate of 8.0%, collateralized by
computer equipment.
Until their expiration, two other facilities were utilized for portions
of fiscal 2004 including:
o A warehouse line of credit with Credit Suisse First Boston Mortgage
Capital, LLC originally for $200.0 million. $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
September 30, 2003. The expiration date was subsequently extended to
October 17, 2003, but no new advances were permitted under this
facility subsequent to September 30, 2003. This facility was paid
down in full on October 16, 2003. The interest rate on the facility
was based on one-month LIBOR plus a margin. Advances under this
facility were collateralized by pledged loans.
o A $25.0 million warehouse line of credit facility from Residential
Funding Corporation. Under this warehouse facility, advances could
be obtained, subject to specific conditions described in the
agreements. In connection with our receipt of a waiver of our
non-compliance with financial covenants at September 30, 2003, we
agreed not to make further advances under this line. Interest rates
on the advances were based on one-month LIBOR plus a margin. The
obligations under this agreement were collateralized by pledged
loans. This facility was paid down in full on October 16, 2003 and
it expired pursuant to its terms on October 31, 2003.
Until its expiration, we also had available to us a $300.0 million
mortgage conduit facility. This facility expired pursuant to its terms on July
5, 2003. The facility provided for the sale of loans into an off-balance sheet
facility. See "-- Application of Critical Accounting Estimates" for further
discussion of the off-balance sheet features of this facility. On October 16,
2003, we refinanced through another mortgage warehouse conduit facility $40.0
million of loans that were previously held in the above off-balance sheet
mortgage conduit facility. We also refinanced an additional $133.5 million of
mortgage loans in the new conduit facility, which were previously held in other
warehouse facilities, including the $50.0 million warehouse facility, which
expired on October 17, 2003. On October 31, 2003, we completed a
privately-placed securitization, with servicing released, of the $173.5 million
of loans that had been transferred to this conduit facility. This conduit
facility terminated upon the disposition of the loans held by it.
94
On September 22, 2003, we entered into definitive agreements with JP
Morgan Chase Bank for a $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) have a net worth of at least $28.0 million
by September 30, 2003; with quarterly increases of $2.0 million thereafter; (ii)
apply 60% of our net cash flow from operations each quarter to reduce the
outstanding amount of subordinated debentures commencing with the quarter ending
March 31, 2004; (iii) as of the end of any month, commencing January 31, 2004,
the aggregate outstanding balance of subordinated debentures must be less than
the aggregate outstanding balance as of the end of the prior month; and (iv)
provide a parent company guaranty of 10% of the outstanding principal amount of
loans under the facility. This facility had a term of 364 days and by its
original terms would have expired September 21, 2004. This facility 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 debentures not to
exceed $705.0 million at any time, and our ownership of an amount of repurchased
loans not to exceed 1.5% of the managed portfolio.
On September 20, 2004, we entered into an amendment to our $200.0
million credit facility which extended the scheduled expiration date of this
credit facility from September 21, 2004 to September 30, 2004.
On September 30, 2004, we entered into an amendment to our $200.0
million credit facility which extends the expiration date of this credit
facility from September 30, 2004 to November 5, 2004, subject to earlier
termination upon the occurrence of any of the specified events or conditions
described in the facility documents, and decreases this facility from $200.0
million to $100.0 million. Since entering into this facility on September 22,
2003, the amount outstanding under this facility at any given time has not
exceeded $100.0 million. In addition, the amendment includes changes which
reduce the advance rate if the amount outstanding under the facility exceeds
$75.0 million. The amendment also changes the portfolio composition requirements
to accommodate fluctuations in the pledged loans at the beginning and end of
each month, providing greater flexibility to us. The purpose of the amendment is
to allow us to continue to borrow under this facility, subject to its terms as
described above, while we finalize the definitive agreement for a new credit
facility. In light of this amendment, on October 1, 2004, we entered into an
amendment to the $250.0 million credit facility described below which decreased
the amount of the additional credit facilities that we must maintain from $200.0
million to $100.0 million, provided that there continues to be at least $40.0
million available for funding loans between the time they are closed by a title
agency or closing attorney and the time documentation for the loans is received
by the collateral agent, as originally required by the facility agreements.
On September 17, 2004, we executed a commitment letter dated as of
September 16, 2004 for a mortgage warehouse credit facility with a warehouse
lender for the purpose of funding our home mortgage loan originations. The
commitment letter provides for a facility that will consist of a $100.0 million
senior secured revolving warehouse line of credit, which may be increased prior
to closing to $150.0 million at the option of the warehouse lender. The
commitment letter provides for a facility that will have a term of one year from
closing with the right to extend for up to two additional one-year terms upon
mutual agreement of the parties, with interest equal to LIBOR plus a margin. The
facility will be secured by the mortgage loans which are funded by advances
under the facility, as well as all assets, accounts receivable and all related
proceeds held by the special purpose entity organized to facilitate this
transaction referred to as the borrower. The stock of the borrower will also be
pledged to the warehouse lender. We paid a due diligence fee and also agreed to
pay fees of $1.3 million upon commitment, $1.0 million at closing and
approximately $3.8 million over the next twelve months plus a non-usage fee
based on the difference between the average daily outstanding balance for the
current month and the maximum credit amount under the facility, as well as the
lender's out-of-pocket expenses. The commitment letter and the closing of the
facility will be subject to such customary and commercially reasonable terms,
covenants, events of default and conditions as the warehouse lender deems
appropriate. It is anticipated that this $100.0 million facility will contain
representations and warranties, events of default and covenants which are
customary for facilities of this type and will be structured similarly to our
$250.0 million credit facility.
The warehouse lender may terminate the commitment at any time prior
to entering into a definitive agreement if we fail to fulfill our obligations
under the commitment letter, the warehouse lender determines that it is likely
that the borrower is not capable of entering into a definitive agreement prior
to October 20, 2004 or there is a material adverse change in the business,
assets, liabilities, operations or condition of the borrower. The commitment
letter expires upon the earlier to occur of: the execution of a definitive
agreement, October 20, 2004 and our closing of another similar credit facility
with a lender other than this warehouse lender. While we anticipate that we will
close on the facility with this warehouse lender, there can be no assurance that
these negotiations will result in a definitive agreement or that this agreement
will contain terms and conditions acceptable to us.
95
We also sold the interest-only strips and servicing rights related to
five of our mortgage securitization trusts to an affiliate of this facility
provider under the terms of a September 27, 2004 sale agreement. The sale of
these assets was undertaken as part of our negotiations to obtain the new $100.0
million warehouse credit facility and to raise cash to pay fees on new warehouse
credit facilities and as a result, we did not realize their full value as
reflected on our books. We wrote down the carrying value of these interest-only
strips and servicing rights by $5.4 million at June 30, 2004 to reflect their
values under the terms of the sale agreement.
On October 14, 2003, we entered into definitive agreements with
Chrysalis Warehouse Funding, LLC for a revolving mortgage loan warehouse credit
facility of up to $250.0 million to fund loan originations. The $250.0 million
facility has a term of three years with an interest rate on amounts outstanding
equal to the one-month LIBOR plus a margin and the yield maintenance fees (as
defined in the agreements). We also agreed to pay an affiliate of the lender
fees of $8.9 million upon closing and approximately $10.3 million annually plus
a non-usage fee based on the difference between the average daily outstanding
balance for the current month and the maximum credit amount under the facility,
as well as the lender's out-of-pocket expenses. Advances under this facility are
collateralized by specified pledged loans. Additional credit support for a
portion of the facility was created by granting a security interest in
substantially all of our interest-only strips and residual interests which we
contributed to a special purpose entity organized to facilitate this
transaction. The interest-only strips and residual interests contributed to this
special purpose entity also secured our fee obligations under this facility to
an affiliate of the lender, as described above. The interest-only strips sold
pursuant to the previously described sale agreement of September 27, 2004 were
part of the interest-only strips contributed to this special purpose entity for
the purpose of securing our fee obligations to this lender affiliate. In
consideration for the release by this lender affiliate of its lien on the
interest-only strips involved in the September 27, 2004 sale, we prepaid $3.5
million of fees owed or to be owed to the lender affiliate.
This $250.0 million facility contains representations and warranties,
events of default and covenants which are customary for facilities of this type,
as well as our agreement to: (i) restrict the total amount of indebtedness
outstanding under the indenture related to our subordinated debentures to $750.0
million or less; (ii) make quarterly reductions commencing in April 2004 of an
amount of subordinated debentures pursuant to the formulas set forth in the loan
agreement; (iii) maintain maximum interest rates offered on subordinated
debentures not to exceed 10 percentage points above comparable rates for FDIC
insured products; and (iv) maintain minimum cash and cash equivalents of not
less than $10.0 million. In addition to events of default which are typical for
this type of facility, an event of default would occur if: (1) we are unable to
sell subordinated debentures for more than three consecutive weeks or on more
than two occasions in a 12 month period; and (2) certain members of management
are not executive officers and a satisfactory replacement is not found within 60
days.
The definitive agreements for this $250.0 million facility granted the
lender an option for a period of 90 days commencing on the first anniversary of
entering into the definitive agreements to increase the credit amount to $400.0
million with additional fees and interest payable by us.
96
We intend to amend the security agreements related to the senior
collateralized subordinated notes to accommodate a request from the lender on
our $250.0 million credit facility, and its affiliate, dated September 30, 2004,
to clarify an inconsistency between these agreements and the $250.0 million
credit facility documents related to liens on certain assets previously pledged
by ABFS Warehouse Trust 2003-1 to Clearwing, the affiliate of the lender.
Although after November 5, 2004 we expect to have mortgage loan
warehouse credit facilities available totaling at a minimum $500.0 million, the
proceeds of these credit facilities may only be used to fund loan originations
and may not be used for any other purpose. Consequently, we will have to
generate cash to fund the balance of our business operations from other sources,
such as whole loan sales, additional financings and sales of subordinated
debentures. We are currently negotiating additional credit facilities to provide
additional borrowing capacity to fund the increased level of loan originations
expected under our adjusted business strategy, however, assurances can be given
that we will succeed in obtaining new credit facilities or that these facilities
will contain terms and conditions acceptable to us.
WAIVERS AND AMENDMENTS OF FINANCIAL COVENANTS RELATED TO OUR CREDIT
AGREEMENTS AND SERVICING AGREEMENTS. Our warehouse credit agreements require
that we comply with one or more financial covenants regarding, for example, net
worth, leverage, net income, liquidity, total debt and debt to equity and other
debt ratios. Each agreement has multiple individualized financial covenant
thresholds and ratio limits that we must meet as a condition to drawing on a
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 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.
As a result of the loss experienced during fiscal 2003, we were not in
compliance with the terms of certain 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
existing at June 30, 2003 (one for $50.0 million and the other for $200.0
million, which was reduced to $50.0 million as described below). We obtained
waivers from these covenant provisions from both lenders. Commencing August 21,
2003, the lender under the $50.0 million warehouse credit facility (which had
been amended in December 2002 to add a letter of credit facility) granted us a
series of waivers for our non-compliance with a financial covenant in that
credit facility through November 30, 2003 and on September 22, 2003, in
connection with the creation of a $200.0 million credit facility on the same
date, reduced this facility to an $8.0 million letter of credit facility, which
secured the lease on our principal executive office. This letter of credit
facility expired according to its terms on December 22, 2003, but the underlying
letter of credit was renewed for a one year term on December 18, 2003. We also
entered into an amendment to the $200.0 million credit facility which provided
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 expiration date of
this facility from November 2003 to September 30, 2003. We entered into
subsequent amendments to this credit facility, which extended the expiration
date until October 17, 2003. This facility was paid down in full on October 16,
2003 and expired on October 17, 2003.
In addition, in light of the losses experienced during fiscal 2004, we
requested and obtained waivers or amendments to several credit facilities to
address our non-compliance with certain financial covenants.
97
The lender under a $25.0 million credit facility agreed to amend such
facility in light of our non-compliance at September 30, 2003 with the
requirement that our net income not be less than zero for two consecutive
quarters. Pursuant to the revised terms of our agreement with this lender, no
additional advances were made under this facility after September 30, 2003. This
facility was paid down in full on October 16, 2003 and expired pursuant to its
terms on October 31, 2003.
On September 22, 2003, the lender under the $200.0 million facility
agreed to extend the deadline for our registration statement to be declared
effective by the SEC to November 10, 2003. Our registration statement was
declared effective on November 7, 2003. The lender on the $200.0 million credit
facility agreed to extend the date by which we were required to close an
additional credit facility of at least $200.0 million from October 3, 2003 to
October 8, 2003. We subsequently obtained an additional waiver from this lender,
which extended this required closing date for obtaining the additional credit
facility to October 14, 2003 (this condition was satisfied by the closing of the
$250.0 million facility described above). Prior to the closing of the second
credit facility, our borrowing capacity on the $200.0 million facility was
limited to $80.0 million. We entered into two amendments to the sale and
servicing agreement with the lender under our $200.0 million facility which
clarified the scope of particular financial covenants: one amendment dated as of
May 12, 2004 clarified the scope of the financial covenant regarding the
maintenance of minimum adjusted tangible net worth; and one amendment dated as
of June 30, 2004 clarified the scope of the financial covenant regarding the
maintenance of minimum cash and cash equivalents. This lender waived our
noncompliance with the minimum net worth requirements at September 30, 2003,
October 31, 2003, November 30, 2003, December 31, 2003, March 31, 2004, June 30,
2004, July 31, 2004, August 31, 2004 and September 30, 2004. This lender also
waived our noncompliance with: the minimum adjusted tangible net worth
requirement for all monthly compliance periods commencing with the month ending
April 30, 2004 and continuing through the month ending September 30, 2004; our
noncompliance with the minimum cash and cash equivalents requirement on December
31, 2003, April 30, 2004 and May 31, 2004; and our noncompliance on September
30, 2004 with requirements regarding the aggregate cash flow from all
securitization trusts and the ratio of debt to adjust tangible net worth.
We have continued to operate on the basis of waivers granted by the
lender under this facility to each of these events of noncompliance. The
expiration date of this facility was originally September 21, 2004, but the
lender agreed to extend the expiration date until November 5, 2004 in
consideration for, among other things, a reduction in the amount that could be
borrowed under this facility to $100.0 million. Consequently, we currently
anticipate that we will be out of compliance with one or more of the financial
covenants contained in this facility at October 31, 2004 and will need an
additional waiver for this noncompliance from this lender to continue to
operate.
A provision in our $250.0 million credit facility required us to
maintain another credit facility for $200.0 million with a $40.0 million
sublimit of such facility available for funding loans between the time they are
closed by a title agency or closing attorney and the time documentation for the
loans is received by the collateral agent. As a result of the reduction of our
$200.0 million facility to $100.0 million, as described above, we entered into
an amendment to the master loan and security agreement governing our $250.0
million facility which reduced the required amount for another facility to
$100.0 million. In the event we do not extend the $200.0 million (now $100.0
million) facility beyond its November 5, 2004 expiration date, or in the event
we do not otherwise enter into definitive agreements with other lenders by
November 5, 2004 which satisfy the above-described requirements in our $250.0
million facility for $100.0 million in additional credit facilities and a $40.0
million sublimit, we will need an additional amendment to the $250.0 million
facility or a waiver from the lender to continue to operate.
Additionally, as a result of being out of compliance at various times
since June 30, 2003 with the net worth requirement in several of our servicing
agreements, we requested and obtained waivers of this non-compliance from the
bond insurers associated with each of two separable groups of these servicing
agreements. In connection with the waiver of the net worth covenant granted by
one of these bond insurers, for the remaining term of the related servicing
agreements, we amended the servicing agreements on September 30, 2003
principally to provide for 120-day term-to-term servicing and for our
appointment as servicer for an initial 120-day period commencing as of October
1, 2003. The bond insurer re-appointed us as servicer under these amended
servicing agreements for additional 120-day terms commencing, respectively, on
January 29, 2004, May 27, 2004 and September 23, 2004. The second of these bond
insurers waived our non-compliance with net worth requirements on an oral basis
from September 30, 2003 through March 9, 2004, at which time it executed a
written waiver document which confirmed its prior oral waivers and extended
these waivers through March 14, 2004. Additionally, we entered into an agreement
with this second bond insurer on February 20, 2004 which amended the related
servicing agreements principally to provide for 30-day term-to-term servicing
and which re-appointed us as servicer for an initial term through March 15,
2004. Subsequently, this bond insurer, on a monthly basis, has given us a waiver
of the net worth covenant and re-appointed us as servicer for an additional
one-month term under these amended servicing agreements for all relevant periods
since the execution of the amended servicing agreements. Our reappointment as
servicer under these amended servicing agreements occurs in the sole discretion
of the associated bond insurer.
98
Separately, one bond insurer, as a condition to its participation in
our October 31, 2003 privately-placed securitization, required that we amend the
servicing agreement related to a previous public securitization in which the
bond insurer had provided financial guarantee insurance to the Class M
certificate. The resulting amendment to this servicing agreement, dated October
31, 2003, provided, among other things, for a specifically designated back-up
servicer, for 90-day term-to-term servicing and for our re-appointment as
servicer for an initial 90-day term commencing October 31, 2003. This bond
insurer subsequently re-appointed us as servicer under the amended servicing
agreement for an additional term through April 30, 2004. On April 30, 2004 this
amended servicing agreement was amended again principally to provide for 30-day
term-to-term servicing and for our reappointment as servicer for a 30-day term
expiring May 31, 2004. On May 24, 2004 this amended servicing agreement was
further amended principally to provide for minor administrative changes to the
agreement and to reappoint us as servicer for an additional term expiring June
30, 2004. This bond insurer has re-appointed us as servicer under this amended
servicing agreement for successive additional terms expiring on, respectively,
July 31, 2004, August 31, 2004, September 30, 2004 and October 31, 2004. Our
re-appointment as servicer under this amended servicing agreement is determined
by reference to our compliance with its provisions.
Also separately, on March 5, 2004, we entered into agreements with
another bond insurer which amended the servicing agreements related to all
securitizations insured by this bond insurer. These amendments principally
provided for a specifically designated back-up servicer. The original provisions
of these servicing agreements providing for 3-month term-to-term servicing were
not altered by these amendments. We were continuously re-appointed as servicer
under these servicing agreements prior to the described amendments and we have
continuously been re-appointed as servicer for all relevant periods subsequent
to the described amendments. Our re-appointment as servicer under these amended
servicing agreements is determined by reference to our compliance with their
provisions.
As a result of the foregoing amendments to our servicing agreements,
all of our servicing agreements associated with bond insurers now provide for
term-to-term servicing. See "Risk Factors -- 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, impair our ability to repay our
outstanding debt and negatively impact the value of our capital stock" for
information regarding the impact of these amendments to servicing agreements.
We intend to amend the security agreements related to the senior
collateralized subordinated notes to accommodate a request from the lender on
our $250.0 million credit facility, and its affiliate, dated September 30, 2004,
to clarify an inconsistency between these agreements and the $250.0 million
credit facility documents related to liens on certain assets previously pledged
by ABFS Warehouse Trust 2003-1 to Clearwing, the affiliate of the lender. See
"-- Liquidity and Capital Resources" for additional information regarding these
amendments.
Because we anticipate incurring losses at least through the first
quarter of fiscal 2005 and as a result of any non-compliance with other
financial covenants, we anticipate that we will need to obtain additional
waivers. We cannot assure you as to whether or in what form a waiver or
modification of these agreements would be granted to us.
SUBORDINATED DEBENTURES. The issuance of subordinated debentures funds
the majority of our remaining operating cash requirements. We rely significantly
on our ability to issue subordinated debentures since our cash flow from
operations is not sufficient to meet these requirements. In order to expand our
businesses we have issued subordinated debentures to partially fund growth and
to partially fund maturities of subordinated debentures. In addition, we utilize
proceeds from the issuance of subordinated debentures to fund
overcollateralization. During the fiscal year ended June 30, 2004, subordinated
debentures decreased by $196.7 million compared to an increase of $63.8 million
in fiscal 2003. The reduction in subordinated debentures outstanding at June 30,
2004 was primarily due to the exchange offers and the resulting conversion of
$177.8 million of subordinated debentures through June 30, 2004 into 93.8
million of shares of Series A preferred stock and $84.0 million of senior
collateralized subordinated notes. The decrease also resulted from our temporary
discontinuation of sales of new subordinated debentures for a portion of the
first quarter of fiscal 2004. In July 2004 and August 2004, we converted an
additional $30.8 million of subordinated debentures into 15.6 million shares of
Series A preferred stock and $15.2 million of senior collateralized subordinated
notes.
On December 1, 2003, we mailed the first exchange offer to holders of
our subordinated debentures issued prior to April 1, 2003. Holders of such
subordinated debentures had the ability to exchange their debentures for (i)
equal amounts of senior collateralized subordinated notes and shares of Series A
preferred stock; and/or (ii) dollar-for-dollar for shares of Series A preferred
stock. Senior collateralized subordinated notes issued in the exchange have
interest rates equal to 10 basis points above the subordinated debentures
tendered. Senior collateralized subordinated notes with maturities of 12 months
were issued in exchange for subordinated debentures tendered with maturities of
less than 12 months, while subordinated debentures with maturities greater than
36 months were exchanged for senior collateralized subordinated notes with the
same maturity or a maturity of 36 months. All other senior collateralized
99
subordinated notes issued in the exchange have maturities equal to the
subordinated debentures tendered. The senior collateralized subordinated notes
outstanding are secured by a security interest in certain cash flows originating
from interest-only strips of certain of our subsidiaries held by ABFS Warehouse
Trust 2003-1 with an aggregate value of at least an amount equal to 150% of the
principal balance of the senior collateralized subordinated notes issued in the
first exchange offer plus priority lien obligations secured by interest-only
strips and/or the cash flows from the interest-only strips; provided that, such
collateral coverage may not fall below 100% of the principal balance of the
senior collateralized subordinated notes issued in the first exchange offer, as
determined by us on any quarterly balance sheet date. In the event of
liquidation, to the extent the collateral securing the senior collateralized
subordinated notes is not sufficient to repay these notes, the deficiency
portion of the senior collateralized subordinated notes will rank junior in
right of payment behind our senior indebtedness and all of our other existing
and future senior debt and behind the existing and future debt of our
subsidiaries and equally in right of payment with the deficiency portion of the
senior collateralized subordinated notes, and any future subordinated debentures
issued by us and other unsecured debt.
On May 14, 2004, we mailed the second exchange offer to holders of up
to $120,000,000 of investment notes issued prior to November 1, 2003, which
offered holders of such notes the ability to exchange their investment notes on
substantially the same terms described above.
Under the terms of the exchange offers, the following amounts of
subordinated dentures were exchanged for shares of Series A preferred stock and
senior collateralized subordinated notes (in thousands):
Shares of Senior
Subordinated Series A Collateralized
Debentures Preferred Subordinated
By Closing Dates Exchanged Stock Issued Notes Issued
- ---------------- ------------ ------------ ---------------
First exchange offer:
December 31, 2003................................ $ 73,554 39,095 $ 34,459
February 6, 2004................................. 43,673 22,712 20,961
--------- ------- ---------
Results of first exchange offer............... 117,227 61,807 55,420
--------- ------- ---------
Second exchange offer:
June 30, 2004.................................... 60,589 31,980 28,609
July 31, 2004.................................... 25,414 12,908 12,506
August 23, 2004.................................. 5,397 2,730 2,667
--------- ------- ---------
Results of second exchange offer.............. 91,400 47,618 43,782
--------- ------- ---------
Cumulative results of exchange offers............... $ 208,627 109,425 $ 99,202
========= ======= =========
Note: results as of June 30, 2004, which include the
first exchange offer and the June 30, 2004 closing
of the second exchange offer....................... $ 177,816 93,787 $ 84,029
========= ======= =========
At June 30, 2004, our interest in the cash flows from the interest-only
strips held in the trust which secure the senior collateralized subordinated
notes totaled $411.9 million of which approximately $125.5 million represented
150% of the outstanding principal balance of senior collateralized subordinated
notes. After the August 23, 2004 closing of the exchange offer, the
interest-only strips securing the senior collateralized subordinated notes
totaled $148.2 million.
Anthony J. Santilli, our Chairman, Chief Executive Officer and
President, Beverly Santilli, formerly our First Executive Vice President, and
Dr. Jerome Miller, our director, each held subordinated debentures eligible to
participate in the first exchange offer. Each named individual tendered all such
eligible subordinated debentures in the first exchange offer and as of February
6, 2004, the expiration date of the first exchange offer, pursuant to the terms
of the first exchange offer, were holders of the following number of shares of
Series A preferred stock (SAPS) and aggregate amount of senior collateralized
subordinated notes (SCSN) outstanding: Mr. Santilli: SAPS - 4,691, SCSN -
$4,691; Mrs. Santilli: SAPS - 4,691, SCSN - $4,691; Dr. Miller: SAPS - 30,164,
SCSN - $30,164.
Under a registration statement declared effective by the SEC on
November 7, 2003, we registered $295.0 million of subordinated debentures. Of
the $295.0 million, $134.7 million of debt from this registration statement was
available for future issuance as of June 30, 2004.
100
In the event we are unable to offer additional subordinated debentures
for any reason, we have developed a contingent financial restructuring plan
including cash flow projections for the next twelve-month period. Based on our
current cash flow projections, we anticipate being able to make all scheduled
subordinated debenture maturities and vendor payments.
The contingent financial restructuring plan is based on actions that we
would take, in addition to those indicated in our adjusted business strategy, to
reduce our 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 obtaining working capital funding. No assurance can be given that we will be
able to successfully implement the contingent financial restructuring plan, if
necessary, and repay our outstanding debt when due.
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. To the extent that we fail to
maintain our credit facilities or obtain alternative financing on acceptable
terms and increase our loan originations, we may have to sell loans earlier than
intended and further restructure our operations which could further hinder our
ability to repay the subordinated debentures when due.
The weighted-average interest rate of our subordinated debentures
issued in the month of June 2004 was 11.09%, compared to a weighted-average
interest rate of 7.49% for subordinated debentures issued in the month of June
2003. We had reduced the interest rates offered on subordinated debentures
beginning in the fourth quarter of fiscal 2001 and had continued reducing rates
through the fourth quarter of fiscal 2003 in response to decreases in market
interest rates as well as declining cash needs during that period. However,
during fiscal 2004, the weighted-average interest rate on subordinated
debentures we issued had steadily increased, reflecting our financial condition.
Subordinated debentures issued at our peak rate, which was in February 2001, was
at a rate of 11.85%. We expect to reduce the interest rates offered on
subordinated debentures over time as our business and cash needs, our financial
condition, liquidity, future results of operations, market interest rates and
competitive factors permit. The weighted average remaining maturity of our
subordinated debentures at June 2004 was 13.5 months compared to 19.5 months at
June 2003.
TERMS OF THE SERIES A PREFERRED STOCK. The Series A preferred stock has
a par value of $0.001 per share and may be redeemed at our option at a price
equal to the liquidation value plus accrued and unpaid dividends after the
second anniversary of the issuance date. At June 30, 2004, 93,787,111 shares of
the Series A preferred stock were issued and outstanding.
Upon any voluntary or involuntary liquidation, the holders of the
Series A preferred stock will be entitled to receive a liquidation preference of
$1.00 per share, plus accrued and unpaid dividends to the date of liquidation.
Based on the shares of Series A preferred stock outstanding on June 30, 2004,
the liquidation value equals $93.8 million. After completion of all closings
under the second exchange offer, the liquidation value increased to $109.4
million.
Monthly cash dividend payments are $0.008334 per share of Series A
preferred stock (equivalent to $0.10 per share annually or 10% annually of the
liquidation value). Payment of cash dividends on the Series A preferred stock is
subject to compliance with applicable Delaware state law. Based on the shares of
Series A preferred stock outstanding on June 30, 2004, the annual cash dividend
requirement equals $9.4 million. After completion of all closings under the
second exchange offer, the annual cash dividend requirement increased to $10.9
million.
101
On or after the second anniversary of the issuance date (or on or after
the one year anniversary of the issuance date if no dividends are paid on the
Series A preferred stock), each share of the Series A preferred stock is
convertible at the option of the holder into a number of shares of the our
common stock determined by dividing: (A) $1.00 plus an amount equal to accrued
but unpaid dividends (if the conversion date is prior to the second anniversary
of the issuance date because the Series A preferred stock has become convertible
due to a failure to pay dividends), $1.20 plus an amount equal to accrued but
unpaid dividends (if the conversion date is prior to the third anniversary of
the issuance date but on or after the second anniversary of the issuance date)
or $1.30 plus an amount equal to accrued but unpaid dividends (if the conversion
date is on or after the third anniversary of the issuance date) by (B) the
market value of a share of our common stock (which figure shall not be less than
$5.00 per share regardless of the actual market value on the conversion date).
Based on the $5.00 per share market value floor and if each share of
Series A preferred stock issued in the first exchange offer and the second
exchange offer converted on the anniversary dates listed below, the number of
shares of the our common stock which would be issued upon conversion follows
(shares in thousands):
As of June 30, 2004 As of August 23, 2004
----------------------------- -----------------------------
Convertible Convertible
Number of into Number Number of into Number
Preferred of Common Preferred of Common
Shares Shares Shares Shares
--------- ----------- --------- -----------
Second anniversary date.... 93,787 22,509 109,425 26,262
Third anniversary date..... 93,787 24,384 109,425 28,451
As described above, the conversion ratio of the Series A preferred
stock increases during the first three years following its issuance, which
provides the holders of the Series A preferred stock with a discount on the
shares of common stock that will be issued upon conversion. Under guidance
issued by the EITF in issue 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,"
this discount, or beneficial conversion feature, must be valued and amortized to
the income statement as additional non-cash preferred dividends over the
three-year period that the holders of the Series A preferred stock earn the
discount.
We computed the value of the beneficial conversion feature using the
conversion ratio of $1.30 to $5.00, which is the conversion term that is most
beneficial to the investor, and would result in the issuance of 24.5 million
shares of common stock based on the shares of Series A preferred stock that were
issued through June 30, 2004. The value of the beneficial conversion feature
equals the excess of the intrinsic value of those 24.5 million shares of common
stock at their closing prices on the dates the preferred stock was issued, over
the value of the Series A preferred stock on the same dates. The value of the
Series A preferred stock was equal to the carrying value of the subordinated
debentures exchanged. For closings under the exchange offers through June 30,
2004, the value of the beneficial conversion feature was $10.7 million. During
fiscal 2004, amortization of $0.8 million was added to the $2.9 million of cash
dividends declared resulting in a total charge to the income statement of $3.7
million. The offset to the charge to the income statement for the amortization
of the beneficial conversion feature is recorded to additional paid in capital.
For closings under the exchange offers through August 23, 2004, the value of the
beneficial conversion feature was $11.3 million. Amortization of the total value
of the beneficial conversion feature will be $3.6 million in fiscal 2005, $3.8
million in fiscal 2006 and $3.0 million for fiscal 2007.
SALES INTO SPECIAL PURPOSE ENTITIES AND OFF-BALANCE SHEET FACILITIES.
In the past, we have relied significantly on access to the asset-backed
securities market through securitizations to provide permanent funding of our
loan production. Our adjusted business strategy will continue to rely on access
to this market, although to a lesser extent. We also may 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 debentures 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.
102
OTHER LIQUIDITY CONSIDERATIONS. At our annual meeting of shareholders
held on December 31, 2003, our shareholders approved three proposals to enable
us to consummate the first exchange offer: a proposal to increase the number of
authorized shares of common stock from 9.0 million to 209.0 million, a proposal
to increase the number of authorized shares of preferred stock from 3.0 million
to 203.0 million, and a proposal to authorize us to issue Series A preferred
stock in connection with our first exchange offer and the common stock issuable
upon the conversion of the Series A preferred stock.
At a special meeting of stockholders held on June 29, 2004, our
shareholders approved a proposal to authorize the issuance of shares of Series A
preferred stock in connection with our second exchange offer and the common
stock issuable upon the conversion of the Series A preferred stock.
Shareholder approval of these issuances of securities was required
pursuant to the NASDAQ Corporate Governance Rules as the issuance of such shares
could result in a change in control of our company. In addition to meeting the
requirements of the exchange offers, 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.
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.
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 debentures, increases in delinquencies and
credit losses in our total 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 debentures could be impaired. Additionally, under the
Servicemembers Civil Relief Act, 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 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.
103
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.
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 13, 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. Prior to its
preclusion in July 2003, we 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 on new loans in some of the states where we originate loans. Prior to this
rule becoming effective, 80% to 85% of the home mortgage loans we originated
contained prepayment fees. The origination of a high percentage of loans with
prepayment fees impacts our securitization gains and securitization assets by
helping to reduce the likelihood of a borrower prepaying their loan, thereby
prolonging the life of a securitization, and increasing the amounts of residual
cash flow, servicing fees and prepayment fees we can expect to collect over the
life of a securitization. We currently expect that the percentage of loans that
we will originate in the future containing prepayment fees will decrease to
approximately 65% to 70%. During fiscal 2004, approximately 72% of the loans we
originated contained prepayment fees. This decrease in prepayment fee
penetration will potentially reduce the amount of gains and securitization
assets we will record on any future securitizations. Because there are many
other variables including market conditions, which will also impact
securitizations, we are unable to quantify the impact of this rule on any future
securitization assets and related gains until we complete a publicly-placed
securitization of loans which we originated since this rule became 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. On May 26, 2004, the New Jersey Supreme Court reversed the
decision of the Appellate Division of the Superior Court of New Jersey and held
that the Parity Act had preempted the New Jersey Prepayment Law, which
prohibited housing lenders from imposing prepayment penalties. However, the
plaintiff has petitioned the United States Supreme Court for certiorari in this
matter.
104
Although we are licensed or otherwise qualified to originate loans in
46 states, our loan originations are concentrated mainly in the eastern half of
the United States. Recent expansion has positioned us to increase originations
in the western portion of the United States, especially California. 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 a small number of states could hinder our
ability to operate profitably and reduce the funds available to repay our
outstanding debt which could negatively impact the value of our capital stock."
We are also subject, from time to time, to private litigation resulting
from alleged "predatory lending" practices. 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, which may hinder
our ability to operate profitably, negatively impair our ability to repay our
outstanding debt and negatively impact the value of our capital stock."
On May 20, 2004, the purported consumer class action lawsuit captioned
Moore v. American Business Financial Services, Inc. et al, No. 003237 was filed
against us, our lending subsidiaries and an unrelated party in the Philadelphia
Court of Common Pleas. The lawsuit was brought on behalf of residential mortgage
consumers and challenges the validity of our deed in lieu of foreclosure and
force-placed insurance practices as well as certain mortgage service fees
charged by us. This lawsuit relates, in part, to the same subject matter as the
U.S. Attorney's inquiry concluded in December 2003 with no findings of
wrongdoing as discussed below. The lawsuit seeks actual and treble damages,
statutory damages, punitive damages, costs and expenses of the litigation and
injunctive relief. Procedurally, this lawsuit is in a very preliminary stage. We
believe the complaint contains fundamental factual inaccuracies and that we have
numerous defenses to these allegations. We intend to vigorously defend this
lawsuit. Due to the inherent uncertainties in litigation and because the
ultimate resolution of this proceeding is influenced by factors outside of our
control, we are currently unable to predict the ultimate outcome of this
litigation or its impact on our financial position or results of operations.
SECURITIES CLASS ACTION LAWSUITS AND SHAREHOLDER DERIVATIVE ACTION. In
January and February of 2004, four class action lawsuits were filed against us
and certain of our officers and directors. Lead plaintiffs and counsel were
appointed on June 3, 2004. A consolidated amended class action complaint that
supersedes these four complaints was filed on August 19, 2004 in the United
States District Court for the Eastern District of Pennsylvania.
The consolidated amended class action complaint brings claims on behalf
of a class of all purchasers of our common stock for a proposed class period of
January 27, 2000 through June 26, 2003. The consolidated complaint names us, our
director and Chief Executive Officer, Anthony Santilli, our Chief Financial
Officer, Albert Mandia, and former director, Richard Kaufman, as defendants and
alleges that we and the named directors and officers violated Sections 10(b) and
20(a) of the Exchange Act. The consolidated complaint alleges that, during the
applicable class period, our forbearance and deferment practices enabled us to,
among other things, lower our delinquency rates to facilitate the securitization
of our loans which purportedly allowed us to collect interest income from our
securitized loans and inflate our financial results and market price of our
common stock. The consolidated amended class action complaint seeks unspecified
compensatory damages, costs and expenses related to bringing the action, and
other unspecified relief.
105
On March 15, 2004, a shareholder derivative action was filed against
us, as a nominal defendant, and our director and Chief Executive Officer,
Anthony Santilli, our Chief Financial Officer, Albert Mandia, our directors,
Messrs. Becker, DeLuca and Sussman, and our former director Mr. Kaufman, as
defendants, in the United States District Court for the Eastern District of
Pennsylvania. The lawsuit was brought nominally on behalf of the Company, as a
shareholder derivative action, alleging that the named directors and officers
breached their fiduciary duties to the Company, engaged in the abuse of control,
gross mismanagement and other violations of law during the period from January
27, 2000 through June 25, 2003. The lawsuit seeks unspecified compensatory
damages, equitable or injunctive relief and costs and expenses related to
bringing the action, and other unspecified relief. The parties have agreed to
stay this case pending disposition of any motion to dismiss the consolidated
amended complaint filed in the putative consolidated securities class action.
Procedurally, these lawsuits are in a very preliminary stage. We
believe that we have several defenses to the claims raised by these lawsuits and
intend to vigorously defend the lawsuits. Due to the inherent uncertainties in
litigation and because the ultimate resolution of these proceedings is
influenced by factors outside of our control, we are currently unable to predict
the ultimate outcome of this litigation or its impact on our financial position,
results of operations or cash flows. See "Risk Factors -- We are subject to
private litigation, including lawsuits resulting from the alleged "predatory"
lending practices, as well as securities class action and derivative lawsuits,
the impact of which on our financial position is uncertain. The inherent
uncertainty related to litigation of this type and the preliminary stage of
these suits makes it difficult to predict the ultimate outcome or potential
liability that we may incur as a result of these matters."
JOINT AGREEMENT WITH THE U.S. ATTORNEY'S OFFICE. On December 22, 2003,
we entered into a Joint Agreement with the Civil Division of the U.S. Attorney's
Office for the Eastern District of Pennsylvania which ended the inquiry by the
U.S. Attorney initiated pursuant to the civil subpoena dated May 14, 2003. The
U.S. Attorney's inquiry focused on our forbearance policies, primarily on our
practice of requesting a borrower who entered into forbearance agreement to
execute a deed in lieu of foreclosure. In response to the inquiry and as part of
the Joint Agreement, we, among other things, have adopted a revised forbearance
policy, which became effective on November 19, 2003 and will make an $80
thousand contribution to a housing counseling organizations approved by the U.S.
Department of Housing and Urban Development. We do not believe that the Joint
Agreement with the U.S. Attorney has had a significant impact on our operations.
See "Legal Proceedings."
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are prepared in accordance with
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.
106
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," referred to as SFAS No. 140 in this
document, and "gain-on-sale" accounting to our loan securitizations. Gains on
sales of loans through securitizations for the fiscal year ended June 30, 2004
were 15.6% of total revenues compared to 70.8% for the fiscal year ended June
30, 2003. The decline in the percentage of total revenues comprised of
securitization gains resulted from our inability to complete securitizations in
the first, third and fourth quarters of fiscal 2004 and the reduction in loans
originated during fiscal 2004. 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 may
retain based upon their relative fair values. Estimates of the fair values of
the interest-only strips and the servicing rights we may retain are discussed
below. We believe the accounting estimates related to gain on sale are critical
accounting estimates because more than 80% of the securitization gains in fiscal
2003 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.
INTEREST-ONLY STRIPS. Interest-only strips, which represent the right
to receive future cash flows from securitized loans, represented 44.0% of our
total assets at June 30, 2004 and 51.6% of our total assets at June 30, 2003 and
are carried at their fair values. Interest-only strips are initially recorded at
their allocated cost basis at the time of recording a securitization gain and in
accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and
Equity Securities," referred to as SFAS No. 115 in this document, are then
written up to their fair value through other comprehensive income, a component
of stockholders' equity.
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. 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 for impairment.
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, and SFAS No. 115, decreases in the fair value of
interest-only strips that are deemed to be other than temporary adjustments to
fair value are recorded through the income statement, which would adversely
affect our income in the period of adjustment. Additionally, to the extent any
individual interest-only strip has a portion of its initial write up to fair
value still remaining in other comprehensive income, other than temporary
decreases in its fair value would first be recorded as a reduction to other
comprehensive income, which would adversely affect our stockholders' equity in
the period of adjustment.
107
During fiscal 2004, we recorded total pre-tax other than temporary
valuation adjustments on our interest only-strips of $57.0 million, of which, in
accordance with EITF 99-20, $39.6 million was charged as expense to the income
statement and $17.4 million was charged to other comprehensive income. During
fiscal 2003, we recorded total pre-tax other than temporary valuation
adjustments on our interest-only strips of $58.0 million, of which $39.9 million
was charged as expense to the income statement and $18.1 million was charged to
other comprehensive income. The valuation adjustments primarily reflect the
impact of higher than anticipated prepayments on securitized loans experienced
during fiscal 2004 and fiscal 2003 due to the continuing low interest rate
environment. Additionally, on June 30, 2004, we wrote down the carrying value of
our interest-only strips related to five of our mortgage securitization trusts
by $4.1 million to reflect their values under the terms of a September 27, 2004
sale agreement. The sale of these assets was undertaken as part of our
negotiations to obtain the new $100.0 million warehouse credit facility
described in "-- Liquidity and Capital Resources" and to raise cash to pay fees
on new warehouse credit facilities and as a result, we did not realize their
full value as reflected on our books. See "-- 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, impair our ability to repay our outstanding debt and
negatively impact the value of our capital stock."
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 7.1% of our total assets at June 30, 2004 and
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 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 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.
108
A review for impairment is performed on a quarterly basis by
stratifying the serviced loans by loan type, home mortgage or business purpose
loans, which we consider to be the predominant risk characteristic in the
portfolio of loans we service. In establishing loan type as the predominant risk
characteristic, we considered the following additional loan characteristics and
determined these characteristics as mostly uniform within our two types of
serviced loans and not predominant for risk stratification:
o Fixed versus floating rate loans - All loans we service in our
securitizations are fixed-rate loans.
o Conforming versus non-conforming loans - All loans we service are
sub-prime (non-conforming) loans, with over 80% of the loans serviced
having credit grades of A or B.
o Interest rate on serviced loans - The serviced loan portfolio has a
high penetration rate of prepayment fees. Sub-prime borrowers, in
general, are not as influenced by movement in market interest rates as
conforming borrowers. A sub-prime borrower's ability to `rate shop' is
generally limited due to personal credit circumstances that are not
market driven.
o Loan collateral - All loans we service are secured by real estate, with
approximately 85% secured with first liens on residential property.
o Individual loan size - The average loan size in our serviced portfolio
is $75 thousand. The serviced portfolio is approximately $2.1 billion
at June 30, 2004 with approximately 25 thousand loans. There are no
significant defining groupings with respect to loan size. No loans are
greater than $1.0 million, only $10.8 million of loans have principal
balances greater than $500 thousand, and only $34.5 million of loans
have principal balances greater than $350 thousand.
o Geographic location of loans - The largest percentage of loans we
service are geographically located in the mid-Atlantic and northeast
sections of the United States.
o Original loan term - Home equity loan terms are primarily 180, 240 or
360 months. Business purpose loan terms are primarily 120 or 180
months.
If our quarterly 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.
Our valuation analyses indicated that valuation adjustments of $5.5 million and
$5.3 million were required during fiscal 2004 and 2003, respectively, for
impairment of servicing rights due to higher than expected prepayment
experience. Additionally, on June 30, 2004, we wrote down the carrying value of
our servicing rights related to five of our mortgage securitization trusts by
$1.3 million to reflect their values under the terms of a September 27, 2004
sale agreement. The sale of these assets was undertaken as part of our
negotiations to obtain the new $100.0 million warehouse credit facility
described in "-- Liquidity and Capital Resources" and to raise cash to pay fees
on new warehouse credit facilities and as a result, we did not realize their
full value as reflected on our books. In accordance with SFAS No. 140, the write
downs were recorded as a charge to the income statement. Impairment is measured
as the excess of carrying value over fair value. See "-- 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 estimated
impact on our financial statements of changes in assumptions.
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.
DEFERRED TAX ASSET. Estimates of deferred tax assets and deferred tax
liabilities make up the deferred income tax asset on our balance sheet. These
estimates involve significant judgments and estimates by management, which may
have a material impact on the carrying value of the deferred income tax asset.
We periodically review the deferred income tax asset to determine if it is more
likely than not that we will realize this deferred tax asset.
109
Our net deferred income tax position changed from a liability of $17.0
million at June 30, 2003 to an asset of $59.1 million at June 30, 2004. For more
detail on this net deferred income tax asset, see Note 14 of the June 30, 2004
Consolidated Financial Statements. This change from a liability position is the
result of recording $68.3 million of federal and state income tax benefits on
our pre-tax loss for the fiscal year ended June 30, 2004. These federal and
state income tax benefits will be realized against anticipated future years'
state and federal taxable income. Factors we considered in determining that it
is more likely than not we will realize this deferred tax asset included: (i)
the circumstances producing the losses for the fourth quarter of fiscal 2003 and
the fiscal year ended June 30, 2004; (ii) our historical profitability prior to
the fourth quarter of fiscal 2003; (iii) the anticipated impact that our
adjusted business strategy will have on producing more currently taxable income
than our previous business strategy produced due to higher loan originations and
shifting from securitizations to whole loan sales; (iv) the achievability of
anticipated levels of future taxable income under our adjusted business
strategy; and (v) the likely utilization of our net operating loss
carryforwards. Additionally, we consider tax-planning strategies we can use to
increase the likelihood that the deferred income tax asset will be realized.
Our adjusted business strategy, as described in "Business -- Business
Strategy," will more likely than not produce the level of loan originations that
we need to achieve taxable income. For the month of May 2003, we originated
$169.0 million of loans, an historical monthly high under our previous business
strategy. In the month of September 2004 under our adjusted business strategy,
we originated $234.0 million of loans and management believes that amount would
have been higher if not for the impact of hurricanes in some of the states in
which we originate loans. Once our adjusted business strategy is fully
implemented, we anticipate increasing our loan originations to approximately
$400.0 million to $600.0 million per month, which will return us to profitable
operations. We have significantly expanded our geographic reach and established
a strong presence on the west coast in fiscal 2004, and are continuing to apply
our adjusted business strategy, particularly as it relates to expanding our
broker channel and offering adjustable rate mortgages, purchase money mortgages
and more competitively priced fixed rate mortgages. Additionally, economic
conditions are favorable for loan originations with growing GDP and employment,
high real estate values and moderate increases in interest rates.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained
on non-accrual loans to account for delinquent loans and leases and delinquent
loans that have been repurchased from securitization trusts. The allowance is
maintained at a level that management determines is adequate to absorb estimated
probable losses. The allowance is calculated based upon management's estimate of
our ability to collect on outstanding loans based upon a variety of factors,
including, periodic analysis of the loans, 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 charge-offs reduce the allowance. Delinquent loans are charged
off against the allowance in the period in which a loan is deemed fully
uncollectable or when liquidated in a payoff or sale. If the actual collection
of outstanding loans 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.
DERIVATIVE FINANCIAL INSTRUMENTS. We utilize derivative financial
instruments to manage the effect of changes in interest rates on the fair value
of our loans between the date loans are originated at fixed interest rates and
the date the terms and pricing for a whole loan sale are fixed or the date the
fixed interest rate pass-through certificates to be issued by a securitization
trust are priced. See "-- Interest Rate Risk Management -- Strategies for Use of
Derivative Financial Instruments" for more detail.
Derivative contracts receive hedge accounting only if they are
designated as a hedge and are expected to be, and are, highly effective in
substantially reducing interest rate risk arising from the pools of mortgage
loans exposing us to risk. Under hedge accounting, the gain or loss derived from
these derivative financial instruments, which are designated as fair value
hedges, is reported in the Statement of Income (included in the caption "gains
and losses on derivative financial instruments") as it occurs with an offsetting
adjustment to the hedged loans attributable to the risk being hedged also
reported in the Statement of Income. The fair value of derivative financial
instruments is determined based on quoted market prices. The fair value of the
hedged loans is determined based on current pricing of these assets in a whole
loan sale or securitization. Cash flows resulting from fair value hedges are
reported in the period they occur.
Assuming a hedge relationship continues to be highly effective,
determined as described below, the relationship continues until the mortgage
loan pool is sold in a whole loan sale, is committed to a forward sale agreement
or is sold in a securitization. When a hedge relationship is terminated, the
derivative financial instrument may be re-designated as a hedge of a new
mortgage pool.
110
The effectiveness of our fair value hedges is periodically assessed.
Fair value hedges must meet specific effectiveness tests to be considered highly
effective. Over time the change in the fair values of the derivative financial
instrument must be within 80 to 120 percent of the change in the fair value of
the hedged loans due to the designated risk. If highly effective correlation
does not exist, we discontinue hedge accounting prospectively.
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, 2004 and 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 related to
interest-only strips and servicing rights in the fiscal year ended June 30,
2004, see "-- Securitizations."
INITIAL ADOPTION OF ACCOUNTING POLICIES. In conjunction with the
relocation of our corporate headquarters to new leased office space, we entered
into a lease agreement and certain governmental grant agreements, which provided
us with reimbursement for certain expenditures related to our office relocation.
The reimbursable expenditures included 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 are 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 were initially recorded as a liability. Grant
funds received to offset expenditures for capitalizable items are classified 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 were recognized in the income statement
as an offset to the expense item.
IMPACT OF CHANGES IN CRITICAL ACCOUNTING ESTIMATES IN PRIOR FISCAL YEARS
DISCOUNT RATES. 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 as expense 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 and the amount of
the adjustments related to changes in discount rates were as follows:
o We recorded total pre-tax valuation adjustments on our interest
only-strips of $58.0 million, of which $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 reductions in discount rates are discussed in
more detail below.
111
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.
See "- Application of Critical Accounting Estimates - Interest-Only
Strips" for a discussion of how valuation adjustments are recorded.
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 had 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 had declined approximately 475 basis points and
five-year rates have declined approximately 375 basis points over
that period.
o The interest rates on the bonds issued in our securitizations over
that same timeframe also had experienced a sustained period of
decline. The trust certificate pass-through interest rate had
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 had 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 favored the continuation of low
interest rates for the foreseeable future.
o Economic analysis of interest rates and data released at the time of
the June 30, 2003 evaluation supported declining mortgage
refinancings even though predicting the continuation of low interest
rates for the foreseeable future.
o The interest rates paid on subordinated debentures issued, which is
used to fund our interest-only strips, had declined from a high of
11.85% in February 2001 to a 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.
112
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.
The blended rate used to value our interest-only strips at June 30,
2003 was 9%.
From June 2000 to March 2003, the discount rate applied in determining
the fair value of servicing rights was 11%, which was 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%. The impact of the June 30,
2003 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.
PREPAYMENT RATES. From the second quarter of fiscal 2002 through the
fourth quarter of fiscal 2004, we revised the prepayment rate assumptions used
to value our securitization assets, thereby decreasing the fair value of these
assets. See "-- Securitizations" for discussion of the impacts of these
revisions in prepayment rate assumptions.
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.
We have used special purpose entities and off-balance sheet facilities
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. We expect to use off-balance sheet
facilities in any future securitizations.
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.
113
When we securitize loans, we also may retain the right to service the
loans. We do not service the loans in the 2003-2 securitization, our most recent
securitization, which closed in October 2003. 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 debentures and our operating cash needs.
We may retain the rights to service the loans we sell through
securitizations. If we retain the servicing rights, 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, 2004 and 2003, the mortgage securitization trusts held
loans with an aggregate principal balance due of $1.9 billion and $3.4 billion
as assets and owed $1.7 billion and $3.2 billion to third party investors,
respectively. Revenues from the sale of loans to securitization trusts were
$15.1 million, or 15.6% of total revenues for the fiscal year ended June 30,
2004 and $171.0 million, or 70.8% of total revenues for the fiscal year ended
June 30, 2003. The revenues for fiscal 2004 and 2003 are net of $2.9 million and
$5.1 million, respectively, of expenses for underwriting fees, legal fees and
other expenses associated with securitization transactions during that period.
We have interest-only strips and servicing rights with fair values of $459.1
million and $73.7 million, respectively at June 30, 2004, which combined
represent 51% of our total assets. Net cash flows received from interest-only
strips and servicing rights were $194.7 million for fiscal 2004 and $132.1
million for fiscal 2003. 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 that was available to us
until July 5, 2003. 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 30, 2003, $222.3 million of the loans which were in the
facility at June 30, 2003 were sold in whole loan sales as directed by the
facility sponsor. At September 30, 2003, the off-balance sheet mortgage conduit
facility held loans with principal balances due of $40.5 million as assets and
owed $36.0 million to third parties. This conduit facility was refinanced in the
October 16, 2003 refinancing described under "-- Liquidity and Capital Resources
- -- Credit Facilities."
114
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 may 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.
In a declining interest rate environment, such as experienced during
fiscal 2003, securitization pass-through interest rates generally decline, which
can lead to higher interest rate spreads. Increased interest rate spreads result
in increases in the residual cash flow we expect to receive on securitized
loans, the amount of cash we receive at the closing of a securitization from the
sale of notional bonds or premiums on investor certificates and corresponding
increases in the gains we recognize on the sale of loans in a securitization. In
our fiscal 2003 securitizations, we experienced improved interest rate spreads.
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. No
assurances can be made that market interest rates will remain at current levels
or that we can complete securitizations in the future. 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 "-- Interest Rate Risk Management --
Strategies for Use of Derivative Financial Instruments" for a discussion of our
hedging strategies.
While a declining interest rate environment can lead to higher interest
rate spreads, a declining interest rate environment could also 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. This has been our
experience since fiscal 2002.
115
Declining interest rates and resulting high prepayment rates over the
last eleven quarters have required revisions to our estimates of the value of
our securitization assets. Beginning in the second quarter of fiscal 2002 and on
a quarterly basis thereafter, our prepayment rates, as well as those throughout
the mortgage industry, remained at higher than expected levels due to continuing
low interest rates during this period. As a result, over the last eleven
quarters we have recorded cumulative pre-tax write downs to our interest-only
strips in the aggregate amount of $175.8 million and pre-tax adjustments to the
value of servicing rights of $17.9 million, for total adjustments of $193.7
million, mainly due to the higher than expected prepayment experience. During
the same period, we reduced the discount rates we apply to value our
securitization assets, resulting in net favorable pre-tax valuation impacts of
$20.9 million on interest-only strips and $7.1 million on servicing rights. The
discount rates were reduced primarily to reflect the impact of the sustained
decline in market interest rates. Additionally, on June 30, 2004, we wrote down
the carrying value of our interest-only strips and servicing rights related to
five of our mortgage securitization trusts by $5.4 million to reflect their
values under the terms of a September 27, 2004 sale agreement. The sale of these
assets was undertaken as part of our negotiations to obtain the new $100.0
million warehouse credit facility described in "-- Liquidity and Capital
Resources" and to raise cash to pay fees on new warehouse credit facilities and
as a result, we did not realize their full value as reflected on our books. The
following table summarizes the net cumulative write downs recorded on our
securitization assets over the last eleven quarters (in thousands):
TOTAL INCOME OTHER
WRITE DOWN STATEMENT COMPREHENSIVE
(WRITE UP) IMPACT INCOME IMPACT
---------- --------- -------------
PRE-TAX ADJUSTMENT RESULTING FROM:
Prepayments.............................. $ 193,743 $ 128,667 $ 65,076
Discount rate............................ (28,038) (18,427) (9,611)
Loss on sale............................. 5,452 3,446 2,006
---------- ---------- ----------
Net cumulative write down................ $ 171,157 $ 113,686 $ 57,471
========== ========== ==========
See "- Application of Critical Accounting Estimates - Interest-Only
Strips" for a discussion of how valuation adjustments are recorded in the income
statement or other comprehensive income.
During fiscal 2004, we recorded total pre-tax valuation adjustments on
our interest-only strips and servicing rights of $63.8 million, of which $46.4
million was charged as expense to the income statement and $17.4 million was
charged to other comprehensive income. These adjustments primarily reflect the
impact of higher than anticipated prepayments on securitized loans experienced
in fiscal 2004 due to the low interest rate environment experienced during
fiscal 2004. The fiscal 2004 valuation adjustment also includes a write down of
the carrying value of our interest-only strips and servicing rights related to
five of our mortgage securitization trusts of $5.4 million to reflect their
values under the terms of a September 27, 2004 sale agreement. This compares to
total pre-tax valuation adjustments on our securitization assets of $63.3
million during the fiscal year ended June 30, 2003, of which $45.2 million was
charged as expense to the income statement and $18.1 million was reflected as an
adjustment to other comprehensive income. The breakout of the total adjustments
in fiscal 2004 and 2003 between interest-only strips and servicing rights was as
follows (in thousands):
116
YEAR ENDED JUNE 30, 2004 YEAR ENDED JUNE 30, 2003
-------------------------------------- ----------------------------------------
INCOME OTHER INCOME OTHER
TOTAL STATEMENT COMPREHENSIVE TOTAL STATEMENT COMPREHENSIVE
WRITE DOWN IMPACT INCOME IMPACT WRITE DOWN IMPACT INCOME IMPACT
---------- --------- ------------- ---------- --------- -------------
Interest-only strips.......... $ 57,031 $ 39,659 $ 17,372 $ 57,973 $ 39,900 $ 18,073
Servicing rights.............. 6,791 6,791 -- 5,282 5,282 --
------------------------------------- ---------------------------------------
Total securitization assets... $ 63,822 $ 46,450 $ 17,372 $ 63,255 $ 45,182 $ 18,073
===================================== =======================================
The valuation adjustment on interest-only strips for fiscal 2004
included the net impact of a December 31, 2003 reduction in the discount rate
applied to value the residual cash flows from interest-only strips from 11% to
10%, and a subsequent increase in that discount rate at June 30, 2004 back to
11%. The discount rate was reduced to 10% on December 31, 2003 from 11% on
September 30, 2003 and June 30, 2003 primarily to reflect the impact of the
sustained decline in market interest rates. The increase back to 11% at June 30,
2004 was made to reflect an increase in market interest rates that had occurred
since the end of the March 2004 quarter. The December 31, 2004 reduction in
discount rate had a favorable impact of $8.4 million on that quarter's valuation
adjustment. The June 30, 2004 increase in discount rate had an unfavorable
impact of $8.4 million on that quarter's valuation adjustment.
The long duration of historically low interest rates, combined with
increasing home values and high consumer debt levels has given borrowers an
extended opportunity to engage in mortgage refinancing activities, which
resulted in elevated prepayment experience. Low interest rates and increasing
home values provide incentive to borrowers to convert high cost consumer debt
into lower rate tax deductible loans. As home values have increased, lenders
have been highly successful in educating borrowers that they have the ability to
access the cash value in their homes.
The persistence of historically low interest rate levels, unprecedented
in the last 40 years, has made the forecasting of prepayment levels difficult.
We assumed for each quarter end valuation that the decline in interest rates had
stopped and a rise in interest rates would occur in the near term. This
assumption was supported by published data. Consistent with this view that
interest rates would rise, 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. We believe that once we are beyond the low interest rate
environment and its impact on prepayments, the long recurring and highly
unfavorable prepayment experience over the last eleven quarters will subside.
Also, the rate of increase in home values has slowed considerably, which we
expect will mean that fewer borrowers will have excess value in their homes to
access. The Mortgage Bankers Association of America has forecast as of September
17, 2004 that mortgage refinancings as a percentage share of total mortgage
originations will decline from 49% in the second quarter of calendar 2004 to 24%
in the second quarter of calendar 2005. The Mortgage Bankers Association of
America has also projected in its September 2004 economic forecast that the
10-year treasury rate (which generally affects mortgage rates) will increase
steadily each quarter in their forecast. As a result of our analysis of these
factors, we believe prepayments will continue to remain at higher than normal
levels for the near term before declining to historical prepayment levels and
then further declining in the future. See the table "-- Summary of Material
Mortgage Loan Securitization Valuation Assumptions and Actual Experience at June
30, 2004" for our current prepayment assumptions. See "-- Prepayment Rates" for
more detail regarding prepayment assumptions. 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.
117
The following tables detail the pre-tax write downs of the
securitization assets by quarter and detail the impact to the income statement
and to other comprehensive income in accordance with the provisions of SFAS No.
115 and EITF 99-20 as they relate to interest-only strips and SFAS No. 140 as it
relates to servicing rights (in thousands):
FISCAL YEAR 2004:
INCOME OTHER
TOTAL STATEMENT COMPREHENSIVE
QUARTER ENDED WRITE DOWN IMPACT INCOME IMPACT
- ----------------------------------------- ---------- --------- -------------
September 30, 2003....................... $ 16,658 $ 10,795 $ 5,863
December 31, 2003........................ 14,724 11,968 2,756
March 31, 2004........................... 23,191 15,085 8,106
June 30, 2004............................ 9,249 8,602 647
--------- ---------- ---------
Total Fiscal 2004........................ $ 63,822 $ 46,450 $ 17,372
========= ========== =========
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
========= ========== =========
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, 2004, 2003 and 2002
(dollars in thousands):
118
YEAR ENDED JUNE 30,
---------------------------------------------
SECURITIZATIONS: 2004 2003 2002
---------- ----------- -----------
Business loans............................................. $ 11,027 $ 112,025 $ 129,074
Home equity loans.......................................... 130,380 1,311,739 1,222,061
---------- ----------- -----------
Total...................................................... $ 141,407 $ 1,423,764 $ 1,351,135
========== =========== ===========
Gain on sale of loans through securitization............... $ 15,107 $ 170,950 $ 185,580
Securitization gains as a percentage of total revenue...... 15.6% 70.8% 74.9%
Whole loan sales........................................... $ 808,378 $ 28,013 $ 57,679
Premiums on whole loan sales............................... $ 18,725 $ 655 $ 2,448
As demonstrated in the fourth quarter of fiscal 2003 and the fiscal
year ended June 30, 2004, our quarterly revenues and net income will 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 the level of profitability realized on a
securitization. These factors include conditions in the securities markets, such
as fluctuations in interest rates, conditions in the asset-backed securities
markets relating to the loans we originate, credit quality of the total
portfolio of loans we originate or potential changes to the legal and accounting
principles underlying securitization transactions.
INTEREST-ONLY STRIPS. As the holder of interest-only strips, we are
entitled to receive excess (or residual) cash flows and cash flows from the
release of 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 bond fees. In
most of our securitizations, surety bond fees are paid to an unrelated insurance
entity to provide credit enhancement for the trust investors. The forms of
credit enhancement in our securitizations are described below.
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.
Our securitizations provide credit enhancement to the trust investors
through the use of overcollateralization, a surety bond and/or subordinate bond
structures. The terms and conditions of credit enhancements are specific to each
securitization and are determined at inception for the life of the trust. All of
our securitizations require overcollateralization as the primary credit
enhancement for the benefit of the trust investors. Overcollateralization levels
are generally established by bond rating agencies. A second form of credit
enhancement is provided from a third party surety bond provider, the use of
subordinate investor bond structures, or a combination of both. Subordinate
investor bonds receive a higher rate of interest for the higher risk associated
with their investment and typically have a defined principal amortization, which
maintains a specified ratio of subordinate bonds to senior bonds. Third party
surety bond providers receive monthly fees, which are deducted from the excess
interest cash flow from the trust and in return the surety bond provider
guarantees the repayment of principal to the trust investors. The surety bond
fee amount is specific to each applicable securitization and generally ranges
from 0.19% to 0.45% annually on the applicable investor notes outstanding. The
surety bond provider establishes their annual surety bond fee based on the
levels of overcollateralization set for each securitization trust and their
assessment of credit risk in each pool of securitized loans.
119
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, 2004, investments in interest-only strips totaled $459.1 million,
including the fair value of overcollateralization related cash flows of $216.9
million.
OVERCOLLATERALIZATION REQUIREMENTS. Overcollateralization requirements
are specific to each securitization. The amount of required
overcollateralization, often referred to as specified overcollateralization,
varies during the life of the trust. The requirements for overcollateralization
typically include:
o 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.
o 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. All residual cash flows are initially retained by the
trust until the final target is reached. The final target is maintained
until the stepdown date. 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.
o 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 final target levels when delinquencies fall below the
specified limits. See "- Trigger Management" for a discussion of
securitization trusts holding excess overcollateralization.
o The stepdown requirement is a percentage of the remaining unpaid
principal balance of securitized loans. The step-down target percentage
is typically twice the percentage of the final target and is applied
each period to the current unpaid principal balance of the remaining
loans in the securitized pool. During the stepdown period, the
overcollateralization amount is reduced through cash payments to us
until the overcollateralization balance declines to a specific floor.
The floor percentage is typically 0.50% to 1.00% of the original
principal balance of the loans in the securitized pool and provides for
a minimum constant amount of overcollateralization for the remaining
life of the trust. The ability to stepdown may be precluded during
periods in which delinquencies exceed specified limits. The
overcollateralization levels return to the target levels when
delinquencies fall below the specified limits.
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 not the
obligation, to repurchase a limited amount of delinquent loans from
securitization trusts. See "-- Repurchase Rights" for a summary of the amount of
delinquent loans which we have the right, but not obligation, to repurchase from
securitization trusts. In addition, we may elect to repurchase delinquent 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. The related REO writedown for REO repurchased is recorded through
general and administrative expense in the period of repurchase. Our ability to
repurchase these loans does not disqualify us for sale accounting under SFAS No.
140 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.
120
At June 30, 2004, four of our twenty six mortgage securitization trusts
were under a triggering event as a result of delinquencies exceeding specified
levels. There were no securitization trusts exceeding specified loss levels at
June 30, 2004. At June 30, 2003, none of our mortgage securitization trusts were
under a triggering event. Approximately $8.0 million of excess
overcollateralization is being held by the four trusts as of June 30, 2004. For
the fiscal year ended June 30, 2004, we repurchased delinquent loans with an
aggregate unpaid principal balance of $54.0 million from securitization trusts
primarily for trigger management. We cannot predict when the four trusts
currently exceeding triggers will be below trigger limits and release the excess
overcollateralization. In order for these trusts to release the excess
overcollateralization, delinquent loans would need to decline, or we would need
to repurchase delinquent loans of up to $10.4 million as of June 30, 2004. 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 debentures 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, impair our ability to repay
our outstanding debt and negatively impact the value of our capital stock."
Additionally, our repurchase activity increases prepayments, which may result in
unfavorable prepayment experience. See "-- Prepayment Rates" for more detail
regarding prepayment assumptions. See "-- Securitizations" for more detail of
the effect prepayments have on our financial statements. Also see "Total
Portfolio Quality -- Delinquent Loans and Leases" for further discussion of the
impact of delinquencies.
The following table presents the four securitization trusts under a
triggering event at June 30, 2004, their related specified limit on
delinquencies, their actual delinquencies at June 30, 2004, the related amounts
of actual excess overcollateralization and the maximum target amounts of excess
overcollateralization. The amount by which the maximum target amounts of excess
overcollateralization exceeds current excess overcollateralization amounts will
be withheld by the trusts from future residual cash flows, as long as the actual
delinquency levels continue to exceed the specified limit, until the maximum
amount is reached.
121
SUMMARY OF SECURITIZATION TRUSTS UNDER TRIGGERING EVENTS
(dollars in thousands)
ACTUAL JUNE 30, 2004
DELINQUENCIES
--------------------
AMOUNT ACTUAL
SPECIFIED ABOVE JUNE 30, 2004 MAXIMUM TARGET
SECURITIZATION TRIGGER SPECIFIED EXCESS OVER- EXCESS OVER-
TRUST TRIGGER EXCEEDED LIMIT % LIMIT (A) COLLATERALIZATION COLLATERALIZATION
-------------- ---------------- --------- ----- --------- ----------------- -----------------
1996-2(c) Rolling 6 month 60+
day delinquency rate 11.25% 12.34% $ 243 $ 124 $ 2,879 (b)
1999-3 Rolling 6 month 60+
day delinquency rate 9.75% 9.91% 201 307 5,901 (b)
2001-3 Rolling 3 month 90+
day delinquency rate 12.50% 13.62% 5,395 3,528 3,528
2001-4 Rolling 3 month 90+
day delinquency rate 12.50% 13.28% 4,518 4,085 4,085
-----------------------------------------------
$ 10,357 $ 8,044 $ 16,393
===============================================
- ------------
(a) In order for these trusts to release the excess overcollateralization,
delinquent loans would need to decline, or we would need to repurchase
delinquent loans of up to $10.4 million as of June 30, 2004.
(b) Residual cash flows will be retained by the securitization trust until this
maximum is reached or the actual delinquency level returns to the specified
limit.
(c) Under the terms of a September 27, 2004 sale agreement, we sold the
interest-only strip related to 1996-2.
The following table summarizes the principal balances of loans and REO
we have repurchased from the mortgage loan securitization trusts, the valuation
adjustments recorded through the provision for loan losses for loans repurchased
and the REO writedown recorded through general and administrative expense for
REO repurchased during fiscal years 2004, 2003 and 2002. We received $40.9
million, $37.6 million and $19.2 million of proceeds from the liquidation of
repurchased loans and REO for fiscal years 2004, 2003 and 2002, respectively. We
carried as assets on our balance sheet, repurchased loans and REO in the amounts
of $5.2 million, $9.2 million and $8.2 million at June 30, 2004, 2003 and 2002,
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.
122
SUMMARY OF LOANS AND REO REPURCHASED FROM MORTGAGE LOAN SECURITIZATION TRUSTS
(DOLLARS IN THOUSANDS)
2003-1 2002-1 2001-3 2001-2 2001-1 2000-4 2000-3 2000-2 2000-1 1999-4
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
YEAR ENDED JUNE 30, 2004:
Repurchases by original loan type:
Business purpose loans............ $ 219 $ -- $ 592 $ 1,713 $ 1,008 $ 2,252 $ 631 $ 1,386 $ 925 $ 1,324
Home equity loans................. -- 35 1,129 2,937 4,152 3,493 2,145 2,699 2,702 4,864
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 219 $ 35 $ 1,721 $ 4,650 $ 5,160 $ 5,745 $ 2,776 $ 4,085 $ 3,627 $ 6,188
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original balance of
loans securitized............... 0.05% 0.01% 0.57% 1.31% 1.88% 2.09% 1.85% 1.35% 1.53% 2.79%
Number of loans and REO
repurchased..................... 1 1 23 40 64 63 28 53 54 102
Repurchases by loan or REO:
Loans repurchased................. $ 219 $ 35 $ 1,121 $ 3,818 $ 4,593 $ 4,464 $ 2,159 $ 3,428 $ 2,280 $ 4,596
REO repurchased................... -- -- 600 832 567 1,281 617 657 1,347 1,592
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 219 $ 35 $ 1,721 $ 4,650 $ 5,160 $ 5,745 $ 2,776 $ 4,085 $ 3,627 $ 6,188
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Valuation adjustment at repurchase:
Loans repurchased (a)............. $ 55 $ 11 $ 409 $ 774 $ 1,456 $ 1,195 $ 515 $ 938 $ 784 $ 1,753
REO repurchased (b)............... -- -- 140 202 179 472 230 215 480 611
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 55 $ 11 $ 549 $ 976 $ 1,635 $ 1,667 $ 745 $ 1,153 $ 1,264 $ 2,364
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
YEAR ENDED JUNE 30, 2003:
Repurchases by original loan type:
Business purpose loans............ $ -- $ -- $ 349 $ -- $ 543 $ 223 $ 144 $ 2,065 $ 1,573 $ 2,719
Home equity loans................. -- -- 853 -- 4,522 520 839 4,322 4,783 5,175
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ -- $ -- $ 1,202 $ -- $ 5,065 $ 743 $ 983 $ 6,387 $ 6,356 $ 7,894
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized....................... -- -- 0.40% -- 1.84% 0.27% 0.66% 2.11% 2.68% 3.56%
Number of loans and REO
repurchased..................... -- -- 11 -- 51 9 11 59 65 97
Repurchases by loan or REO:
Loans repurchased................. $ -- $ -- $ 560 $ -- $ 2,957 $ 46 $ 393 $ 1,688 $ 1,868 $ 3,382
REO repurchased................... -- -- 642 -- 2,108 697 590 4,699 4,488 4,512
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ -- $ -- $ 1,202 $ -- $ 5,065 $ 743 $ 983 $ 6,387 $ 6,356 $ 7,894
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Valuation adjustment at repurchase:
Loans repurchased (a)............. $ -- $ -- $ 112 $ -- $ 603 $ 9 $ 78 $ 442 $ 386 $ 817
REO repurchased (b)............... -- -- 87 -- 667 250 147 1,557 1,235 1,770
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ -- $ -- $ 199 $ -- $ 1,270 $ 259 $ 225 $ 1,999 $ 1,621 $ 2,587
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
YEAR ENDED JUNE 30, 2002:
Repurchases by original loan type:
Business purpose loans............ $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 194
Home equity loans................. -- -- -- -- -- -- -- -- 84 944
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 84 $ 1,138
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized....................... -- -- -- -- -- -- -- -- 0.04% 0.51%
Number of loans and REO
repurchased..................... -- -- -- -- -- -- -- -- 2 18
Repurchases by loan or REO:
Loans repurchased................. $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 84 $ 228
REO repurchased................... -- -- -- -- -- -- -- -- -- 910
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 84 $ 1,138
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Valuation adjustment at repurchase:
Loans repurchased (a)............. $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 75 $ 123
REO repurchased (b)............... -- -- -- -- -- -- -- -- -- 459
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 75 $ 582
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
- -----------------
(a) The valuation adjustment for loans repurchased is recorded through the
provision for loan losses.
(b) The valuation adjustment for REO repurchased is recorded through general and
administrative expense.
123
SUMMARY OF LOANS AND REO REPURCHASED FROM MORTGAGE LOAN SECURITIZATION TRUSTS
(CONTINUED)
(DOLLARS IN THOUSANDS)
1999-3 1999-2 1999-1 1998-4 1998-3 1998-2 1998-1 1997(C) 1996(C) TOTAL
------ ------ ------ ------ ------ ------ ------ ------- ------- -------
YEAR ENDED JUNE 30, 2004:
Repurchases by original loan type:
Business loans.................... $ 915 $ 1,014 $ 696 $ 497 $ 456 $ -- $ 350 $ 781 $ -- $14,759
Home equity loans................. 2,228 3,472 3,223 1,354 2,825 399 875 579 100 39,211
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 3,143 $ 4,486 $ 3,919 $ 1,851 $ 3,281 $ 399 $ 1,225 $ 1,360 $ 100 $53,970
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized....................... 1.42% 2.04% 2.12% 2.31% 1.64% 0.33% 1.17% 0.78% 0.16%
Number of loans and REO
repurchased..................... 47 58 52 24 33 4 17 19 1 684
Repurchases by loan or REO:
Loans repurchased................. $ 2,185 $ 3,324 $ 2,106 $ 1,687 $ 2,865 $ 355 $ 532 $ 1,295 $ 100 $41,162
REO repurchased................... 958 1,162 1,813 164 416 44 693 65 -- 12,808
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 3,143 $ 4,486 $ 3,919 $ 1,851 $ 3,281 $ 399 $ 1,225 $ 1,360 $ 100 $53,970
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Valuation adjustment at repurchase:
Loans repurchased (a)............. $ 914 $ 995 $ 511 $ 435 $ 771 $ 51 $ 140 $ 405 $ 30 $12,142
REO repurchased (b)............... 317 434 651 44 125 17 115 -- -- 4,232
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 1,231 $ 1,429 $ 1,162 $ 479 $ 896 $ 68 $ 255 $ 405 $ 30 $16,374
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
YEAR ENDED JUNE 30, 2003:
Repurchases by original loan type:
Business loans.................... $ 2,138 $ 1,977 $ 1,199 $ 72 $ 1,455 $ 205 $ 395 $ 744 $ 451 $16,252
Home equity loans................. 3,697 3,140. 4,432 549 3,211 1,386 610 381 355 38,775
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 5,835 $ 5,117 $ 5,631 $ 621 $ 4,666 $ 1,591 $ 1,005 $ 1,125 $ 806 $55,027
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized..................... 2.63% 2.33% 3.04% 0.78% 2.33% 1.33% 0.96% 0.64% 1.30%
Number of loans and REO
repurchased..................... 83 59 60 7 60 23 13 16 13 637
Repurchases by loan or REO:
Loans repurchased................. $ 1,692 $ 2,263 $ 3,484 $ 309 $ 2,553 $ 686 $ 598 $ 817 $ 513 $23,809
REO repurchased................... 4,143 2,854 2,147 312 2,113 905 407 308 293 31,218
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 5,835 $ 5,117 $ 5,631 $ 621 4,666 $ 1,591 $ 1,005 $ 1,125 $ 806 $55,027
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Valuation adjustment at repurchase:
Loans repurchased (a)............. $ 385 $ 336 $ 797 $ 62 $ 503 $ 144 $ 22 $ 160 $ 157 $ 5,013
REO repurchased (b)............... 1,674 739 375 54 344 87 97 69 69 9,221
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 2,059 $ 1,075 $ 1,172 $ 116 $ 847 $ 231 $ 119 $ 229 $ 226 $14,234
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
YEAR ENDED JUNE 30, 2002:
Repurchases by original loan type:
Business loans.................... $ 1,006 $ 341 $ 438 $ 632 $ 260 $ 516 $ 1,266 $ 1,912 $ 104 $ 6,669
Home equity loans................. 3,249 2,688 2,419 4,649 5,575 1,548 1,770 462 183 23,571
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 4,255 $ 3,029 $ 2,857 $ 5,281 $ 5,835 $ 2,064 $ 3,036 $ 2,374 $ 287 $30,240
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
% of Original Balance of Loans
Securitized....................... 1.92% 1.38% 1.54% 6.60% 2.92% 1.72% 2.89% 1.36% 0.46%
Number of loans and REO
repurchased..................... 47 31 33 58 61 24 37 26 4 341
Repurchases by loan or REO:
Loans repurchased................. $ 1,221 $ 1,375 $ 1,437 $ 2,535 $ 2,702 $ 818 $ 1,611 $ 1,641 $ -- $13,653
REO repurchased................... 3,034 1,654 1,420 2,746 3,133 1,246 1,425 733 287 16,587
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 4,255 $ 3,029 $ 2,857 $ 5,281 $ 5,835 $ 2,064 $ 3,036 $ 2,374 $ 287 $30,240
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Valuation adjustment at repurchase:
Loans repurchased (a)............. $ 235 $ 132 $ 222 $ 528 $ 557 $ 149 $ 747 $ 244 $ -- $ 3,012
REO repurchased (b)............... 899 508 606 851 633 370 490 426 110 5,352
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total........................... $ 1,134 $ 640 $ 828 $ 1,379 $ 1,190 $ 519 $ 1,237 $ 670 $ 110 $ 8,364
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
- ----------------
(a) The valuation adjustment for loans repurchased is recorded through the
provision for loan losses.
(b) The valuation adjustment for REO repurchased is recorded through general and
administrative expense.
(c) Amounts represent combined repurchases and percentages for two 1997
securitization pools and two 1996 securitization pools.
124
REPURCHASE RIGHTS. SFAS No. 140 was effective on a prospective basis
for transfers of financial assets occurring after March 31, 2001. For
securitizations recoded under SFAS No. 140 which have removal of accounts
provisions providing us with a contractual right to repurchase delinquent loans,
SFAS No. 140 requires that we recognize the loans which are subject to these
rights as assets on our balance sheet and record a liability to reflect the
repurchase cost. SFAS No. 140 requires this accounting treatment because the
default by the borrower has given us effective control over the loan whether or
not we actually repurchase these loans. For securitization trusts 2001-2 through
2003-2, to which this rule applies, we have the contractual right to repurchase
a limited amount of loans greater than 180 days past due, but no obligation to
do so. As delinquent loans in securitization trusts 2001-2 through 2003-2 age
greater than 180 days past due, we record an asset reflecting the estimated fair
value of the loans and a liability to reflect the repurchase cost. In accordance
with the provisions of SFAS No. 140, we have recorded on our June 30, 2004
balance sheet an asset of $39.0 million and a liability of $45.9 million for
delinquent loans subject to the removal of accounts provisions under
securitization trusts 2001-2 through 2003-2.
For securitization trusts 1996-1 through 2001-1, we also have rights to
repurchase a limited amount of delinquent loans, but are not obligated to do so.
No liabilities or assets have been recorded on our balance sheet related to
these rights.
The following table summarizes the amount of delinquent loans in
securitization trusts, which we have the right, but not obligation, to
repurchase as of June 30, 2004 (in thousands):
REPURCHASE RIGHTS NOT REQUIRED TO BE REPURCHASE RIGHTS ACCOUNTED FOR
ACCOUNTED FOR UNDER SFAS 140 UNDER SFAS 140 (B)
------------------------------------ --------------------------------
AMOUNT OF AMOUNT OF
TRUST LOANS TRUST LOANS
----- ----------- ----- ---------
1996 (a) $ 891 2001-2 $ 2,124
1997 (a) 1,745 2001-3 3,077
1998 (a) 5,847 2001-4 6,320
1999-1 3,027 2002-1 6,400
1999-2 4,189 2002-2 7,600
1999-3 3,957 2002-3 7,400
1999-4 3,893 2002-4 7,600
2000-1 1,458 2003-1 3,700
2000-2 4,232 2003-2 1,642
--------
2000-3 10,104 Sub-total $ 45,863
--------
2000-4 7,713
2001-1 7,240 Total $100,159
-------- ========
Sub-total $ 54,296
--------
- -------------
(a) Amounts represent combined repurchase rights for four 1998 securitization
pools, two 1997 securitization pools and two 1996 securitization pools.
Under the terms of a September 27, 2004 sale agreement, we sold the interest
only strips related to the following five securitization trusts: 1996-2,
1997-1, 1997-2, 1998-1 and 1998-2.
(b) The liability for loans subject to repurchase rights under SFAS No. 140 of
$45.9 million is recorded on our balance sheet.
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.
125
SUMMARY OF SELECTED MORTGAGE LOAN SECURITIZATION TRUST INFORMATION
CURRENT BALANCES AS OF JUNE 30, 2004
(dollars in millions)
2003-2 2003-1 2002-4 2002-3 2002-2 2002-1 2001-4
------ ------ ------ ------ ------ ------ ------
ORIGINAL BALANCE OF LOANS SECURITIZED:
Business loans............................. $ 27 $ 33 $ 30 $ 34 $ 34 $ 32 $ 29
Home equity loans.......................... 146 417 350 336 346 288 287
------- ------- ------- ------- ------- ------- -------
Total.................................... $ 173 $ 450 $ 380 $ 370 $ 380 $ 320 $ 316
======= ======= ======= ======= ======= ======= =======
CURRENT BALANCE OF LOANS SECURITIZED:
Business loans............................. $ 23 $ 24 $ 23 $ 23 $ 23 $ 19 $ 18
Home equity loans.......................... 117 236 175 147 140 102 93
------- ------- ------- ------- ------- ------- -------
Total.................................... $ 140 $ 260 $ 198 $ 170 $ 163 $ 121 $ 111
======= ======= ======= ======= ======= ======= =======
WEIGHTED-AVERAGE INTEREST RATE ON LOANS
SECURITIZED:
Business loans............................. 15.62% 15.89% 16.03% 15.95% 16.00% 15.85% 15.78%
Home equity loans.......................... 8.86% 9.70% 10.50% 10.87% 10.91% 10.91% 10.70%
Total.................................... 9.98% 10.26% 11.13% 11.58% 11.62% 11.67% 11.50%
Percentage of first mortgage loans............ 88% 87% 87% 87% 88% 91% 90%
Weighted-average loan-to-value................ 76% 77% 76% 77% 76% 75% 77%
Weighted-average remaining term (months) on
loans securitized.......................... 267 251 241 234 220 216 212
Original balance of Trust Certificates........ $ 173 $ 450 $ 376 $370 $ 380 $ 320 $ 322
Current balance of Trust Certificates......... $ 136 $ 239 $ 176 $ 157 $ 150 $ 107 $ 97
Weighted-average pass-through interest rate
to Trust Certificate holders(a)............ 8.00% 5.53% 6.72% 7.18% 8.26% 8.90% 5.35%
Highest Trust Certificate pass-through
interest rate.............................. 8.00% 3.78% 8.61% 6.86% 7.39% 6.51% 5.35%
OVERCOLLATERALIZATION REQUIREMENTS(D):
REQUIRED PERCENTAGES:
Initial.................................... -- -- 1.00% -- -- -- --
Final target............................... 4.10% 5.50% 5.75% 3.50% 3.50% 4.50% 4.25%
Stepdown overcollateralization............. 8.20% 11.00% 11.50% 7.00% 7.00% 9.00% 8.50%
REQUIRED DOLLAR AMOUNTS:
Initial.................................... $ -- $ -- $ 4 $ -- $ -- $ -- $ --
Final target............................... $ 7 $ 25 $ 22 $ 13 $ 13 $ 14 $ 13
CURRENT STATUS:
Overcollateralization amount............... $ 4 $ -- $ 22 $ 13 $ 13 $ 14 $ 14
Final target reached or anticipated date
to reach................................ 1/2005 12/2004 Yes Yes Yes Yes Yes
Stepdown reached or anticipated date to
reach................................... 11/2006 4/2006 1/2006 10/2005 7/2005 10/2004 Yes(c)
ANNUAL SURETY FEE(D) ......................... 0.45% 0.20% (b) (b) (b) 0.21% 0.20%
SERVICING RIGHTS:
Original balance........................... $ -- $ 16 $ 14 $ 13 $ 15 $ 13 $ 13
Current balance............................ $ -- $ 10 $ 8 $ 7 $ 7 $ 6 $ 6
- -------------------
(a) Rates for securitizations 2002-1 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 "-- Results of Operations -- Year Ended June 30, 2004 Compared to Year
Ended June 30, 2003 -- Gain on Sale of Loans -- Securitizations" for
further description of the notional bonds.
(b) Credit enhancement was provided through a senior / subordinate certificate
structure.
(c) Although the final target has been reached, this trust is exceeding
delinquency limits, and the trust is retaining additional
overcollateralization. We cannot predict when normal residual cash flow
will resume. See "-- Trigger Management" for further detail.
(d) See "- Interest-Only Strips" for a discussion of credit enhancements in our
securitizations and "- Overcollateralization Requirements" for further
detail on overcollateralization.
126
SUMMARY OF SELECTED MORTGAGE LOAN SECURITIZATION TRUST INFORMATION (CONTINUED)
CURRENT BALANCES AS OF JUNE 30, 2004
(dollars in millions)
2001-3 2001-2 2001-1 2000-4 2000-3 2000-2 2000-1
------ ------ ------ ------ ------ ------ ------
ORIGINAL BALANCE OF LOANS SECURITIZED:
Business loans............................. $ 31 $ 35 $ 29 $ 27 $ 16 $ 28 $ 25
Home equity loans.......................... 269 320 246 248 134 275 212
------- ------- ------- ------- ------- ------- -------
Total.................................... $ 300 $ 355 $ 275 $ 275 $ 150 $ 303 $ 237
======= ======= ======= ======= ======= ======= =======
CURRENT BALANCE OF LOANS SECURITIZED:
Business loans............................. $ 17 $ 18 $ 12 $ 9 $ 4 $ 10 $ 8
Home equity loans.......................... 81 81 55 54 28 58 39
------- ------- ------- ------- ------- ------- -------
Total.................................... $ 98 $ 99 $ 67 $ 63 $ 32 $ 68 $ 47
======= ======= ======= ======= ======= ======= =======
WEIGHTED-AVERAGE INTEREST RATE ON LOANS
SECURITIZED:
Business loans............................. 15.92% 15.90% 15.99% 16.08% 16.17% 16.02% 16.16%
Home equity loans.......................... 11.15% 11.23% 11.47% 11.62% 11.45% 11.43% 11.42%
Total.................................... 11.99% 12.10% 12.27% 12.24% 12.11% 12.11% 12.22%
Percentage of first mortgage loans............ 90% 90% 89% 87% 90% 85% 80%
Weighted-average loan-to-value................ 75% 75% 74% 75% 76% 76% 76%
Weighted-average remaining term (months) on
loans securitized.......................... 207 202 201 192 191 198 184
Original balance of Trust Certificates........ $ 306 $ 355 $ 275 $ 275 $ 150 $ 300 $ 235
Current balance of Trust Certificates......... $ 86 $ 90 $ 61 $ 57 $ 29 $ 60 $ 41
Weighted-average pass-through interest rate to
Trust Certificate holders ................. 5.75% 6.51% 8.87% 7.05% 7.61% 7.07% 7.09%
Highest Trust Certificate pass-through interest
rate....................................... 6.14% 6.99% 6.28% 7.05% 7.61% 8.04% 7.93%
OVERCOLLATERALIZATION REQUIREMENTS(B):
REQUIRED PERCENTAGES:
Initial.................................... -- -- -- -- -- 0.90% 0.75%
Final target............................... 4.00% 4.40% 4.10% 4.50% 4.75% 5.95% 5.95%
Stepdown overcollateralization............. 8.00% 8.80% 8.20% 9.00% 9.50% 11.90% 11.90%
REQUIRED DOLLAR AMOUNTS:
Initial.................................... -- -- -- -- -- $ 3 $ 2
Final target............................... $ 12 $ 16 $ 11 $ 12 $ 7 $ 18 $ 14
CURRENT STATUS:
Overcollateralization amount............... $ 12 $ 9 $ 6 $ 6 $ 3 $ 8 $ 6
Final target reached or anticipated date to
reach.................................... Yes Yes Yes Yes Yes Yes Yes
Stepdown reached or anticipated date to
reach.................................... Yes(a) Yes Yes Yes Yes Yes Yes
ANNUAL SURETY FEE(B) ......................... 0.20% 0.20% 0.20% 0.21% 0.21% 0.21% 0.19%
SERVICING RIGHTS:
Original balance........................... $ 12 $ 15 $ 11 $ 14 $ 7 $ 14 $ 10
Current balance............................. $ 5 $ 5 $ 3 $ 4 $ 1 $ 3 $ 2
- ---------------
(a) Although the final target has been reached, this trust is exceeding
delinquency limits, and the trust is retaining additional
overcollateralization. We cannot predict when normal residual cash flow will
resume. See "-- Trigger Management" for further detail.
(b) See "- Interest-Only Strips" for a discussion of credit enhancements in our
securitizations and "- Overcollateralization Requirements" for further
detail on overcollateralization.
127
SUMMARY OF SELECTED MORTGAGE LOAN SECURITIZATION TRUST INFORMATION (CONTINUED)
CURRENT BALANCES AS OF JUNE 30, 2004
(dollars in millions)
1999-4 1999-3 1999-2 1999-1 1998(a) 1997(a) 1996(a)
------ ------ ------ ------ ------- ------- -------
ORIGINAL BALANCE OF LOANS SECURITIZED:
Business loans............................. $ 25 $ 28 $ 30 $ 16 $ 57 $ 45 $ 29
Home equity loans.......................... 197 194 190 169 448 130 33
------- ------- ------- ------- ------- ------- -------
Total...................................... $ 222 $ 222 $ 220 $ 185 $ 505 $ 175 $ 62
======= ======= ======= ======= ======= ======= =======
CURRENT BALANCE OF LOANS SECURITIZED:
Business loans............................. $ 8 $ 8 $ 7 $ 4 $ 10 $ 6 $ 4
Home equity loans.......................... 41 41 42 35 67 14 3
------- ------- ------- ------- ------- ------- -------
Total...................................... $ 49 $ 49 $ 49 $ 39 $ 77 $ 20 $ 7
======= ======= ======= ======= ======= ======= =======
WEIGHTED-AVERAGE INTEREST RATE ON LOANS
SECURITIZED:
Business loans............................. 16.15% 15.93% 15.53% 15.95% 15.79% 15.93% 15.98%
Home equity loans.......................... 11.00% 10.79% 10.51% 10.62% 10.85% 11.51% 11.16%
Total...................................... 11.81% 11.62% 11.23% 11.19% 11.47% 12.86% 13.93%
Percentage of first mortgage loans............ 85% 87% 88% 94% 90% 83% 78%
Weighted-average loan-to-value................ 76% 76% 76% 77% 76% 77% 64%
Weighted-average remaining term (months) on
loans securitized........................... 182 187 193 191 181 137 97
Original balance of Trust Certificates........ $ 220 $ 219 $ 219 $ 184 $ 498 $ 171 $ 61
Current balance of Trust Certificates......... $ 44 $ 44 $ 44 $ 35 $ 69 $ 17 $ 4
Weighted-average pass-through interest rate to
Trust Certificate holders................... 7.02% 6.86% 6.73% 6.56% 6.38% 7.17% 7.67%
Highest Trust Certificate pass-through interest
rate........................................ 7.68% 7.49% 7.13% 6.58% 6.94% 7.53% 7.95%
OVERCOLLATERALIZATION REQUIREMENTS(C):
REQUIRED PERCENTAGES:
Initial.................................... 1.00% 1.00% 0.50% 0.50% 1.50% 2.43% 1.94%
Final target............................... 5.50% 5.00% 5.00% 5.00% 5.10% 7.43% 8.94%
Stepdown overcollateralization............. 11.00% 10.00% 10.00% 10.00% 10.21% 14.86% 16.45%
REQUIRED DOLLAR AMOUNTS:
Initial.................................. $ 2 $ 2 $ 1 $ 1 $ 7 $ 4 $ 1
Final target............................. $ 12 $ 11 $ 11 $ 9 $ 26 $ 13 $ 6
CURRENT STATUS:
Overcollateralization amount.............. $ 5 $ 5 $ 5 $ 4 $ 8 $ 3 $ 3
Final target reached or anticipated date
to reach................................ Yes Yes Yes Yes Yes Yes Yes
Stepdown reached or anticipated date to
reach................................... Yes Yes(b) Yes Yes Yes Yes Yes(b)
ANNUAL SURETY FEE (C)........................ 0.21% 0.21% 0.19% 0.19% 0.22% 0.26% 0.18%
SERVICING RIGHTS:
Original balance........................... $ 10 $ 10 $ 10 $ 8 $ 18 $ 7 $ 4
Current balance............................ $ 2 $ 2 $ 2 $ 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. Under the terms of a September 27, 2004 sale
agreement, we sold the interest-only strips related to 1996-2, 1997-1,
1997-2, 1998-1 and 1998-2.
(b) Although the final target has been reached, this trust is exceeding
delinquency limits, and the trust is retaining additional
overcollateralization. We cannot predict when normal residual cash flow
will resume. See "-- Trigger Management" for further detail.
(c) See "- Interest-Only Strips" for a discussion of credit enhancements in our
securitizations and "- Overcollateralization Requirements" for further
detail on overcollateralization.
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.
128
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.
At June 30, 2004, we applied a discount rate of 11% to the estimated
residual cash flows. This is an increase from the discount rate of 10% applied
in the March 31, 2004 and December 31, 2003 valuations. The increase to 11% at
June 30, 2004 was made to reflect an increase in market interest rates that had
occurred since the end of the March 2004 quarter. In determining the discount
rate that we apply to residual cash flows, we follow what we believe to be a
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% and on December 31, 2003 we further reduced that discount
rate to 10%, to reflect the impact of sustained decreases in market interest
rates.
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 the December 31,
2003 reduction in discount rate from 11% to 10% was to increase the valuation of
our interest-only strips by $8.4 million at December 31, 2003. The 11% discount
rate that we apply to our residual cash flow portion of our interest-only strips
also reflects the other characteristics of our securitized loans described
below:
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 had prepayment fees and approximately 80% to 85% of
securitized home equity loans had prepayment fees. At June 30, 2004
in our total portfolio, approximately 45% to 50% of securitized
business purpose loans had prepayment fees and approximately 50% to
55% of securitized home equity loans had 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.
129
o A portfolio mix of first and second mortgage loans of 85-90% and
10-15%, 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. At June 30, 2003 and 2004, 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, 2004 and
2003.
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 to an average of the actual
experience of other similar pools of mortgage loans at the same age. Current
economic conditions, current interest rates, loans repurchased from
securitization trusts and other factors are considered in our analysis of
prepayment experience and in forecasting future prepayment levels.
Our analysis of prepayment experience and our forecast of prepayments
consider that prepayments on securitized loans may be initiated by the borrower,
such as a refinancing for a lower interest rate, initiated by the servicer in
the collection process for delinquent loans, or as a result of our repurchase of
delinquent loans from the securitization trusts for trigger management. See "--
Trigger Management" for a discussion of our loan repurchase activities and the
amount of loans we have repurchased from securitization trusts. Prepayments
initiated by the borrower are viewed as voluntary prepayments. Voluntary
prepayments are the most significant component of our prepayment experience,
generally representing approximately 91% of total prepayments, and are full cash
payoffs of a securitized loan. Prepayments initiated by the servicer are viewed
as involuntary prepayments, generally representing approximately 4% of our total
prepayment experience and are the result of delinquent loan bulk sales, REO
liquidations and settlements on delinquent loans. Losses on these involuntary
prepayments are absorbed by the securitization trusts. See "-- Credit Loss
Rates." Prepayments as a result of our repurchase of delinquent loans from the
securitization trusts are also viewed as involuntary and generally represent
approximately 5% of our total prepayment experience. Losses on the liquidation
of repurchased loans are absorbed on our books. See "-- Credit Loss Rates." Both
voluntary and involuntary loan prepayments are incorporated in our prepayment
assumption forecasts.
130
Our practice in forecasting prepayment assumptions had been to use an
average historical prepayment rate of similar pools for the expected constant
prepayment rate assumption while a pool of mortgage loans was less than a year
old even though actual experience may be different. During that period, before a
pool of mortgage loans reached its expected constant prepayment rate, actual
experience both quantitatively and qualitatively was generally not considered
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 was 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.
As was previously discussed, for the past eleven quarters, our actual
prepayment experience was generally higher, most significantly on home equity
loans, than our historical averages for prepayments prior to that eleven-quarter
period. The long duration of historically low interest rates, combined with
increasing home values and high consumer debt levels has given borrowers an
extended opportunity to engage in mortgage refinancing activities, which
resulted in elevated prepayment experience. Low interest rates and increasing
home values provide incentive to borrowers to convert high cost consumer debt
into lower rate tax deductible loans. As home values have increased, lenders
have been highly successful in educating borrowers that they have the ability to
access the cash value in their homes.
The persistence of historically low interest rate levels, unprecedented
in the last 40 years, has made the forecasting of prepayment levels difficult.
We assumed for each quarter end valuation that the decline in interest rates had
stopped and a rise in interest rates would occur in the near term. Economic
conditions and published mortgage industry surveys supported our assumption. We
believe that once we are beyond the low interest rate environment and its
imnpact on prepayments, the long recurring and highly unfavorable prepayment
experience over the last eleven quarters will subside. Also, the rate of
increase in home values has slowed considerably, which we expect will mean that
fewer borrowers will have excess value in their homes to access. As a result of
our analysis of these factors, we believe prepayments will continue to remain at
higher than normal levels for the near term before declining to historical
prepayment levels and then further declining in the future. See the table "--
Summary of Material Mortgage Loan Securitization Valuation Assumptions and
Actual Experience at June 30, 2004" for our current prepayment assumptions.
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. See "-- Securitizations" for
further detail regarding the impact of our recent prepayment experience and
published information available from the Mortgage Bankers Association of
America.
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, such as our customer
retention incentive program, 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.
131
CREDIT LOSS RATES. Credit loss rates are analyzed in a similar manner
to prepayment rates. Credit loss assumptions are compared to actual loss
experience for individual mortgage loan pools and averages for similar mortgage
loan pools. Delinquency trends, economic conditions, loans repurchased from
securitization trusts and other factors are also considered. If our analysis
indicates that loss experience may be different from our assumptions, we would
adjust our assumptions as necessary. See the table "-- Summary of Material
Mortgage Loan Securitization Valuation Assumptions and Actual Experience at June
30, 2004" for our current credit loss assumptions and actual credit loss
experience. However, we cannot predict with certainty what credit loss
experience will be in the future. Any unfavorable difference between the
assumptions used to value securitization assets and actual experience may have a
significant adverse impact on the value of these assets.
We may elect to repurchase delinquent loans from securitization trusts
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. See "-- Trigger Management" for a discussion of our loan
repurchase activities and the amount of loans we have repurchased from
securitization trusts. Once a loan has been included in a pool of securitized
loans, its performance, including historical loss experience if the loan has
been repurchased, is reflected in the performance of that pool of mortgage
loans.
We may enter into deferment and forbearance arrangements with borrowers
in our managed portfolio who experience financial hardships. See "-- On Balance
Sheet Portfolio Quality -- Deferment and Forbearance Arrangements" and "-- Total
Portfolio Quality -- Deferment and Forbearance Arrangements" for more detail
regarding these arrangements. Any credit losses ultimately realized on these
arrangements are included in total historical losses of the loans' original pool
of securitized loans, which are used in developing credit loss assumptions.
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.
SENSITIVITY ANALYSIS. The table below summarizes at June 30, 2004 the
amount of securitized loans in our securitization trusts, the carry value of our
securitization assets and the weighted-average life of our securitized loans.
Securitized collateral balance................................... $ 1,928,086
Balance sheet carrying value of retained interests (a)........... $ 532,824
Weighted-average collateral life (in years)...................... 5.0
- -----------------
(a) Amount includes interest-only strips and servicing rights.
132
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):
IMPACT OF ADVERSE CHANGE
----------------------------
10% CHANGE 20% CHANGE
---------- ----------
Prepayment speed............................. $ 21,427 $ 41,611
Credit loss rate............................. 3,994 7,987
Floating interest rate certificates (a)...... 949 1,899
Discount rate................................ 17,510 33,926
- --------------
(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."
133
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, 2004
2003-2 2003-1 2002-4 2002-3 2002-2 2002-1 2001-4
------ ------ ------ ------ ------ ------ ------
Interest-only strip residual discount rate:
Initial valuation.......................... 11% 13% 13% 13% 13% 13% 13%
Current valuation.......................... 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation.......................... 8% 7% 9% 7% 7% 7% 7%
Current valuation.......................... 8% 5% 9% 7% 7% 7% 5%
Servicing rights discount rate:
Initial valuation.......................... (e) 11% 11% 11% 11% 11% 11%
Current valuation.......................... (e) 9% 9% 9% 9% 9% 9%
Prepayment rates(a):
INITIAL ASSUMPTION (B):
Business loans.......................... 11% 11% 11% 11% 11% 11% 11%
Home equity loans....................... 22% 22% 22% 22% 22% 22% 22%
Ramp period (months):
Business loans.......................... 27 27 27 27 27 27 27
Home equity loans....................... 30 30 30 30 30 30 30
CURRENT EXPERIENCE (C):
Business loans.......................... 15% 28% 15% 23% 25% 31% 19%
Home equity loans....................... 31% 55% 48% 45% 42% 44% 38%
CURRENT ASSUMPTION(D):
Business loans
Months 1 through 3.................... 13% 23% 16% 21% 35% 28% 29%
Months 4 through 12................... 16% 21% 21% 20% 17% 14% 11%
Months thereafter..................... 16% 10% 10% 10% 10% 10% 10%
Home equity loans
Months 1 through 3.................... 30% 43% 39% 37% 35% 37% 39%
Months 4 through 12................... 20% 20% 20% 20% 20% 20% 20%
Months 13 through 24.................. 15% 15% 15% 15% 15% 15% 15%
Months thereafter..................... 12% 12% 12% 12% 12% 12% 12%
Annual credit loss rates:
Initial assumption......................... 0.52% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Actual experience.......................... 0.05% 0.02% 0.05% 0.11% 0.15% 0.15% 0.23%
Current assumption......................... 0.52% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Servicing fees:
Contractual fees........................... (e) 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Ancillary fees............................. (e) 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
- ---------------------
(a) Prepayment rates are expressed as Constant Prepayment Rate (CPR).
(b) The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected CPR. 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.
(c) Current experience is a six-month historical average.
(d) Current assumption is a blended average projected during the time period
described.
(e) Servicing rights for the 2003-2 loans were sold to a third party servicer.
134
SUMMARY OF MATERIAL MORTGAGE LOAN SECURITIZATION
VALUATION ASSUMPTIONS AND ACTUAL EXPERIENCE AT JUNE 30, 2004 (CONTINUED)
2001-3 2001-2 2001-1 2000-4 2000-3 2000-2 2000-1
------ ------ ------ ------ ------ ------ ------
Interest-only strip residual discount rate:
Initial valuation..................... 13% 13% 13% 13% 13% 13% 11%
Current valuation..................... 11% 11% 11% 11% 11% 11% 11%
Interest-only strip
overcollateralization discount rate:
Initial valuation..................... 7% 7% 6% 7% 8% 8% 8%
Current valuation..................... 6% 7% 6% 7% 8% 8% 8%
Servicing rights discount rate:
Initial valuation..................... 11% 11% 11% 11% 11% 11% 11%
Current valuation..................... 9% 9% 9% 9% 9% 9% 9%
Prepayment rates (a):
INITIAL ASSUMPTION (B):
Business loans ..................... 11% 11% 11% 10% 10% 10% 10%
Home equity loans................... 22% 22% 22% 24% 24% 24% 24%
Ramp period (months):
Business loans...................... 24 24 24 24 24 24 24
Home equity loans................... 30 30 30 24 24 24 18
CURRENT EXPERIENCE (C):
Business loans...................... 9% 30% 31% 29% 44% 17% 31%
Home equity loans................... 39% 41% 48% 40% 40% 35% 44%
CURRENT ASSUMPTION (D):
Business loans
Months 1 through 3................ 22% 14% 24% 31% 14% 17% 11%
Months 4 through 12............... 10% 10% 11% 11% 12% 10% 11%
Months thereafter................. 10% 10% 10% 10% 10% 10% 10%
Home equity loans
Months 1 through 3................ 38% 35% 34% 28% 36% 33% 23%
Months 4 through 12............... 20% 20% 20% 20% 20% 20% 20%
Months 13 through 24.............. 15% 15% 15% 15% 15% 15% 15%
Months thereafter................. 12% 12% 12% 12% 12% 12% 12%
Annual credit loss rates:
Initial assumption.................... 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Actual experience..................... 0.46% 0.53% 0.85% 0.50% 0.53% 0.56% 0.72%
Current assumption.................... 0.50% 0.50% 0.55% 0.50% 0.50% 0.55% 0.70%
Servicing fees:
Contractual fees....................... 0.50% 0.50% 0.50% 0.70% 0.50% 0.50% 0.50%
Ancillary fees......................... 1.25% 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
- -----------------
(a) Prepayment rates are expressed as Constant Prepayment Rate (CPR).
(b) The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected CPR. 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.
(c) Current experience is a six-month historical average.
(d) Current assumption rates are a blended average during the projected time
period described.
135
SUMMARY OF MATERIAL MORTGAGE LOAN SECURITIZATION
VALUATION ASSUMPTIONS AND ACTUAL EXPERIENCE AT JUNE 30, 2004 (CONTINUED)
1999-4 1999-3 1999-2 1999-1 1998(e) 1997(e) 1996(e)
------ ------ ------ ------ ------- ------- -------
Interest-only strip residual discount rate:
Initial valuation............................ 11% 11% 11% 11% 11% 11% 11%
Current valuation............................ 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation............................ 8% 7% 7% 7% 7% 7% 8%
Current valuation............................ 8% 7% 7% 7% 7% 7% 8%
Servicing rights discount rate:
Initial valuation............................ 11% 11% 11% 11% 11% 11% 11%
Current valuation............................ 9% 9% 9% 9% 9% 9% 9%
Prepayment rates(a):
INITIAL ASSUMPTION (B):
Business loans ............................ 10% 10% 10% 10% 13% 13% 13%
Home equity loans.......................... 24% 24% 24% 24% 24% 24% 24%
Ramp period (months):
Business loans............................. 24 24 24 24 24 24 24
Home equity loans.......................... 18 18 18 18 12 12 12
CURRENT EXPERIENCE (C):
Business loans............................. 27% 27% 33% 16% 19% 29% 24%
Home equity loans.......................... 44% 32% 40% 33% 30% 21% 22%
CURRENT ASSUMPTION (D):
Business loans
Months 1 through 3..................... 17% 28% 16% 18% 23% 22% 32%
Months 4 through 12.................... 11% 11% 12% 10% 11% 12% 10%
Months thereafter...................... 10% 10% 10% 10% 10% 10% 10%
Home equity loans
Months 1 through 3..................... 33% 25% 27% 31% 29% 31% 44%
Months 4 through 12.................... 20% 20% 20% 20% 20% 20% 20%
Months 13 through 24 15% 15% 15% 15% 15% 15% 15%
Months thereafter...................... 12% 12% 12% 12% 12% 12% 12%
Annual credit loss rates:
Initial assumption........................... 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Actual experience............................ 0.79% 0.68% 0.44% 0.54% 0.53% 0.35% 0.38%
Current assumption........................... 0.85% 0.65% 0.45% 0.55% 0.58% 0.40% 0.45%
Servicing fees:
Contractual fees............................. 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%
- -------------------
(a) Prepayment rates are expressed as Constant Prepayment Rate (CPR).
(b) The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected CPR. 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.
(c) Current experience is a six-month historical average.
(d) Current assumption is a blended average during the projected time period
described.
(e) Amounts represent weighted-average percentages for four 1998 securitization
pools, two 1997 securitization pools and two 1996 securitization pools.
Under the terms of a September 27, 2004 sale agreement, we sold the
interest-only strips related to 1996-2, 1997-1, 1997-2, 1998-1 and 1998-2.
136
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. We do not service the loans in the 2003-2
securitization, our most recent securitization, which closed in October 2003.
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 funds 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 "--
Application of Critical Accounting Estimates -- Servicing Rights" for a
discussion of the $6.8 million write down of servicing rights recorded in fiscal
2004 including the impact of our sale of servicing rights related to five of our
securitization trusts under the terms of a September 27, 2004 sale agreement and
"-- Impact of Changes in Critical Accounting Estimates in Prior Fiscal Years"
for a discussion of the $5.3 million write down of servicing rights recorded in
fiscal 2003.
On June 30, 2003, we reduced the discount rate on servicing rights cash
flows to 9% and used the same discount rate to value servicing rights at June
30, 2004. 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.
Servicing rights can be terminated under certain circumstances, such as
our failure to make required servicer payments, defined changes of control,
reaching specified loss levels on underlying mortgage pools and failure to
obtain renewals under term-to-term agreements. All of our servicing agreements
associated with bond insurers now provide for term-to-term servicing with terms
ranging from 30 days to 120 days. Under the term-to-term servicing provisions in
certain of our servicing agreements, the associated bond insurers have the right
to elect not to re-appoint us as servicer in their sole discretion. See "--
Overview -- Credit Facilities, Servicing Agreements and Waivers Related to
Financial Covenants" and "-- Liquidity and Capital Resources."
The origination of a high percentage of loans with prepayment fees
impacts our servicing rights and income in two ways. Prepayment fees help 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.
137
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 total 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 eleven quarters, our prepayment experience has exceeded our
expectations for prepayments on our total portfolio and as a result we have
written down the value of our securitization assets. See "-- 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 " -- Securitizations" for information on the
volume of whole loan sales and premiums recorded for the fiscal years ended June
30, 2004, 2003 and 2002. 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. See "--
Overview -- Business Strategy Adjustments" 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.
Many of our whole loan sale agreements with purchasers include recourse
provisions obligating us to repurchase loans at the sales price in the event of
unfavorable delinquency performance of the loans sold or to refund premiums if a
sold loan prepays within a specified period. The duration of these obligations
typically ranges from 60 days to one year from the date of the loan sale.
Premium refund obligations typically decline monthly over the obligation period.
We reserve for these premium obligations at the time of sale through an expense
charge against the gain on sale. The amount of the reserve is calculated based
on the expected near term delinquency and prepayment performance of the sold
loans and the premiums received at the time of sale. At June 30, 2004, the
reserve for repurchase and payoff obligations of premiums received, included in
miscellaneous liabilities on the balance sheet, was $307 thousand.
138
The following table summarizes as of June 30, 2004, the aggregate
principal balance of loans which we have sold with recourse that are still
subject to recourse provisions and the quarter during which our recourse
obligations on those loans terminate (in thousands):
PRINCIPAL
QUARTER ENDED BALANCE
------------- ---------
September 30, 2004............ $443,306
December 31, 2004............. 73,512
March 31, 2005................ 4,346
June 30, 2005................. 102,827
--------
$623,991
========
RESULTS OF OPERATIONS
SUMMARY FINANCIAL RESULTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED JUNE 30, PERCENTAGE CHANGE
------------------------ -------------------------------------
2004 2003 2002 '04/'03 '03/'02
---------- -------- --------- -------- --------
Total revenues................ $ 97,072 $241,406 $ 247,901 (59.8)% (2.6)%
Total expenses................ $ 276,794 $290,426 $ 234,351 (4.7)% 23.9%
Income (loss) before dividends
on preferred stock.......... $ (111,428) $(29,902) $ 7,859 (272.6)% (480.5)%
Dividends on preferred stock.. $ 3,718 $ -- $ -- -- --
Net income (loss) attributable
to common stock............. $ (115,146) $(29,902) $ 7,859 (285.1)% (480.5)%
Return on average assets...... (11.60)% (3.07)% 0.94%
Return on average equity...... (566.80)% (44.20)% 11.75%
Earnings (loss) per common share:
Basic...................... $ (34.07) $ (9.32) $ 2.44 (265.6)% (482.0)%
Diluted.................... $ (34.07) $ (9.32) $ 2.26 (265.6)% (512.4)%
Common dividends declared per
share....................... $ -- $ 0.291 $ 0.255 (100.0)% 14.1%
OVERVIEW
FISCAL YEAR ENDED JUNE 30, 2004. For fiscal 2004, we recorded a net
loss attributable to common stock of $115.1 million compared to a net loss of
$29.9 million in fiscal 2003. During fiscal 2004, preferred dividends of $3.7
million were recorded on the Series A preferred stock, which was issued in the
exchange offers. There were no preferred dividends in fiscal 2003.
The loss for fiscal 2004 primarily resulted from our previously
discussed short-term liquidity issues, including the absence of credit
facilities until the second quarter of fiscal 2004, which substantially reduced
our loan origination volume and our ability to generate revenues, our inability
to complete a publicly underwritten securitization during fiscal 2004, and our
shift in business strategy to focus on whole loan sales. Additionally, a charge
to the income statement of $46.4 million for pre-tax valuation adjustments on
our securitization assets and operating expense levels that would support
greater loan origination volume also contributed to the loss for fiscal 2004.
Loan origination volume decreased to $982.7 million in fiscal 2004, compared to
origination volume of $1,666.5 million in fiscal 2003. Primarily as a result of
this decline in loan originations and our business strategy adjustments,
combined gains on sales of loans through securitizations and whole loan sales
declined $137.8 million from $171.6 million in fiscal 2003, to $33.8 million in
fiscal 2004. While we originated loans at a substantially reduced level during
the first three quarters of fiscal 2004, our expense base for the period would
have supported greater origination volume.
139
See discussions below for more detail on loan originations, gains on
sale of loans, securitization assets valuation adjustments, and other revenues
and expenses.
Total stockholders' equity was reduced to $11.9 million at June 30,
2004 as a result of the $115.1 million net loss attributable to common stock and
the $17.4 million pre-tax reduction to other comprehensive income for
adjustments on our securitization assets for fiscal 2004, partially offset by
the issuance of $93.8 million of Series A preferred stock in the exchange offer
closing through June 30, 2004.
The loss per common share for fiscal 2004 was $34.07 on average common
shares of 3,380,000 compared to a loss per common share of $9.32 on average
common shares of 3,210,000 for fiscal 2003. No common dividends were paid in
fiscal 2004. Common dividends of $0.291 per share were paid in fiscal 2003.
On May 13, 2004, our Board of Directors declared a 10% stock dividend
payable June 8, 2004 to common shareholders of record on May 25, 2004. 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 2002 have been similarly adjusted for the effect of
a 10% stock dividend declared on August 21, 2002, which was paid on September
13, 2002 to common shareholders of record on September 3, 2002.
The following schedule details our loan originations during the fiscal
years ended June 30, 2004, 2003 and 2002, by loan type (in thousands):
YEAR ENDED JUNE 30,
------------------------------------------
2004 2003 2002
---------- ------------ ------------
Home mortgage loans.............. $ 982,093 $ 1,543,730 $ 1,246,505
Business purpose loans........... 587 122,790 133,352
---------- ------------ ------------
Total loan originations.......... $ 982,680 $ 1,666,520 $ 1,379,857
========== ============ ============
Home mortgage loans are 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. Total
home mortgage loan originations decreased $561.6 million, or 36.4%, for fiscal
2004 to $982.1 million from $1.5 billion for fiscal 2003. Liquidity issues had
substantially reduced our ability to originate home mortgage loans. Our adjusted
business strategy emphasizes whole loan sales, smaller publicly underwritten or
privately-placed securitizations and reducing costs. Based on our adjusted
business strategy, we no longer originate loans through retail branches, which
were a high cost origination channel, and plan to continue increasing our broker
channel origination sources. Our home mortgage loan origination subsidiaries
will continue to focus on increasing efficiencies and productivity gains by
refining marketing techniques and integrating technological improvements into
the loan origination process as we work through our liquidity issues. In
addition, as part of our focus on developing broker relationships, a lower cost
source of originations, we acquired broker operations located in West Hills,
California and Austin, Texas, opened new offices in Irvine, California and
Edgewater, Maryland to support our broker operations and have expanded the
broker business within HomeAmerican Credit. See "Business -- Business Strategy."
140
The following schedule details our home mortgage loan originations by
source for the fiscal years ended June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
------------------------------------------
2004 2003 2002
---------- ------------ ------------
Direct channel.................. $ 467,406 $ 538,877 $ 488,110
Retail branches................. 649 160,272 127,207
Broker channel.................. 371,777 642,670 485,267
Bank Alliance Services program . 142,261 201,911 145,921
---------- ------------ ------------
Total home mortgage loans....... $ 982,093 $ 1,543,730 $ 1,246,505
========== ============ ============
During fiscal 2004, our subsidiary, American Business Credit, Inc.,
originated $587 thousand in business purpose loans. During fiscal year ended
June 30, 2003, American Business Credit, Inc. originated $122.8 million of
business purpose loans. Previously discussed liquidity issues substantially
reduced our ability to originate business purpose loans in fiscal 2004. Pursuant
to our adjusted business strategy and depending on the availability of a credit
facility to fund business purpose loans, we may continue to originate business
purpose loans, however at lower volumes, to meet demand in the whole loan sale
and securitization markets. See "Business -- Business Strategy."
YEAR ENDED JUNE 30, 2004 COMPARED TO YEAR ENDED JUNE 30, 2003
REVENUES
TOTAL REVENUES. For fiscal 2004, total revenues decreased $144.3
million, or 59.8%, to $97.1 million from $241.4 million for fiscal 2003. Our
ability to borrow under credit facilities to finance new loan originations was
limited for much of the first six months of fiscal 2004 and our inability to
complete a publicly underwritten securitization in all of fiscal 2004 (we
completed a privately-placed securitization during the second quarter of fiscal
2004 discussed below) accounted for this decrease in total revenues. While we
currently believe we will continue to have credit facilities available to
finance new loan obligations and therefore do not anticipate further decreases
in total revenues, we cannot assure you that we will be successful in
maintaining existing credit facilities, or replacing or obtaining alternative
credit facilities.
GAIN ON SALE OF LOANS - SECURITIZATIONS. For fiscal 2004, gains of
$15.1 million were recorded on the securitization of $141.4 million of loans.
This was a decrease of $155.9 million, or 91.2% below gains of $171.0 million
recorded on securitizations of $1.4 billion of loans for fiscal 2003.
The decrease in securitization gains for fiscal 2004 was due to our
inability to complete a publicly underwritten securitization in all of fiscal
2004 and our reduced level of loan originations in fiscal 2004. We completed a
privately-placed securitization, with servicing released, recognizing gains on
$135.9 million of loans on October 31, 2003. The $15.1 million in gains recorded
in fiscal 2004 resulted from $135.9 million of loans securitized in the second
quarter, the sale of $5.5 million of loans into an off-balance sheet facility
before its expiration on July 5, 2003 and additional gains realized from our
residual interests in $35.0 million of loans remaining in the off-balance sheet
facility from June 30, 2003 until the October 31, 2003 privately-placed
securitization.
141
GAIN ON SALE OF LOANS - WHOLE LOAN SALES. Gains on whole loan sales
increased to $18.7 million for the year ended June 30, 2004 from gains of $0.7
million for the year ended June 30, 2003. The volume of whole loan sales
increased $780.4 million, to $808.4 million for the year ended June 30, 2004
from $28.0 million for the year ended June 30, 2003. The increase in the volume
of whole loan sales for the year ended June 30, 2004 resulted from our adjusted
business strategy which emphasizes more whole loan sales and our inability to
complete securitizations in the fourth quarter of fiscal 2003 and the first,
third and fourth quarters of fiscal 2004. Due to our adjusted business strategy,
we anticipate further increases in gains on whole loan sales. See "Business --
Business Strategy" and "-- Liquidity and Capital Resources" for further detail.
INTEREST AND FEES. For the year ended June 30, 2004, interest and fee
income decreased $1.7 million, or 8.6%, to $17.7 million compared to $19.4
million in fiscal 2003. 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 loans originated and sold
during the same quarter.
The following schedule details interest and fees for the years ended
June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Interest on loans and invested cash.. $ 12,901 $ 10,495 $ 9,506
Other fees........................... 4,831 8,900 9,384
---------- ---------- ----------
Total interest and fees.............. $ 17,732 $ 19,395 $ 18,890
========== ========== ==========
During the year ended June 30, 2004, interest income increased $2.4
million, or 22.9%, to $12.9 million from $10.5 million for the year ended June
30, 2003. The increase for the twelve-month period resulted from our carrying a
higher average loan balance during the first, third, and fourth quarters of
fiscal 2004 as compared to fiscal 2003 due to our inability to complete
securitizations in the fourth quarter of fiscal 2003 and the first, third and
fourth quarters of fiscal 2004. This increase was partially offset by a decrease
of $0.6 million of investment interest income due to lower invested cash
balances and lower interest rates on invested cash balances due to general
decreases in market interest rates.
Other fees decreased $4.1 million for the year ended June 30, 2004, or
45.7%, to $4.8 million from $8.9 million for the year ended June 30, 2003. This
decrease was mainly due to our reduced ability to originate loans during the
first nine months of fiscal 2004. While we currently believe we will continue to
have credit facilities available to finance new loan obligations and therefore
do not anticipate further decreases in other fees, we cannot assure you that we
will be successful in maintaining existing credit facilities, or replacing or
obtaining alternative credit facilities. Additionally, our ability to collect
certain fees in connection with loans we originate and sell in the future may be
impacted by proposed laws and regulations by various authorities. See "-- Legal
and Regulatory Considerations."
INTEREST ACCRETION ON INTEREST-ONLY STRIPS. Interest accretion of $40.2
million was earned in fiscal 2004 compared to $47.3 million in fiscal 2003. The
decrease reflects the decline in the balance of our interest-only strips of
$139.2 million, or 23.3%, to $459.1 million at June 30, 2004 from $598.3 million
at June 30, 2003. However, cash flows from interest-only strips for the year
ended June 30, 2004 totaled $151.1 million, an increase of $63.9 million from
the year ended June 30, 2003 due to additional securitizations reaching final
target overcollateralization levels and stepdown overcollateralization levels.
We expect to experience continued declines in the amount of interest accretion
on our interest-only strips until we can resume selling our loans into quarterly
securitizations.
142
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, 2004, servicing income
increased $1.8 million, or 59.1%, to $4.9 million from $3.1 million for the year
ended June 30, 2003. Contractual fees decreased in fiscal 2004 compared to
fiscal 2003 due to the decline in our managed portfolio resulting primarily from
our inability to complete securitizations in four of the five quarters from June
2003 to June 2004. This was partially offset by an increase in loan prepayment
fees received in fiscal 2004. The amortization of servicing rights decreased due
to lower fees received. Amortization is recognized in proportion to contractual
and ancillary fees collected.
The following table summarizes the components of servicing income for
the years ended June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
------------------------------------------
2004 2003 2002
---------- ------------ ------------
Contractual fees.................. $ 12,486 $ 15,943 $ 13,624
Prepayment fees................... 23,424 19,787 13,011
Other ancillary fees.............. 7,702 9,205 8,679
Amortization of servicing rights.. (38,762) (41,886) (29,831)
---------- ------------ ------------
Net servicing income.............. $ 4,850 $ 3,049 $ 5,483
========== ============ ============
On September 27, 2004, we sold the servicing rights related to five of
our mortgage securitization trusts. This sale will not have a significant impact
on our future net servicing income. In fiscal 2004, we recognized net servicing
income of $170 thousand for servicing these five securitization trusts.
OTHER INCOME. On January 22, 2004, we executed an agreement to sell our
interests in the remaining leases in our portfolio. The terms of the agreement
included a cash sale price of approximately $4.8 million in exchange for our
lease portfolio balance as of December 31, 2003. We received the cash from this
sale in January 2004 and recognized a net gain of $0.5 million.
143
EXPENSES
TOTAL EXPENSES. Total expenses decreased $13.6 million, or 4.7%, to
$276.8 million for the year ended June 30, 2004 compared to $290.4 million for
the year ended June 30, 2003. The decrease for the period was mainly a result of
decreases in sales and marketing expenses, general and administrative expenses,
decreases in losses on derivative financial instruments and securitization
assets valuation adjustments during the year ended June 30, 2004, partially
offset by increases in provision for credit losses and employee related costs.
INTEREST EXPENSE. The three major components of interest expense are
interest on subordinated debentures, interest on warehouse lines of credit used
to fund loans, and interest on senior collateralized subordinated notes. During
fiscal 2004, interest expense increased only $40 thousand, remaining constant at
$68.1 million, compared to the same amount for the year ended June 30, 2003.
However, as a result of the exchange offers, we recorded preferred dividends of
$3.7 million in fiscal 2004 on the Series A preferred stock issued in exchange
for subordinated debentures. In fiscal 2005, we anticipate preferred dividends
will exceed $14 million.
The increase in interest expense to fund loans due to higher average
outstanding balances under warehouse lines of credit and interest expense on
senior collateralized subordinated notes in the exchange offers were offset by a
decrease in interest expense on subordinated debentures due to the decline in
average subordinated debentures outstanding as a result of the exchange offers.
The following schedule details interest expense for the years ended
June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Interest on subordinated debentures.. $ 61,386 $ 66,480 $ 67,223
Interest to fund loans............... 4,121 1,527 1,429
Interest on senior collateralized
subordinated notes ................ 2,519 -- --
Other interest....................... 112 91 31
---------- ---------- ----------
Total interest expense............... $ 68,138 $ 68,098 $ 68,683
========== ========== ==========
Average subordinated debentures outstanding during fiscal 2004 were
$648.5 million compared to $690.7 million during the year ended June 30, 2003.
The decrease was primarily the result of the exchange offers. Average interest
rates paid on subordinated debentures were 9.15% during the year ended June 30,
2004 compared to 9.27% during the year ended June 30, 2003 and 10.64% during the
year ended June 30, 2002.
We had reduced the interest rates offered on subordinated debentures
beginning in the fourth quarter of fiscal 2001 and had continued reducing rates
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
weighted-average interest rate of subordinated debentures issued at its peak
rate, which was the month of February 2001, was 11.85%, compared to the average
interest rate of 7.49% on subordinated debentures issued in the month of June
2003. However, during fiscal 2004, the weighted-average interest rate on
subordinated debentures we issued had steadily increased, reflecting our
financial condition. The weighted-average interest rate on subordinated
debentures we issued during the month of June 2004 was 11.09%. We expect to
reduce the interest rates offered on subordinated debentures over time as our
business and cash needs, our financial condition, liquidity, future results of
operations, market interest rates and competitive factors permit.
144
The average outstanding balances under warehouse lines of credit were
$126.8 million during the year ended June 30, 2004, compared to $51.1 million
during the year ended June 30, 2003. The increase in the average balance on
warehouse lines was due to a higher volume of loans held on balance sheet during
fiscal 2004 as a result of our inability to complete securitizations in the
fourth quarter of fiscal 2003 and the first, third and fourth quarters of fiscal
2004 and our adjusted business strategy. Interest rates paid on warehouse lines
during fiscal 2004 were generally based on one-month LIBOR plus an interest rate
spread ranging from 2.00% to 2.50%. One-month LIBOR has increased from
approximately 1.12% at June 30, 2003 to 1.37% at June 30, 2004. Due to our
adjusted business strategy, we anticipate further increases in both average
outstanding balances under warehouse lines of credit and the resulting interest
expense to fund loans. While we currently believe we will continue to have
credit facilities available to finance new loan obligations, we cannot assure
you that we will be successful in maintaining existing credit facilities, or
replacing or obtaining alternative credit facilities.
The average outstanding balance on senior collateralized subordinated
notes was $25.8 million during the year ended June 30, 2004. The senior
collateralized subordinated notes were issued in the exchange offers. The
average rate paid on senior collateralized subordinated notes was 9.79% during
the year ended June 30, 2004.
PROVISION FOR CREDIT LOSSES. The provision for credit losses for the
year ended June 30, 2004 increased $7.7 million, or 118.1%, to $14.3 million,
compared to $6.6 million for the year ended June 30, 2003. The increase in the
provision for loan losses for the year ended June 30, 2004 was primarily due to
loan charge-offs resulting from the higher amounts of delinquent loans
repurchased from securitization trusts and higher principal loss severity. The
provision for credit losses includes adjustments to the carrying value of loans
available for sale, which are delinquent and expected to be sold at a loss or
ineligible for securitization. In addition, a related allowance for loan losses
on repurchased loans is included in our provision for credit losses in the
period of repurchase. During the year ended June 30, 2004 we repurchased $41.2
million of loans from securitization trusts and recorded a provision for credit
losses of $12.1 million on those repurchases, compared to loan repurchases of
$23.8 million and a provision of $5.0 million in fiscal 2003. Principal loss
severity on loans generally ranged from 20% to 30% in fiscal 2004 and from 15%
to 35% in fiscal 2003. See "-- Securitizations -- Trigger Management" for
further discussion and information regarding repurchases from securitization
trusts.
The following schedule details the provision for credit losses for the
years ended June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Loans available for sale (a)........ $ (1,277) $ 1,056 $ (117)
Non-accrual loans................... 15,776 5,133 5,255
Leases ............................. (210) 364 1,319
---------- ---------- ----------
Total Provision for Credit Losses... $ 14,289 $ 6,553 $ 6,457
========== ========== ==========
- --------------
(a) Under our previous business strategy of securitizing substantially all of
our loan originations, we carried loans on balance sheet for up to 120 days
and therefore, in addition to providing for estimated credit losses on
delinquent loans, we provided for estimated credit losses on current loans
not expected to be eligible for securitizations. When securitizations
occurred, any excess fair value adjustment for credit losses was reversed
through the provision for credit losses.
The allowance for credit losses was $1.5 million, or 42.4% of
non-accrual loans at June 30, 2004, compared to $1.5 million, or 16.1%, of
non-accrual loans and leases at June 30, 2003 and $3.4 million, or 22.7% of
non-accrual loans and leases at June 30, 2002. Non-accrual loans were $3.5
million at June 30, 2004, compared to $5.4 million at June 30, 2003. See "-- On
Balance Sheet Portfolio Quality" for information on non-accrual loans carried on
our balance sheet. 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.
145
The following table summarizes changes in the allowance for credit
losses for the years ended June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Balance at beginning of period...... $ 1,529 $ 3,442 $ 2,099
Provision for credit losses......... 15,566 5,497 6,574
Charge-offs......................... (16,891) (7,812) (5,533)
Recoveries.......................... 1,265 402 302
---------- ---------- ----------
Balance at end of period............ $ 1,469 $ 1,529 $ 3,442
========== ========== ==========
The following tables summarize the changes in the allowance for credit
losses by loan and lease type for the year ended June 30, 2004 (in thousands):
BUSINESS HOME
PURPOSE MORTGAGE EQUIPMENT
LOANS LOANS LEASES TOTAL
- ---------------------------------------- --------- -------- --------- -------
Balance at beginning of period.......... $ 504 $ 855 $ 170 $ 1,529
Provision for credit losses............. 3,344 12,432 (210) 15,566
Charge-offs............................. (3,582) (12,182) (1,127) (16,891)
Recoveries.............................. 84 14 1,167 1,265
--------- -------- ------- --------
Balance at end of period................ $ 350 $ 1,119 $ -- $ 1,469
========= ======== ======= ========
The following table summarizes net charge-off experience by loan type
for the years ended June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Business purpose loans............ $ 3,498 $ 1,984 $ 924
Home mortgage loans............... 12,168 4,913 2,892
Equipment leases.................. (40) 513 1,416
---------- ---------- ----------
Total............................. $ 15,626 $ 7,410 $ 5,232
========== ========== ==========
EMPLOYEE RELATED COSTS. For the year ended June 30, 2004, employee
related costs increased $8.4 million, or 20.3%, to $50.0 million from $41.6
million in fiscal 2003. The increase in employee related costs for the year
ended June 30, 2004 was primarily attributable to a decrease in the amount of
expenses deferred under SFAS No. 91, "Accounting for Nonrefundable Fees and
Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases," referred to as SFAS No. 91 in this document, due to the reduction in
loan originations and the inability to defer costs of loan origination personnel
under SFAS No. 91. The total decrease in SFAS No. 91 deferrals was $18.8 million
during fiscal 2004. A decrease in base salaries of $9.9 million due to workforce
reductions discussed below partially offset the effect of reduced SFAS No. 91
cost deferrals.
Total employees at June 30, 2004 were 969 compared to 1,119 at June 30,
2003. Since June 30, 2003, our workforce has experienced a net reduction of 150
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. However, we expect to increase our sales,
servicing and support positions as necessary in the future to handle higher
levels of loan originations. Since June 30, 2003 we reduced our workforce by
approximately 255 employees and experienced a net loss of approximately 90
additional employees who have resigned. Partially offsetting this workforce
reduction, we have added 195 loan origination employees in our broker channel as
part of our business strategy's focus on expanding our broker operations.
146
Factors affecting the level of future employee related costs include
future staffing decisions related to our business strategy, our loan origination
levels, and our ability or inability to defer loan originations costs under SFAS
No. 91. See "Business - Business Strategy" for further discussion.
SALES AND MARKETING EXPENSES. For the year ended June 30, 2004, sales
and marketing expenses decreased $12.0 million, or 43.3%, to $15.7 million from
$27.8 million for the year ended June 30, 2003. The decrease was primarily due
to reductions in direct mail advertising for home mortgage and business purpose
loan originations. The reduction in direct mail advertising costs of $13.0
million in fiscal 2004 was mainly due to our reduced ability to originate home
mortgage loans during the first nine months of fiscal 2004, our focus on
expanding loan originations in our broker channel, which does not utilize direct
mail advertising, and the absence of a credit facility to fund business purpose
loans. While we expect to continue streamlining our direct mail costs in the
future by offering a wider array of loan products and targeting customer
segments that we believe will enable us to increase our loan origination
conversion rates, we expect direct mail expense to increase over the fiscal 2004
expense level as home mortgage originations increase. By increasing our
conversion rates, we expect to be able to lower our overall sales and marketing
costs per dollar originated. See "Business -- Business Strategy" for further
discussion.
Partially offsetting the reduction in direct mail advertising expense
in fiscal 2004 was an increase of $1.4 million in advertising costs related to
subordinated debentures.
(GAINS) AND LOSSES ON DERIVATIVE FINANCIAL INSTRUMENTS. The following
table summarizes (gains) and losses on derivative financial instruments and
gains and losses on hedged loans for the years ended June 30, 2004, 2003 and
2002 (in thousands):
YEAR ENDED JUNE 30,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Hedge accounting:
(Gains) losses on derivatives.... $ (1,252) $ 7,037 $ --
(Gains) losses on hedged loans... 2,283 (6,160) --
Trade accounting:
Related to pipeline.............. 1,520 3,796 296
Related to whole loan sales...... (5,097) (551) --
Related to interest-only strips.. (28) 911 726
Other, net.......................... 13 4 --
---------- ---------- ----------
Total (gains) and losses............ $ (2,561) $ 5,037 $ 1,022
========== ========== ==========
For more detail on our hedging and trading activities see "-- Interest
Rate Risk Management -- Strategies for Use of Derivative Financial Instruments."
147
GENERAL AND ADMINISTRATIVE EXPENSES. For the year ended June 30, 2004,
general and administrative expenses decreased $11.5 million, or 11.9%, to $84.7
million from $96.2 million for the year ended June 30, 2003. The decrease was
primarily attributable to a decrease of $19.4 million in costs associated with
servicing and collecting our total managed portfolio including expenses
associated with REO and delinquent loans, and a $7.0 million decrease in costs
associated with customer retention incentives, partially offset by $13.8 million
in fees on new credit facilities.
Beginning in the fourth quarter of fiscal 2002, we offered customer
retention incentives to borrowers who were exploring loan refinancing
opportunities for the purpose of lowering their monthly loan payments. In an
attempt to retain the loans we were servicing for these borrowers, we offered
the borrowers the opportunity to receive a monthly cash rebate equal to a
percentage of their scheduled monthly loan payments for periods of six to twelve
months. When we were successful in retaining these loans, we reduced the level
of loan prepayments in our managed portfolio of securitized loans. To initially
qualify for this program, a borrower has to be current on their loan principal
and interest payments and to continue to qualify and receive each month's cash
rebate, a borrower has to remain current. The percentage of rebates on scheduled
monthly loan payments offered to participants ranged from 10% to 25%.
For those borrowers who elected to participate in customer retention
incentives, we recorded a liability for the amount of future cash payments that
we expected to make under this program. The following table summarizes the
activity for customer retention incentives and the related balance sheet
liability for the years ended June 30, 2004, 2003, 2002 (in thousands):
Year Ended June 30,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Balance at beginning of year........ $ 5,231 $ 753 $ --
Liability accrued for new
participants...................... 5,705 10,719 833
Participants leaving the program:
Loan became delinquent........... (801) (194) (28)
Loans paid off................... (3,084) (1,691) --
---------- ---------- ----------
Net charge to income statement. 1,820 8,834 805
Cash payments made to participants.. (5,774) (4,356) (52)
---------- ---------- ----------
Balance at end of year.............. $ 1,277 $ 5,231 $ 753
========== ========== ==========
Principal amount outstanding on
loans participating at period
end (a).......................... $ 344,764 $ 477,076 $ 41,218
========== ========== ==========
- -----------------
(a) These are loans included in mortgage securitization trusts, which are
serviced by us.
Factors affecting future general and administrative expense levels
include the size of our total managed portfolio, which decreased 42.7% in fiscal
2004, the amount of future loan originations and the costs associated with
obtaining new or increasing existing credit facilities.
SECURITIZATION ASSETS VALUATION ADJUSTMENT. During fiscal 2004, we
recorded total pre-tax valuation adjustments on our interest-only strips and
servicing rights of $63.8 million, of which $46.4 million was charged as expense
to the income statement and $17.4 million was charged to other comprehensive
income. These adjustments primarily reflect the impact of higher than
anticipated prepayments on securitized loans experienced in fiscal 2004 due to
the low interest rate environment experienced during fiscal 2004. The pre-tax
valuation adjustment recorded on our interest-only strips was $57.0 million, of
which $39.6 million was charged as expense to the income statement and $15.4
million was charged to other comprehensive income. The pre-tax valuation
adjustment recorded on our servicing rights was $6.8 million, all of which was
charged as expense to the income statement. Additionally, the fiscal 2004
valuation adjustment also includes a write down of the carrying value of our
interest-only strips and servicing rights related to five of our mortgage
securitization trusts of $5.4 million to reflect their values under the terms of
a September 27, 2004 sale agreement. The write down on interest-only strips was
$4.1 million and the write down on servicing rights was $1.3 million. The sale
of these assets was undertaken as part of our negotiations to obtain the new
$100.0 million warehouse credit facility described in "-- Liquidity and Capital
Resources" and to raise cash to pay fees on new warehouse credit facilities and
as a result, we did not realize their full value as reflected on our books. See
"- Application of Critical Accounting Estimates - Interest-Only Strips" for a
discussion of how valuation adjustments are recorded and "-- Off-Balance Sheet
Arrangements" and "-- Securitizations" for more detail on securitization assets
valuations.
148
This compares to total pre-tax valuation adjustments on our
securitization assets of $63.3 million during the year ended June 30, 2003, of
which $45.2 million was charged as expense to the income statement and $18.1
million was reflected as an adjustment to other comprehensive income. The
pre-tax valuation adjustment recorded on our interest-only strips was $58.0
million, of which $39.9 million was charged as expense to the income statement
and $18.1 million was charged to other comprehensive income. The pre-tax
valuation adjustment recorded on our servicing rights was $5.3 million.
PROVISION FOR INCOME TAX EXPENSE (BENEFIT). In fiscal 2004 our tax
benefit increased $49.2 million from $19.1 million to $68.3 million as a result
of a $130.7 million decline in pre-tax income. The utilization of our net
operating loss carry forwards are dependent on future taxable income from
operations and it is more likely than not we will be able to primarily utilize
all benefits within two years. Our adjusted business strategy of shifting to
primarily whole loan sales will result in a quicker recognition and a higher
level of taxable income. Our previous business strategy of using primarily
securitizations allowed for the deferral of taxable income. See "-- Application
of Critical Accounting Estimates -- Deferred Tax Asset" for a discussion of the
factors we considered in determining that it is more likely than not we will
realize these benefits.
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 a 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. 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 "-- Securitizations" for further discussion of this facility.
During fiscal 2003, we saw increases in interest rate spreads on our
three term 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 "-- Securitizations" for
further detail of how securitization gains are calculated.
149
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.
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.
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.
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 loans
originated and sold during the same quarter.
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. See "-- Legal and Regulatory Considerations."
150
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.
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.
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 debentures 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 debentures 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 debentures were reduced beginning in the
fourth quarter of fiscal 2001 and had 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 debentures issued at its peak rate, which was the month of February
2001, was 11.85% compared to the average interest rate of subordinated
debentures issued in the month of June 2003 of 7.49%.
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 provision for credit losses on repurchased loans is recorded in
the period of repurchase. See "--Securitizations -- Trigger Management" for
further discussion of repurchases from securitization trusts. See "-- Year Ended
June 30, 2004 Compared to Year Ended June 30, 2003 -- Provision for Credit
Losses" for the components of our provision for credit losses for the years
ended June 30, 2003 and 2002.
151
The allowance for credit losses was $1.5 million, or 16.1% of
non-accrual loans and leases at June 30, 2003 compared to $3.4 million, or 22.7%
of non-accrual loans and leases at June 30, 2002. The allowance for credit
losses as a percentage of non-accrual loans and leases 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 a decrease in the expected loss
severity on these non-accrual loans.
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.......... $ 1,278 $ 1,844 $ 320 $ 3,442
Provision for credit losses............. 1,210 3,923 364 5,497
Charge-offs............................. (2,022) (4,924) (866) (7,812)
Recoveries.............................. 38 12 352 402
--------- -------- ------- --------
Balance at end of period................ $ 504 $ 855 $ 170 $ 1,529
========= ======== ======= ========
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. Increases in payroll and benefits
expenses for the increased number of employees were offset by reductions of
management bonus accruals due to our overall financial performance 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 debentures.
(GAINS) AND LOSSES ON DERIVATIVE FINANCIAL INSTRUMENTS. For the year
ended June 30, 2003, losses on derivative financial instruments increased $4.0
million, or 492.9%, to $5.0 million from $1.0 million for the year ended June
30, 2002. The increase was due primarily to increases losses from trading
activities of $2.9 million and losses from hedging activities of $.9 million.
GENERAL AND ADMINISTRATIVE EXPENSES. For the year ended June 30, 2003,
general and administrative expenses increased $22.3 million, or 30.2%, to $96.2
million from $73.9 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 portfolio including
expenses associated with REO and delinquent loans and $8.0 million related to
costs associated with customer retention incentives. See "-- Year Ended June 30,
2004 Compared to Year Ended June 30, 2003 -- General and Administrative
Expenses" for a description of customer retention incentives.
152
SECURITIZATION ASSETS VALUATION ADJUSTMENT. During fiscal 2003, pre-tax
write downs of $45.2 million were charged as expense to the income statement,
compared to $22.1 million for fiscal 2002. Of these write downs, $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 a 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 "-- 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.
BALANCE SHEET INFORMATION
BALANCE SHEET DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
JUNE 30,
------------------------------------------
2004 2003 2002
----------- ----------- ---------
Cash and cash equivalents.............................. $ 910 $ 36,590 $ 99,599
Restricted cash........................................ 13,307 10,885 9,000
Loan and lease receivables:
Loans available for sale........................... 304,275 263,419 46,141
Non-accrual loans.................................. 1,993 3,999 3,645
Lease receivables.................................. -- 3,984 7,891
Interest and fees receivable........................... 18,089 10,838 9,595
Deferment and forbearance advances receivable.......... 6,249 4,341 2,697
Loans subject to repurchase rights..................... 38,984 23,761 9,028
Interest-only strips................................... 459,086 598,278 512,611
Servicing rights....................................... 73,738 119,291 125,288
Receivable for sold loans.............................. -- 26,734 --
Deferred income tax asset.............................. 59,133 -- --
Total assets........................................... 1,042,870 1,159,351 876,375
Subordinated debentures................................ 522,609 719,540 655,720
Senior collateralized subordinated notes............... 83,639 -- --
Warehouse lines and other notes payable................ 241,200 212,916 8,486
Accrued interest payable............................... 37,675 45,448 43,069
Deferred income tax liability.......................... -- 17,036 35,124
Total liabilities...................................... 1,030,955 1,117,282 806,997
Total stockholders' equity............................. 11,915 42,069 69,378
Book value per common share ......................... $ 3.31 $ 12.98 $ 22.18
153
JUNE 30, 2004 COMPARED TO JUNE 30, 2003
Total assets decreased $116.5 million, or 10.0%, to $1,042.9 million at
June 30, 2004 from $1,159.4 million at June 30, 2003 primarily due to decreases
in cash and cash equivalents, interest-only strips, servicing rights and
receivable for sold loans. Increases in loans available for sale and deferred
income tax assets partially offset these decreases.
Cash and cash equivalents decreased $35.7 million, or 97.5%, due to
liquidity issues described in "- Liquidity and Capital Resources," which reduced
our ability to originate loans for sale and resulted in our operating losses
during fiscal 2004, and from a reduction in the issuance of subordinated
debentures.
Loans available for sale increased $40.9 million, or 15.5% to $304.3
million. Loans available for sale at June 30, 2004 were at a historically high
level due to our business strategy adjustments and our inability to complete
publicly underwritten securitizations in fiscal 2004 (we completed a
privately-placed securitization during the second quarter of fiscal 2004).
Interest and fees receivable increased $7.3 million, or 66.9%, to $18.1
million at June 30, 2004 from $10.8 million at June 30, 2003. This increase is
mainly due to increases in tax and insurance payments advanced on behalf of
borrowers whose loans we service and late fees.
Loans subject to repurchase rights increased $15.2 million, or 64.1%,
due to increases in the amount of delinquent loans eligible for repurchase from
securitization trusts. See "- Securitizations - Repurchase Rights" for a more
information on loans subject to repurchase rights.
Interest-only strips at June 30, 2004 decreased $139.2 million, or
23.3%, from June 30, 2003 as a result of valuation adjustments and our inability
to complete a securitization during the first, third and fourth quarters of
fiscal 2004. See "-- Securitizations" for a discussion of valuation adjustments
recorded on our interest-only strips. Activity in our interest-only strips for
the years ended June 30, 2004, 2003 and 2002 was as follows (in thousands):
JUNE 30,
-----------------------------------
2004 2003 2002
---------- --------- ---------
Balance at beginning of period ......................................... $ 598,278 $ 512,611 $ 398,519
Initial recognition of interest-only strips, including initial
overcollateralization of $0, $10,641 and $0......................... 25,523 160,116 153,463
Cash flow from interest-only strips..................................... (178,457) (160,417) (100,692)
Required purchases of additional overcollateralization.................. 27,334 73,253 47,271
Interest accretion...................................................... 40,176 47,347 35,386
Termination of lease securitization (a)................................. (1,759) (1,890) --
Adjustment for obligation to repurchase loans........................... 2,687 2,600 1,596
Adjustments to fair value recorded through other comprehensive income (b) (15,037) 4,558 (879)
Other than temporary fair value adjustment (c).......................... (39,659) (39,900) (22,053)
---------- --------- ---------
Balance at end of period................................................ $ 459,086 $ 598,278 $ 512,611
========== ========= =========
- -----------------
(a) Reflects release of lease collateral from lease securitization trusts which
were terminated in accordance with the trust documents after the full payout
of trust note certificates. Lease receivables of $1.8 million and $1.6
million, respectively, were recorded on our balance sheet at December 31,
2003 and 2002 as a result of the terminations.
(b) Adjustments to the carrying value of interest-only strips for the initial
write up to fair value are recorded through other comprehensive income at
the time of impairment, which is a component of stockholders' equity.
Additionally, to the extent any individual interest-only strip has a portion
of its initial write up to fair value still remaining in other comprehensive
income, other than temporary decreases in its fair value would first be
recorded as a reduction to other comprehensive income.
(c) Recorded through the income statement.
154
The following table summarizes our purchases of overcollateralization
by securitization trust for the years ended June 30, 2004, 2003 and 2002.
Purchases of overcollateralization represent amounts of residual cash flows from
interest-only strips retained by the securitization trusts to establish required
overcollateralization levels in the trust. Overcollateralization represents our
investment in the excess of the aggregate principal balance of loans in a
securitized pool over the aggregate principal balance of trust certificates. See
"-- Securitizations" for a discussion of overcollateralization requirements.
SUMMARY OF MORTGAGE LOAN SECURITIZATION OVERCOLLATERALIZATION PURCHASES
(IN THOUSANDS)
2003-2 2003-1 2002-4 2002-3 OTHER(A) TOTAL
------ ------ ------ ------ -------- -----
YEAR ENDED JUNE 30, 2004:
Required purchases of
additional
overcollateralization......$ 3,872 $16,587 $ 9,323 $ 1,978 $(4,426) $27,334
======= ======= ======= ======= ======= =======
(a) includes the recovery of $9.5 million of overcollateralization from an
off-balance sheet mortgage conduit facility.
2003-1 2002-4 2002-3 2002-2 2002-1 2001-4 2001-3 2001-2 OTHER TOTAL
------ ------ ------ ------ ------ ------ ------ ------ ----- -----
YEAR ENDED JUNE 30, 2003:
Initial overcollateralization.$ -- $ 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
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Servicing rights decreased $45.5 million, or 38.2%, to $73.7 million at
June 30, 2004 from $119.3 million at June 30, 2003, primarily due to our
inability to complete a securitization in the first, third and fourth quarters
of fiscal 2004, completing a privately-placed securitization with servicing
released in the second quarter of fiscal 2004, amortization of servicing rights
and a $6.8 million write down of servicing rights mainly due to the impact of
higher than expected prepayment experience.
Total liabilities decreased $86.3 million, or 7.7%, to $1,031.0 million
at June 30, 2004 from $1,117.3 million at June 30, 2003 primarily due to
decreases in subordinated debentures outstanding and accrued interest payable as
a result of the exchange offers, a decrease in accounts payable and accrued
expenses primarily due to a reduction in our liability for costs associated with
customer retention incentives (see "- Results of Operations -- Year Ended June
30, 2004 Compared to Year Ended June 30, 2003 - General and Administrative
Expenses" for a description of customer retention incentives) and a decrease in
our deferred income tax liability. Partially offsetting these decreases were
increases in warehouse lines and other notes payable, liabilities for loans
subject to repurchases rights (see "- Securitizations - Repurchase Rights" for a
more information on loans subject to repurchase rights.) and other liabilities.
Other liabilities increased $7.8 million, or 12.2%, to $71.9 million from $64.0
million due to an increase of $11.5 million in our liability to fund closed
loans, and recording an unearned rent incentive of $8.2 million related to our
corporate headquarters lease, partially offset by a $5.7 million reduction in
liabilities recorded for derivative financial instruments.
155
During the year ended June 30, 2004, subordinated debentures decreased
$197.0 million, or 27.4%, to $522.6 million primarily due to the conversion of
$177.8 million of subordinated debentures into 93.8 million shares of Series A
preferred stock and $84.0 million of senior collateralized subordinated notes
and the temporary discontinuation of sales of new subordinated debentures for
approximately a six-week period during the first quarter of fiscal 2004. See "--
Liquidity and Capital Resources" for further information regarding outstanding
debt.
Warehouse lines and other notes payable increased $28.3 million at June
30, 2004, or 13.3%, primarily due to the increase in loans available for sale.
Our net deferred income tax position changed from a liability of $17.0
million at June 30, 2003 to an asset of $59.1 million at June 30, 2004. This
change from a liability position is the result of the federal and state tax
benefits of $68.3 million recorded on our pre-tax loss for the year ended June
30, 2004, which will be realized against anticipated future years' state and
federal taxable income. In addition, a federal benefit of $5.3 million was
recognized on the portion of the valuation adjustment on our interest-only
strips, which was recorded through other comprehensive income. These benefits
were partially offset by refunds totaling $0.3 million on our June 30, 2002 and
2003 federal tax returns. See "-- Application of Critical Accounting Estimates
- -- Deferred Tax Asset" for a discussion of the factors we considered in
determining that it is more likely than not we will realize this deferred income
tax asset.
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
loans available for sale, 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
debentures issued during fiscal year 2003 and also due to our inability to
complete a quarterly securitization in the fourth quarter of fiscal year 2003.
Loans available for sale increased $217.5 million due to our inability
to complete a quarterly securitization in the fourth quarter of fiscal 2003.
Loans subject to repurchase rights increased $14.7 million or 163.2%
due to increases in the amount of delinquent loans eligible for repurchase from
securitization trusts. See "-- Securitizations -- Repurchase Rights" for more
detail.
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.
156
Total liabilities at June 30, 2003 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 debentures outstanding,
accounts payable and accrued expenses, liabilities for loans subject to
repurchases rights, 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 (see "- Results of Operations --
Year Ended June 30, 2004 Compared to Year Ended June 30, 2003 - General and
Administrative Expenses" for a description of customer retention incentives) and
liabilities to our securitization trust collection accounts for periodic
interest advances on delinquent loans. Our liability for loans subject to
repurchases rights (see "- Securitizations - Repurchase Rights" for a more
information on loans subject to repurchase rights.) increased $17.3 million.
Other liabilities increased $23.7 million, or 58.9%, to $64.0 million from $40.3
million due to an increase of $5.3 million in our liability to fund closed
loans, recording an unearned rent incentive of $9.5 million related to our
corporate headquarters lease and a $6.3 million liability recorded for unsettled
interest rate swaps.
During fiscal 2003, subordinated debentures increased $63.8 million, or
9.7%, to $719.5 million due to sales of subordinated debentures 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
debentures was due to the reinvestment of accrued interest on the subordinated
debentures at maturity. 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 in fiscal 2003.
157
ON BALANCE SHEET PORTFOLIO QUALITY
The following table provides data concerning delinquency experience,
non-accrual loans, real estate owned and loss experience for loans and leases on
our balance sheet at June 30, 2004, 2003 and 2002. (dollars in thousands):
JUNE 30
---------------------------------------------------------------------
2004 2003 2002
--------------------- ------------------ ---------------------
DELINQUENCY BY TYPE: AMOUNT % AMOUNT % AMOUNT %
- -------------------- ------------- ----- ---------- ----- ------------- -----
BUSINESS PURPOSE LOANS (a)
Total portfolio................ $ 1,210 $ 17,126 $ 10,949
============= ========== ==============
Period of delinquency:
31-60 days................... $ -- --% $ 46 0.27% $ -- --%
61-90 days................... -- -- 84 0.49 -- --
Over 90 days................. 1,125 92.98 2,275 13.28 3,536 32.30
------------- ----- ---------- ----- ------------- -----
Total delinquencies.......... $ 1,125 92.98% $ 2,405 14.04% $ 3,536 32.30%
============= ===== ========== ===== ============= =====
Amount of loans in non-accrual
status (b)................... 1,125 2,427 3,674
============= ========== =============
REO............................ $ 900 $ 1,522 $ 1,289
============= ========== =============
HOME MORTGAGE LOANS (a)
Total portfolio................ $ 302,393 $ 246,073 $ 40,663
============= ========== =============
Period of delinquency:
31-60 days................... $ 69 0.02% $ 207 0.08% $ 64 0.16%
61-90 days................... 201 0.07 -- -- 319 0.78
Over 90 days................. 2,204 0.73 2,549 1.04 2,780 6.84
------------- ----- ---------- ----- ------------- -----
Total delinquencies.......... $ 2,474 0.82% $ 2,756 1.12% $ 3,163 7.78%
============= ===== ========== ===== ============= =====
Amount of loans in non-accrual
status(b).................... 2,337 2,931 3,317
============= ========== =============
REO............................ $ 1,020 $ 3,254 $ 2,495
============= ========== =============
EQUIPMENT LEASES (c)
Total portfolio................ $ -- $ 4,126 $ 7,774
============= ========== =============
Period of delinquency:
31-60 days................... $ -- --% $ 46 1.11% $ 172 2.21%
61-90 days................... -- -- 3 0.07 8 0.10
Over 90 days................. -- -- 62 1.50 79 1.02
------------- ----- ---------- ----- ------------- -----
Total delinquencies.......... $ -- --% $ 111 2.69% $ 259 3.33%
============= ===== ========== ===== ============= =====
TOTAL ON BALANCE SHEET LOANS AND
LEASES (a)
Total loans and leases......... $ 303,603 $ 267,325 $ 59,386
============= ========== =============
Period of delinquency:
31-60 days................... $ 69 0.02% $ 299 0.11% $ 236 0.40%
61-90 days................... 201 0.07 87 0.03 327 0.55
Over 90 days................. 3,329 1.10 4,886 1.83 6,395 10.77
------------- ----- ---------- ----- ------------- -----
Total delinquencies.......... $ 3,599 1.19% $ 5,272 1.97% $ 6,958 11.72%
============= ===== ========== ===== ============= =====
Amount of loans in non-accrual
status(b).................... 3,462 1.14 5,358 2.00 6,991 11.77
============= ===== ========== ===== ============= =====
REO............................ $ 1,920 0.63% $ 4,776 1.79% $ 3,784 6.37%
============= ===== ========== ===== ============= =====
NET LOSSES EXPERIENCED DURING
THE PERIOD (d):
On Loans:
Non-accrual loans......... $ 15,666 9.06% $ 6,897 5.03% $ 3,816 3.38%
Loans available for sale.. -- -- -- -- -- --
On Leases...................... (40) (2.00) 513 8.14 1,416 13.23
On REO......................... 6,467 3.74 9,375 6.84 3,812 3.37
------------- ---------- -------------
Total net losses.............. $ 22,093 12.63% $ 16,785 11.71% $ 9,044 7.31%
============= ===== ========== ===== ============= =====
- ------------------
(a) Includes loans carried on our balance sheet as available for sale,
non-accrual loans and leases. Excludes deferred direct origination costs and
allowance for loan losses. Non-accrual loans consist primarily of loans
repurchased from securitization trusts. Leases consist of primarily loans
that are held for sale.
(b) Non-accrual loans are included in total delinquencies in the "On Balance
Sheet Portfolio Quality" table.
(c) We sold our interests in the leasing portfolio on January 22, 2004.
(d) Percentage based on annualized losses and average loans available for sale,
non-accrual loans and leases.
158
DELINQUENT LOANS AVAILABLE FOR SALE. Total delinquent loans available
for sale (loans with payments past due greater than 30 days) were $245 thousand
at June 30, 2004, compared to $225 thousand and $216 thousand at June 30, 2003
and 2002, respectively. Total delinquent loans available for sale as a
percentage of loans available for sale were 0.08% at June 30, 2004 compared to
0.09% and 0.48% at June 30, 2003 and 2002, respectively. If a loan available for
sale becomes contractually delinquent for 90 days or more, it is placed on
non-accrual status and transferred to non-accrual loans. We do not anticipate
significant increases in the amount of delinquent loans available for sale
because our adjusted business strategy focuses on whole loan sales, which result
in loans being held on our books for short periods. The amount of loans
available for sale which were transferred to non-accrual loans was $2.8 million
for the year ended June 30, 2004, $0.7 million for the year ended June 30, 2003
and $1.5 million for the year ended June 30, 2002. The following table
summarizes delinquent loans available for sale at June 30, 2004, 2003 and 2002
(dollars in thousands):
JUNE 30
--------------------------------------------------------------------
2004 2003 2002
-------------------- ----------------- --------------------
AMOUNT % AMOUNT % AMOUNT %
------------- ---- ---------- ---- ------------- ----
Total loans available for sale... $ 300,141 $ 257,840 $ 44,619
============= ========== ==============
Period of delinquency:
31-60 days..................... $ 69 0.02% $ 142 0.06% $ 35 0.08%
61-90 days..................... 176 0.06 83 0.03 181 0.40
Over 90 days................... -- -- -- -- -- --
------------- ---- ---------- ---- ------------- ----
Total delinquencies............ $ 245 0.08% $ 225 0.09% $ 216 0.48%
============= ==== ========== ==== ============= ====
NON-ACCRUAL LOANS. 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 consist primarily of loans repurchased from securitization trusts, but
also include loans previously carried as available for sale when they become
contractually delinquent for 90 days or more. The following table summarizes
non-accrual loans by source at June 30, 2004, 2003 and 2002 (in thousands):
JUNE 30,
------------------------------------
2004 2003 2002
------- ------- -------
Repurchased from securitization trusts............ $ 3,281 $ 4,674 $ 4,985
Transferred from loans available from sale........ 181 684 2,006
------- ------- -------
Total non-accrual loans........................... $ 3,462 $ 5,358 $ 6,991
======= ======= =======
DEFERMENT AND FORBEARANCE ARRANGEMENTS. From time to time, borrowers in
the portfolio of loans which we manage 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 may 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 the borrower's 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.
In a deferment arrangement, we make advances 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
payment plan. Borrowers must provide a written explanation of their hardship,
which generally requests relief from their delinquent 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 ranging from approximately 12 to 42 months, depending on
the period for which deferment is requested, 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 at least two
senior vice presidents.
159
Principal guidelines currently applicable to the deferment process
include: (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 two senior
vice presidents. If the deferment arrangement is approved, a collector contacts
the borrower regarding the approval and the revised payment terms.
For borrowers who are three or more payments delinquent, we will
consider using a forbearance arrangement. In a forbearance arrangement, we make
advances 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 will create a
payment plan for the borrower which 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 on behalf of the borrower.
Principal guidelines currently applicable to the forbearance process
include the following: (i) the borrower must have first and/or second mortgages
with us; (ii) the borrower's account was originated at least six months prior to
the request for forbearance; (iii) the borrower's account must be at least three
payments delinquent to qualify for a forbearance agreement; (iv) the borrower
must submit a written request for forbearance containing an explanation for his
or her previous delinquency and setting forth the reasons that the borrower now
believes he or she is able to meet his or her loan obligations; and (v) the
borrower must make a down payment of at least one month's past due payments of
principal and interest in order to enter into a forbearance agreement, and the
borrower who is six or more payments delinquent must make a down payment of at
least two past due payments. No request for forbearance may be denied without
review by our senior vice president of collections or his designee.
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 also depends upon one or more of the
following factors: our assessment of the individual borrower's current financial
situation, reasons for the delinquency 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.
160
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 principal and interest loan payments. 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, we will generally declare the account in default, reflect it
as a delinquent loan in our delinquency statistics and resume collection
actions.
Information regarding the principal amounts of loans in our managed
portfolio under deferment and forbearance arrangements and the principal amounts
of loans which entered into deferment and forbearance arrangements during the
years ended June 30, 2004 and 2003 is presented in "-- Total Portfolio Quality
- -- Deferment and Forbearance Arrangements."
Advances made under deferment and forbearance arrangements result from
a new credit decision regarding the borrower's ability to repay the advance, as
well as perform under the original terms of the original loan, and do not
involve any modification of the terms of the original loan. These arrangements
are considered a new lending activity and do not qualify as troubled debt
restructurings under SFAS No. 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructurings." We record the advances that we make under
deferment and forbearance arrangements with borrowers as receivables on our
balance sheet. We carry these receivables at their estimated recoverable
amounts. If the original loan returns to a delinquency status of 90 days or more
past due, we write the receivable off to expense. During the fiscal year ended
June 30, 2004, we did not record any fee income on these arrangements while we
recorded $100 thousand and $59 thousand during fiscal years ended June 30, 2003
and 2002, respectively.
The following table presents information regarding our on balance sheet
receivables for advances to borrowers related to deferment and forbearance
arrangements for the years ended June 30, 2004 and 2003 (in thousands):
ADVANCES RECEIVABLE
------------------------------------
UNDER UNDER
DEFERMENT FORBEARANCE TOTAL
--------- ----------- --------
Balance June 30, 2002 ................ $ 563 $ 2,134 $ 2,697
Advances on new arrangements ......... 1,754 3,895 5,649
Payments received .................... (641) (2,069) (2,710)
Receivables written off .............. (390) (905) (1,295)
------- ------- -------
Balance June 30, 2003 ................ $ 1,286 $ 3,055 $ 4,341
------- ------- -------
Advances on new arrangements ......... 4,178 2,598 6,776
Payments received .................... (1,633) (2,078) (3,711)
Receivables written off .............. (520) (637) (1,157)
------- ------- -------
Balance June 30, 2004 ................ $ 3,311 $ 2,938 $ 6,249
======= ======= =======
REAL ESTATE OWNED. REO, comprising foreclosed properties and deeds
acquired in lieu of foreclosure, decreased to $1.9 million at June 30, 2004,
compared to $4.8 million at June 30, 2003 and $3.8 million at June 30, 2002. The
decrease in the volume of REO on our balance sheet was mainly due to processes
we had implemented beginning in fiscal 2003 to decrease the cycle time in the
disposition of REO properties. Also contributing to the decrease were lower REO
repurchases from the securitization trusts during fiscal 2004.
The activity in REO carried on our balance sheet during the years ended
June 30, 2004, 2003 and 2002 was as follows. For total REO purchased from
securitization trusts and the valuation loss recorded at the time of purchase,
see the table Summary of Loans and REO Repurchased from Mortgage Loan
Securitization Trusts in "-- Securitizations -- Trigger Management." (in
thousands):
161
-------------------------------
YEAR ENDED JUNE 30,
-------------------------------
2004 2003 2002
-------- -------- --------
Balance at beginning of period ...................... $ 4,776 $ 3,784 $ 2,322
Properties acquired through foreclosure (a) ......... 471 2,771 3,319
Properties purchased from securitization trusts (a) . 8,576 21,998 11,236
Sales/liquidation proceeds .......................... (11,840) (22,273) (13,252)
Property revaluation losses ......................... (352) (833) (282)
Gain (Loss) on sale/liquidation ..................... 289 (671) 441
-------- -------- --------
Balance at end of period ............................ $ 1,920 $ 4,776 $ 3,784
======== ======== ========
- ----------------
(a) At lower of cost or net realizable value.
LOSS EXPERIENCE. During the year ended June 30, 2004, we experienced
net loan, lease and REO charge-offs of $22.1 million or 12.63% on an annualized
basis. During the year ended June 30, 2003, we experienced net charge-offs of
$16.8 million or 11.71% on an annualized basis. During the year ended June 30,
2002, we experienced net charge-offs of $9.0 million, or 7.31% on an annualized
basis. Principal loss severity experience on delinquent loans generally has
ranged from 20% to 30% of principal and loss severity experience on REO
generally has ranged from 20% to 40% of principal. The increase in net
charge-offs from the prior periods was mainly due to the larger volume of loans
that became delinquent, were repurchased from securitization trusts and/or, were
liquidated during the period, as well as economic conditions and the seasoning
of the total portfolio. See the table "Summary of Loans and REO Repurchased from
Mortgage Loan Securitization Trusts" for further detail of loan repurchase
activity.
162
TOTAL PORTFOLIO QUALITY
The following table provides data concerning delinquency experience,
real estate owned and loss experience for the total loan and lease portfolio in
which we have interests, either because the loans and leases are on our balance
sheet or sold into securitizations in which we have retained interests. The
total portfolio is divided into the portion of the portfolio managed and
serviced by us, and the portion of the portfolio serviced by others. See "--
Reconciliation of Non-GAAP Financial Measures" for a reconciliation of total
portfolio and REO measures to our balance sheet. See "-- Deferment and
Forbearance Arrangements" for the amounts of previously delinquent loans managed
by us 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 the deferment or forbearance arrangement) (dollars in thousands):
JUNE 30
-----------------------------------------------------------------------
2004 2003 2002
------------------------- ---------------------- ----------------------
DELINQUENCY BY TYPE: AMOUNT % AMOUNT % AMOUNT %
MANAGED BY ABFS:
BUSINESS PURPOSE LOANS
Total portfolio......... $ 255,200 $ 393,098 $ 361,638
============= ============ ============
Period of delinquency:
31-60 days............. $ 4,847 1.90% $ 4,849 1.23% $ 2,449 0.68%
61-90 days............. 4,241 1.66 4,623 1.18 1,648 0.46
Over 90 days........... 51,625 20.23 38,237 9.73 32,987 9.12
------------- -------- ------------ ------- ------------ -------
Total delinquencies.... $ 60,713 23.79% $ 47,709 12.14% $ 37,084 10.25%
============= ======== ============ ======= ============ =======
REO...................... $ 3,725 $ 5,744 $ 6,220
============= ============ =============
HOME MORTGAGE LOANS
Total portfolio.......... $ 1,836,678 $ 3,249,501 $ 2,675,559
============= ============ ============
Period of delinquency:
31-60 days............. $ 35,301 1.92% $ 48,427 1.49% $ 37,213 1.39%
61-90 days............. 18,961 1.03 24,124 0.74 22,919 0.86
Over 90 days........... 104,441 5.69 108,272 3.33 73,410 2.74
------------- -------- ------------ ------- ------------ -------
Total delinquencies.... $ 158,703 8.64% $ 180,823 5.56% $ 133,542 4.99%
============= ======== ============ ======= ============ =======
REO...................... $ 30,675 $ 22,256 $ 27,825
============= ============ ============
EQUIPMENT LEASES (A)
Total portfolio.......... $ - $ 8,475 $ 28,992
============= ============ ============
Period of delinquency:
31-60 days............. $ - % $ 162 1.91% $ 411 1.42%
61-90 days............. - 83 0.98 93 0.32
Over 90 days........... - 154 1.82 423 1.46
------------- -------- ------------ ------- ------------ -------
Total delinquencies.... $ - % $ 399 4.71% $ 927 3.20%
============= ======== ============ ======= ============ =======
TOTAL MANAGED BY ABFS
Total loans and leases... $ 2,091,878 $ 3,651,074 $ 3,066,189
============= ============ ============
Period of delinquency:
31-60 days............. $ 40,148 1.92% $ 53,438 1.46% $ 40,073 1.31%
61-90 days............. 23,202 1.11 28,830 0.79 24,660 0.80
Over 90 days........... 156,066 7.46 146,663 4.02 106,820 3.48
------------- -------- ------------ ------- ------------ -------
Total delinquencies.... $ 219,416 10.49% $ 228,931 6.27% $ 171,553 5.59%
============= ======== ============ ======= ============ =======
REO...................... $ 34,400 1.64% $ 28,000 0.77% $ 34,045 1.11%
============= ======== ============ ======= ============ =======
SERVICED BY OTHERS (B):
Total portfolio serviced by
others................... $ 139,811 $ - $ -
============= ============ ============
Period of delinquency:
31-60 days............. $ 6,976 4.99% $ - -% $ - -%
61-90 days............. 3,636 2.60 - - - -
Over 90 days........... 8,105 5.80 - - - -
------------- -------- ------------ ------- ------------ -------
Total delinquencies.... $ 18,717 13.39% $ - -% $ - -%
============= ======== ============ ======= ============ =======
163
TOTAL PORTFOLIO QUALITY (CONTINUED)
JUNE 30
-------------------------------------------------------------------
2004 2003 2002
-------------------- ------------------ ------------------
AMOUNT % AMOUNT % AMOUNT %
---------- ------ ---------- ------ ---------- ------
TOTAL PORTFOLIO.............. $2,231,689 $3,651,074 $3,066,189
========== ========== ==========
Period of delinquency:
31-60 days............... $ 47,124 2.11% $ 53,438 1.46% $ 40,073 1.31%
61-90 days............... 26,838 1.20 28,830 0.79 24,660 0.80
Over 90 days............. 164,171 7.36 146,663 4.02 106,820 3.48
---------- ----- ---------- ----- ----------- -----
Total delinquencies...... $ 238,133 10.67% $ 228,931 6.27% $ 171,553 5.59%
========== ===== ========== ====== =========== =====
REO.......................... $ 34,400 1.54% $ 28,000 0.77% $ 34,045 1.11%
========== ===== ========== ====== =========== =====
NET LOSSES EXPERIENCED
DURING THE PERIOD (C):
On Loans:
Absorbed by securitization
trusts.................. $ 8,782 0.32% $ 4,861 0.15% $ 2,618 0.09%
Non-accrual loans.......... 19,676(d) 0.71 6,897 0.21 3,816 0.14
Loans available for sale... - - - - - -
On Leases................. (40) (1.25) 513 2.91 1,416 3.20
On REO:
Absorbed by
securitization trusts... 5,648 0.20 8,358 0.25 5,231 0.19
REO on balance sheet....... 6,467 0.23 9,375 0.28 3,812 0.14
---------- ---------- ----------
Total net losses............ $ 40,533 1.46% $ 30,004 0.90% $ 16,893 0.60%
========== ====== ========== ===== ========== =====
- ---------------------
(a) We sold our interests in the leasing portfolio on January 22, 2004.
(b) We do not service the mortgage loans in the 2003-2 securitization
trust, our most recent securitization, which closed in October 2003.
(c) Percentage based on annualized losses and average total portfolio.
(d) $15.7 million was charged to the provision for credit losses and $4.0
million was charged to General and Administrative expenses.
We do not service the mortgage loans in the 2003-2 securitization
trust, our most recent securitization, which closed in October 2003. A third
party services the $139.8 million of mortgage loans in that trust. Those loans
and their delinquency status are included in the above Total Portfolio Quality
table because we have retained securitization interests in the form of
interest-only strips on our balance sheet. Due to different servicing practices,
which may be followed by other loan servicers, loans serviced by others may
perform less favorably and incur higher delinquencies and losses than the loans
in the portfolio managed by us. We adjusted the initial loss assumption applied
in valuing our interest-only strip from the 2003-2 securitization to account for
this risk. No mortgage loans in the total portfolio were serviced by third
parties prior to October 2003.
DEFERMENT AND FORBEARANCE ARRANGEMENTS. See "-- On Balance Sheet
Portfolio Quality -- Deferment and Forbearance Arrangements" for a discussion of
how these arrangements arise and our policies and practices regarding deferment
and forbearance arrangements.
The following table presents, as of the end of our last nine quarters,
information regarding loans under deferment and forbearance arrangements, which
are reported as current loans 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 the deferment or forbearance arrangement) and thus not included in
delinquencies in the delinquency table (dollars in thousands):
164
CUMULATIVE UNPAID PRINCIPAL BALANCE
----------------------------------------------------------------
% OF
PORTFOLIO
UNDER UNDER MANAGED BY
DEFERMENT FORBEARANCE TOTAL(A) ABFS
----------- ----------- ----------- ----------
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
September 30, 2003................. 141,547 80,467 222,014 7.47
December 31, 2003.................. 152,664 75,769 228,433 9.17
March 31, 2004..................... 162,576 66,844 229,420 10.46
June 30, 2004...................... 160,572 55,776 216,348 10.34
- ------------------
(a) Included in cumulative unpaid principal balance are loans with
arrangements that were entered into longer than twelve months ago. At
June 30, 2004, there was $29.9 million of cumulative unpaid principal
balance under deferment arrangements and $31.8 million of cumulative
unpaid principal balance under forbearance arrangements that were
entered into prior to July 2003.
Additionally, there are loans under deferment and forbearance
arrangements, which have returned to delinquent status. At June 30, 2004 there
was $55.8 million of cumulative unpaid principal balance under deferment
arrangements and $51.7 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 and the first six months of
fiscal 2004, we experienced a pronounced increase in the number of borrowers
under deferment arrangements and in light of the weakened economic environment
during that twelve-month period we made use of deferment arrangements to a
greater degree than in prior periods. The economic conditions that contributed
most to the greater use of deferment arrangements during this period related to
increased unemployment, loss of one job in two income households, and reductions
in normal working hours and overtime. Since December 2003, we have experienced a
reduction in new deferment arrangements due to improving economic conditions and
if the improving economic environment continues, we expect to continue to
experience a reduction in new deferment arrangements.
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 and 2004 (dollars in thousands):
165
UNPAID PRINCIPAL BALANCE IMPACTED BY
ARRANGEMENTS ENTERED INTO
DURING THE QUARTER
-------------------------------------------------
% OF
PORTFOLIO
UNDER UNDER MANAGED BY
QUARTER ENDED: DEFERMENT FORBEARANCE TOTAL ABFS
- -------------- ---------- ----------- ----------- ----------
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
September 30, 2003............ 58,419 15,955 74,374 2.50
December 31, 2003............. 52,029 14,272 66,301 2.66
March 31, 2004................ 32,812 4,139 36,951 1.69
June 30, 2004................. 32,332 982 33,314 1.59
- ----------------------
The following table presents a summary of the activity, in terms of the
principal balance, of loans under these arrangements for the years ended June
30, 2004 and 2003 (in thousands):
YEAR ENDED JUNE 30, 2004 YEAR ENDED JUNE 30, 2003
--------------------------------- -------------------------------
UNDER UNDER UNDER UNDER
DEFERMENT FORBEARANCE DEFERMENT FORBEARANCE
------------- ---------------- ------------- --------------
Principal balance beginning of period... $ 110,487 $ 87,199 $ 64,958 $ 73,705
Plus loans entering arrangements:
First time arrangements............. 166,288 32,459 106,781 83,942
Repeat arrangements................. 9,304 2,889 3,810 12,741
Less loans that changed status:
Loans returned to current status.... 54,246 34,569 23,777 24,710
Loans returned to delinquent
status(a).......................... (121,008) (78,863) (57,700) (86,142)
Less loans exiting the program:
Loans charged off................... (120) (101) (54) (118)
Loans paid off...................... (47,445) (16,610) (20,775) (13,510)
Loan principal payments received.... (771) (259) (94) (29)
Loans that completed program........ (10,409) (5,507) (10,216) (8,100)
--------- ---------- --------- ----------
Principal balance end of period......... $ 160,572 $ 55,776 $ 110,487 $ 87,199
========= ========== ========= ==========
- --------------------
(a) During the year ended June 30, 2004, $2.5 million and $4.2 million of
loans previously under forbearance and deferment arrangements,
respectively, which had returned to delinquent status, were foreclosed.
Any credit losses realized on loans under these arrangements are
included in total portfolio historical losses, which are used in developing
credit loss assumptions.
166
DELINQUENT LOANS AND LEASES. Total delinquencies (loans and leases with
payments past due greater than 30 days, excluding REO) in the total portfolio
were $238.1 million at June 30, 2004 compared to $228.9 million and $171.6
million at June 30, 2003 and 2002, respectively. Total delinquencies as a
percentage of the total portfolio were 10.67% at June 30, 2004 compared to 6.27%
and 5.59% at June 30, 2003 and 2002, respectively. The increase in delinquencies
and delinquency percentages in fiscal 2004 and 2003 were mainly due to the
impact on our borrowers of weak and uncertain economic conditions, which may
include the reduction in other sources of credit to our borrowers, and the
seasoning of the total portfolio. As the total portfolio seasons, or ages, more
borrowers can be expected to incur credit problems. These factors have resulted
in a significant increase in the usage of deferment and forbearance activities
during the 2003 and 2004 fiscal years. In addition, the delinquency percentage
has increased due to high loan prepayment experience resulting from borrowers'
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 amount of loans originated and securitized
and an increase in whole loan sales with servicing released also contributed to
the increase in the delinquency percentage at June 30, 2004 from June 30, 2003.
As the total portfolio continues to season, and if our economy does not continue
to improve, the delinquency rate may increase.
REAL ESTATE OWNED. Total REO, comprising foreclosed properties and
deeds acquired in lieu of foreclosure, increased to $34.4 million, or 1.54% of
the total portfolio at June 30, 2004 compared to $28.0 million, or 0.77% at June
30, 2003 and $34.0 million, or 1.11% at June 30, 2002. The increase in REO at
June 30, 2004 occurred during the fourth quarter of fiscal 2004. During the
fourth quarter, we slowed down the sales and liquidations of REO properties in
the total portfolio and implemented a program to identify REO properties whose
values may be maximized through rehabilitation. We intend to put greater effort
into rehabilitating those REO properties and renting the properties to create
sales value. It is too early in this program to predict how successful the
program may be. As the total portfolio continues to season and if our economy
does not continue to improve, the REO balance may increase.
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, Treasury yields and one-month LIBOR yields. Changes in these
interest rates impact 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 debentures). We 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.
167
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 debentures 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 debentures, 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
long-term and short-term liquidity.
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 "-- 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, 2004
-------------------------------------------------------------------------------------------
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 available for sale (a) ...... $301,040 $ 35 $ 38 $ 40 $ 44 $ 3,078 $304,275 $309,722
Interest-only strips .............. 112,168 101,796 72,722 60,753 52,247 270,626 670,312 459,086
Servicing rights .................. 20,897 16,388 14,033 12,126 10,452 49,474 123,370 73,738
Investments held to maturity (b) .. 839 -- -- -- -- -- 839 839
RATE SENSITIVE LIABILITIES:
Fixed interest rate borrowings..... $354,416 $175,468 $ 47,127 $ 10,043 $ 6,509 $ 14,298 $607,861 $606,651
Average interest rate ............. 9.87% 9.65% 10.23% 9.63% 11.59% 11.92% 9.90%
Variable interest rate
borrowings .................... $239,587 $ -- $ -- $ -- $ -- $ -- $239,587 $239,587
Average interest rate ............. 3.76% -- -- -- -- -- 3.76%
- --------------------
(a) For purposes of this table, all loans which qualify for securitization
or whole loan sale are reflected as maturing within twelve months,
since loans available for sale are generally held for less than three
months prior to securitization or whole loan sale.
(b) This investment was repaid in July 2004.
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 -- 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 0.2%. 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
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.
168
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, 2004, $219.4 million of debt issued by loan
securitization trusts was floating interest rate certificates based on one-month
LIBOR, representing 12.6% 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 stockholders'
equity. As of June 30, 2004, the interest rate sensitivity for $191.5 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. 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. The interest rate sensitivity for $128.5 million of
floating interest rate certificates issued from the 2003-2 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 portfolio were subject to
prepayment fees. At June 30, 2004, approximately 50-55% of business loans and
50-55% of home equity loans in the total portfolio were 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 "-- Securitizations"
for further information regarding these assumptions and the impact of
prepayments during this period.
SUBORDINATED DEBENTURES AND SENIOR COLLATERALIZED SUBORDINATED NOTES.
We also experience interest rate risk to the extent that as of June 30, 2004
approximately $252.0 million of our liabilities were comprised of fixed interest
rate subordinated debentures and senior collateralized subordinated notes
outstanding with scheduled maturities of greater than one year. To the extent
that market interest rates demanded on subordinated debentures 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. The following discussion breaks down our use of derivative
financial instruments into hedging activity and trading activity.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Financial Instruments and Hedging Activities," referred to as SFAS No. 133 in
this document. 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. If a derivative is trading, changes in its fair value are
recognized in earnings.
169
The value of a derivative financial instrument is based on 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.
HEDGE ACCOUNTING
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 terms and pricing
for a whole loan sale are fixed or the date the fixed interest rate pass-through
certificates to be issued by a securitization trust are priced. Generally, the
period between loan origination and pricing for whole loan sales is less than 45
days and the period between loan origination and pricing of the pass-through
interest rate is less than three months. The types of derivative financial
instruments we use to mitigate the effects of changes in fair value of our loans
due to interest rate changes may include interest rate swaps, futures and
forward contracts, including forward sale agreements. 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.
RELATED TO LOANS EXPECTED TO BE SOLD THROUGH SECURITIZATIONS. We may
specifically designate derivative contracts as hedges of mortgage loans, which
we expect to include in a term securitization at a future date. The mortgage
loans 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
changes in fair value due to 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 receive on the subsequent securitization. At June 30, 2004 and 2003, we did
not have any outstanding derivative financial instruments designated as hedges
of loans we expected to sell through securitizations.
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. Derivative contracts may be specifically designated
as hedges of mortgage loans, which we would expect to include 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, Eurodollar futures, forward
starting interest rate swaps, forward treasury sales or derivative contracts of
similar underlying securities. We also enter into forward sale agreements to
manage this risk.
170
In March 2004, we entered into a forward sale agreement providing for
the sale of $300.0 million of home mortgage loans and business purpose loans at
a price of 104.4%. We sold loans under this commitment in the amount of $224.0
million during the month of March 2004 and $51.6 million during the month of
April 2004, satisfying our commitment under this forward sale agreement, and
recognizing gains of $8.4 million.
In May 2004, we entered into a forward sale agreement providing for the
sale of $175.0 million of home mortgage loans at a price of 101.6%. We sold
loans under this commitment in the amount of $92.9 million during the month of
May 2004 and $67.5 million during the month of June 2004, satisfying our
commitment under this forward sale agreement, and recognizing gains of $1.8
million on the loans sold in the quarter ended June 30, 2004.
On June 28, 2004, we entered into a forward sale agreement providing
for the sale of $275.0 million of home mortgage loans at a price of 101.5%. We
expect to satisfy this commitment in July and August 2004 with loans recorded on
our balance sheet at June 30, 2004. We did not recognize any gains or losses on
this forward sale agreement at June 30, 2004.
DISQUALIFIED HEDGING RELATIONSHIP IN FISCAL 2003. 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 derivatives designated as a hedge of mortgage loans
previously expected to be securitized would not be achieved, and we discontinued
hedge accounting for $170.0 million of forward starting interest rate swaps.
Losses of $4.0 million on these $170.0 million of interest rate swaps were
charged to the Statement of Income in the fourth quarter of fiscal 2003. An
offsetting increase of $3.7 million in the value of the hedged mortgage loans
was also recorded in the Statement of Income, representing the change in fair
value of the loans for the hedged risk until the date that we learned that the
securitization market was not available. The $170.0 million of interest rate
swaps were reclassified as trading contracts.
SUMMARY OF HEDGE ACCOUNTING. 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 fiscal years ended
June 30, 2004, 2003 and 2002. Ineffectiveness related to qualified hedging
relationships during each 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,
----------------------------------------
2004 2003 2002
---------- ---------- ----------
Gains and losses on derivatives recorded in
securitization gains and offset by gains and losses
recorded on loan securitizations:
Losses on derivative financial instruments................. $ -- $ (3,806) $ (9,401)
Recorded in gains and losses on derivative financial
instruments:
Gains (losses) on derivative financial instruments......... $ 1,157 $ (7,037) $ --
Gains (losses) on hedged loans............................. $ (2,283) $ 6,160 $ --
Amount settled in cash - received (paid)................... $ 656 $ (5,041) $ (9,401)
171
At June 30, 2004 and 2003, the notional amounts of forward sale
agreements, Eurodollar futures contracts and forward starting interest rate swap
contracts accounted for as hedges and related unrealized gains and losses
recorded as assets or liabilities on the balance sheet were as follows (in
thousands):
AT JUNE 30,
-------------------------------------------------------
2004 2003
------------------------- -------------------------
NOTIONAL UNREALIZED NOTIONAL UNREALIZED
AMOUNT (LOSS) AMOUNT LOSS
----------- ----------- ----------- ----------
Forward sale agreement.................. $ 275,000 $ -- $ 275,000 $ --
Eurodollar futures contracts............ $ 27,962 $ (103) $ -- $ --
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 settled in cash by June 30, 2003.
The sensitivity of the Eurodollar futures contracts classified as fair
value hedges as of June 30, 2004 to a 0.1% change in market interest rates is $9
thousand.
TRADE ACCOUNTING
Generally, we do not enter into derivative financial instrument
contracts for trading purposes. However, we have entered into derivative
financial instrument contracts, which were not designated or qualified as
accounting hedges in accordance with SFAS No. 133. In these cases the derivative
contracts are recorded as an asset or liability on the balance sheet at fair
value and gains and losses are included in the income statement.
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.
However due to declining 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. During the year ended June 30, 2004, we did not utilize derivative
financial instruments to protect future securitization spreads on loans in our
pipeline.
RELATED TO LOANS EXPECTED TO BE SOLD THROUGH WHOLE LOAN SALE
TRANSACTIONS. During fiscal 2004 and 2003, we used Eurodollar futures contracts
or interest rate swap contracts to manage interest rate risk on loans in our
pipeline or loans expected to be sold in whole loan sale transactions.
Forward starting interest rate swap contracts with a notional amount of
$170.0 million were carried over from a fiscal 2003 disqualified hedging
relationship. These forward starting interest rate swap contracts were used to
manage the effect of changes in market interest rates on the fair value of
fixed-rate mortgage loans that were sold in the first quarter of fiscal 2004 and
the contracts were closed in that quarter. We had elected not to designate these
derivative contracts as an accounting hedge.
172
We recorded the following gains and losses on the fair value of
derivative financial instruments classified as trading for the years ended June
30, 2004 and 2003. There were no derivative contracts classified as trading for
the year ended June 30, 2002 except those noted below at June 30, 2002 to manage
the exposure to changes in the fair value of certain interest-only strips due to
changes in one-month LIBOR (in thousands):
YEAR ENDED JUNE 30,
-------------------
2004 2003
------- --------
Trading Gains/(Losses) on Eurodollar futures contracts:
Related to loan pipeline ...................................... $(1,425) $ --
Trading Gains/(Losses) on forward starting interest rate swaps:
Related to loan pipeline ...................................... $ -- $(3,796)
Related to whole loan sales ................................... $ 5,097 $ 441
Amount settled in cash - (paid) ............................... $(1,187) $(2,671)
At June 30, 2004 and 2003, outstanding Eurodollar futures contracts or
forward starting interest rate swap contracts used to manage interest rate risk
on loans in our pipeline or expected to be sold in whole loan sale transactions
and associated unrealized gains and unrealized losses recorded as assets and
liabilities on the balance sheet were as follows (in thousands):
JUNE 30, 2004 JUNE 30, 2003
------------------------ ----------------------
NOTIONAL UNREALIZED NOTIONAL UNREALIZED
AMOUNT (LOSS) AMOUNT GAIN
--------- ----------- -------- ----------
Eurodollar futures contracts............ $202,038 $(851) $ -- $ --
Forward starting interest rate swaps... $ -- $ -- $170,000 $ 441
The sensitivity of the Eurodollar futures contracts held as trading as
of June 30, 2004 to a 0.1% change in market interest rates is $66 thousand.
RELATED TO INTEREST-ONLY STRIPS. We had an interest rate swap contract,
which was not designated as an accounting hedge, designed to reduce the exposure
to changes in the fair value of certain interest-only strips due to changes in
one-month LIBOR. This contract matured in April 2004. Unrealized gains and
losses on the interest rate swap contract are due to changes in the interest
rate swap yield curve during the periods the contract was in place. Net gains
and losses on this interest rate swap contract included the amount of cash
settlement with the contract counter party each period. Net gains and losses on
this interest rate swap contract for the fiscal years ended June 30, 2004, 2003
and 2002 were as follows (in thousands):
YEAR ENDED JUNE 30,
-------------------------------
2004 2003 2002
------- -------- --------
Unrealized gain (loss) on interest rate swap
contract......................................... $ 335 $ 127 $ (460)
Cash interest paid on interest rate swap contract.... (307) (1,038) (266)
------- -------- --------
Net gain (loss) on interest rate swap contract....... $ 28 $ (911) $ (726)
======= ======== ========
173
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 whole loan sales or 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.
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 (272,264 shares after the
effect of stock dividends) 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 (272,264 shares after
the effect of stock dividends) of our common stock, and is shown as a reduction
of stockholders' equity in our financial statements. Mr. Santilli is current in
all payments required by the loan agreement.
In February 2003, we awarded 2,000 shares (2,200 shares after the
effect of subsequent stock dividends) of our common stock to each of Warren E.
Palitz and Jeffrey S. Steinberg as newly appointed members of our Board of
Directors.
Jeffrey S. Steinberg, formerly one of our directors and currently an
Executive Vice President, received $58 thousand in consulting fees from us
during the quarter ended December 31, 2003 and $60 thousand in consulting fees
during the quarter ended March 31, 2004 prior to his resignation from our Board
of Directors on February 20, 2004. Mr. Steinberg received the consulting fees
for assisting us during these two fiscal quarters with the implementation of the
adjusted business strategy, including the expansion of our broker network into
California, Texas and Maryland. Mr. Steinberg was instrumental in negotiating
agreements to purchase broker assets in these states and in quickly organizing
these assets into loan production facilities. Mr. Steinberg's compensation was
determined by reference to the fees charged by finders and brokers, including
investment bankers, for efforts to find and purchase loan production assets.
Barry Epstein, Managing Director of the National Wholesale Residential
Mortgage Division, received 200,000 shares (220,000 shares after giving effect
to subsequent stock dividends) of common stock on December 24, 2003 under the
terms of his employment agreement, subject to the transfer restrictions and
forfeiture provisions provided for in a restricted stock agreement until
achievement of certain performance goals stipulated in both agreements. The
shares were issued by us as a material inducement for Mr. Epstein's employment.
The performance goals have been met, and the transfer and forfeiture provisions
have been terminated, with respect to 100,000 shares (110,000 shares after
giving effect to subsequent stock dividends).
We employ members of the immediate family of three of our executive
officers (one of whom is also a director) 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. ("L&A"), a real estate
brokerage and management firm in which our Director, Mr. Sussman, was a
shareholder until December 31, 2002 and is now Chairman Emeritus, acted as our
agent in connection with the lease of our current corporate office space. As a
result of this transaction, L&A received a commission of $978,439 from the
landlord of the leased office space during fiscal 2003 and is entitled to
receive an additional commission of the same amount in the future upon the
fulfillment of certain conditions which have been fulfilled. We believe this
commission in the aggregate to be consistent with market and industry standards.
Pursuant to an exit agreement between L&A and Mr. Sussman, Mr. Sussman received
a distribution from L&A during fiscal 2003 on account of the first commission
payment consistent with his percentage stock ownership of L&A in the amount of
$59,212 and is entitled to receive the same amount upon L&A's receipt of the
second commission payment. As part of our agreement with L&A, L&A reimbursed us
in the amount of $229,214 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.
174
Anthony J. Santilli, our Chairman, Chief Executive Officer and
President, Beverly Santilli, our Executive Vice President, and Dr. Jerome
Miller, our director, each held subordinated debentures eligible to participate
in the first exchange offer. Each named individual tendered all such eligible
subordinated debentures in the first exchange offer and as of February 6, 2004,
the expiration date of the first exchange offer, pursuant to the terms of the
first exchange offer, were holders of the following number of shares of Series A
preferred stock (SAPS) and aggregate amount of senior collateralized
subordinated notes (SCSN): Mr. Santilli: SAPS - 4,691, SCSN - $4,691; Mrs.
Santilli: SAPS - 4,691, SCSN - $4,691; Dr. Miller: SAPS - 30,164, SCSN -
$30,164.
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
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 total portfolio and total real estate owned, referred to as
REO, information. The total portfolio measure includes loans and leases recorded
on our balance sheet and securitized loans and leases both managed by us and
serviced by others. 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 portfolio and total REO. The following tables reconcile the total
portfolio measures presented in "-- Total Portfolio Quality." (dollars in
thousands):
175
JUNE 30, 2004: DELINQUENCIES
- -----------------------------------------------------------------------------------------
AMOUNT %
---------- ---------
On-balance sheet loan receivables:
Loans available for sale...................... $ 300,141 $ 245
Non-accrual loans............................. 3,462 3,354
------------- ----------
Total on-balance sheet loan receivables... 303,603 3,599 1.19%
Securitized loan receivables..................... 1,928,086 234,534 12.16%
------------- ----------
Total Portfolio............................... $ 2,231,689 $ 238,133 10.67%
============= ==========
On-balance sheet REO............................. $ 1,920
Securitized REO.................................. 32,480
-------------
Total REO........................................ $ 34,400
=============
JUNE 30, 2003: DELINQUENCIES
- -----------------------------------------------------------------------------------------
AMOUNT %
---------- ----------
On-balance sheet loan receivables:
Loans available for sale...................... $ 257,841 $ 225
Non-accrual loans............................. 5,358 4,936
Lease receivables............................. 4,126 111
------------- ----------
Total on-balance sheet loan receivables... 267,325 5,272 1.97%
Securitized loan and lease receivables........ 3,383,749 223,659 6.61%
------------- ----------
Total Portfolio............................... $ 3,651,074 $ 228,931 6.27%
============= ==========
On-balance sheet REO.......................... $ 4,776
Securitized REO............................... 23,224
-------------
Total REO..................................... $ 28,000
=============
JUNE 30, 2002: DELINQUENCIES
- -----------------------------------------------------------------------------------------
AMOUNT %
---------- ----------
On-balance sheet loan receivables:
Loans available for sale.................... $ 44,621 $ 216
Non-accrual loans........................... 6,991 6,483
Lease receivables........................... 7,774 259
------------- ----------
Total on-balance sheet loan receivables. 59,386 6,958 11.72%
Securitized loan and lease receivables......... 3,006,803 164,595 5.47%
------------- ----------
Total Portfolio................................ $ 3,066,189 $ 171,553 5.59%
============= ==========
On-balance sheet REO........................... $ 3,784
Securitized REO................................ 30,261
-------------
Total REO...................................... $ 34,045
=============
OFFICE FACILITIES
We presently lease office space for our corporate headquarters in
Philadelphia, Pennsylvania. 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 provided 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 currently $8.0 million. The letter
of credit is currently issued by JPMorgan Chase Bank.
176
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 performed loan servicing and collection activities at this office,
but relocated these activities to our Philadelphia office on July 12, 2004. The
expenses and cash outlay related to the relocation were not material to our
operations.
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.
In connection with the acquisition of the California mortgage broker
operation in December 2003, we assumed the obligations under a lease for
approximately 3,700 square feet of space in West Hills, California. The
remaining term of the lease is 2 years, expiring September 30, 2006 at an annual
rental of approximately $0.1 million.
In connection with the opening of the Irvine, California mortgage
broker operation, we entered into a sublease on March 4, 2004 for approximately
6,400 square feet of space. The term of the sublease is 1 2/3 years and expires
November 30, 2005. The terms of the sublease require average minimum annual
rental payments of $0.1 million.
In connection with the opening of the Maryland mortgage broker
operation, we entered into a sublease on March 15, 2004 for approximately 10,300
square feet of space in Edgewater, Maryland. The term of the sublease is 3 years
and expires March 15, 2007. The terms of the sublease require increased payments
annually for the term of the lease with average minimum annual rental payments
of $0.2 million.
In connection with the acquisition of the Texas broker operation, we
entered into a sublease on June 11, 2004 for approximately 6,000 square feet of
space in Austin, Texas. The term of the sublease is 10 1/2 months, expiring
April 28, 2005 at an annual rental of approximately $0.1 million.
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, 2004 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, we are carrying a liability
of $0.7 million on our balance sheet for our obligation to 2003-1 securitization
trust which was created 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 reduced 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. We have not completed a new securitization
with servicing retained since 2003-1.
177
In December 2002, the FASB issued 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 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 13 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 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.
178
In December 2003, the FASB issued Interpretation No. 46 (revised
December 2003), "Consolidation of Variable Interest Entities" ("FIN 46R"), which
replaces the original FIN No. 46 issued in January 2003. FIN 46R addresses how a
business enterprise should evaluate whether it has a controlling interest in an
entity through means other than voting rights. This interpretation requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or is entitled to receive a majority of the entity's residual returns
or both. The interpretation also requires disclosures about variable interest
entities that the Company is not required to consolidate but in which it has a
significant variable interest. Special Purpose Entities ("SPE") 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 46R
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.
179
ITEM 8. FINANCIAL STATEMENTS
Index to Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accountants........................ 181
Consolidated Balance Sheets as of June 30, 2004 and 2003................... 182
Consolidated Statements of Operations for the years ended
June 30, 2004, 2003 and 2002.......................................... 184
Consolidated Statements of Stockholders' Equity for the years ended
June 30, 2004, 2003 and 2002.......................................... 185
Consolidated Statements of Cash Flow for the years ended
June 30, 2004, 2003 and 2002.......................................... 187
Notes to Consolidated Financial Statements................................. 189
180
REPORT OF INDEPENDENT REGISTERED 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, 2004 and 2003,
and the related consolidated statements of operations, stockholders' equity, and
cash flow for each of the three years in the period ended June 30, 2004. 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 the Standards of the Public Company
Accounting Oversight Board (United States). 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, 2004
and 2003, and the consolidated results of their operations and their cash flow
for each of the three years in the period ended June 30, 2004 in conformity with
accounting principles generally accepted in the United States of America.
/s/ BDO Seidman LLP
BDO Seidman LLP
Philadelphia, Pennsylvania
October 8, 2004
181
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollar amounts in thousands)
JUNE 30,
---------------------------
2004 2003
---------- ----------
ASSETS
Cash and cash equivalents $ 910 $ 36,590
Restricted cash 13,307 10,885
Loan and lease receivables:
Loans available for sale 304,275 263,419
Non-accrual loans (net of allowance for credit losses of $1,469 at June
30, 2004 and $1,359 at June 30, 2003) 1,993 3,999
Lease receivables (net of allowance for credit losses of $170 at June 30,
2003) - 3,984
Interest and fees receivable 18,089 10,838
Deferment and forbearance advances receivable 6,249 4,341
Loans subject to repurchase rights 38,984 23,761
Interest-only strips (includes the fair value of overcollateralization related
cash flows of $216,926 and $279,245 at June 30, 2004 and 2003) 459,086 598,278
Servicing rights 73,738 119,291
Deferred income tax asset 59,133 -
Property and equipment, net 26,047 23,302
Prepaid expenses 13,511 3,477
Receivable for sold loans - 26,734
Other assets 27,548 30,452
---------- ----------
Total assets $1,042,870 $1,159,351
========== ==========
182
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(dollar amounts in thousands)
JUNE 30,
---------------------------
2004 2003
---------------------------
LIABILITIES
Subordinated debentures $ 522,609 $ 719,540
Senior collateralized subordinated notes 83,639 -
Warehouse lines and other notes payable 241,200 212,916
Accrued interest payable 37,675 45,448
Accounts payable and accrued expenses 28,096 30,352
Liability for loans subject to repurchase rights 45,864 27,954
Deferred income tax liability - 17,036
Other liabilities 71,872 64,036
---------------------------
Total liabilities 1,030,955 1,117,282
---------------------------
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001, liquidation preference of $1.00 per share plus
accrued and unpaid dividends to the date of liquidation, authorized,
203,000,000 shares at June 30, 2004 and 3,000,000 shares at June 30,
2003; Issued: 93,787,111 shares of Series A at June 30, 2004 94 -
Common stock, par value $.001, authorized shares 209,000,000 at June 30,
2004 and 9,000,000 at June 30, 2003; Issued: 3,653,165 shares in 2004 and
3,653,165 shares in 2003 (including Treasury shares of 54,823 in 2004
and 411,584 in 2003) 4 4
Additional paid-in capital 107,241 23,985
Accumulated other comprehensive income 4,596 14,540
Unearned compensation (495) -
Stock awards outstanding 95 -
Retained earnings (deficit) (98,324) 13,104
Treasury stock, at cost (696) (8,964)
---------------------------
12,515 42,669
Note receivable (600) (600)
---------------------------
Total stockholders' equity 11,915 42,069
---------------------------
Total liabilities and stockholders' equity $1,042,870 $1,159,351
===========================
See accompanying notes to financial statements.
183
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED JUNE 30,
2004 2003 2002
---------------------------------------
(amounts in thousands,
except per share data)
REVENUES
Gain on sale of loans:
Securitizations $ 15,107 $ 170,950 $ 185,580
Whole loan sales 18,725 655 2,448
Interest and fees 17,732 19,395 18,890
Interest accretion on interest-only strips 40,176 47,347 35,386
Servicing income 4,850 3,049 5,483
Other income 482 10 114
---------------------------------------
Total revenues 97,072 241,406 247,901
---------------------------------------
EXPENSES
Interest 68,138 68,098 68,683
Provision for credit losses 14,289 6,553 6,457
Employee related costs 50,026 41,601 36,313
Sales and marketing 15,734 27,773 25,958
(Gains) and losses on derivative financial instruments (2,561) 5,037 1,022
General and administrative 84,718 96,182 73,865
Securitization assets valuation adjustment 46,450 45,182 22,053
---------------------------------------
Total expenses 276,794 290,426 234,351
---------------------------------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (179,722) (49,020) 13,550
Provision for income taxes (benefit) (68,294) (19,118) 5,691
---------------------------------------
INCOME (LOSS) BEFORE DIVIDENDS ON PREFERRED STOCK (111,428) (29,902) 7,859
Dividends on preferred stock 3,718 - -
---------------------------------------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCK $(115,146) $ (29,902) $ 7,859
=======================================
EARNINGS (LOSS) PER COMMON SHARE:
Basic $ (34.07) $ (9.32) $ 2.44
Diluted $ (34.07) $ (9.32) $ 2.26
AVERAGE COMMON SHARES:
Basic 3,380 3,210 3,227
Diluted 3,380 3,210 3,471
See accompanying notes to financial statements.
184
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK
------------------------------------------------------
(amounts in thousands) ACCUMULATED
NUMBER OF NUMBER OF ADDITIONAL OTHER
SHARES SHARES PAID-IN COMPREHENSIVE
OUTSTANDING AMOUNT OUTSTANDING AMOUNT CAPITAL INCOME
--------------------------------------------------------------------------------------
Balance, June 30, 2001 - $ - 3,593 $ 4 $ 23,984 $10,337
Comprehensive income:
Net income - - - - - -
Net unrealized gains on
interest-only strips - - - - - 1,142
--------------------------------------------------------------------------------------
Total comprehensive income - - - 1,142
Stock dividend (10% of outstanding
shares) - - - - - -
Cash dividends ($0.28 per share) - - - - - -
Repurchase of treasury shares - - (466) - - -
Exercise of stock options - - 1 - 1 -
--------------------------------------------------------------------------------------
Balance, June 30, 2002 - - 3,128 4 23,985 11,479
Comprehensive income (loss):
Net loss - - - - - -
Net unrealized gains on
interest-only strips - - - - - 3,061
--------------------------------------------------------------------------------------
Total comprehensive income (loss) - - - - - 3,061
Exercise of non employee stock
options - - 63 - - -
Exercise of employee stock options - - 5 - - -
Shares issued to employees - - 42 - - -
Shares issued to directors - - 4 - - -
Stock dividend (10% of outstanding
shares) - - - - - -
Cash dividends ($0.32 per share) - - - - - -
--------------------------------------------------------------------------------------
Balance, June 30, 2003 - - 3,242 4 23,985 14,540
COMPREHENSIVE INCOME (LOSS):
NET LOSS - - - - - -
NET UNREALIZED LOSS ON
INTEREST-ONLY STRIPS - - - - - (9,944)
--------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME (LOSS) - - - - - (9,944)
ISSUANCE OF PREFERRED STOCK 93,787 94 - - 92,981 -
ISSUANCE OF RESTRICTED STOCK - - 220 - (1,548) -
VESTING OF RESTRICTED STOCK (110,000
SHARES) - - - - - -
EMPLOYEE STOCK GRANT - - 136 - (1,287) -
STOCK AWARDS OUTSTANDING - - - - - -
STOCK DIVIDEND (10% OF OUTSTANDING - -
SHARES) - - - - (3,993) -
CASH DIVIDENDS DECLARED ON
PREFERRED STOCK ($0.05 PER SHARE) - - - - (2,897) -
PREFERRED STOCK BENEFICIAL
CONVERSION FEATURE:
AMORTIZATION OF BENEFICIAL
CONVERSION DISCOUNT - - - - 821 -
NON-CASH PREFERRED
DIVIDEND - - - - (821) -
--------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2004 93,787 $ 94 3,598 $ 4 $107,241 $ 4,596
======================================================================================
See accompanying notes to financial statements.
185
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
TOTAL
UNEARNED STOCK AWARDS RETAINED TREASURY NOTE STOCKHOLDERS'
(amounts in thousands) COMPENSATION OUTSTANDING EARNINGS STOCK RECEIVABLE EQUITY
--------------------------------------------------------------------------------------
Balance, June 30, 2001 $ - $ - $ 43,922 $(10,785) $ (600) $ 66,862
Comprehensive income:
Net income - - 7,859 - - 7,859
Net unrealized gains on
interest-only strips - - - - - 1,142
--------------------------------------------------------------------------------------
Total comprehensive income - - 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 - - - (5,652) - (5,652)
Exercise of stock options - - - - - 1
--------------------------------------------------------------------------------------
Balance, June 30, 2002 - - 47,968 (13,458) (600) 69,378
Comprehensive income (loss):
Net loss - - (29,902) - - (29,902)
Net unrealized gains on
interest-only strips - - - - - 3,061
--------------------------------------------------------------------------------------
Total comprehensive income (loss) - - (29,902) - - (26,841)
Exercise of non employee stock
options - - (569) 619 - 50
Exercise of employee stock options - - (31) 51 - 20
Shares issued to employees - - (119) 492 - 373
Shares issued to directors - - (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 - - 13,104 (8,964) (600) 42,069
COMPREHENSIVE INCOME (LOSS):
NET LOSS - - (111,428) - - (111,428)
NET UNREALIZED LOSS ON INTEREST-
ONLY STRIPS - - - - - (9,944)
--------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME (LOSS) - - (111,428) - - (121,372)
ISSUANCE OF PREFERRED STOCK - - - - - 93,075
ISSUANCE OF RESTRICTED STOCK (990) - - 2,538 - -
VESTING OF RESTRICTED STOCK (110,000
SHARES) 495 - - - - 495
EMPLOYEE STOCK GRANT - - - 1,737 - 450
STOCK AWARDS OUTSTANDING - 95 - - - 95
STOCK DIVIDEND (10% OF OUTSTANDING
SHARES) - - - 3,993 - -
CASH DIVIDENDS DECLARED ON
PREFERRED STOCK ($0.05 PER SHARE) - - - - - (2,897)
PREFERRED STOCK BENEFICIAL
CONVERSION FEATURE:
AMORTIZATION OF BENEFICIAL
CONVERSION FEATURE - - - - - 821
NON-CASH PREFERRED
DIVIDEND - - - - - (821)
--------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2004 $ (495) $ 95 $ (98,324) $ (696) $ (600) $ 11,915
======================================================================================
See accompanying notes to financial statements.
186
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
YEAR ENDED JUNE 30,
2004 2003 2002
-------------------------------------------
(dollar amounts in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (111,428) $ (29,902) $ 7,859
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Gain on sales of loans (33,832) (171,605) (188,028)
Depreciation and amortization 48,481 53,614 40,615
Interest accretion on interest-only strips (40,176) (47,347) (35,386)
Securitization assets valuation adjustment 46,450 45,182 22,053
Provision for credit losses 14,289 6,553 6,457
Loans and leases originated for sale (1,058,557) (1,732,346) (1,434,176)
Proceeds from sale of loans and leases 1,014,914 1,463,714 1,452,999
Principal payments on loans and leases 26,169 19,136 12,654
(Increase) decrease in accrued interest and fees on loan and lease
receivables (9,159) (2,887) 4,257
Purchase of initial overcollateralization on securitized loans - (10,641) -
Required purchase of additional overcollateralization on
securitized loans (27,334) (73,253) (47,271)
Cash flow from interest-only strips 178,457 160,417 100,692
Increase (decrease) in prepaid expenses (10,034) 163 (183)
(Decrease) increase in accrued interest payable (7,773) 2,379 10,370
(Decrease) increase in accounts payable and accrued expenses (2,758) 17,037 5,366
Accrued interest payable reinvested in subordinated debentures 38,328 38,325 31,706
(Decrease) increase in deferred income taxes (70,814) (22,185) 4,595
Increase (decrease) in loans in process 11,467 5,321 736
(Payments) on derivative financial instruments (838) (8,750) (9,667)
Other, net 970 1,700 1,045
-------------------------------------------
Net cash provided by (used in) operating activities 6,822 (285,375) (13,307)
-------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment, net (9,883) (12,450) (4,472)
Principal receipts and maturity of investments 42 36 28
-------------------------------------------
Net cash used in investing activities (9,841) (12,414) (4,444)
-------------------------------------------
187
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (CONTINUED)
YEAR ENDED JUNE 30,
2004 2003 2002
-------------------------------------
(dollar amounts in thousands)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of subordinated debentures $ 166,034 $ 181,500 $ 224,062
Redemptions of subordinated debentures (223,443) (156,005) (137,998)
Net borrowings (repayments) on revolving lines of credit 53,636 179,594 (34,077)
Principal payments on lease funding facility - (2,129) (3,345)
Principal payments under capital lease obligations (319) (213) -
Net borrowings (repayments) of other notes payable (26,158) 26,158 (5,156)
Financing costs incurred (2,170) (841) (1,743)
Exercise of employee stock options - 20 1
Exercise of non-employee stock options - 50 -
Lease incentive receipts 4,562 9,465 -
Cash dividends paid on common stock - (934) (834)
Cash dividends paid on preferred stock (2,381) - -
Repurchase of treasury stock - - (5,652)
-------------------------------------
Net cash (used in) provided by financing activities (30,239) 236,665 35,258
-------------------------------------
Net (decrease) increase in cash and cash equivalents and
restricted cash (33,258) (61,124) 17,507
Cash and cash equivalents and restricted cash at beginning of year 47,475 108,599 91,092
-------------------------------------
Cash and cash equivalents and restricted cash at end of year $ 14,217 $ 47,475 $ 108,599
=====================================
SUPPLEMENTAL DISCLOSURES:
Cash paid during the year for:
Interest $ 37,583 $ 27,394 $ 26,729
Income taxes $ 752 $ 787 $ 1,511
Noncash transaction recorded in the acquisitions of mortgage
broker operations:
Increase in warehouse lines and other notes payable $ 1,125 $ - $ -
Increase in accounts payable and other accrued expenses $107 $ - $ -
Increase in other assets $1,232 $ - $ -
Noncash transaction recorded for conversion of subordinated
debentures into preferred stock and senior collateralized
subordinated notes:
Decrease in subordinated debentures $ 177,426 $ - $ -
Increase in senior collateralized subordinated notes $ 83,639 $ - $ -
Increase in preferred stock $ 94 $ - $ -
Increase in additional paid-in capital $ 93,693 $ - $ -
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.
188
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
American Business Financial Services, Inc. ("ABFS"), together with its
subsidiaries (the "Company"), is a 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 mortgage
loans through its principal direct and indirect subsidiaries. The Company also
processes and purchases home mortgage loans from other financial institutions
through the Bank Alliance Services program.
Historically, the Company's loans primarily consisted of fixed interest rate
loans secured by first or second mortgages on one-to-four family residences. The
Company's recent business strategy adjustments include increasing loan
originations by offering adjustable rate loans and purchase money mortgage
loans. 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 the Company's 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 network of mortgage brokers. During fiscal 2004, the Company
acquired broker operations in West Hills, California and Austin, Texas and
opened new offices in Edgewater, Maryland and Irvine, California to support the
Company's broker operations. 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 direct retail
branch offices. Effective June 30, 2003, the Company discontinued originating
loans through direct retail branch offices. The Company's loan servicing and
collection activities were performed at our Bala Cynwyd, Pennsylvania office,
and were relocated to our Philadelphia office on July 12, 2004.
In addition, the Company offers subordinated debentures 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 and funding loan overcollateralization requirements under its credit
facilities), investments in systems and technology and for general corporate
purposes.
BUSINESS CONDITIONS
GENERAL. For its ongoing operations, the Company depends upon frequent
financings, including the sale of unsecured subordinated debentures, borrowings
under warehouse credit facilities or lines of credit and it also depends on the
sale of loans on a whole loan basis or through publicly underwritten or
privately-placed securitizations. If the Company is unable to renew or obtain
adequate funding on acceptable terms through its sale of subordinated debentures
or under a warehouse credit facility, or other borrowings, or if it is unable to
sell or securitize its loans, the lack of adequate funds would adversely impact
liquidity and result in continued losses or reduce profitability. To the extent
that the Company is not successful in replacing existing subordinated debentures
and senior collateralized subordinated notes upon maturity, maintaining adequate
warehouse credit facilities or lines of credit to fund increasing loan
originations, or securitizing and selling its loans, it may have to limit future
loan originations and restructure its operations. Limiting loan originations or
restructuring operations could impair the Company's ability to repay
subordinated debentures and senior collateralized subordinated notes at maturity
and may result in continued losses.
189
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS CONDITIONS (CONTINUED)
The Company has historically experienced negative cash flow from operations
since 1996 primarily because, in general, its business strategy of selling loans
through securitizations had not generated cash flow immediately. However, during
fiscal 2004, the Company experienced positive cash flow from operations of $6.8
million, primarily due to sales of loans on a whole loan basis it originated in
fiscal 2003. The following table compares the principal amount of loans sold in
whole loan sales during the year ended June 30, 2004, to the amount of loans
originated during the same period (in thousands).
Whole Loan Loans
Quarter Ended Sales Originated
----------------------------------------------------- ------------ ----------
September 30, 2003 $245,203 $124,052
December 31, 2003 7,975 (a) 103,084
March 31, 2004 228,629 241,449
June 30, 2004 326,571 514,095
------------ --------
Total for year ended June 30, 2004 $808,378 $982,680
============ ========
- ----------
(a) During the quarter ended December 31, 2003, the Company completed a
securitization of $173.5 million of mortgage loans.
For the fiscal year ended June 30, 2004, the Company recorded a net loss
attributable to common stock of $115.1 million. The loss primarily resulted
from: a) liquidity issues described below, which substantially reduced the
Company's ability to originate loans and generate revenues during the first nine
months of fiscal 2004, b) the Company's inability to complete securitizations of
loans during the first, second and third quarters of fiscal 2004, c) operating
expense levels which would support greater loan origination volume, and d) $46.4
million of pre-tax charges for valuation adjustments on its securitization
assets. The valuation adjustments reflect the impact of higher than anticipated
prepayments on securitized loans experienced during fiscal 2004 due to the
continuing low interest rate environment. In fiscal 2004, the Company originated
$982.7 million of loans, which represents a significant reduction as compared to
$1.67 billion of loans originated in the prior fiscal year.
For the fiscal year ended June 30, 2003, the Company recorded a loss of $29.9
million. The loss in fiscal 2003 was primarily due to the Company's inability to
complete a securitization of loans during the fourth quarter of fiscal 2003 and
to $45.2 million of net pre-tax charges for net valuation adjustments recorded
on securitization assets.
LIQUIDITY CONCERNS. The Company's short-term liquidity has been negatively
impacted by several events and issues, which have occurred starting in the
fourth quarter of fiscal 2003.
First, the Company's inability to complete a securitization during the fourth
quarter of fiscal 2003 adversely impacted its short-term liquidity position and
contributed to the loss for fiscal 2003. Because there was no securitization,
$453.4 million of the Company's $516.1 million of revolving credit and conduit
facilities then available was drawn upon at June 30, 2003. 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 loan originations in fiscal 2004 until it sold existing loans,
extended existing credit facilities, or added new credit facilities.
190
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS CONDITIONS (CONTINUED)
Second, the Company's ability to finance new loan originations in the first
three months of fiscal 2004 using borrowings under certain of its credit
facilities which carried over into fiscal 2004 was limited, terminated or
expired by October 31, 2003. Further advances under a non-committed portion of
one of these 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, amendments to this credit facility
eliminated the non-committed portion of this facility, reduced the committed
portion to $50.0 million and accelerated the expiration date from November 2003
to September 30, 2003. Also, 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, expired pursuant to its terms on July 5, 2003. In
addition, the Company was unable to borrow under a $25.0 million warehouse
facility after September 30, 2003, and this facility expired on October 31,
2003.
Third, even though the Company was successful in obtaining one new credit
facility in September 2003 and obtaining a second new credit facility in October
2003, see Remedial Actions to Address Liquidity Issues below, its ability to
finance new loan originations in the second and third quarters of fiscal 2004
with borrowings under these new credit facilities was limited. The limitations
resulted from requirements to fund overcollateralization, which is discussed
below, in connection with new loan originations.
Fourth, the Company's temporary discontinuation of sales of new subordinated
debentures for approximately a six-week period during the first quarter of
fiscal 2004 further impaired its liquidity.
As a result of these liquidity issues, the Company's loan origination volume was
substantially reduced. From July 1, 2003 through June 30, 2004, the Company
originated $982.7 million of loans, which represents a significant reduction as
compared to originations of $1.67 billion of loans in fiscal 2003. As a result
of the decrease in loan originations and liquidity issues described above, the
Company incurred a loss in fiscal 2004 and depending on the Company's ability to
complete securitizations and recognize gains in the future, it anticipates
incurring losses at least through the first quarter of fiscal 2005.
The combination of the Company's current cash position and expected sources of
operating cash in fiscal 2005 may not be sufficient to cover its operating cash
requirements. For the next six to twelve months the Company expects to augment
its sources of operating cash with proceeds from the issuance of subordinated
debentures. In addition to repaying maturing subordinated debentures, proceeds
from the issuance of subordinated debentures will be used to fund
overcollateralization requirements in connection with loan originations and fund
the Company's operating losses. The Company can provide no assurances that it
will be able to continue issuing subordinated debentures. In the event the
Company is unable to offer additional subordinated debentures for any reason, it
has developed a contingent financial restructuring plan. This plan is described
later in this note under "Subordinated Debentures and Senior Collateralized
Subordinated Notes." On June 30, 2004, the Company had unrestricted cash of
approximately $0.9 million and up to $210.4 million available under its credit
facilities. Advances under these credit facilities can only be used to fund loan
originations and not for any other purposes. The Company anticipates that
depending upon the size of its future quarterly securitizations, it will need to
increase loan originations to approximately $400.0 million to $500.0 million per
month to return to profitable operations. If the Company is unable to complete
quarterly securitizations, it will need to increase its loan originations to
approximately $500.0 million to $600.0 million per month to return to
profitability. For the quarter ended June 30, 2004, the Company originated
$514.1 million of loans, including a monthly high of $208.5 million.
191
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS CONDITIONS (CONTINUED)
The Company plans to achieve these increased levels of loan originations through
the continued application of its business strategy adjustments, particularly as
related to building an expanded broker channel and offering adjustable rate
mortgages and more competitively priced fixed rate mortgages. The following
actions were undertaken in fiscal 2004 to increase the Company's ability to
originate loans in its broker channel: (i) in December 2003 the Company hired an
experienced industry professional to manage the wholesale business; (ii) in
December 2003 the Company acquired a broker operation with 35 employees (67
employees at June 30, 2004) located in California; (iii) in February 2004, the
Company opened a mortgage broker office in Irving, California; (iv) in March
2004, the Company opened a mortgage broker office in Maryland and hired three
experienced senior managers and a loan origination staff of 40 (56 employees at
June 30, 2004); and (v) in June 2004 the Company acquired a broker operation
with 35 employees located in Texas. In addition, the Company hired 25 mortgage
broker account executives in its Upland Mortgage Broker Services division to
expand its broker presence in the eastern, southern and mid-western areas of the
United States and retained 67 employees in its Upland Broker Services
Philadelphia headquarters to support its growing broker network. In total at
June 30, 2004, the Company had 285 employees in its broker operations, including
136 account executives.
The Company's ability to achieve those levels of loan originations could be
hampered by a failure to implement its business strategy adjustments and by loan
funding limitations should the Company fail to maintain or replace adequate
credit facilities to finance new loan obligations.
Due to losses recorded in each of the quarters in fiscal 2004, the Company
requested and obtained waivers for its non-compliance with financial covenants
in its credit facility agreements and servicing agreements. See Note 10 for more
detail.
192
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS CONDITIONS (CONTINUED)
REMEDIAL ACTIONS TO ADDRESS LIQUIDITY ISSUES. The Company undertook specific
remedial actions to address liquidity issues including:
o The Company adjusted its business strategy beginning in early fiscal 2004.
The adjusted business strategy focuses on shifting from gain-on-sale
accounting and the use of securitization transactions as the Company's
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.
o The Company solicited bids and commitments from participants in the whole
loan sale market and entered into forward sale agreements. In total, from
June 30, 2003 through June 30, 2004, the Company sold approximately $1.1
billion (which includes $222.3 million of loans sold by the expired
mortgage conduit facility) of loans through whole loan sales. From July 1,
2004 through September 30, 2004, the Company sold an additional $586.5
million of loans through whole loan sales.
o The Company has entered into an informal arrangement with one recurring
purchaser of its loans whereby the purchaser maintains members of their
loan underwriting staff on the Company's premises to facilitate their
purchase of the Company's loans promptly after the Company originates them.
This arrangement accelerates the Company's receipt of cash proceeds from
the sale of loans, accelerates the pay down of its advances under its
warehouse credit facilities and adds to its liquidity. This quicker
turnaround time is expected to enable the Company to operate with smaller
committed warehouse credit facilities than would otherwise be necessary.
o On October 31, 2003, the Company completed a privately-placed
securitization, with servicing released, of $173.5 million of loans.
o The Company entered into two definitive loan agreements during fiscal 2004
for the purpose of funding its loan originations. These two agreements
replaced those credit facilities, which carried over into fiscal 2004 but
were limited, terminated or expired by October 31, 2003. The Company
entered into the first agreement on September 22, 2003 with a financial
institution for a one-year $200.0 million credit facility. It entered into
the second agreement on October 14, 2003 with a warehouse lender for a
three-year revolving mortgage loan warehouse credit facility of up to
$250.0 million. The one-year facility was extended to November 5, 2004 and
on September 30, 2004 was reduced to $100.0 million. The three-year $250.0
million warehouse credit facility continues to be available. See Note 10
for information regarding the terms of these facilities.
193
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS CONDITIONS (CONTINUED)
o The Company has recently entered into a commitment letter and anticipates
entering into a definitive loan agreement with a warehouse lender for a
one-year $100.0 million credit facility to replace the maturing $200.0
million credit facility (reduced to $100.0 million). However, no assurances
can be given that the Company will enter into a definitive agreement
regarding the $100.0 million credit facility or that this agreement will
contain the terms and conditions acceptable to it. The Company also sold
the interest-only strips and servicing rights related to five of its
mortgage securitization trusts to an affiliate of this facility provider
under the terms of a September 27, 2004 sale agreement. The sale of these
assets was undertaken as part of the negotiations to obtain the new $100.0
million warehouse credit facility and to raise cash to pay fees on new
warehouse credit facilities and as a result, the Company did not realize
their full value as reflected on its books. The Company wrote down the
carrying value of these interest-only strips and servicing rights by $5.4
million at June 30, 2004 to reflect their values under the terms of the
sale agreement.
o The Company is currently negotiating additional credit facilities to
provide additional borrowing capacity to fund the increased level of loan
originations expected under its adjusted business strategy, however, no
assurances can be given that the Company will succeed in obtaining new
credit facilities or that these facilities will contain terms and
conditions acceptable to it.
o The Company mailed an Offer to Exchange on December 1, 2003 and May 14,
2004 ("the exchange offers") to holders of its subordinated debentures in
order to increase stockholders' equity and reduce the amount of outstanding
debt. These exchange offers resulted in the exchange of $208.6 million of
the Company's subordinated debentures for 109.4 million shares of Series A
preferred stock and $99.2 million of senior collateralized subordinated
notes. See Notes 10 and 11 for more detail on the terms of the exchange
offers, senior collateralized subordinated notes and preferred stock
issued. The issuance of 109.4 million shares of Series A preferred stock
results in an annual cash preferred dividend obligation of $10.9 million.
o On January 22, 2004, the Company executed an agreement to sell its
interests in the remaining leases in its portfolio. The terms of the
agreement included a cash sale price of approximately $4.8 million in
exchange for the Company's lease portfolio balance as of December 31, 2003.
The Company received the cash from this sale in January 2004 and recognized
a net gain of $0.5 million.
o The company suspended payment of quarterly dividends on its common stock
beginning in the first quarter of fiscal 2004.
To the extent that the Company fails to maintain its credit facilities or obtain
alternative financing on acceptable terms and increase its loan originations, it
may have to sell loans earlier than intended and further restructure its
operations. While the Company currently believes that it will be able to
restructure its operations, if necessary, it can provide no assurances that such
restructuring will enable it to attain profitable operations or repay
subordinated debentures or senior collateralized subordinated notes when due.
194
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BUSINESS CONDITIONS (CONTINUED)
SUBORDINATED DEBENTURES AND SENIOR COLLATERALIZED SUBORDINATED NOTES. At June
30, 2004 there were approximately $326.2 million of subordinated debentures and
$28.1 million of senior collateralized subordinated notes, maturing within
twelve months. The Company obtains the funds to repay the subordinated
debentures and senior collateralized subordinated notes at their maturities by
selling additional subordinated debentures and selling loans on a whole loan
basis and securitizing loans. Cash flow from operations, the sale 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, although the Company's ability to utilize the
interest-only strips in this fashion could be restricted in whole or in part by
the terms of the Company's $250.0 million warehouse credit facility and senior
collateralized subordinated notes, both of which are collateralized by the
interest-only strips at the present time. See Note 5 for more detail.
The Company can provide no assurances that it will be able to continue issuing
subordinated debentures. In the event the Company is unable to offer additional
subordinated debentures for any reason, 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
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 obtaining working capital funding. No assurance can be given that the
Company will be able to successfully implement the contingent financial
restructuring plan, if necessary, and repay its outstanding debt when due.
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.
195
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIS OF FINANCIAL STATEMENT PRESENTATION (CONTINUED)
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 on
May 13, 2004 and 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 11 for
further description.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of short-term investments with an initial maturity of
three months or less.
RESTRICTED CASH
The Company held restricted cash balances of $8.0 million at June 30, 2004
collateralizing a letter of credit facility, $3.1 million and $4.9 million
related to borrower escrow accounts at June 30, 2004 and 2003, respectively, and
$2.1 million and $6.0 million at June 30, 2004 and 2003, respectively, related
to deposits for future settlement of derivative financial instruments.
LOAN AND LEASE RECEIVABLES
Loans available for sale are loans the Company plans to sell or securitize and
are carried at the lower of amortized 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.
Non-accrual loans consist primarily of loans repurchased from securitization
trusts and transferred from loans available for sale that are greater than 90
days delinquent. Non-accrual loans are carried at cost less an allowance for
credit losses.
Lease receivables were financing leases on equipment the Company originated
prior to December 1999 carried at cost less an allowance for credit losses.
Effective December 31, 1999, the Company discontinued originating equipment
leases, but continued to service its portfolio of leases until its sale in
January 2004.
INTEREST AND FEES RECEIVABLE
Interest and fees receivables are comprised mainly of accrued interest
receivable on loans and fees on loans that are less than 90 days delinquent. Fee
receivables include, among other types of fees, late fees and taxes and
insurance advances.
196
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FORBEARANCE AND DEFERMENT ADVANCES RECEIVABLES
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.
Advances made under deferment and forbearance arrangements result from a new
credit decision regarding the borrower's ability to repay the advance, as well
as perform under the original terms of the original loan, and do not involve any
modification of the terms of the original loan. These arrangements are
considered a new lending activity and do not qualify as troubled debt
restructurings under Statement of Financial Accounting Standard ("SFAS") No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings." The
Company records the advances that it makes under deferment and forbearance
arrangements with borrowers as receivables on its balance sheet. The Company
carries these receivables at their estimated recoverable amounts. If the
original loan returns to a delinquency status of 90 days or more past due, the
Company writes the receivable off to expense. During the fiscal year ended June
30, 2004, the Company did not record any fee income on these arrangements while
it recorded $99 thousand and $59 thousand during fiscal years ended June 30,
2003 and 2002, respectively.
LOANS SUBJECT TO REPURCHASE RIGHTS / LIABILITY FOR LOANS SUBJECT TO REPURCHASE
RIGHTS
Loans subject to repurchase rights is comprised of loans which were securitized
under SFAS No. 140 that the Company has a right to repurchase because of a
default by the borrower. SFAS No. 140 was effective on a prospective basis for
transfers of financial assets occurring after March 31, 2001. For
securitizations recorded under SFAS No. 140 which have removal of accounts
provisions providing the Company with a contractual right to repurchase
delinquent loans, SFAS No. 140 requires that it recognize the loans which are
subject to these rights as assets on its balance sheet and record a liability to
reflect the repurchase cost. SFAS No. 140 requires this accounting treatment
because the default by the borrower has given the Company effective control over
the loans whether or not the Company actually repurchases these loans. For
securitization trusts 2001-2 through 2003-2, to which this rule applies, the
Company has the contractual right to repurchase a limited amount of loans
greater than 180 days past due, but no obligation to do so. As delinquent loans
in securitization trusts 2001-2 through 2003-2 age greater than 180 days past
due, the Company records an asset representing the fair value of the loans and a
liability to reflect the repurchase cost. In accordance with the provisions of
SFAS No. 140, the Company has recorded on its June 30, 2004 balance sheet an
asset of $39.0 million and a liability of $45.9 million for delinquent loans
subject to these removal of accounts provisions under securitization trusts
2001-2 through 2003-2.
197
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOANS SUBJECT TO REPURCHASE RIGHTS / LIABILITY FOR LOANS SUBJECT TO REPURCHASE
RIGHTS (CONTINUED)
For securitization trusts 1996-1 through 2001-1, the Company also has rights to
repurchase a limited amount of delinquent loans, but is not obligated to do so.
No liabilities or assets have been recorded on its balance sheet related to
these rights. The amount of delinquent loans in securitization trusts 1996-1
through 2000-1 which the company has the right to repurchase as of June 30, 2004
was $54.3 million.
ALLOWANCE FOR CREDIT LOSSES
The Company's allowance for credit losses on non-accrual loans and leases is
maintained to account for delinquent loans and leases and delinquent loans that
have been repurchased from securitization trusts. The allowance is maintained at
a level that management determines is adequate to absorb estimated probable
losses. 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 non-accrual
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 against
the allowance in the period in which a loan is deemed fully uncollectable or
when liquidated in a payoff. Management considers the current allowance to be
adequate.
LOAN AND LEASE ORIGINATION COSTS AND FEES
Direct loan and lease origination costs and loan fees such as points 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 sold, or in the case of leases, as amortization expense over the term
of the leases.
INTEREST-ONLY STRIPS
Prior to June 30, 2003, the Company sold most of the loans it originated through
securitizations. In connection with these securitizations, the Company received
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. Interest-only strips are initially recorded at
their allocated cost basis at the time of recording a securitization gain and in
accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and
Equity Securities," referred to as SFAS No. 115 in this document, are then
written up to their fair value through other comprehensive income, a component
of stockholders' equity.
198
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTEREST-ONLY STRIPS (CONTINUED)
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"). Management based its
estimates of prepayment and credit loss rates 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.
PREPAYMENT RATES. The assumptions the Company uses to estimate future prepayment
rates are regularly compared to actual prepayment experience of the individual
securitization pools of mortgage loans and to an average of the actual
experience of other similar pools of mortgage loans at the same age. Current
economic conditions, current interest rates, loans repurchased from
securitization trusts and other factors are considered in our analysis of
prepayment experience and in forecasting future prepayment levels.
Analysis of prepayment experience and forecasts of prepayments consider that
prepayments on securitized loans may be initiated by the borrower, such as a
refinancing for a lower interest rate, initiated by the servicer in the
collection process for delinquent loans, or as a result of our repurchase of
delinquent loans from the securitization trusts for trigger management.
Prepayments initiated by the borrower are viewed as voluntary prepayments.
Voluntary prepayments are the most significant component of prepayment
experience, generally representing approximately 91% of total prepayments, and
are full cash payoffs of a securitized loan. Prepayments initiated by the
servicer are viewed as involuntary prepayments, generally representing
approximately 4% of total prepayment experience and are the result of delinquent
loan bulk sales, REO liquidations and settlements on delinquent loans. Losses on
these involuntary prepayments are absorbed by the securitization trusts.
Prepayments as a result of the Company's repurchase of delinquent loans from the
securitization trusts are also viewed as involuntary and generally represent
approximately 5% of total prepayment experience. Losses on the liquidation of
repurchased loans are absorbed on the Company's books. Both voluntary and
involuntary loan prepayments are incorporated in the Company's prepayment
assumption forecasts.
The Company's practice in forecasting prepayment assumptions for calculation of
the initial securitization gain and subsequent revaluations had been to use an
average historical prepayment rate of similar pools for the expected constant
prepayment rate assumption while a pool of mortgage loans was less than a year
old even though actual experience may be different. During that period, before a
pool of mortgage loans reached its expected constant prepayment rate, actual
experience both quantitatively and qualitatively was generally not considered
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 was 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.
199
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTEREST-ONLY STRIPS (CONTINUED)
For the past eleven quarters, actual prepayment experience was generally higher,
most significantly on home equity loans, than historical averages for
prepayments prior to that eleven-quarter period. The long duration of
historically low interest rates, combined with increasing home values and high
consumer debt levels has given borrowers an extended opportunity to engage in
mortgage refinancing activities, which resulted in elevated prepayment
experience. Low interest rates and increasing home values provide incentive to
borrowers to convert high cost consumer debt into lower rate tax deductible
loans. As home values have increased, lenders have been highly successful in
educating borrowers that they have the ability to access the cash value in their
homes.
For the past eleven quarters, the Company assumed for each quarter end valuation
that the decline in interest rates had stopped and a rise in interest rates
would occur in the near term. Economic conditions and published mortgage
industry surveys supported the Company's assumption. The Company believes that
once it is beyond the low interest rate environment and its impact on
prepayments, the long recurring and highly unfavorable prepayment experience
over the past eleven quarters will subside. Also, the rate of increase in home
values has slowed considerably, which the Company expects will mean that fewer
borrowers will have excess value in their homes to access. As a result of
analysis of these factors, the Company believes prepayments will continue to
remain at higher than normal levels for the near term before declining to
historical prepayment levels and then further declining in the future. However,
the Company cannot predict with certainty what prepayment experience will be in
the future. Any unfavorable difference between the assumptions used to value
securitization assets and actual experience may have a significant adverse
impact on the value of these assets. See the table "Summary of Material Mortgage
Loan Securitization Valuation Assumptions and Actual Experience at June 30,
2004" in Note 5 for current prepayment assumptions.
In addition to the use of prepayment fees on loans it originated, the Company
has implemented programs and strategies in an attempt to reduce loan
prepayments. 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, such as the customer
retention incentive program, to qualified borrowers to deter prepayment of their
loan. The Company 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
for individual mortgage loan pools and averages for similar mortgage loan pools.
Delinquency trends, economic conditions, loans repurchased from securitization
trusts and other factors are also considered. If the analysis indicates that
loss experience may be different from assumptions, the Company would adjust its
assumptions as necessary. See the table "Summary of Material Mortgage Loan
Securitization Valuation Assumptions and Actual Experience at June 30, 2004" in
Note 5 for current credit loss assumptions and actual credit loss experience.
However, the Company cannot predict with certainty what credit loss experience
will be in the future. Any unfavorable difference between the assumptions used
to value securitization assets and actual experience may have a significant
adverse impact on the value of these assets.
200
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTEREST-ONLY STRIPS (CONTINUED)
The Company may elect to repurchase delinquent loans from securitization trusts
to limit the level of delinquencies and losses in the securitization trusts, and
as a result, it can avoid exceeding specified limits on delinquencies and losses
that trigger a temporary reduction or discontinuation of cash flow from its
interest-only strips. See Note 4 for the amount of loans the Company has
repurchased from securitization trusts. Once a loan has been included in a pool
of securitized loans, its performance, including historical loss experience if
the loan has been repurchased, is reflected in the performance of that pool of
mortgage loans.
The Company may enter into deferment and forbearance arrangements with borrowers
in its managed portfolio who experience financial hardships. Any credit losses
ultimately realized on these arrangements are included in total portfolio
historical losses, which are used in developing credit loss assumptions.
PERIODIC REVALUATIONS. 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. 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, and SFAS No. 115,
decreases in the fair value of interest-only strips that are deemed to be other
than temporary adjustments to fair value are recorded through the income
statement, which would adversely affect our income in the period of adjustment.
Additionally, to the extent any individual interest-only strip has a portion of
its initial write up to fair value still remaining in other comprehensive
income, other than temporary decreases in its fair value would first be recorded
as a reduction to other comprehensive income, which would adversely affect our
stockholders' equity in the period of adjustment. During fiscal 2004, the
Company recorded total pre-tax other than temporary valuation adjustments on its
interest only-strips of $57.0 million, of which, in accordance with EITF 99-20,
$39.6 million was charged as expense to the income statement and $17.4 million
was charged to other comprehensive income. During fiscal 2003, the Company
recorded total pre-tax other than temporary valuation adjustments on its
interest-only strips of $58.0 million, of which $39.9 million was charged as
expense to the income statement and $18.1 million was charged to other
comprehensive income. The valuation adjustments primarily reflect the impact of
higher than anticipated prepayments on securitized loans experienced during
fiscal 2004 and fiscal 2003 due to the continuing low interest rate environment.
See Note 5 Securitizations for more information on valuation assumptions
adjustments recorded.
201
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTEREST-ONLY STRIPS (CONTINUED)
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.
SERVICING RIGHTS
When loans are sold through a securitization, the loans' servicing rights have
generally been retained and the Company capitalizes the benefit associated with
the rights to service securitized loans. However, the Company does not service
the loans in the 2003-2 securitization, the Company's most recent
securitization, which closed in October 2003.
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 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 rates are monitored against
actual experience and other economic conditions and are changed if deemed
necessary. A review for impairment is performed on a quarterly basis by
stratifying the serviced loans by loan type, home equity or business purpose
loans, which is considered to be the predominant risk characteristic in the
portfolio of loans the Company services. In establishing loan type as the
predominant risk characteristic, the Company considered the following additional
loan characteristics and determined these characteristics as mostly uniform
within its two types of serviced loans and not predominant for risk
stratification:
o Fixed versus floating rate loans - All loans the Company services in its
securitizations are fixed-rate loans.
o Conforming versus non-conforming loans - All loans the Company services are
sub-prime (non-conforming) loans, with over 80% of the loans serviced
having credit grades of A or B.
o Interest rate on serviced loans - The serviced loan portfolio has a high
penetration rate of prepayment fees. Sub-prime borrowers, in general, are
not as influenced by movement in market interest rates as conforming
borrowers. A sub-prime borrower's ability to 'rate shop' is generally
limited due to personal credit circumstances that are not market driven.
202
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SERVICING RIGHTS (CONTINUED)
o Loan collateral - All loans the Company services are secured by real
estate, with approximately 85% secured with first liens on residential
property.
o Individual loan size - The average loan size in the Company's serviced
portfolio is $75 thousand. The serviced portfolio is approximately $2.1
billion at June 30, 2004 with approximately 25 thousand loans. There are no
significant defining groupings with respect to loan size. No loans are
greater than $1.0 million, only $10.8 million of loans have principal
balances greater than $500 thousand, and only $34.5 million of loans have
principal balances greater than $350 thousand.
o Geographic location of loans - The largest percentage of loans the Company
services are geographically located in the mid-Atlantic and northeast
sections of the United States.
o Original loan term - Home equity loan terms are primarily 180, 240 or 360
months. Business purpose loan terms are primarily 120 or 180 months.
If the Company's quarterly 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.
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.
PREPAID EXPENSES
Prepaid assets are comprised mainly of amounts paid for fees on warehouse lines
and operating lines of credit (facility fees), insurance coverage and printed
marketing materials and customer lists, which have not yet been utilized. Costs
for facility fees, printed materials and customer lists are expensed as they are
utilized. Other marketing and advertising costs are expensed as incurred.
Prepaid expenses at June 30, 2004 included $10.4 million for prepaid facility
fees.
203
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
debenture 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 consisted of
asset-backed securities that the Company had the positive intent and ability to
hold to maturity. These investments were stated at amortized cost. These
investments were liquidated in July 2004 due to the clean-up call and collapse
of the securitization trust that had issued these investments.
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.) and the 2004 acquisitions of broker operations in California and Texas.
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, 2004, no goodwill impairment existed.
For segment reporting purposes, the goodwill balance is allocated to the loan
origination segment.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Beginning in the fourth quarter of fiscal 2002, the Company offered customer
retention incentives to borrowers who were exploring loan refinancing
opportunities for the purpose of lowering their monthly loan payments. In an
attempt to retain the loans the Company was servicing for these borrowers, it
offered the borrowers the opportunity to receive a monthly cash rebate equal to
a percentage of their scheduled monthly loan payments for periods of six to
twelve months. When the Company was successful in retaining these loans, it was
able to reduce the level of loan prepayments in its managed portfolio of
securitized loans. To initially qualify for this program, a borrower has to be
current on their loan principal and interest payments and to continue to qualify
and receive each month's cash rebate, a borrower has to remain current. The
percentage of rebates on scheduled monthly loan payments offered to participants
ranged from 15% to 20%. No new participants in this program will be added after
the first quarter of fiscal 2005. Included in accounts payable and accrued
expenses at June 30, 2004 and 2003 was $1.3 million and $5.2 million,
respectively, representing the Company's estimate of its liability for future
payments to borrowers under this program. Included in general and administrative
expenses for the years ended June 30, 2004, 2003 and 2002 was $1.8 million, $8.8
million and $0.8 million, respectively, representing the expense of this program
in these years.
204
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 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.
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.
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 may cause earlier
suspension if collection is doubtful.
Servicing income is recognized as contractual fees and other fees for servicing
loans and leases are earned, net of amortization of servicing rights assets.
DERIVATIVE FINANCIAL INSTRUMENTS
A primary market risk exposure that the Company faces is interest rate risk.
Interest rate risk arises from the potential impact that changes in interest
rates will have on the fair value of the Company's loans between the date fixed
rate loans are originated and the date the terms and pricing for a whole loan
sale or a securitization are fixed.
205
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
From time to time, the Company utilizes 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 terms and pricing
for a whole loan sale are fixed or the fixed interest rate pass-through
certificates to be issued by a securitization trust are priced. Generally, the
period between loan origination and pricing for whole loan sales is less than 45
days and the period between loan origination and pricing of the pass-through
interest rate on a securitization is less than three months. The types of
derivative financial instruments the Company uses to mitigate the effects of
changes in fair value of the Company's loans due to interest rate changes may
include interest rate swaps, futures and forward contracts, including forward
loan sale agreements. 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 derivative contracts are executed, they may be specifically
designated and documented as fair value hedges of mortgage loans, which the
Company expects to sell in whole loan sale transactions or a term securitization
at a future date. The mortgage loans 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. Even
variable interest rate mortgages originated by the Company are generally fixed
rate for the first two or three years.
Mortgage loans to be sold in whole loan sale transactions are generally priced
to yield a spread against Treasury or interest rate swap yield curves having
maturities matching the maturities of the mortgage loan pool being sold. The
Company may hedge the impact that changes in Treasury or interest rate swap
yield curves may have on the fair value of its loans with forward starting
interest rate swaps, Eurodollar futures, forward treasury sales or derivative
contracts of similar underlying securities. Assuming this hedge relationship
continues to be highly effective, determined as described below, hedge
accounting continues until the mortgage loan pool is sold in a whole loan sale
or the mortgage loan pool is committed to a forward sale agreement. When a hedge
relationship is terminated, the derivative financial instrument may be
re-designated as a hedge of a new mortgage pool.
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 the impact that potential
interest rate changes in interest rate swap yield curves may have on the fair
value of its loans with forward starting interest rate swaps, Eurodollar
futures, forward treasury sales or derivative contracts of similar underlying
securities. Assuming this hedge relationship continues to be highly effective,
determined as described below, the relationship continues until the mortgage
loan pool is sold in a securitization. When a hedge relationship is terminated,
the derivative financial instrument may be re-designated as a hedge of a new
mortgage pool.
These practices have provided strong correlation between changes in the fair
value of the derivative financial instruments the Company uses as hedges and
changes in the fair value of the hedged loans due to the designated hedged
206
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
risk. Derivative contracts receive hedge accounting only if they are designated
as a hedge and are expected to be, and are, highly effective in substantially
reducing interest rate risk arising from the pools of mortgage loans exposing
the Company to risk. Under hedge accounting, the gain or loss derived from these
derivative financial instruments, which are designated as fair value hedges, is
reported in the Statement of Income (included in the caption "gains and losses
on derivative financial instruments") as it occurs with an offsetting adjustment
to the hedged loans attributable to the risk being hedged also reported in the
income statement. The fair value of derivative financial instruments is
determined based on quoted market prices. The fair value of the hedged loans is
determined based on current pricing of these assets in a whole loan sale or
securitization. Cash flows resulting from fair value hedges are reported in the
period they occur.
The effectiveness of the Company's fair value hedges is periodically assessed.
Fair value hedges must meet specific effectiveness tests to be considered highly
effective. Over time the change in the fair values of the derivative financial
instrument must be within 80 to 120 percent of the change in the fair value of
the hedged loans due to the designated risk. If highly effective correlation
does not exist, the Company discontinues hedge accounting prospectively. The
Company has no derivative financial instruments designated as cash flow hedges.
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 were not designated or qualified as
accounting hedges. In these cases, the derivative financial instruments are
recorded as an asset or liability on the balance sheet at fair value and gains
and losses are included in the Statement of Income (included in the caption
"gains and losses on derivative financial instruments") as they occur. These
contracts have been used to protect the fair value of loans in the Company's
pipeline and to reduce its 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 Company has sold mortgage loans through securitizations. 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
had entered into an interest rate swap agreement to lock in a fixed interest
rate on certain of the Company's securitizations' variable rate tranches. This
interest rate swap matured in April 2004. The swap agreement required a net cash
settlement on a monthly basis of the difference between the fixed interest rate
on the swap and the LIBOR rate paid on the certificates. The fair value of this
swap agreement was based on estimated market values for the sale of the contract
provided by a third party. Net changes in the fair value during a period were
included in gains and losses on derivative financial instruments 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.
207
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
Additionally, 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. The interest rate sensitivity
for $128.6 million of floating interest rate certificates issued from the 2003-2
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.
The value of derivative financial instruments is based on 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. The Company's exposure to credit risk in a derivative
transaction is represented by the fair value of those derivative financial
instruments in a gain position. The Company attempts to manage this exposure by
limiting its derivative financial instruments to those traded on major exchanges
and where its counterparties are major financial institutions.
See Note 20 for further discussion of the Company's use of derivative financial
instruments.
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.
Estimates of deferred tax assets and liabilities make up the deferred income tax
asset on the Company's balance sheet. These estimates involve significant
judgments and estimates by management, which may have a material impact on the
carrying value of the deferred income tax asset. The deferred income tax asset
is periodically reviewed to determine if it is more likely than not that the
Company will realize this deferred tax asset.
208
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS
The Company has stock option plans that provide for the periodic granting of
options to key employees and non-employee directors and accounts for options
granted under these plans under APB Opinion No. 25 "Accounting for Stock Issued
to Employees" ("APB No. 25"). The Company accounts for fixed stock options
issued under these plans using the intrinsic value method 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. The Company accounts for performance
based stock options issued under these plans as variable stock options and
recognizes compensation expense based on the fair value of the Company's common
stock, as measured on the date of the grant, on a straight-line basis over the
vesting period of these stock options.
Had the Company accounted for fixed stock options granted under these plans
using the fair value method of SFAS No. 123 "Accounting for Stock-Based
Compensation" ("SFAS No. 123") and SFAS No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("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,
2004 2003 2002
-------------------------------------
Net income (loss) attributable to common
stock, as reported $(115,146) $(29,902) $7,859
Stock based compensation costs, net of tax
effects determined under fair value method
for all awards 712(a) (130) (170)
-------------------------------------
Pro forma $(114,434) $(30,032) $7,689
=====================================
Earnings (loss) per share - basic
As reported $ (34.07) $ (9.32) $ 2.44
Pro forma (33.86) (9.36) 2.38
Earnings (loss) per share - diluted
As reported $ (34.07) $ (9.32) $ 2.26
Pro forma (33.86) (9.36) 2.22
- ------------
(a) The pro forma adjustments for stock option costs are favorable to net income
(loss) because the value of stock options forfeited during these periods
exceeded the value of stock options vesting during these periods.
209
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 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, the Company is carrying a liability
of $0.7 million on its balance sheet for its obligation to 2003-1 securitization
trust which was created 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 reduced 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 rate of the loans.
The Company has not completed a new securitization with servicing retained since
2003-1.
In December 2002, the FASB issued SFAS No. 148 which amends SFAS No. 123. 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 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 its 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 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. The Company cannot predict whether the
guidance will change its 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.
210
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)
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, therefore, it will have no effect
on its 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. The Company does not have any
instruments with such characteristics and do not expect SFAS No. 150 to have a
material impact on its financial condition or results of operations.
In December 2003, the FASB issued Interpretation No. 46 (revised December 2003),
"Consolidation of Variable Interest Entities" ("FIN 46R"), which replaces the
original FIN No. 46 issued in January 2003. FIN 46R addresses how a business
enterprise should evaluate whether it has a controlling interest in an entity
through means other than voting rights. This interpretation requires a variable
interest entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's activities or
is entitled to receive a majority of the entity's residual returns or both. The
interpretation also requires disclosures about variable interest entities that
the Company is not required to consolidate but in which it has a significant
variable interest. Special Purpose Entities ("SPE") 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 46R
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.
211
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
2. ACQUISITIONS
On December 24, 2003, the Company acquired a broker operation with 35 employees
located in California that operates primarily on the west coast of the United
States for the purpose of expanding its capacity to originate loans through its
broker channel, especially in the state of California. Assets acquired in this
transaction, mostly fixed assets, were not material. The purchase price was
comprised of issuing a $475 thousand convertible non-negotiable promissory note
to the seller and assuming $107 thousand of liabilities. As a result of this
transaction, the Company increased its goodwill by $582 thousand.
The $475 thousand convertible non-negotiable promissory note issued in the
December 2003 acquisition bears interest at 6% per annum and matures June 30,
2005. At any time on or after December 24, 2004 and before January 31, 2005, the
holder of the note has the option to convert the note into the number of shares
of common stock determined by dividing the outstanding principal amount of the
note and accrued interest, if any, by $5.00, subject to adjustment for any
changes in the capitalization of the Company affecting its common stock.
On June 11, 2004, the Company acquired a broker operation with 35 employees
located and primarily operating in the state of Texas. This acquisition was also
for the purpose of expanding the Company's capacity to originate loans through
its broker channel. Assets acquired in this transaction, mostly fixed assets,
were not material. The purchase price was comprised of issuing a $650 thousand
convertible non-negotiable promissory note to the seller and $150 thousand of
cash. As a result of this transaction, the Company increased its goodwill by
$612 thousand.
The $650 thousand convertible non-negotiable promissory note issued in the June
2004 acquisition bears interest at 8% per annum and is to be paid in five
semi-annual installments of $108 thousand each commencing on December 31, 2004.
The final semi-annual installment is due on June 30, 2007. At any semi-annual
installment date, the holder of the note has the option to convert the note into
the number of shares of the Company's common stock as determined by dividing the
semi-annual principal payment amount by the closing price per common share on
the immediately preceding semi-annual payment date, subject to adjustment for
any changes in the capitalization of the Company affecting its common stock.
212
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
3. LOAN AND LEASE RECEIVABLES
LOANS AVAILABLE FOR SALE
Loans available for sale were comprised of the following (in thousands):
JUNE 30,
2004 2003
--------- ----------
Loans available for sale, secured by real estate, principal
balance $ 300,143 $ 257,840
Valuation allowance (a) (42) (1,319)
Deferred direct loan origination costs 4,453 6,850
Other (b) (279) 48
--------- ----------
$ 304,275 $ 263,419
========= ==========
- --------------
(a) For estimated credit losses.
(b) Represents the SFAS No. 133 adjustment to the fair value of hedged loans.
Real estate secured loans have contractual maturities of up to 30 years.
The activity in the valuation allowance against available for sale loans is
summarized as follows (in thousands):
YEAR ENDED JUNE 30,
2004 2003 2002
----------------------------------
Balance at beginning of year $ 1,319 $ 263 $ 380
Provision adjustment (a) (1,277) 1,056 (117)
------- -------- ------
Ending Balance $ 42 $ 1,319 $ 263
======= ======== ======
- --------------
(a) Net (charge) / credit to the provision for credit losses. Under the
Company's previous business strategy of securitizing substantially all of
its loan originations, the Company carried loans available for sale on
balance sheet for up to 120 days and therefore, in addition to providing for
estimated credit losses on delinquent loans available for sale, it provided
for estimated credit losses on current loans not expected to be eligible for
securitizations. When securitizations occurred, any excess valuation
allowance for credit losses on loans securitized was reversed through the
provision for credit losses.
213
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
3. LOAN AND LEASE RECEIVABLES (CONTINUED)
NON-ACCRUAL LOANS
At June 30, 2004 and June 30, 2003, the accrual of interest income was suspended
on real estate secured loans of $3.5 million and $5.4 million, respectively.
Non-accrual loans at June 30, 2004 and 2003 were comprised of the following (in
thousands):
JUNE 30,
2004 2003
--------- ----------
Loans repurchased from securitization trusts $ 3,281 $ 4,674
Loans transferred from available for sale 181 684
Net non-accrual loans -------- -------
3,462 5,358
Allowance for credit losses (1,469) (1,359)
Net non-accrual loans -------- -------
$ 1,993 $ 3,999
======== =======
Average balances of non-accrual loans during the years ended June 30, 2004 and
2003 were $7.3 million and $8.6 million, respectively.
LEASE RECEIVABLES
Lease receivables were comprised of the following (in thousands):
JUNE 30,
2004 2003
--------- ----------
Leases, net of unearned income of $550 in 2003 $ - $ 4,126
Deferred direct origination costs - 28
Allowance for credit losses - (170)
Net lease receivables -------- --------
$ - $ 3,984
======== ========
Substantially all leases were direct finance-type leases whereby the lessee had
the right to purchase the leased equipment at the lease expiration for a nominal
amount.
On January 22, 2004, the Company executed an agreement to sell its interests in
the remaining leases in its portfolio. The terms of the agreement included a
cash sale price of approximately $4.8 million in exchange for the Company's
lease portfolio balance as of December 31, 2003. The Company received the cash
from this sale in January 2004 and recognized a net gain of $0.5 million.
214
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
4. ALLOWANCE FOR CREDIT LOSSES
The activity in the allowance for credit losses on non-accrual loans and leases
is summarized as follows (in thousands):
YEAR ENDED JUNE 30,
2004 2003 2002
--------------------------------------------
Balance at beginning of year $ 1,529 $ 3,442 $ 2,100
Provision for credit losses:
Business purpose loans 3,344 1,210 1,716
Home equity loans 12,432 3,923 3,539
Equipment leases (210) 364 1,319
--------------------------------------------
Total provision 15,566 5,497 6,574
--------------------------------------------
Loan charge-offs:
Business purpose loans (3,582) (2,022) (948)
Home equity loans (12,182) (4,925) (2,897)
Equipment leases (1,127) (865) (1,689)
--------------------------------------------
Total loan charge offs (16,891) (7,812) (5,534)
--------------------------------------------
Recoveries of loans previously charged off:
Business purpose loans 84 38 24
Home equity loans 14 12 5
Equipment leases 1,167 352 273
--------------------------------------------
Total recoveries 1,265 402 302
--------------------------------------------
Total charge-offs, net (15,626) (7,410) (5,232)
--------------------------------------------
Balance at end of year $ 1,469 $ 1,529 $ 3,442
============================================
Ratio of net charge offs in the portfolio to
the average portfolio (a) 8.93% 5.17% 4.23%
Ratio of allowance to non-accrual loans and
leases 42.44% 16.08% 22.65%
- -------------
(a) The average portfolio includes loans available for sale, non-accrual loans
and leases.
The following schedule details the provision for credit losses for the years
ended June 30, 2004, 2003 and 2002 (in thousands):
YEAR ENDED JUNE 30,
2004 2003 2002
--------------------------------------------
Loans available for sale (a) $ (1,277) $ 1,056 $ (117)
Non-accrual loans 15,776 5,133 5,255
Leases (210) 364 1,319
-------- --------- --------
Total Provision for Credit Losses $ 14,289 $ 6,553 $ 6,457
======== ========= ========
- ----------------
(a) Under the Company's previous business strategy of securitizing substantially
all of its loan originations, the Company carried loans available for sale
on its balance sheet for up to 120 days and therefore, in addition to
providing for estimated credit losses on delinquent loans, it provided for
estimated credit losses on current loans not expected to be eligible for
securitizations. When securitizations occurred, any excess valuation
allowance for credit losses on loans securitized was reversed through the
provision for credit losses.
215
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
4. ALLOWANCE FOR CREDIT LOSSES (CONTINUED)
While the Company is under no obligation to do so, at times it elects to
repurchase delinquent loans from the 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, it 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. The Company has the right, but not the obligation, to repurchase a
limited amount of delinquent loans from securitization trusts. In addition, the
Company may elect to repurchase delinquent 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 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. The foreclosed and delinquent loans the Company
typically elects 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 the provision for credit losses in the period of repurchase. The
related REO writedown for REO repurchased is recorded through general and
administrative expense in the period of repurchase. The Company's ability to
repurchase these loans does not disqualify sale accounting under SFAS No. 140 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.
At June 30, 2004, four of the Company's twenty-six mortgage securitization
trusts were under a triggering event as a result of delinquencies exceeding
specified levels. There were no securitization trusts exceeding specified loss
levels at June 30, 2004. At June 30, 2003, none of the Company's mortgage
securitization trusts were under a triggering event. Approximately $8.0 million
of excess overcollateralization is being held by the four trusts as of June 30,
2004. For the fiscal year ended June 30, 2004, the Company repurchased
delinquent loans with an aggregate unpaid principal balance of $54.0 million
from securitization trusts primarily for trigger management. The Company cannot
predict when the four trusts currently exceeding triggers will be below trigger
limits and release the excess overcollateralization. In order for these trusts
to release the excess overcollateralization, delinquent loans would need to
decline, or the company would need to repurchase delinquent loans of up to $10.4
million as of June 30, 2004. If delinquencies increase and the Company 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. The Company's ability to continue to manage
triggers in its securitization trusts in the future is affected by the
availability of cash from operations or through the sale of subordinated
debentures to fund these repurchases.
216
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
4. ALLOWANCE FOR CREDIT LOSSES (CONTINUED)
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,
--------------------------------------------
2004 2003 2002
-------- ---------- --------
By original loan type:
Business purpose loans $ 14,759 $ 16,252 $ 6,669
Home equity loans 39,211 38,775 23,571
-------- ---------- --------
Total $ 53,970 $ 55,027 $ 30,240
======== ========== ========
By loans and REO:
Loans repurchased $ 41,162 $ 23,809 $ 13,653
REO purchased 12,808 31,218 16,587
-------- ---------- --------
Total $ 53,970 $ 55,027 $ 30,240
======== ========== ========
Number of loans repurchased 684 637 341
======== ========== ========
The Company received $40.9 million, $37.6 million and $19.2 million of proceeds
from the liquidation of repurchased loans and REO during the years ended June
30, 2004, 2003 and 2002, respectively. The Company had repurchased loans
remaining on the balance sheet in the amounts of $3.3 million, $4.7 million and
$5.0 million at June 30, 2004, 2003 and 2002, respectively and REO of $1.9
million, $4.5 million and $3.2 million at June 30, 2004, 2003 and 2002,
respectively.
217
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATIONS
The following schedule details loan securitization activity (dollars in
millions):
YEAR ENDED JUNE 30,
2004 2003 2002
--------------------------------------------
Loans securitized:
Business purpose loans $ 11.0 $ 112.0 $ 129.1
Home equity loans 130.4 1,311.7 1,222.0
--------------------------------------------
$ 141.4 $ 1,423.7 $ 1,351.1
============================================
Number of term securitizations:
Business purpose and home equity loans 1 3 4
Cash proceeds:
Business purpose and home equity loans $ 139.3 $ 1,445.0 $ 1,374.6
Securitization gains:
Business purpose and home equity loans $ 15.1 $ 171.0 $ 185.6
The table below summarizes certain cash flows received from and paid to
securitization trusts (in millions):
YEAR ENDED JUNE 30,
2004 2003
------ ------
Proceeds from new securitizations $ 139.3 $ 1,445.0
Contractual servicing fees received 43.6 44.9
Other cash flows received on retained interests (a) 151.1 87.2
Purchases of delinquent or foreclosed assets (54.0) (55.0)
Servicing advances (11.6) (10.3)
Reimbursement of servicing advances 11.8 11.6
- -----------
(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 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.
218
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATIONS (CONTINUED)
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 September
30, 2003, $222.3 million of the loans which were in the facility at June 30,
2003 were sold in whole loan sales as directed by the facility sponsor. At
September 30, 2003, the facility held loans with principal balances of $40.5
million as assets and owed $36.0 million to third parties. This conduit facility
was refinanced in an October 16, 2003 refinancing as described in Note 10.
Declining interest rates and resulting high prepayment rates over the last
eleven quarters have required revisions to our estimates of the value of our
securitization assets. Beginning in the second quarter of fiscal 2002 and on a
quarterly basis thereafter, our prepayment rates, as well as those throughout
the mortgage industry, remained at higher than expected levels due to continuing
low interest rates during this period. As a result, over the last eleven
quarters, the Company has recorded cumulative pre-tax write downs to its
interest-only strips in the aggregate amount of $175.8 million and pre-tax
adjustments to the value of servicing rights of $17.9 million, for total
adjustments of $193.7 million, mainly due to the higher than expected prepayment
experience. During the same period, the Company reduced the discount rates it
applies to value its securitization assets, resulting in net favorable pre-tax
valuation impacts of $20.9 million on interest-only strips and $7.1 million on
servicing rights. The discount rates were reduced primarily to reflect the
impact of the sustained decline in market interest rates. Additionally, on June
30, 2004, the Company wrote down the carrying value of its interest-only strips
and servicing rights related to five of its mortgage securitization trusts by
$5.4 million to reflect their values under the terms of a September 27, 2004
sale agreement. The sale of these assets was undertaken as part of the
negotiations to obtain a new $100.0 million warehouse credit facility described
in Note 10 and to raise cash to pay fees on new warehouse credit facilities. The
following table summarizes the net cumulative write downs recorded on the
Company's securitization assets over the last eleven quarters (in thousands):
219
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATIONS (CONTINUED)
TOTAL INCOME OTHER
WRITE DOWN STATEMENT COMPREHENSIVE
(WRITE UP) IMPACT INCOME IMPACT
---------- ---------- -------------
PRE-TAX ADJUSTMENT RESULTING FROM:
Prepayments $ 193,743 $ 128,667 $ 65,076
Discount rate (28,038) (18,427) (9,611)
Loss on sale 5,452 3,446 2,006
---------- ---------- ----------
Net cumulative write down $ 171,157 $ 113,686 $ 57,471
========== ========== ==========
During fiscal 2004, the Company recorded total pre-tax valuation adjustments on
its interest-only strips and servicing rights of $63.8 million, of which $46.4
million was charged as expense to the income statement and $17.4 million was
charged to other comprehensive income. These adjustments primarily reflect the
impact of higher than anticipated prepayments on securitized loans experienced
in fiscal 2004 due to the low interest rate environment experienced during
fiscal 2004. The fiscal 2004 valuation adjustment also includes a write down of
the carrying value of interest-only strips and servicing rights related to five
of the Company's mortgage securitization trusts of $5.4 million to reflect their
values under the terms of a September 27, 2004 sale agreement. The sale of these
assets was undertaken as part of negotiations to obtain a new $100.0 million
warehouse credit facility and to raise cash to pay fees on new warehouse credit
facilities and as a result, the Company did not realize their full value as
reflected on its books. This compares to total pre-tax valuation adjustments on
the Company's securitization assets of $63.3 million during the year ended June
30, 2003, of which $45.2 million was charged as expense to the income statement
and $18.1 million was reflected as an adjustment to other comprehensive income.
The breakout of the total adjustments in fiscal 2004 and 2003 between
interest-only strips and servicing rights was as follows (in thousands):
YEAR ENDED JUNE 30, 2004 YEAR ENDED JUNE 30, 2003
------------------------------------ ----------------------------------------
TOTAL INCOME OTHER TOTAL INCOME OTHER
WRITE STATEMENT COMPREHENSIVE WRITE STATEMENT COMPREHENSIVE
DOWN IMPACT INCOME IMPACT DOWN IMPACT INCOME IMPACT
-------- -------- ------------- -------- --------- -------------
Interest-only strips $ 57,031 $ 39,659 $ 17,372 $ 57,973 $ 39,900 $ 18,073
Servicing rights 6,791 6,791 -- 5,282 5,282 --
-------- -------- --------- --------- --------- ---------
Total securitization assets $ 63,822 $ 46,450 $ 17,372 $ 63,255 $ 45,182 $ 18,073
======== ======== ========= ========= ========= =========
The valuation adjustment on interest-only strips for fiscal 2004 included the
net impact of a December 31, 2003 reduction in the discount rate applied to
value the residual cash flows from interest-only strips from 11% to 10%, and a
subsequent increase in that discount rate at June 30, 2004 back to 11%. The
discount rate was reduced to 10% on December 31, 2003 from 11% on September 30,
2003 and June 30, 2003 primarily to reflect the impact of the sustained decline
in market interest rates. The increase back to 11% at June 30, 2004 was made to
reflect an increase in market interest rates that had occurred since the end of
the March 2004 quarter. The December 31, 2004 reduction in discount rate had a
favorable impact of $8.4 million on that quarter's valuation adjustment. The
June 30, 2004 increase in discount rate had an unfavorable impact of $8.4
million on that quarter's valuation adjustment.
220
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATION (CONTINUED)
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 and EITF
99-20 as they relate to interest-only strips and SFAS No. 140 as it relates to
servicing rights (in thousands):
FISCAL YEAR 2004:
INCOME OTHER
TOTAL STATEMENT COMPREHENSIVE
QUARTER ENDED WRITE DOWN IMPACT INCOME IMPACT
- ----------------------------------------- ---------- ---------- -------------
September 30, 2003 $ 16,658 $ 10,795 $ 5,863
December 31, 2003 14,724 11,968 2,756
March 31, 2004 23,191 15,085 8,106
June 30, 2004 9,249 8,602 647
---------- ---------- ---------
Total Fiscal 2004 $ 63,822 $ 46,450 $ 17,372
========== ========== =========
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
========== ========== =========
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 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.
221
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATIONS (CONTINUED)
SUMMARY OF MATERIAL MORTGAGE LOAN SECURITIZATION
VALUATION ASSUMPTIONS AND ACTUAL EXPERIENCE AT JUNE 30, 2004
2003-2 2003-1 2002-4 2002-3 2002-2 2002-1 2001-4
------ ------ ------ ------ ------ ------ ------
Interest-only strip residual discount rate:
Initial valuation 11% 13% 13% 13% 13% 13% 13%
Current valuation 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation 8% 7% 9% 7% 7% 7% 7%
Current valuation 8% 5% 9% 7% 7% 7% 5%
Servicing rights discount rate:
Initial valuation (e) 11% 11% 11% 11% 11% 11%
Current valuation (e) 9% 9% 9% 9% 9% 9%
Prepayment rates(a):
INITIAL ASSUMPTION (b):
Business loans 11% 11% 11% 11% 11% 11% 11%
Home equity loans 22% 22% 22% 22% 22% 22% 22%
Ramp period (months):
Business loans 27 27 27 27 27 27 27
Home equity loans 30 30 30 30 30 30 30
CURRENT EXPERIENCE (c):
Business loans 15% 28% 15% 23% 25% 31% 19%
Home equity loans 31% 55% 48% 45% 42% 44% 38%
CURRENT ASSUMPTION(d):
Business loans
Months 1 through 3 13% 23% 16% 21% 35% 28% 29%
Months 4 through 12 16% 21% 21% 20% 17% 14% 11%
Months thereafter 14% 13% 12% 11% 10% 10% 10%
Home equity loans
Months 1 through 3 30% 43% 39% 37% 35% 37% 39%
Months 4 through 12 20% 20% 20% 20% 20% 20% 20%
Months 13 through 24 15% 15% 15% 15% 15% 15% 15%
Months thereafter 12% 12% 12% 12% 12% 12% 12%
Annual credit loss rates:
Initial assumption 0.52% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Actual experience 0.05% 0.02% 0.05% 0.11% 0.15% 0.15% 0.23%
Current assumption 0.52% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Servicing fees:
Contractual fees (e) 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Ancillary fees (e) 1.25% 1.25% 1.25% 1.25% 1.25% 1.25%
- --------------
(a) Prepayment rates are expressed as Constant Prepayment Rate (CPR).
(b) The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected CPR. 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.
(c) Current experience is a six-month historical average.
(d) Current assumption is a blended average projected during the time period
described.
(e) Servicing rights for the 2003-2 loans were sold to a third party servicer.
222
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATIONS (CONTINUED)
SUMMARY OF MATERIAL MORTGAGE LOAN SECURITIZATION
VALUATION ASSUMPTIONS AND ACTUAL EXPERIENCE AT JUNE 30, 2004 (CONTINUED)
2001-3 2001-2 2001-1 2000-4 2000-3 2000-2 2000-1
------ ------ ------ ------ ------ ------ ------
Interest-only strip residual discount rate:
Initial valuation 13% 13% 13% 13% 13% 13% 11%
Current valuation 11% 11% 11% 11% 11% 11% 11%
Interest-only strip
overcollateralization discount rate:
Initial valuation 7% 7% 6% 7% 8% 8% 8%
Current valuation 6% 7% 6% 7% 8% 8% 8%
Servicing rights discount rate:
Initial valuation 11% 11% 11% 11% 11% 11% 11%
Current valuation 9% 9% 9% 9% 9% 9% 9%
Prepayment rates (a):
INITIAL ASSUMPTION (b):
Business loans 11% 11% 11% 10% 10% 10% 10%
Home equity loans 22% 22% 22% 24% 24% 24% 24%
Ramp period (months):
Business loans 24 24 24 24 24 24 24
Home equity loans 30 30 30 24 24 24 18
CURRENT EXPERIENCE (c):
Business loans 9% 30% 31% 29% 44% 17% 31%
Home equity loans 39% 41% 48% 40% 40% 35% 44%
CURRENT ASSUMPTION (d):
Business loans
Months 1 through 3 22% 14% 24% 31% 14% 17% 11%
Months 4 through 12 10% 10% 11% 11% 12% 10% 11%
Months thereafter 10% 10% 10% 10% 10% 10% 10%
Home equity loans
Months 1 through 3 38% 35% 34% 28% 36% 33% 23%
Months 4 through 12 20% 20% 20% 20% 20% 20% 20%
Months 13 through 24 15% 15% 15% 15% 15% 15% 15%
Months thereafter 12% 12% 12% 12% 12% 12% 12%
Annual credit loss rates:
Initial assumption 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Actual experience 0.46% 0.53% 0.85% 0.50% 0.53% 0.56% 0.72%
Current assumption 0.50% 0.50% 0.55% 0.50% 0.50% 0.55% 0.70%
Servicing fees:
Contractual fees 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%
- ---------------
(a) Prepayment rates are expressed as Constant Prepayment Rate (CPR).
(b) The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected CPR. 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.
(c) Current experience is a six-month historical average.
(d) Current assumption rates are a blended average during the projected time
period described.
223
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATIONS (CONTINUED)
SUMMARY OF MATERIAL MORTGAGE LOAN SECURITIZATION
VALUATION ASSUMPTIONS AND ACTUAL EXPERIENCE AT JUNE 30, 2004 (CONTINUED)
1999-4 1999-3 1999-2 1999-1 1998(e) 1997(e) 1996(e)
------ ------ ------ ------ ------- ------- -------
Interest-only strip residual discount rate:
Initial valuation 11% 11% 11% 11% 11% 11% 11%
Current valuation 11% 11% 11% 11% 11% 11% 11%
Interest-only strip overcollateralization
discount rate:
Initial valuation 8% 7% 7% 7% 7% 7% 8%
Current valuation 8% 7% 7% 7% 7% 7% 8%
Servicing rights discount rate:
Initial valuation 11% 11% 11% 11% 11% 11% 11%
Current valuation 9% 9% 9% 9% 9% 9% 9%
Prepayment rates(a):
INITIAL ASSUMPTION (b):
Business loans 10% 10% 10% 10% 13% 13% 13%
Home equity loans 24% 24% 24% 24% 24% 24% 24%
Ramp period (months):
Business loans 24 24 24 24 24 24 24
Home equity loans 18 18 18 18 12 12 12
CURRENT EXPERIENCE (c):
Business loans 27% 27% 33% 16% 19% 29% 24%
Home equity loans 44% 32% 40% 33% 30% 21% 22%
CURRENT ASSUMPTION (d):
Business loans
Months 1 through 3 17% 28% 16% 18% 23% 22% 32%
Months 4 through 12 11% 11% 12% 10% 11% 12% 10%
Months thereafter 10% 10% 10% 10% 10% 10% 10%
Home equity loans
Months 1 through 3 33% 25% 27% 31% 29% 31% 44%
Months 4 through 12 20% 20% 20% 20% 20% 20% 20%
Months 13 through 24 15% 15% 15% 15% 15% 15% 15%
Months thereafter 12% 12% 12% 12% 12% 12% 12%
Annual credit loss rates:
Initial assumption 0.30% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
Actual experience 0.79% 0.68% 0.44% 0.54% 0.53% 0.35% 0.38%
Current assumption 0.85% 0.65% 0.45% 0.55% 0.58% 0.40% 0.45%
Servicing fees:
Contractual fees 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%
- -----------
(a) Prepayment rates are expressed as Constant Prepayment Rate (CPR).
(b) The prepayment ramp is the length of time before a pool of mortgage loans
reaches its expected CPR. 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.
(c) Current experience is a six-month historical average.
(d) Current assumption is a blended average during the projected time period
described.
(e) Amounts represent weighted-average percentages for four 1998 securitization
pools, two 1997 securitization pools and two 1996 securitization pools.
Under the terms of a September 27, 2004 sale agreement, the Company sold
the interest-only strips related to 1996-2, 1997-1, 1997-2, 1998-1 and
1998-2.
224
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
5. SECURITIZATIONS (CONTINUED)
The table below summarizes at June 30, 2004 the amount of securitized loans in
our securitization trusts, the carrying value of our securitization assets and
the weighted-average life of our securitized loans.
Securitized collateral balance $1,928,086
Balance sheet carrying value of retained interests (a) $ 532,824
Weighted-average collateral life (in years) 5.0
- -------------
(a) Amount includes interest-only strips and servicing rights.
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):
IMPACT OF
ADVERSE CHANGE
------------------------------------
10% CHANGE 20% CHANGE
-------------- ---------------
Prepayment speed $ 21,427 $ 41,611
Credit loss rate 3,994 7,987
Floating interest rate certificates (a) 949 1,899
Discount rate 17,510 33,926
- -----------
(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.
225
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
6. INTEREST-ONLY STRIPS
Interest-only strips were comprised of the following (in thousands):
JUNE 30,
2004 2003
------------------------
Interest-only strips
Available for sale $ 459,086 $ 597,166
Trading assets -- 1,112
------------------------
$ 459,086 $ 598,278
=========================
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, 2004 and 2003, the fair value
of overcollateralization related cash flows were $216.9 million and $279.2
million, respectively.
The activity for interest-only strip receivables is summarized as follows (in
thousands):
JUNE 30,
2004 2003
------------------------------
Balance at beginning of period $ 598,278 $ 512,611
Initial recognition of interest-only strips, including initial
overcollateralization of $0 million and $10.6 million 25,523 160,116
Cash flow from interest-only strips (178,457) (160,417)
Required purchases of additional overcollateralization 27,334 73,253
Interest accretion 40,176 47,347
Termination of lease securitization (a)
(1,759) (1,890)
Adjustment for loans subject to repurchase rights 2,687 2,600
Adjustments to fair value recorded through other comprehensive
income (b) (15,037) 4,558
Other than temporary fair value adjustment (c) (39,659) (39,900)
------------------------------
Balance at end of period $ 459,086 $ 598,278
==============================
(a) Reflects release of lease collateral from lease securitization trusts
which were terminated in accordance with the trust documents after the
full payout of trust note certificates. Lease receivables of $1.8 and
$1.6 million were recorded on the balance sheets at December 31, 2003
and 2002 as a result of these terminations.
(b) Adjustments to the carrying value of interest-only strips for the
initial write up to fair value are recorded through other comprehensive
income, which is a component of stockholders' equity. Additionally, to
the extent any individual interest-only strip has a portion of its
initial write up to fair value still remaining in other comprehensive
income at the time of impairment, other than temporary decreases in its
fair value would first be recorded as a reduction to other
comprehensive income.
(c) Recorded through the income statement.
See Note 5 for a further description of the write downs recognized in fiscal
years 2004 and 2003.
226
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
7. SERVICING RIGHTS
The total managed loan and lease portfolio, which includes loans held by the
Company as available for sale, non-accrual loans, leases and securitized loans
and leases the Company services for others, is as follows (in thousands):
JUNE 30,
2004 2003
---------------------------------
Home equity loans $ 1,836,670 $ 3,249,501
Business purpose loans 255,200 393,098
Equipment leases -- 8,475
---------------------------------
$ 2,091,870 $ 3,651,074
=================================
The activity for the loan and lease servicing rights asset is summarized as
follows (in thousands):
YEAR ENDED JUNE 30,
2004 2003
---------------------------------
Balance at beginning of year $ 119,291 $ 125,288
Initial recognition of servicing rights -- 41,171
Amortization (38,762) (41,886)
Write down (6,791) (5,282)
---------------------------------
Balance at end of year $ 73,738 $ 119,291
=================================
Servicing rights are valued quarterly by the Company based on the current
estimated fair value of the servicing asset. During fiscal 2004 and 2003, the
Company recorded total pre-tax valuation adjustments on its servicing rights of
$6.8 million and $5.3 million, respectively, which were charged to the income
statement. The fiscal 2004 valuation adjustment includes a June 30, 2004 write
down of $1.3 million of servicing rights related to five mortgage securitization
trusts to reflect their values under the terms of a September 27, 2004 sale
agreement. The sale of these assets was undertaken as part of the negotiations
to obtain new $100.0 million warehouse credit facility and to raise cash to pay
fees on new warehouse credit facilities and as a result, the Company did not
realize their full value as reflected on its books. See Note 5 for more detail
and key assumptions used in the periodic valuation of the servicing rights.
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 5.
As a result of our non-compliance at September 30, 2003 with the net worth
covenant in several of our servicing agreements, the Company requested and
obtained waivers of the non-compliance from the two financial insurers
representing bond holders. In connection with a waiver of the net worth covenant
granted by one of these bond insurers for the remaining term of the related
servicing agreements, the Company amended the servicing agreements on September
30, 2003 principally to provide for 120-day term-to-term servicing and for its
appointment as servicer for
227
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
7. SERVICING RIGHTS (CONTINUED)
an initial 120-day period commencing as of October 1, 2003. The Company was
re-appointed as servicer for additional 120-day terms under these amended
servicing agreements on January 29, 2004, May 27, 2004 and September 23, 2004.
The second of these bond insurers waived the Company's non-compliance with net
worth requirements on an oral basis from September 30, 2003 through March 9,
2004, at which time it confirmed its prior oral waiver in writing and extended
the waiver through March 14, 2004. On February 20, 2004 the Company entered into
an agreement with this second bond insurer amending the related servicing
agreements principally to provide for 30-day term-to-term servicing and to
re-appoint the Company as servicer for an initial term through March 15, 2004.
Subsequently, this bond insurer, on a monthly basis, has given the Company a
waiver of the net worth covenant and re-appointed it as servicer under these
amended servicing agreements for all relevant periods since the execution of the
amended servicing agreements. Reappointment as servicer under these amended
servicing agreements occurs in the sole discretion of each respective bond
insurer.
Separately, one bond insurer, as a condition to its participation in the
Company's October 31, 2003 securitization, required that the Company amend the
servicing agreement related to a previous securitization in which the bond
insurer had participated as bond insurer. The resulting amendment, dated October
31, 2003, to this servicing agreement provided, among other things, for a
specifically designated back-up servicer, for 90-day term-to-term servicing and
for the Company's re-appointment as servicer for an initial 90-day term
commencing October 31, 2003. This bond insurer subsequently re-appointed the
Company as servicer under the amended servicing agreement for an additional term
through April 30, 2004. On April 30, 2004 this amended servicing agreement was
further amended principally to provide for 30-day term-to-term servicing and for
the Company's reappointment as servicer for a 30-day term expiring May 31, 2004.
In connection with a third amendment to this amended servicing agreement, which
modified certain administrative terms of this agreement, the Company was
reappointed as servicer for a term expiring June 30, 2004. The bond insurer has
subsequently reappointed the Company on a monthly basis as servicer under this
amended servicing agreement for all relevant periods including the current
30-day period. The Company has regularly been reappointed as servicer under
these agreements for all relevant periods under the agreements. Reappointment as
servicer under this amended servicing agreement is determined by reference to
the Company's continued compliance with its terms.
Also separately, on March 5, 2004, the Company entered into agreements with
another bond insurer which amended the servicing agreements related to all
securitizations insured by this bond insurer. These amendments principally
provided for a specifically designated back-up servicer. The original provisions
of these servicing agreements providing for 3-month term-to-term servicing were
not altered by these amendments. Reappointment as service user under these
amended servicing agreements is determined by reference to the Company's
continued compliance with their terms.
As a result of the foregoing amendments to our servicing agreements, all of our
servicing agreements associated with bond insurers now provide for term-to-term
servicing.
228
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
8. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the following (in thousands):
JUNE 30,
2004 2003
---------- ----------
Computer software $ 20,917 $ 20,282
Computer hardware 2,582 3,816
Office furniture and equipment 7,474 4,680
Leasehold improvements 12,818 8,585
---------- ----------
43,791 37,363
Less accumulated depreciation and amortization 17,744 14,061
---------- ----------
$ 26,047 $ 23,302
========== ==========
Depreciation and amortization expense was $7.1 million, $8.6 million and $6.8
million for the years ended June 30, 2004, 2002 and 2002, respectively.
9. OTHER ASSETS AND OTHER LIABILITIES
Other assets were comprised of the following (in thousands):
JUNE 30,
2004 2003
---------- ----------
Goodwill $ 16,315 $ 15,121
Financing costs, debt offerings 3,567 3,984
Real estate owned 1,920 4,776
Investments held to maturity 839 881
Due from securitization trusts for
servicing related activities 792 1,344
Other 4,115 4,346
---------- ----------
$ 27,548 $ 30,452
========== ==========
229
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
9. OTHER ASSETS AND OTHER LIABILITIES (CONTINUED)
The activity in other real estate owned during the years ended June 30, 2004,
2003 and 2002 was as follows (in thousands):
YEAR ENDED JUNE 30,
2004 2003 2002
----------------------------------------
Balance at beginning of period $ 4,776 $ 3,784 $ 2,322
Properties acquired through foreclosure (a) 471 2,771 3,319
Properties purchased from securitization
trusts (a) 8,576 21,998 11,236
Sales/liquidation proceeds (11,840) (22,273) (13,252)
Property revaluation losses (352) (833) (282)
Gain (loss) on sale/liquidation 289 (671) 441
----------------------------------------
Total $ 1,920 $ 4,776 $ 3,784
========================================
(a) At lower of cost or net realizable value.
Other liabilities were comprised of the following (in thousands):
JUNE 30,
2004 2003
--------- ---------
Commitments to fund closed loans $ 46,654 $ 35,187
Unearned lease incentives 12,793 9,465
Deferred rent incentive 4,908 --
Escrow deposits held 3,113 4,885
Funds held in suspense 1,383 6,103
Periodic advance guarantee 670 650
Sold loan recourse liability 307 82
Hedging liabilities, at fair value 103 6,335
Trading liabilities, at fair value 851 334
Other 1,090 995
--------- ---------
$ 71,872 $ 64,036
========= =========
See Note 19 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 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.
Deferred rent incentive represents the accrual of future rent payments, which
will be made mainly in conjunction with the lease agreement for the Company's
corporate office space in Philadelphia, Pennsylvania. This lease agreement,
which is for a term of eleven years, required no cash rent
230
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
9. OTHER ASSETS AND OTHER LIABILITIES (CONTINUED)
payments during its first year. The Company is recording rent expense equal to
the aggregate cash rent payments, which will be paid in years two through
eleven, on a straight-line basis over the full eleven year life of the lease.
The balance in the deferred rent incentive accrual was established during the
first year and will be reduced to zero on a straight-line basis over years two
through eleven.
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE
Subordinated debentures was comprised of the following (in thousands):
JUNE 30,
2004 2003
---------- ---------
Subordinated debentures (a) $ 509,928 $ 702,423
Subordinated debentures - money market notes (b) 12,681 17,117
---------- ---------
Total subordinated debentures $ 522,609 $ 719,540
========== =========
Senior collateralized subordinated notes were comprised of the following (in
thousands):
JUNE 30,
2004 2003
---------- ---------
Senior collateralized subordinated notes (c) $ 83,639 $ --
========== ==========
Warehouse lines and other notes payable were comprised of the following (in
thousands):
JUNE 30,
2004 2003
--------- ---------
Warehouse revolving line of credit (d) $ 53,223 $ --
Warehouse revolving line of credit (e) 186,364 --
Warehouse and operating revolving line of credit (f) -- 30,182
Warehouse revolving line of credit (g) -- 136,098
Warehouse revolving line of credit (h) -- 19,671
Capitalized leases (i) 488 807
Convertible promissory notes (j) 1,125 --
Bank overdraft (k) -- 26,158
--------- ---------
Total warehouse lines and other notes payable $ 241,200 $ 212,916
========= =========
- -------------
(a) Subordinated debentures due July 2004 through July 2014, interest rates
ranging from 5.30% to 13.99%; average rate at June 30, 2004 was 10.04%,
average remaining maturity was 13.5 months, subordinated to all of the
Company's senior indebtedness. The average rate on subordinated debentures
including money market notes was 9.91% at June 30, 2004.
231
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
(b) Subordinated debentures - money market notes due upon demand, interest rate
at 4.88%; subordinated to all of the Company's senior indebtedness.
(c) Senior collateralized subordinated notes due July 2004 through July 2014,
interest rates ranging from 5.40% to 13.10%; average rate at June 30, 2004
was 9.92%, average remaining maturity was 19.2 months. The senior
collateralized subordinated notes are secured by a security interest in
certain cash flows originating from interest-only strips of certain of the
Company's subsidiaries held by ABFS Warehouse Trust 2003-1 with an
aggregate value of at least an amount equal to 150% of the outstanding
principal balance of the senior collateralized subordinated notes issued in
the Exchange Offer plus priority lien obligations secured by the
interest-only strips and/or the cash flows from the interest-only strips;
provided that, such collateral coverage may not fall below 100% of the
outstanding principal balance of the senior collateralized subordinated
notes, as determined by the Company on any quarterly balance sheet date. In
the event of liquidation, to the extent the collateral securing the senior
collateralized subordinated notes is not sufficient to repay these notes,
the deficiency portion of the senior collateralized subordinated notes will
rank junior in right of payment behind the Company's senior indebtedness
and all of the Company's other existing and future senior debt and behind
the existing and future debt of the Company's subsidiaries and equally in
right of payment with the subordinated debentures, and any future
subordinated debentures issued by the Company and other unsecured debt.
Senior collateralized subordinated notes were issued in connection with the
December 1, 2003 and June 30, 2004 Exchange Offers. At June 30, 2004, the
Company's interest in the cash flows from the interest-only strips held in
the trust which secure the senior collateralized subordinated notes totaled
$411.9 million, of which $125.5 million represents 150% of the outstanding
principal balance of the senior collateralized subordinated notes at June
30, 2004.
(d) $200.0 million warehouse revolving line of credit with JPMorgan Chase Bank
entered into on September 22, 2003 and expiring September 2004. The
maturity date of this facility was extended to November 5, 2004 and on
September 30, 2004 the facility amount was reduced to $100.0 million.
Interest rates on the advances under this facility are based upon one-month
LIBOR plus a margin. Obligations under the facility are collateralized by
pledged loans.
(e) $250.0 million warehouse revolving line of credit with Chrysalis Warehouse
Funding, LLC, entered into on October 14, 2003 and expiring October 2006.
Interest rates on the advances under this facility are based upon one-month
LIBOR plus a margin. Obligations under the facility are collateralized by
pledged loans and certain interest-only strips. Interest-only strips secure
obligations in an amount not to exceed 10% of the outstanding principal
balance under this facility and the obligations due under the fee letter
related to this facility. Assuming the entire $250.0 million available
under this credit facility were utilized, the maximum amount secured by the
interest-only strips would be approximately $53.7 million.
(f) Originally a $50.0 million warehouse and operating revolving line of credit
with JPMorgan Chase Bank, collateralized by certain pledged loans, advances
to securitization trusts, real estate owned and certain interest-only
strips, which was replaced for warehouse lending purposes by the $200.0
million facility on September 22, 2003. Pursuant to an amendment, this
facility remained in place as an $8.0 million letter of credit facility to
secure lease obligations for corporate office space, until it expired in
December 2003. In December 2003, the Company was issued a stand alone
letter of credit for $8.0 million collateralized by cash.
(g) Originally a $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
232
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
September 30, 2003. The expiration date was subsequently extended to
October 17, 2003, but no new advances were permitted under this facility
subsequent to September 30, 2003. This facility was paid down in full on
October 16, 2003. The interest rate on the facility was based on one-month
LIBOR plus a margin. Advances under this facility were collateralized by
pledged loans.
(h) Previously a $25.0 million warehouse line of credit facility from
Residential Funding Corporation. Under this warehouse facility, advances
could be obtained, subject to specific conditions described in the
agreements. Interest rates on the advances were based on one-month LIBOR
plus a margin. The obligations under this agreement were collateralized by
pledged loans. This facility was paid down in full on October 16, 2003 and
it expired pursuant to its terms on October 31, 2003.
(i) Capitalized leases, maturing through January 2006, imputed interest rate of
8.0%, collateralized by computer equipment.
(j) Consists of two convertible non-negotiable promissory notes issued for the
acquisition of certain assets and operations of two mortgage broker
businesses. The first note, issued December 23, 2003, bears interest at 6%
per annum and matures June 30, 2005. At any time on or after December 24,
2004 and before January 31, 2005, the holder of the note has the option to
convert the note into the number of shares of common stock determined by
dividing the outstanding principal amount of the note and accrued interest,
if any, by $5.00, subject to adjustment for any changes in the
capitalization of the Company affecting its common stock. The second note,
issued June 11, 2004, bears interest at 8% per annum and is to be paid in
five semi-annual installments of $108 thousand each commencing on December
31, 2004. The final semi-annual installment is due on June 30, 2007. At any
semi-annual installment date, the holder of the note has the option to
convert the note into the number of shares of the Company's common stock as
determined by dividing the semi-annual principal payment amount by the
closing price per common share on the immediately preceding semi-annual
payment date, subject to adjustment for any changes in the capitalization
of the Company affecting its common stock.
(k) Overdraft amount on bank accounts paid on the following business day.
Principal payments on subordinated debentures, senior collateralized
subordinated notes, warehouse lines and other notes payable for the next five
years are as follows (in thousands):
Year ended June 30,
---------- ----------
2005 $ 594,873
2006 174,394
2007 47,331
2008 10,043
2009 6,509
At June 30, 2004, warehouse lines and other notes payable were collateralized by
$252.3 million of loan 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, which expired pursuant to its terms
in January 2004, where fundings were collateralized by investments in the
99-A lease securitization trust and Class R and X certificates of Mortgage
Loan Trust 2001-2.
233
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
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 5 for further discussion of the
off-balance sheet features of this facility.
Interest rates paid on the revolving credit facilities range from London
Inter-Bank Offered Rate ("LIBOR") plus 2.00% to LIBOR plus 2.50%. The
weighted-average interest rate paid on the revolving credit facilities was 3.76%
and 2.24% at June 30, 2004 and June 30, 2003, respectively.
In September 2002, the Company entered into a series of leases for computer
equipment, which qualify as capital leases. The original principal amount of
debt recorded under these leases was $1.0 million. The leases have an imputed
interest rate of 8.0% and mature through January 2006.
Until its expiration, the Company also had available a $300.0 million mortgage
conduit facility. This facility expired pursuant to its terms on July 5, 2003.
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 was
paid down in full on October 16, 2003.
On October 16, 2003, the Company refinanced through another mortgage warehouse
conduit facility $40.0 million of loans that were previously held in the
off-balance sheet mortgage conduit facility described above. The Company also
refinanced an additional $133.5 million of mortgage loans in the new conduit
facility, which were previously held in other warehouse facilities, including
the $50.0 million warehouse facility which expired on October 17, 2003. The more
favorable advance rate under this conduit facility as compared to the expired
facilities, which previously held these loans, along with loans fully funded
with Company cash resulted in the Company's receipt of $17.0 million in cash. On
October 31, 2003, the Company completed a privately-placed securitization of the
$173.5 million of loans, with servicing released, that had been transferred to
this conduit facility. The terms of this conduit facility provided that it will
terminate upon the disposition of the loans held by it.
FINANCIAL AND OTHER COVENANTS
GENERAL. 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 of limits that the
Company must meet as a condition to drawing on a 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 at the option of the
lender, entitles the lender to, among other things, 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 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 the Company's liquidity and capital resources.
234
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
COVENANTS UNDER JUNE 30, 2004 CREDIT FACILITIES. On September 22, 2003, the
Company entered into definitive agreements with JP Morgan Chase Bank for a
$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) have a net worth of at least $28.0 million by September 30, 2003;
with quarterly increases of $2.0 million thereafter; (ii) apply 60% of its net
cash flow from operations each quarter to reduce the outstanding amount of
subordinated debentures commencing with the quarter ending March 31, 2004; (iii)
as of the end of any month, commencing January 31, 2004, the aggregate
outstanding balance of subordinated debentures must be less than the aggregate
outstanding balance as of the end of the prior month; and (iv) provide a parent
company guaranty of 10% of the outstanding principal amount of loans under the
facility. This facility had a term of 364 days and by its original terms would
have expired September 21, 2004. This facility 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 the Company services for others) at the end
of each fiscal quarter of less than 12.0%, its subordinated debentures not to
exceed $705.0 million at any time, and its ownership of an amount of repurchased
loans not to exceed 1.5% of the managed portfolio.
On September 20, 2004, the Company entered into an amendment to its $200.0
million credit facility which extended the scheduled expiration date of this
credit facility from September 21, 2004 to September 30, 2004.
On September 30, 2004, the Company entered into an amendment to its $200.0
million credit facility which extends the expiration date of this credit
facility from September 30, 2004 to November 5, 2004 subject to earlier
termination upon the occurrence of any of the specified events or conditions
described in the facility documents, and decreases this facility from $200.0
million to $100.0 million. Since entering into this facility on September 22,
2003, the amount outstanding under this facility at any give time has not
exceeded $100.0 million. In addition, the amendment includes changes which
reduce the advance rate if the amount outstanding under the facility exceeds
$75.0 million. The amendment also changes the portfolio composition requirements
to accommodate fluctuations in the pledged loans at the beginning and end of
each month, providing greater flexibility to the Company. The purpose of the
amendment is to allow the Company to continue to borrow under this facility,
subject to its terms as described above, while it finalizes the definitive
agreement for a new credit facility. In light of this amendment, on October 1,
2004, the Company entered into an amendment to the $250.0 million credit
facility described below which decreased the amount of the additional credit
facilities that it must maintain from $200.0 million to $100.0 million, provided
that there continues to be at least $40.0 million of wet funding as originally
required by the facility agreements.
On October 14, 2003, the Company entered into definitive agreements with
Chrysalis Warehouse Funding, LLC. for a revolving mortgage loan warehouse credit
facility of up to $250.0 million to fund loan originations. The $250.0 million
facility has a term of three years with an interest rate on amounts outstanding
equal to the one-month LIBOR plus a margin and the yield maintenance fees (as
defined in the agreements). The Company also agreed to pay an affiliate of the
lender fees of $8.9 million upon closing and approximately $10.3 million
annually plus a non-usage fee based on the difference between the average daily
outstanding balance for the current month and the maximum credit amount under
the facility, as well as the lender's out-of-pocket expenses. Advances under
this facility are collateralized by specified pledged loans. Additional credit
support for a portion of the facility was created by granting a security
interest in substantially all of the Company's interest-only strips and residual
interests which the Company contributed to a special purpose entity organized by
it to facilitate this transaction. The interest-only strips and residual
interests contributed to this special purpose entity also secured the Company's
fee obligations under this facility to an affiliate of the lender, as described
above. The interest-only strips sold pursuant to the previously described sale
agreement of September 27, 2004 were part of the interest-only strips
contributed to this special purpose entity for the purpose of securing the
Company's fee obligations to this lender affiliate. In consideration for the
release by this lender affiliate of its lien on the interest-only strips
involved in the September 27, 2004 sale, the Company prepaid $3.5 million of
fees owed or to be owed to the lender affiliate.
This $250.0 million facility contains representations and warranties, events of
default and covenants which are customary for facilities of this type, as well
as the Company's agreement to: (i) restrict the total amount of indebtedness
outstanding under the indenture related to its subordinated debentures to $750.0
million or less; (ii) make quarterly reductions commencing in April 2004 of an
amount of subordinated debentures pursuant to the formulas set forth in the loan
agreement; (iii) maintain maximum interest rates offered on subordinated
debentures not to exceed 10 percentage points above comparable rates for FDIC
insured products; and (iv) maintain minimum cash and cash equivalents of not
less than $10.0 million. In addition to events of default which are typical for
this type of facility, an event of default would occur if: (1) the Company is
unable to sell subordinated debentures for more than three consecutive weeks or
on more than two occasions in a 12 month period; and (2) certain members of
management are not executive officers and a satisfactory replacement is not
found within 60 days.
235
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
The definitive agreements for this $250.0 million facility granted the lender an
option for a period of 90 days commencing on the first anniversary of entering
into the definitive agreements to increase the credit amount to $400.0 million
with additional fees and interest payable by the Company.
In a related transaction, the Company also sold the interest-only strips and
servicing rights related to five of its mortgage securitization trusts to an
affiliate of this facility provider under the terms of a September 27, 2004 sale
agreement. The sale of these assets was undertaken as part of the Company's
negotiations to obtain the new $100.0 million warehouse credit facility and to
raise cash to pay fees on new warehouse credit facilities and as a result, the
Company did not realize their full value as reflected on its books. The Company
wrote down the carrying value of these interest-only strips and servicing rights
by $5.4 million at June 30, 2004 to reflect their values under the terms of the
sale agreement.
The Company intends to amend the security agreements related to the senior
collateralized subordinated notes to accommodate a request from the lender on
its $250.0 million credit facility, and its affiliate, dated September 30, 2004,
to clarify an inconsistency between these agreements and the $250.0 million
credit facility documents related to liens on certain assets previously pledged
by ABFS Warehouse Trust 2003-1 to Clearwing, the affiliate of the lender.
COVENANTS UNDER A NEW CREDIT FACILITY. On September 17, 2004, the Company
executed a commitment letter dated as of September 16, 2004 for a mortgage
warehouse credit facility with a warehouse lender for the purpose of funding its
home mortgage loan originations. The commitment letter provides for a facility
that will consist of a $100.0 million senior secured revolving warehouse line of
credit, which may be increased prior to closing to $150.0 million at the option
of the warehouse lender. The commitment letter provides for a facility that will
have a term of one year from closing with the right to extend for up to two
additional one-year terms upon mutual agreement of the parties, with interest
equal to LIBOR plus a margin. The facility will be secured by the mortgage loans
which are funded by advances under the facility, as well as all assets, accounts
receivable and all related proceeds held by the special purpose entity organized
to facilitate this transaction referred to as the borrower. The stock of the
borrower will also be pledged to the warehouse lender. The Company paid a due
diligence fee and also agreed to pay fees of $1.3 million upon commitment, $1.0
million at closing and approximately $3.8 million over the next twelve months
plus a non-usage fee based on the difference between the average daily
outstanding balance for the current month and the maximum credit amount under
the facility, as well as the lender's out-of-pocket expenses. The commitment
letter and the closing of the facility will be subject to such customary and
commercially reasonable terms, covenants, events of default and conditions as
the warehouse lender deems appropriate. It is anticipated that this $100.0
million facility will contain representations and warranties, events of default
and covenants which are customary for facilities of this type and will be
similar to those contained in the Company's $250.0 million credit facility.
The warehouse lender may terminate the commitment at any time prior to entering
into a definitive agreement if the Company fails to fulfill its obligations
under the commitment letter, the warehouse lender determines that it is likely
that the borrower is not capable of entering into a definitive agreement prior
to October 20, 2004 or there is a material adverse change in the business,
assets, liabilities, operations or condition of the borrower. The commitment
letter expires upon the earlier to occur of: the execution of a definitive
agreement, October 20, 2004 and the Company's closing of another similar credit
facility with a lender other than this warehouse lender. While the Company
anticipates that it will close on the facility with this warehouse lender, there
can be no assurance that these negotiations will result in definitive agreements
or that these agreements will be on terms and conditions acceptable to it.
236
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
WAIVERS AND AMENDMENTS OF FINANCIAL COVENANTS. As a result of the loss
experienced during fiscal 2003, the Company was not in compliance with the terms
of certain 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 existing at June 30, 2003 (one for
$50.0 million and the other for $200.0 million, which was reduced to $50.0
million). The Company obtained waivers from these covenant provisions from both
lenders. Commencing August 21, 2003, the lender under the $50.0 million
warehouse credit facility (which had been amended in December 2002 to add a
letter of credit facility) granted the Company a series of waivers for its
non-compliance with a financial covenant in that credit facility through
November 30, 2003 and on September 22, 2003, in connection with the creation of
the new $200.0 million credit facility on the same date, reduced this facility
to an $8.0 million letter of credit facility, which secured the lease on the
Company's principal executive office. The letter of credit facility expired
according to its terms on December 22, 2003, but the underlying letter of credit
was renewed for a one-year term on December 18, 2003. The Company also entered
into an amendment to the $200.0 million credit facility which provided 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 expiration date of this facility
from November 2003 to September 30, 2003. The Company entered into subsequent
amendments to this credit facility, which extended the expiration date until
October 17, 2003. This facility was paid down in full on October 16, 2003 and
expired on October 17, 2003.
In addition, in light of the losses recorded in each quarter of fiscal 2004, the
Company requested and obtained waivers or amendments to several credit
facilities to address its non-compliance with certain financial covenants.
The terms of the Company's $200.0 million credit facility with JP Morgan Chase
Bank, as amended, required, among other things, that our registration statement
registering $295.0 million of subordinated debentures be declared effective by
the SEC no later than October 31, 2003, that the Company obtain a written
commitment for another credit facility of at least $200.0 million and close that
additional facility by October 3, 2003, that we have a minimum net worth of
$28.0 million at September 30, 2003, $25.0 million at October 31, 2003 and
November 30, 2003, $30.0 million at December 31, 2003, $32.0 million at March
31, 2004 and $34.0 million at June 30, 2004; that we have a minimum adjusted
tangible net worth of $300.0 million and maintain cash and cash equivalents of
$25.0 million as of the end of each quarter during the term of the credit
facility.
The lender under this $200.0 million facility agreed to extend the deadline for
the Company's
237
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
registration statement to be declared effective by the SEC to November 10, 2003.
The Company's registration statement was declared effective on November 7, 2003.
This lender also agreed to extend the date by which the Company was required to
close an additional credit facility of at least $200.0 million from October 3,
2003 to October 8, 2003. The Company subsequently obtained an additional waiver
from this lender, which extended this required closing date for obtaining the
additional credit facility to October 14, 2003 (this condition was satisfied by
the closing of the $250.0 million facility described above). Prior to the
closing of the second credit facility, our borrowing capacity on the new $200.0
million facility was limited to $80.0 million.
This lender under the $200.0 million credit facility also waived the minimum net
worth requirements at September 30, 2003, October 31, 2003, November 30, 2003,
December 31, 2003, March 31, 2004 and June 30, 2004, adjusted tangible net worth
requirements at April 30, 2004, May 31, 2004 and June 30, 2004, and cash and
cash equivalent requirement at December 31, 2004, April 30, 2004 and May 31,
2004.
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.
SUBORDINATED DEBENTURES AND SENIOR COLLATERALIZED SUBORDINATED NOTES
Under a registration statement declared effective by the SEC on November 7,
2003, the Company registered $295.0 million of subordinated debentures. Of the
$295.0 million, $134.7 million of debt from this registration statement was
available for future issuance as of June 30, 2004.
On December 1, 2003, the Company mailed an Exchange Offer, referred to as the
first exchange offer, to holders of eligible debentures. Holders of such
eligible debentures had the ability to exchange their debentures for (i) equal
amounts of senior collateralized subordinated notes and shares of the Series A
Preferred Stock; and/or (ii) dollar-for-dollar for shares of Series A Preferred
Stock. Senior collateralized subordinated notes issued in the exchange have
interest rates equal to 10 basis points above the eligible debentures tendered.
Senior collateralized subordinated notes with maturities of 12 months were
issued in exchange for eligible debentures tendered with maturities of less than
12 months, while eligible debentures with maturities greater than 36 months were
exchanged for senior collateralized subordinated notes with the same maturity or
reduced to 36 months. All other senior collateralized subordinated notes issued
in the first exchange offer have maturities equal to the eligible debentures
tendered. The senior collateralized subordinated notes are secured by a security
interest in certain cash flows originating from interest-only strips of certain
of the Company's subsidiaries held by ABFS Warehouse Trust 2003-1 with an
aggregate value of at least an amount equal to 150% of the principal balance of
the senior collateralized subordinated notes issued in the Exchange Offer plus
priority lien obligations secured by the interest-only strips and/or the cash
flows from the interest-only strips; provided that, such collateral coverage may
not fall below 100% of the principal balance of the senior collateralized
subordinated notes issued in the Exchange Offer, as determined by the Company on
any quarterly balance sheet date. In the event of liquidation, to the extent the
collateral securing the senior collateralized subordinated notes is not
sufficient to repay these notes, the deficiency portion of the senior
collateralized subordinated notes will rank
238
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
SUBORDINATED DEBENTURES AND SENIOR COLLATERALIZED SUBORDINATED NOTES (CONTINUED)
junior in right of payment behind the Company's senior indebtedness and all of
the Company's other existing and future senior debt and behind the existing and
future debt of our subsidiaries and equally in right of payment with the
subordinated debentures, and any future subordinated debentures issued by the
Company and other unsecured debt.
On May 14, 2004, the Company mailed an Exchange Offer, referred to as the second
exchange offer, to holders of eligible debentures. Holders of such eligible
debentures had the ability to exchange their debentures for (i) equal amounts of
senior collateralized subordinated notes and shares of the Series A Preferred
Stock; and/or (ii) dollar-for-dollar for shares of Series A Preferred Stock. The
terms of the second exchange offer were similar to the terms of the first
exchange offer, as described above.
At June 30, 2004, the Company's interest in the cash flows from the
interest-only strips held in the trust, which secure the senior collateralized
subordinated notes, totaled $411.9 million, of which $125.5 million represented
150% of the principal balance of the senior collateralized subordinated notes
outstanding at June 30, 2004.
See Note 11 for the results of the exchange offers as of June 30, 2004. On June
30, 2004, the Company also extended the expiration date of the second exchange
offer to July 31, 2004, which was subsequently extended to August 23, 2004.
After the August 23, 2004 closing of the second exchange offer, the
interest-only strips securing the senior collateralized subordinated notes
totaled $148.2 million.
The Company's subordinated debentures 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 debentures in the event of default following
payment to holders of the senior debt.
239
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
10. SUBORDINATED DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES AND
WAREHOUSE LINES AND OTHER NOTES PAYABLE (CONTINUED)
SUBORDINATED DEBENTURES AND SENIOR COLLATERALIZED SUBORDINATED NOTES (CONTINUED)
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
debentures.
FACILITY FEES
The Company paid commitment fees and non-usage fees on warehouse lines and
operating lines of credit of $23.3 million, $0.4 million and $0.7 million in the
years ended June 30, 2004, 2003 and 2002, respectively.
11. STOCKHOLDERS' EQUITY
EXCHANGE OFFERS
On December 1, 2003, the Company mailed the first exchange offer to holders of
eligible subordinated debentures. On May 14, 2004, the Company mailed the second
exchange offer to holders of eligible subordinated debentures. Holders of
eligible subordinated debentures had the ability to exchange their debentures
for (i) equal amounts of senior collateralized subordinated notes and shares of
Series A Preferred Stock; and/or (ii) dollar-for-dollar for shares of Series A
Preferred Stock. See Note 10 for a description of the terms of the senior
collateralized subordinated notes issued in both exchange offers. See below for
a description of the terms of the Series A Preferred Stock.
Under the first exchange offer and June 30, 2004 closing of the second exchange
offer, the following amounts of subordinated debentures were exchanged for
shares of Series A Preferred Stock and senior collateralized subordinated notes
(in thousands):
Shares of Senior
Subordinated Series A Collateralized
Debentures Preferred Subordinated
By Closing Dates Exchanged Stock Issued Notes Issued
---------------- ------------ ------------ ---------------
First Exchange Offer:
December 31, 2003 $ 73,554 39,095 $ 34,459
February 6, 2004 43,673 22,712 20,961
Second Exchange Offer:
June 30, 2004 60,589 31,980 28,609
--------- ------ ---------
Combined through June 30, 2004 $ 177,816 93,787 $ 84,029
========= ====== =========
240
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
11. STOCKHOLDERS' EQUITY (CONTINUED)
EXCHANGE OFFERS (CONTINUED)
On June 30, 2004, the Company also extended the expiration date of the second
exchange offer to July 31, 2004, which was subsequently extended to August 23,
2004. Following are the results of the July 31, 2004 and August 23, 2004
extensions and the cumulative results of the first and second exchange offers
through August 23, 2004 (in thousands):
Shares of Senior
Subordinated Series A Collateralized
Debentures Preferred Subordinated
Closing Dates Exchanged Stock Issued Notes Issued
------------- ------------ ------------ --------------
July 31, 2004 $ 25,414 12,908 $ 12,506
August 23, 2004 5,397 2,730 2,667
Cumulative results of first and
second exchange offers 208,627 109,425 99,202
TERMS OF THE SERIES A PREFERRED STOCK
General. The Series A Preferred Stock has a par value of $0.001 per share and
may be redeemed at the Company's option after the second anniversary of the
issuance date at a price equal to the liquidation value plus accrued and unpaid
dividends.
Liquidation Preference. Upon any voluntary or involuntary liquidation, the
holders of the Series A Preferred Stock will be entitled to receive a
liquidation preference of $1.00 per share, plus accrued and unpaid dividends to
the date of liquidation. Based on the shares of Series A Preferred Stock
outstanding on June 30, 2004, the liquidation value equals $93.8 million. After
completion of all closings under the second exchange offer, the liquidation
value increased to $109.4 million.
Dividend Payments. Monthly dividend payments will be $0.008334 per share of
Series A Preferred Stock (equivalent to $0.10 per share annually or 10% annually
of the liquidation value). Payment of dividends on the Series A Preferred Stock
is subject to compliance with applicable Delaware state law. Based on the shares
of Series A Preferred Stock outstanding on June 30, 2004, the annual dividend
requirement equals $9.4 million. After completion of all closings under the
second exchange offer, the annual cash dividend requirement increased to $10.9
million.
Conversion into Shares of Common Stock. On or after the second anniversary of
the issuance date (or on or after the one year anniversary of the issuance date
if no dividends are paid on the Series A Preferred Stock), each share of the
Series A Preferred Stock is convertible at the option of the holder into a
number of shares of the Company's common stock determined by dividing: (A) $1.00
plus an amount equal to accrued but unpaid dividends (if the conversion date is
prior to the second anniversary of the issuance date because the Series A
Preferred Stock has become convertible due to a failure to pay dividends), $1.20
plus an amount equal to accrued but unpaid dividends (if the conversion date is
prior to the third anniversary of the issuance date but on or after the second
anniversary of the issuance date) or $1.30 plus an amount equal to accrued but
unpaid dividends (if the conversion date is on or after the third anniversary of
the issuance date)
241
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
11. STOCKHOLDERS' EQUITY (CONTINUED)
TERMS OF THE SERIES A PREFERRED STOCK (CONTINUED)
by (B) the market value of a share of the Company's common stock (which figure
shall not be less than $5.00 per share regardless of the actual market value on
the conversion date).
Based on the $5.00 per share market value floor and if each share of Series A
Preferred Stock issued in the first exchange offer and the second exchange offer
converted on the anniversary dates listed below, the number of shares of the
Company's common stock which would be issued upon conversion follows (shares in
thousands):
As of June 30, 2004 As of August 23, 2004
----------------------------- -----------------------------
Convertible Convertible
Number of into Number Number of into Number
Preferred of Common Preferred of Common
Shares Shares Shares Shares
--------- ----------- --------- -----------
Second anniversary date 93,787 22,509 109,425 26,262
Third anniversary date 93,787 24,384 109,425 28,451
As described above, the conversion ratio of the Series A preferred stock
increases during the first three years following its issuance, which provides
the holders of the Series A preferred stock with a discount on the shares of
common stock that will be issued upon conversion. Under guidance issued by the
EITF in issue 98-5, "Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios," this
discount, or beneficial conversion feature, must be valued and amortized to the
income statement as additional non-cash preferred dividends over the three-year
period that the holders of the Series A preferred stock earn the discount with
an offsetting credit to additional paid-in-capital.
The Company computed the value of the beneficial conversion feature using the
conversion ratio of $1.30 to $5.00, which is the conversion term that is most
beneficial to the investor, and would result in the issuance of 24.5 million
shares of common stock based on the shares of Series A preferred stock that were
issued through June 30, 2004. The value of the beneficial conversion feature
equals the excess of the intrinsic value of those 24.5 million shares of common
stock at their closing prices on the dates the preferred stock was issued, over
the value of the Series A preferred stock on the same dates. The value of the
Series A preferred stock was equal to the carrying value of the subordinated
debentures exchanged. For closings under the exchange offers through June 30,
2004, the value of the beneficial conversion feature was $10.7 million. During
fiscal 2004, amortization of $0.8 million was added to the $2.9 million of cash
dividends declared resulting in a total charge to the income statement of $3.7
million. The offset to the charge to the income statement for the amortization
of the beneficial conversion feature is recorded to additional paid in capital.
For closings under the exchange offers through August 23, 2004, the value of the
beneficial conversion feature was $11.3 million. Amortization of the total value
of the beneficial conversion feature will be $3.6 million in fiscal 2005, $3.8
million in fiscal 2006 and $3.0 million for fiscal 2007.
242
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
11. STOCKHOLDERS' EQUITY (CONTINUED)
RESTRICTED SHARES GRANTED
The Company entered into an employment agreement dated December 24, 2003 with an
experienced industry professional who directs the wholesale business for the
Company. The employment agreement provided for this executive to receive an
award of 200,000 restricted shares (220,000 shares after the effect of
subsequent stock dividends) of the Company's common stock. The vesting of these
restricted shares is subject to the executive achieving performance targets for
the wholesale business and vesting with respect to 110,000 of such shares
occurred as of June 30, 2004. The restricted shares were issued from the
Company's treasury stock with an average cost of $12.69 per share. The market
price of the Company's common stock on June 30, 2004 was $4.50 per common share
and was used to record unearned compensation on the restricted shares. Unearned
compensation will be adjusted as the Company's common stock price changes and
will be expensed over the vesting period of the restricted stock.
EMPLOYEE STOCK GRANT PROGRAM
On May 28, 2004, the Board of Directors approved a stock award of 136,850 shares
to full-time employees who were hired on or before May 28, 2004. This stock
award recognized employees for their contributions during the period of business
strategy adjustments. The shares were issued from the Company's treasury stock,
which had an average cost of $12.69 per share. The market price of the Company's
common stock on May 28, 2004 was $3.29 per common share and was used to record
compensation expense on the number of common shares awarded.
OTHER
On May 13, 2004, the Board of Directors declared a 10% stock dividend payable
June 8, 2004 to common shareholders of record on May 25, 2004. 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 2002 have been similarly adjusted for the effect of a 10% stock dividend
declared on August 21, 2002, which was paid on September 13, 2002 to common
shareholders of record on September 3, 2002.
The Company paid no cash dividends on its common stock during the year ended
June 30, 2004. Cash dividends of $0.291 and $0.255 were paid in the years ended
June 30, 2003 and 2002, respectively.
In May 2002 the Company registered 484,000 shares of its common stock for use in
a dividend reinvestment plan. The dividend reinvestment plan was terminated as
of June 30, 2003 with an aggregate of 9,699 shares having been issued under the
plan. The dividend reinvestment plan was intended to allow shareholders to
purchase the Company's common stock with dividend payments from their existing
common stock holdings.
In December 2003, the Company's shareholders approved an increase in the number
of shares of authorized common stock from 9.0 million shares to 209.0 million
shares and authorized preferred stock from 3.0 million shares to 203.0 million
shares.
243
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
11. STOCKHOLDERS' EQUITY (CONTINUED)
OTHER (CONTINUED)
In December 2003 and June 2004, the Company's shareholders also approved the
issuance of shares of the Series A preferred stock in connection with the
Company's two exchange offers and shares of common stock upon the conversion of
the Series A preferred stock.
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.
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.
12. 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 $276 thousand, $417 thousand and
$350 thousand for the years ended June 30, 2004, 2003 and 2002, respectively.
244
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
13. STOCK OPTION AND STOCK INCENTIVE PLANS
The Amended and Restated 1999 Stock Option Plan of the Company ("1999 Plan") is
available for the grant to officers, other key employees, directors and
important consultants of the Company of options to purchase shares of the
Company's common stock. The 1999 Plan was approved by the Company's
stockholders. Options granted under the 1999 Plan to officers, other key
employees and important consultants of the Company are granted at or above the
market price of the Company's stock on the date of grant and generally expire
five to ten years from the date of grant. Options granted under the 1999 Plan to
non-employee directors are granted at or above the market price of the Company's
stock on the date of grant and generally expire three to ten years from the date
of grant. Options granted under the 1999 Plan may be fully exercisable when
granted or may become fully exercisable only upon the continued employment of
the optionee for a specified period of time, only upon the achievement of
specified performance goals, or only upon the occurrence of both events. At June
30, 2004, options had been granted for all shares of the Company's common stock
previously authorized by the Company's stockholders for issuance under the 1999
Plan and options for the purchase of an additional 104,328 shares of the
Company's common stock had been granted subject to approval by the Company's
stockholders at the Annual Meeting of Stockholders scheduled to be held December
29, 2004 of a proposal to increase the number of shares authorized for issuance
under the 1999 Plan. At June 30, 2004 options granted under the Company's
Amended and Restated 1993 Stock Option Plan ("1993 Plan") and the Company's 1995
Stock Option Plan for Non-Employee Directors ("1995 Plan") were also outstanding
but both the 1993 Plan and 1995 Plan have expired and no further grants can be
made under them.
A summary of key employee stock option activity for the years ended June 30,
2004, 2003 and 2002 follows. Stock option activity has been retroactively
adjusted for the effect of the stock dividends described in Note 11.
WEIGHTED-AVERAGE
NUMBER OF SHARES EXERCISE PRICE
-------------------------------------------
Options outstanding, June 30, 2001 610,064 $ 10.58
Options granted 121,342 11.64
Options exercised (133) 9.77
Options canceled (67,471) 6.65
------------------------------------------
Options outstanding, June 30, 2002 663,802 10.86
Options granted 6,600 12.27
Options exercised (4,400) 4.60
Options canceled (45,611) 13.10
------------------------------------------
Options outstanding, June 30, 2003 620,391 10.72
Options granted 553,849 3.66
Options canceled (244,407) 10.99
------------------------------------------
Options outstanding, June 30, 2004 929,833 $ 6.44
==========================================
A summary of non-employee director stock option activity for the three years
ended June 30, 2004, 2003 and 2002 follows. Stock option activity has been
retroactively adjusted for the effect of the stock dividends described in
Note 11.
245
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
13. STOCK OPTION AND STOCK INCENTIVE PLANS (CONTINUED)
WEIGHTED-AVERAGE
NUMBER OF SHARES EXERCISE PRICE
-------------------------------------------
Options outstanding, June 30, 2001 258,214 $ 6.94
Options granted 65,340 12.70
Options canceled (27,951) 10.74
------------------------------------------
Options outstanding, June 30, 2002 295,603 7.85
Options exercised (96,784) 6.70
Options canceled (13,310) 9.77
------------------------------------------
Options outstanding, June 30, 2003 185,509 8.41
Options canceled (49,632) 8.11
------------------------------------------
Options outstanding, June 30, 2004 135,877 $ 8.52
==========================================
The Company accounts for stock options issued under these plans using the
intrinsic value method except for performance based stock options, which are
accounted for as variable stock options. See Note 1 for more detail.
The weighted-average fair value of options granted during the fiscal years ended
June 30, 2004, 2003 and 2002 were $1.98, $7.00 and $5.85, 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,
2004 2003 2002
--------------------------------------------------
Expected volatility 70% 65% 50%
Expected life 8 YRS. 8 yrs. 8 yrs.
Risk-free interest rate 3.38% - 4.56% 3.3% - 3.8% 3.4% - 5.3%
The following tables summarize information about stock options outstanding under
these plans at June 30, 2004:
OPTIONS OUTSTANDING
- ------------------------------------------------------------------------------------------
WEIGHTED
REMAINING WEIGHTED-
RANGE OF EXERCISE CONTRACTUAL LIFE AVERAGE EXERCISE
PRICES OF OPTIONS NUMBER OF SHARES IN YEARS PRICE
- ------------------------------------------------------------------------------------------
$ 3.09 to 5.12 681,673 8.3 $ 3.72
9.77 to 11.45 208,485 5.7 10.23
12.26 to 14.31 141,598 2.1 13.48
15.65 to 16.82 33,954 3.8 16.38
---------
1,065,710 6.8 6.69
=========
246
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
13. STOCK OPTION AND STOCK INCENTIVE PLANS (CONTINUED)
OPTIONS EXERCISABLE
- ------------------------------------------------------------------------------------------
WEIGHTED
REMAINING WEIGHTED-
RANGE OF EXERCISE CONTRACTUAL LIFE AVERAGE EXERCISE
PRICES OF OPTIONS NUMBER OF SHARES IN YEARS PRICE
- ------------------------------------------------------------------------------------------
$ 3.09 to 5.12 127,626 2.9 $ 3.94
9.77 to 11.45 148,336 5.3 10.08
12.26 to 14.31 136,522 1.9 13.51
15.65 to 16.82 33,116 3.8 16.40
-------
445,600 3.5 9.84
=======
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,
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 177,622
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. On May 28, 2004, 136,850 shares were
granted at a price of $3.29 per share to officers and employees under this plan.
247
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
14. INCOME TAXES
The provision for income taxes consists of the following (in thousands):
YEAR ENDED JUNE 30,
2004 2003 2002
------------------------------------------------
CURRENT
Federal $ 2,370 $ 9 $ 1,455
State 150 400 250
------------------------------------------------
2,520 409 1,705
------------------------------------------------
DEFERRED
Federal (65,289) (19,377) 3,986
State (5,525) (150) -
------------------------------------------------
(70,814) (19,527) 3,986
------------------------------------------------
Total provision for income taxes $ (68,294) $ (19,118) $ 5,691
================================================
There were $4.4 million in federal tax benefits from the utilization of net
operating loss carry forwards in the year ended June 30, 2003 while there were
no tax benefits from the utilization of net operating loss carry forwards in the
year ended June 30, 2004.
The cumulative temporary differences resulted in net deferred income tax assets
or liabilities consisting primarily of the following (in thousands):
JUNE 30,
2004 2003
----------------------------------
Deferred income tax assets:
Allowance for credit losses $ 529 $ 997
Net operating loss carryforwards 139,088 72,581
Other 11,237 14,544
----------------------------------
150,854 88,122
Less valuation allowance 33,394 36,830
----------------------------------
117,460 51,292
----------------------------------
Deferred income tax liabilities:
Interest-only strips and other receivables 58,327 68,328
----------------------------------
58,327 68,328
----------------------------------
Net deferred income tax (asset) liability $ (59,133) $ 17,036
==================================
The Company's net deferred income tax position changed from a liability of $17.0
million at June 30, 2003 to an asset of $59.1 million at June 30, 2004. This
change from a liability position is the result of recording $68.3 million of
federal and state income tax benefits on the Company's pre-tax loss for the year
ended June 30, 2004. These federal and state income tax benefits will be
realized against anticipated future years' state and federal taxable income.
Factors which were considered in determining that it is more likely than not the
Company will realize this deferred tax asset included: (i) the circumstances
producing the losses for the fourth quarter of fiscal 2003 and the year ended
June 30, 2004; (ii) the Company's historical profitability prior to the fourth
248
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
14. INCOME TAXES (CONTINUED)
quarter of fiscal 2003; (iii) the anticipated impact that the Company's adjusted
business strategy will have on producing more currently taxable income than its
previous business strategy produced due to higher loan originations and shifting
from securitizations to whole loan sales; (iv) the achievability of anticipated
levels of future taxable income under the Company's adjusted business strategy;
and (v) the likely utilization of its net operating loss carryforwards.
Additionally, the Company considers tax-planning strategies it can use to
increase the likelihood that the deferred income tax asset will be realized.
The valuation allowance represents the income tax effect of state net operating
loss carry forwards less an amount of $5.4 million which it has been determined
that it is more likely than not the Company will utilize in the next three
years. This $5.4 million benefit will depend on future taxable income from
operations and the implementation of state tax planning. The changes in the
Company's business strategy from primarily securitizations to a combination of
whole loan sales and smaller securitizations will result in a quicker
recognition and a higher level of taxable income.
The Company's net operating loss federal tax benefit of $100.3 million will
likewise depend on future taxable income from operations in addition to the
reversal of timing differences principally related to existing securitization
assets with full net operating loss utilization primarily within two years.
A reconciliation of income taxes at federal statutory rates to the Company's tax
provision is as follows (in thousands):
YEAR ENDED JUNE 30,
2004 2003 2002
-----------------------------------------------
Federal income tax at statutory rates $ (62,903) $ (17,157) $ 4,742
Nondeductible items 35 85 65
Other, net (5,426) (2,046) 884
-----------------------------------------------
$ (68,294) $ (19,118) $ 5,691
===============================================
For financial tax reporting, the Company had a pre-tax loss of $179.7 million on
which a benefit of $68.3 million was recorded. The Company has net Federal
operating loss carry forwards aggregating approximately $286.6 million available
to reduce future Federal income taxes as of June 30, 2004 which will begin to
expire in 2019. The Company has net state operating losses of $145.7 million as
of June 30, 2004 which will expire in 20 years. In addition the other category
includes a $5.4 million state tax benefit which will be utilized within three
years.
249
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
15. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
As of June 30, 2004, the Company leases property under noncancelable operating
leases requiring minimum annual rentals as follows (in thousands):
Year ending June 30,
2005 $ 5,940
2006 5,612
2007 5,605
2008 5,695
2009 5,867
Thereafter 27,883
--------
$ 56,602
========
Rent expense for leased property was $5.6 million, $5.1 million and $4.9
million, respectively, for the years ended June 30, 2004, 2003, and 2002.
EMPLOYMENT AGREEMENTS
In January 1997, the Company entered into employment agreements with three
current executives (which have subsequently been amended with respect to two of
the executives) pursuant to which the three executives are entitled to initial,
collective, annual base salary of $625 thousand, automatic annual increases in
salary for increases in the Consumer Price Index and additional discretionary
merit increases in salary. The agreements with two of the executives provide for
annual cash bonuses of up to 225% of the executive's annual salary based on the
achievement of performance goals established annually by the Company's Board of
Directors. The agreement with the third executive provides for his participation
in the cash bonus plan of the Company on terms established by the Company's
Board of Directors and the Board currently provides for this executive to
receive an annual cash bonus of up to 50% of his annual salary, with the
specific amount set at the discretion of the Chairman. For two of the
executives, the agreements terminate upon the earlier of (i) the executive's
death, permanent disability, termination of employment for cause, voluntary
resignation or 70th birthday; (ii) five years from any anniversary date of the
agreements, or (iii) five years from the date of any notice to the executive of
the Company's intention to terminate the agreement without cause. The agreement
for the third executive terminates upon the earlier of (i) the executive's
death, permanent disability, termination of employment for cause, voluntary
resignation or 70th birthday; (ii) three years from any anniversary date of the
agreements, (iii) three years from the date of any notice to the executive of
the Company's intention to terminate the agreement without cause, or (iv) under
certain circumstances, delivery of notice of termination without cause and
payment of a lump sum equal to one year's salary. In the event of a "change in
control," as defined in the agreements, two of the executives are entitled to
receive a cash payment equal to 299% of their average annual compensation over
the five calendar years preceding the change in control and the third executive
is entitled to receive the same payment but only if he is terminated in
connection with the change in control.
250
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
EMPLOYMENT AGREEMENTS (CONTINUED)
In 1999, the Company entered into an employment agreement with an executive
which terminated in July 2003. This agreement provided for the executive to
receive an initial annual base salary of $335 thousand, subject to annual
increases at the discretion of the Chairman, and an annual cash bonus of up to
50% of the executive's annual base salary upon the achievement of certain
performance goals.
In 1999, the Company entered into an employment arrangement with a current
executive which, as subsequently amended, entitles the executive to receive an
initial annual base salary of $275 thousand and an annual cash bonus of up to
50% of the executive's annual base salary upon the achievement of certain
performance goals. In 1999, the Company entered into an agreement with this
executive which entitles this executive to receive: (i) one year's base salary
if terminated for any reason other than for cause as defined in the agreement;
(ii) to a severance payment equal to two times the executive's highest annual
base salary and bonus earned within a specified period if (A) the executive's
employment is terminated due to a change in control of the Company, or (B) the
executive resigns due to circumstances specified in the agreement within
twenty-four months of a change in control of the Company.
In 1999, the Company entered into an agreement with a current executive which
entitles the executive, in the event the executive is terminated other than for
cause within one year of a change in control, to receive a lump sum payment
determined by adding together the highest annual salary and highest annual cash
bonus received by the executive within the time periods specified in the
agreement and multiplying the resulting sum by a fraction, the denominator of
which is 365 and the numerator of which is the number of days the executive
remained employed following the change in control. In 2004, the Company entered
into an agreement with this same executive which provides for an annual base
salary of $300,000, subject to annual increases at the discretion of the Chief
Executive Officer and Compensation Committee of the Board, an annual bonus in
accordance with the terms of the Management Incentive Plan of up to 50% of
salary, and stock option grants in accordance with the Company's stock option
plans. This agreement also provides that if at any time the executive is
terminated without "cause" (as defined in the agreement), executive is entitled
to receive in twelve equal monthly installments an amount equal to the highest
annual salary received by the executive during the twelve month period prior to
the date of termination plus the highest annual bonus paid to the executive
during the five fiscal year period prior to the date of termination.
Additionally, this agreement provides that if, within one year of a "change of
control" (as defined in the agreement), the executive loses his position with
the Company as set forth in the agreement, then he is entitled to receive a lump
sum payment of the same aggregate amount he would be entitled to receive
following any termination of his employment without cause. This executive's 2004
agreement with the Company superceded his 1999 agreement with the Company.
In December 2003, the Company entered into an employment agreement with a
current executive which entitles the executive to receive salary at the annual
rate of $420,000 and a monthly cash bonus for each month that wholesale
originations (as defined in the agreement) exceed $200 million, with such
monthly bonus determined by multiplying 0.0005 times the amount of wholesale
originations in excess of $200 million, up to an excess of $200 million, and
adding $15,000 to such product if wholesale originations in the relevant month
exceed $400 million. The employment agreement provided for an award to the
executive of 200,000 shares (220,000 shares after adjustment for a subsequent
stock dividend) of the Company's common stock subject to transfer restrictions
and forfeiture until achievement of performance goals set forth in the
employment agreement and a restricted stock agreement entered into
simultaneously with the employment agreement. The performance goal with respect
to 100,000 shares (110,000 shares after adjustment for a subsequent stock
dividend) was satisfied June 30, 2004.
251
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
PERIODIC ADVANCE GUARANTEES
As the servicer of securitized loans, the Company is obligated to advance
interest payments for delinquent loans if it deems 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.
The Company adopted FIN 45 "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others" on a
prospective basis for guarantees that are issued or modified after December 31,
2002. Based on the requirements of this guidance, the Company is carrying on its
balance sheet a $0.7 million liability for its obligations to the ABFS 2003-1
securitization trust, which was created 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.
RECOURSE ON WHOLE LOAN SALES
The Company's whole loan sale agreements with purchasers may include recourse
provisions obligating it to repurchase loans at the sales price in the event of
unfavorable delinquency performance on the loans sold or to refund premiums if a
sold loan prepays. The duration of these obligations typically ranges from 60
days to one year from the date of the loan sale. Premium refund obligations
typically decline monthly over the obligation period. The Company reserves for
these premium obligations at the time of sale through an expense charge against
the gain on sale. The amount of the reserve is calculated based on the expected
near term delinquency and prepayment performance of the sold loans and the
premiums received at the time of sale. At June 30, 2004, the reserve for
repurchase and payoff obligations of premiums received, included in
miscellaneous liabilities on the balance sheet, was $307 thousand.
The following table details as of June 30, 2004, the aggregate principal balance
of loans which the Company has sold with recourse that are still subject to
recourse provisions and the quarter during which its recourse obligations on
those loans mature (dollars in thousands):
PRINCIPAL
QUARTER ENDED BALANCE
------------- ---------
September 30, 2004 $ 443,306
December 31, 2004 73,512
March 31, 2005 4,346
June 30, 2005 102,827
---------
$ 623,991
=========
252
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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. By
way of further example, on December 22, 2003, the Company entered into a Joint
Agreement with the Civil Division of the U.S. Attorney's Office for the Eastern
District of Pennsylvania, which ended the inquiry by the U.S. Attorney initiated
pursuant to the civil subpoena dated May 14, 2003. The U.S. Attorney's inquiry
focused on the Company's forbearance policies, primarily on its practice of
requesting a borrower who entered into forbearance agreement to execute a deed
in lieu of foreclosure. In response to the inquiry and as part of the Joint
Agreement, the Company, among other things, has adopted a revised forbearance
policy, which became effective on November 19, 2003 and agreed to make an $80
thousand contribution to one or more housing counseling organizations approved
by the U.S. Department of Housing and Urban Development. The Company does not
believe that the Joint Agreement with the U.S. Attorney has had a significant
impact on its operations. 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.
16. 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 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 our
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.
253
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
16. LEGAL PROCEEDINGS (CONTINUED)
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 cash flow and liquidity.
17. OTHER LITIGATION - SECURITIES CLASS ACTION LAWSUITS AND SHAREHOLDER
DERIVATIVE ACTION.
In January and February of 2004, four class action lawsuits were filed against
the Company and certain of its officers and directors. Lead plaintiffs and
counsel were appointed on June 3, 2004. A consolidated amended class action
complaint that supersedes these four complaints was filed on August 19, 2004 in
the United States District Court for the Eastern District of Pennsylvania.
The consolidated amended class action complaint brings claims on behalf of a
class of all purchasers of the Company's common stock for a proposed class
period of January 27, 2000 through June 26, 2003. The consolidated complaint
names the Company, its director and Chief Executive Officer, Anthony Santilli,
its Chief Financial Officer, Albert Mandia, and former director, Richard
Kaufman, as defendants and alleges that the Company and the named directors and
officers violated Sections 10(b) and 20(a) of the Exchange Act. The consolidated
complaint alleges that, during the applicable class period, the Company's
forbearance and deferment practices enabled it to, among other things, lower its
delinquency rates to facilitate the securitization of its loans which
purportedly allowed the Company to collect interest income from its securitized
loans and inflate its financial results and market price of its common stock.
The consolidated amended class action complaint seeks unspecified compensatory
damages, costs and expenses related to bringing the action, and other
unspecified relief.
On March 15, 2004, a shareholder derivative action was filed against the
Company, as a nominal defendant, and its director and Chief Executive Officer,
Anthony Santilli, its Chief Financial Officer, Albert Mandia, its directors,
Messrs. Becker, DeLuca and Sussman, and its former director, Mr. Kaufman, as
defendants, in the United States District Court for the Eastern District of
Pennsylvania. The lawsuit was brought nominally on behalf of the Company, as a
shareholder derivative action, alleging that the named directors and officers
breached their fiduciary duties to the Company, engaged in the abuse of control,
gross mismanagement and other violations of law during the period from January
27, 2000 through June 25, 2003. The lawsuit seeks unspecified compensatory
damages, equitable or injunctive relief and costs and expenses related to
bringing the action, and other unspecified relief. The parties have agreed to
stay this case pending disposition of any motion to dismiss the consolidated
amended complaint filed in the putative consolidated securities class action.
Procedurally, these lawsuits are in a very preliminary stage. The Company
believes that it has several defenses to the claims raised by these lawsuits and
intends to vigorously defend the lawsuits. Due to the inherent uncertainties in
litigation and because the ultimate resolution of these proceedings is
influenced by factors outside of its control, the Company is currently unable to
predict the ultimate outcome of this litigation or its impact on its financial
position, results of operations or cash flows.
254
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
18. 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
272,264 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 272,264 shares of the Company's stock,
and is shown as a reduction of stockholders' equity on the accompanying balance
sheet.
In February 2003, the Company awarded 2,000 shares (2,200 shares after the
effect of subsequent stock dividends) of its common stock to each of two newly
appointed members of its Board of Directors.
The Company currently employs members of the immediate family of one of its
directors (who is also an executive officer) and one of its executive officers
(such director and executive officer are married to each other) in various
officer and non-officer positions and currently employs a member of the
immediate family of another executive officer in a non-officer position. The
Company previously employed one member of the immediate family of one
non-employee director, one non-director executive office, and the director and
executive officer referred to in the previous sentence. The Company believes
that the salaries paid to these individuals have been and are competitive with
salaries paid to other employees in similar positions within the Company and in
its industry.
The Company has had, but does not currently have, a business relationship with
members of the immediate family of the director and executive officer referred
to in the first sentence of the previous paragraph pursuant to which the Company
purchased appraisal services, office equipment and real estate advisory
services. These related party transactions were not individually or collectively
material to the Company's results of operations. A business owned by a family
member of the director and executive officer referred to above is listed on an
approved appraiser list for the Company's subsidiaries and as such is eligible
to be chosen by mortgage applicants for appraisal services in connection with a
loan transaction with the Company's lending subsidiaries.
19. 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,
2004 and 2003 (in thousands):
255
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
19. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
JUNE 30, 2004 JUNE 30, 2003
----------------------- -----------------------
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
-------- ---------- --------- ----------
ASSETS
Cash and cash equivalents $ 910 $ 910 $ 36,590 $ 36,590
Restricted cash 13,307 13,307 10,885 10,885
Loans available for sale 304,275 309,039 263,419 296,346
Interest-only strips 459,086 459,086 598,278 598,278
Servicing rights 73,738 78,884 119,291 119,291
Investments held to maturity 839 839 881 946
LIABILITIES
Subordinated debentures, senior
collateralized subordinated notes,
warehouse lines and notes payable $847,448 $ 846,238 $ 932,456 $ 931,302
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.
RESTRICTED CASH - For these short-term instruments, the carrying amount
approximates fair value.
LOANS AVAILABLE FOR SALE - Fair value is determined by reference to
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
of the underlying loans and leases.
INVESTMENTS HELD TO MATURITY - Represent mortgage loan backed securities
retained in securitizations. Fair value for June 30, 2004 was equal to
the investments' cost basis which was recovered in cash received in July
2004 due to the clean-up call and collapse of the securitization trust
that had issued these investments. Fair value for June 30, 2003 was
determined using estimated 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 DEBENTURES, SENIOR COLLATERALIZED SUBORDINATED NOTES,
WAREHOUSE LINES AND NOTES PAYABLE - The fair value of fixed debt is
estimated using the rates currently available to the Company for debt of
similar terms.
256
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
19. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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, 2004 $ 839 $ - $ - $ 839
June 30, 2003 $ 881 $ 65 $ - $ 946
These mortgage backed securities were repaid in July 2004.
20. DERIVATIVE FINANCIAL INSTRUMENTS
On July 1, 2000, the Company adopted SFAS No. 133, which establishes accounting
and reporting standards for derivative financial instruments and hedging
activities. The following disclosures summarize the Company's accounting and
reporting for derivative financial instruments qualifying and classified as
hedging activities and derivative financial instruments classified as trading
activities.
HEDGE ACCOUNTING
RELATED TO LOANS EXPECTED TO BE SOLD THROUGH SECURITIZATIONS. Derivative
contracts may be specifically designated as hedges of mortgage loans, which the
Company expects to be included in a term securitization at a future date. At
June 30, 2004 and 2003, the Company did not have any outstanding derivative
financial instruments designated as hedges of mortgage loans expected to be sold
through securitization.
RELATED TO LOANS EXPECTED TO BE SOLD THROUGH WHOLE LOAN SALE TRANSACTIONS. The
Company may 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. The Company may hedge the effect of changes in market interest
rates with forward sale agreements, Eurodollar futures, forward starting
interest rate swaps, forward treasury
257
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
20. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
sales or derivative contracts of similar underlying securities.
In March 2004, the Company entered into a forward sale agreement providing for
the sale of $300.0 million of home mortgage loans and business purpose loans at
a price of 104.4%. The Company sold loans under this commitment in the amount of
$224.0 million during the month of March 2004 and $51.6 million during the month
of April 2004, satisfying its commitment under this forward sale agreement, and
recognizing net gains of $8.4 million.
In May 2004, the Company entered into a forward sale agreement providing for the
sale of $175.0 million of home mortgage loans at a price of 101.6%. The Company
sold loans under this commitment in the amount of $92.9 million during the month
of May 2004 and $67.5 million during the month of June 2004, satisfying its
commitment under this forward sale agreement, and recognizing net gains of $1.8
million on the loans sold in the quarter ended June 30, 2004.
On June 28, 2004, the Company entered into a forward sale agreement providing
for the sale of $275.0 million of home mortgage loans at a price of 101.5%. The
Company expects to satisfy this commitment during July and August 2004 with
loans recorded on its balance sheet at June 30, 2004. No gains or losses were
recognized on this forward sale agreement at June 30, 2004.
DISQUALIFIED HEDGING RELATIONSHIP IN FISCAL 2003. 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 derivatives designated as a hedge of mortgage loans
previously expected to be securitized would not be achieved, and it discontinued
hedge accounting for $170.0 million of forward starting interest rate swaps.
Losses of $4.0 million on these $170.0 million of interest rate swaps were
charged to the Statement of Income in the fourth quarter of fiscal 2003. An
offsetting increase of $3.7 million in the value of the hedged mortgage loans
was also recorded in the Statement of Income, representing the change in fair
value of the loans for the hedged risk until the date that the Company learned
that the securitization market was not available. The $170.0 million of interest
rate swaps were reclassified as trading contracts.
SUMMARY OF HEDGE ACCCOUNTING. The Company recorded the following gains and
losses on the fair value of derivative financial instruments accounted for as
hedging transactions for the years ended June 30, 2004, 2003 and 2002.
Ineffectiveness related to qualified hedging relationships during each 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):
258
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
20. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
YEAR ENDED JUNE 30,
------------------------------
2004 2003 2002
-------- ------- --------
Gains and losses on derivatives recorded in
securitization gains and offset by gains and losses
recorded on loan securitizations:
Losses on derivative financial instruments $ -- $(3,806) $ (9,401)
Recorded in gains and losses on derivative financial
instruments:
Gains (losses) on derivative financial instruments $ 1,157 $(7,037) $ --
Gains (losses) on hedged loans $(2,283) $ 6,160 $ --
Amount settled in cash - received (paid) $ 656 $(5,041) $ (9,401)
At June 30, 2004 and 2003, the notional amounts of forward sale agreements,
Eurodollar futures contracts and forward starting interest rate swap contracts
accounted for as hedges and unrealized gains and losses recorded as assets or
liabilities on the balance sheet were as follows (in thousands):
JUNE 30, 2004 JUNE 30, 2003
---------------------------- ---------------------------
NOTIONAL UNREALIZED NOTIONAL UNREALIZED
AMOUNT (LOSS) AMOUNT (LOSS)
-------- ---------- -------- ----------
Forward loan sale agreement $ 275,000 $ -- $ 275,000 $ --
Eurodollar futures contracts $ 27,962 $ (103) $ -- $ --
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 settled in cash by June 30, 2003.
The sensitivity of the Eurodollar futures contracts classified as fair value
hedges as of June 30, 2004 to a 0.1% change in market interest rates is $9
thousand.
TRADE ACCOUNTING
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. The 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
259
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
20. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
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. During the year ended June 30, 2004, the Company did not
utilize derivative financial instruments to protect future securitization
spreads on loans in its pipeline.
RELATED TO LOANS EXPECTED TO BE SOLD THROUGH WHOLE LOAN SALE TRANSACTIONS.
During fiscal 2004 and 2003, the Company used Eurodollar futures contracts or
interest rate swap contracts to manage interest rate risk on loans in its
pipeline or loans expected to be sold in whole loan sale transactions.
Forward starting interest rate swap contracts with a notional amount of $170.0
million were carried over from a fiscal 2003 disqualified hedging relationship.
These forward starting interest rate swap contracts were used to manage the
effect of changes in market interest rates on the fair value of fixed-rate
mortgage loans that were sold in the first quarter of fiscal 2004 and the
contracts were closed in that quarter. The Company had elected not to designate
these derivative contracts as an accounting hedge.
SUMMARY OF TRADING ACTIVITY. The following gains and losses were recorded on the
fair value of derivative financial instruments classified as trading for the
years ended June 30, 2004 and 2003. There were no derivative contracts
classified as trading for the year ended June 30, 2002 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):
YEAR ENDED JUNE 30,
---------------------------
2004 2003
----------- -----------
Trading gains(losses) on Eurodollar futures contracts:
Related to loan pipeline $ (1,425) $ --
Trading gains (losses) on forward starting interest rate swaps:
Related to loan pipeline $ -- $ (3,796)
Related to whole loan sales $ 5,097 $ 441
Amount settled in cash - (paid) $ (1,187) $ (2,671)
At June 30, 2004 and 2003, outstanding Eurodollar futures contracts or forward
starting interest rate swap contracts used to manage interest rate risk on loans
in the Company's pipeline or loans expected to be sold in whole loan sale
transactions and the associated unrealized gains and losses recorded as assets
and liabilities on the balance sheet are summarized in the table below. (in
thousands):
260
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
20. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
JUNE 30, 2004 JUNE 30, 2003
---------------------------- ---------------------------
NOTIONAL UNREALIZED NOTIONAL UNREALIZED
AMOUNT (LOSS) AMOUNT GAIN
-------- ---------- -------- ----------
Eurodollar futures contracts $ 202,038 $ (851) $ -- $ --
Forward starting interest rate swaps $ -- $ -- $ 170,000 $ 441
The sensitivity of the Eurodollar futures contracts held as trading as of June
30, 2004 to a 0.1% change in market interest rates is $66 thousand.
RELATED TO INTEREST-ONLY STRIPS. The Company had an interest rate swap contract,
which was not designated as an accounting hedge, designed to reduce the exposure
to changes in the fair value of certain interest-only strips due to changes in
one-month LIBOR. This contract matured in April 2004. Unrealized gains and
losses on the interest rate swap contract were due to changes in the interest
rate swap yield curve during the periods the contract was in place. Net gains
and losses on this interest rate swap contract included the amount of cash
settlement with the contract counter party each period. Net gains and losses
recorded on this interest rate swap contract for the fiscal years ended June 30,
2004, 2003 and 2002 were as follows (in thousands):
YEAR ENDED JUNE 30,
---------------------------------
2004 2003 2002
----- ------- ------
Unrealized gain (loss) on interest rate swap contract $ 335 $ 127 $ (460)
Cash interest received (paid) on interest rate swap contract (307) (1,038) (266)
----- ------- ------
Net gain (loss) on interest rate swap contract $ 28 $ (911) $ (726)
====== ======= ======
261
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
21. RECONCILIATION OF BASIC AND DILUTED EARNINGS PER COMMON SHARE
YEAR ENDED JUNE 30,
2004 2003 2002
-----------------------------------------
(in thousands except per share data)
(Numerator)
EARNINGS (LOSS)
Net income (loss) attributable to common
shares $ (115,146) $ (29,902) $ 7,859
=========================================
(Denominator)
Average Common Shares:
Average common shares outstanding 3,380 3,210 3,227
Average potentially dilutive shares (A) (B) 244
-----------------------------------------
Average common and potentially dilutive
shares 3,380 3,210 3,471
=========================================
Earnings (loss) per common share:
Basic: $ (34.07) $ (9.32) $ 2.44
Diluted: $ (34.07) $ (9.32) $ 2.26
(a) 3,238,634 shares anti-dilutive in fiscal year 2004.
(b) 135,708 shares anti-dilutive in fiscal year 2003.
262
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
22. 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 debenture
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.
263
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
22. SEGMENT INFORMATION (CONTINUED)
YEAR ENDED JUNE 30, 2004
------------------------------------------------------------------------------------------
LOAN TREASURY AND RECONCILING
ORIGINATION FUNDING SERVICING ALL OTHER ITEMS CONSOLIDATED
------------------------------------------------------------------------------------------
(in thousands)
External revenues:
Gain on sale of loans:
Securitizations $ 15,107 $ - $ - $ - $ - $ 15,107
Whole loan sales
18,725 - - - - 18,725
Interest income 11,975 61 493 40,548 - 53,077
Non-interest income 3,875 2 44,266 746 (38,726) 10,163
Inter-segment revenues - 61,788 - 45,005 (106,793) -
Operating expenses:
Interest expense 23,090 63,961 (877) 43,752 (61,788) 68,138
Non-interest expense 69,733 9,922 36,821 38,592 - 155,068
Depreciation and amortization 2,264 68 851 3,955 - 7,138
Interest-only strips valuation
adjustment - - - 46,450 - 46,450
Inter-segment expense 83,731 - - - (83,731) -
Income tax expense (benefit) (49,072) (4,598) 3,026 (17,650) - (68,294)
-----------------------------------------------------------------------------------------
Income (loss) before dividends on
preferred stock $ (80,064) $ (7,502) $ 4,938 $ (28,800) $ - $ (111,428)
=========================================================================================
Segment assets $ 379,179 $ 239,889 $ 76,724 $ 502,534 $ (155,456) $ 1,042,870
=========================================================================================
264
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
22. 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 8,463 422 762 48,195 - 57,842
Non-interest income 8,385 4 45,480 (90) (41,820) 11,959
Inter-segment revenues - 75,422 - 63,259 (138,681) -
Operating expenses:
Interest expense 20,324 66,526 2,467 54,203 (75,422) 68,098
Non-interest expense 65,599 7,379 42,542 52,978 - 168,498
Depreciation and amortization 3,189 108 1,168 4,183 - 8,648
Interest-only strips valuation
adjustment - - - 45,182 - 45,182
Inter-segment expense 105,079 - - - (105,079) -
Income tax expense (benefit) (2,238) 716 25 (17,621) - (19,118)
-----------------------------------------------------------------------------------------
Income (loss) before dividends
on preferred stock $ (3,500) $ 1,119 $ 40 $ (27,561) $ - $ (29,902)
=========================================================================================
Segment assets $ 346,434 $ 156,082 $ 111,254 $ 642,150 $ (96,569) $ 1,159,351
=========================================================================================
265
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
22. 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 6,486 998 1,309 36,099 - 44,892
Non-interest income 8,377 1 35,387 923 (29,707) 14,981
Inter-segment revenues - 70,586 - 70,368 (140,954) -
Operating expenses:
Interest expense 21,299 67,256 298 50,416 (70,586) 68,683
Non-interest expense 40,793 10,041 31,375 54,489 - 136,698
Depreciation and amortization 3,195 142 1,095 2,485 - 6,917
Interest-only strips valuation
adjustment - - - 22,053 - 22,053
Inter-segment expense 100,075 - - - (100,075) -
Income tax expense (benefit) 15,762 (2,459) 1,650 (9,262) - 5,691
-----------------------------------------------------------------------------------------
Income (loss) before dividends
on preferred stock $ 21,767 $ (3,395) $ 2,278 $ (12,791) $ - $ 7,859
=========================================================================================
Segment assets $ 87,495 $ 202,621 $ 124,914 $ 549,472 $ (88,127) $ 876,375
=========================================================================================
266
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
23. 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 2004 QUARTER ENDED
-----------------------------------------------------------------
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
-----------------------------------------------------------------
REVENUES
Gain on sale of loans:
Securitizations $ - $ - $ 14,308 $ 799
Whole sale loans 6,394 9,332 78 2,921
Interest and fees 6,042 4,870 2,167 4,653
Interest accretion on interest-only
strips 9,234 9,605 10,228 11,109
Servicing income 1,040 1,283 1,809 718
Other income 2 478 1 1
---------------------------------------------------------------
Total revenues 22,712 25,568 28,591 20,201
Total expenses (a) 69,336 76,262 68,627 62,569
---------------------------------------------------------------
Income (loss) before provision for
income tax expense (46,624) (50,694) (40,036) (42,368)
Provision for income tax expense
(benefit) (17,717) (19,263) (15,214) (16,100)
---------------------------------------------------------------
Income (loss) before dividends on
preferred Stock (28,907) (31,431) (24,822) (26,268)
Dividends on preferred Stock 1,967 1,751 - -
---------------------------------------------------------------
Net income (loss) attributable to
common stock $ (30,874) $ (33,182) $ (24,822) $ (26,268)
===============================================================
Earnings (loss) per common share:
Basic $ (8.81) $ (9.57) $ (7.59) $ (8.10)
Diluted $ (8.81) $ (9.57) $ (7.59) $ (8.10)
(a) Includes pre-tax adjustments to the fair value of securitization assets of
$8.6 million, $15.1 million, $12.0 million and $10.8 million for the
quarters ended June 30, March 31, December 31 and September 30,
respectively.
267
AMERICAN BUSINESS FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2004
23. QUARTERLY DATA STATEMENT (UNAUDITED) (CONTINUED)
FISCAL 2003 QUARTER ENDED
-----------------------------------------------------------------
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
-----------------------------------------------------------------
REVENUES
Gain on sale of loans:
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) attributable to
common stock $ (34,055) $ 221 $ 2,111 $ 1,821
===============================================================
Earnings (loss) per common share:
Basic $ (10.62) $ 0.07 $ 0.72 $ 0.64
Diluted $ (10.62) $ 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 million and $12.1 million for the
quarters ended June 30, March 31, December 31 and September 30,
respectively.
268
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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 Exchange Act is recorded, processed, summarized and
reported within the time period specified in the Securities and Exchange
Commission's rules and forms.
There has been no changes in internal control over financial reporting
("Internal Control") during the quarter covered by this report that have
materially affected or which are reasonably likely to materially affect Internal
Controls.
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.
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 2004 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 "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.
269
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, 2004, our officers, directors
and greater than 10% beneficial owners have complied with all Section 16(a)
filing requirements, except that Messrs. Becker and Epstein filed late one
Form 4.
CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS
The Board of Directors adopted the Code of Ethics for Senior Financial
Officers that applies to our Chief Executive Officer (i.e., principal executive
officer), Chief Financial Officer (i.e., principal financial officer), principal
accounting officer, controller and any other person performing similar
functions. A copy of the Code of Ethics for Senior Financial Officers is
attached to this Form 10-K as Exhibit 14.
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 2004 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 2004 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.
The following table details information regarding our existing equity
compensation plans as of June 30, 2004 (all share information has been adjusted
to reflect all stock dividends):
Number of Number of securities
securities remaining available for
issued or to be Weighted-average future issuance under
issued upon exercise equity compensation
exercise of price of plans (excluding
outstanding outstanding securities reflected in
options options column (a))
PLAN CATEGORY: (a) (b) (c)
-------------- ----------------- -------------- -------------------------
Equity compensation plans approved by
security holders
Stock Option Plans...................... 961,382(1) $ 7.08 --
Restricted Stock Plan................... 175,625(2) -- 1,997(3)
Equity compensation plans not approved
by security holders
Stock Option Plans...................... 104,328(4) $ 3.16 --
Restricted Stock Grants................. 224,400(5) -- --
--------- ------
Total.................................... 1,465,735 1,997
========= ======
- ------------
(1) Includes options granted pursuant to the Amended and Restated 1993
Stock Option Plan ("1993 Plan"), the 1995 Stock Option Plan for
Non-Employee Directors ("1995 Plan"), and the Amended and Restated 1999
Stock Option Plan ("1999 Plan"). Excludes all expired or terminated
options under all stock plans. No further options will be granted under
the 1993 Plan or 1995 Plan, which have expired except for terms
governing the administration of outstanding options. We intend for
further options to be granted under the 1999 Plan, provided
stockholders approve a proposal to increase the number of shares of
common stock authorized for issuance under the 1999 Plan at the next
Annual Meeting of Stockholders (the "1999 Plan Proposal"). Does not
include 38,444 shares of common stock issued under, and held as of June
30, 2004 by, the American Business Credit, Inc. 401(k) Plan.
270
(2) Common stock awarded under the 2001 Stock Incentive Plan.
(3) Common stock remaining available for awards under the 2001 Stock
Incentive Plan.
(4) Consists entirely of common stock issuable upon the exercise of the
following stock options which were granted under the 1999 Plan subject
to stockholder approval of the 1999 Plan Proposal: options for 54,999
shares at an exercise price of $3.40 per share; options for 22,000
shares at an exercise price of $3.33 per share; and options for 27,329
shares at an exercise price of $3.17 per share.
(5) Includes grants of 2,000 shares (2,200 shares after the effect of stock
dividends) of common stock issued to each of Warren E. Palitz, a
current director, and Jeffrey S. Steinberg, a former director, in
consideration for their board service. Also includes 200,000 shares
(220,000 shares after the effect of stock dividends) granted to Mr.
Epstein, Managing Director of the National Wholesale Residential
Mortgage Division, subject to forfeiture and performance-based vesting
requirements pursuant to Mr. Epstein's employment agreement.
One-hundred thousand (100,000) of these shares (110,000 shares after
the effect of stock dividends) have vested and are no longer subject to
forfeiture.
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 2004 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 2004 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.
271
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation.
(Incorporated by reference from Appendix A to the
Registrant's Definitive Proxy Statement for its 2003 Annual
Meeting of Stockholders filed December 11, 2003).
3.2 Certificate of Designation, Preferences and Rights of Series
A Convertible Preferred Stock. (Incorporated by reference
from Appendix B to the Registrant's Definitive Proxy
Statement for its 2003 Annual Meeting of Stockholders filed
December 11, 2003).
3.3 Amended and Restated Bylaws. (Incorporated by reference from
Exhibit 3.1 of the Registrant's Current Report on Form 8-K
dated September 17, 2004).
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).
272
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
4.7 Form of Unsecured Investment Note (Incorporated by reference
from Exhibit 4.5 of the Registration Statement on Form SB-2
filed May 23, 1997, Registration Number 333-24115).
4.8 Form of Indenture by and between ABFS and U.S. Bank Trust,
National Association, a national banking association
(Incorporated by reference from Exhibit 4.8 of 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).
273
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
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).
4.19 Indenture dated December 31, 2003 by and between ABFS and
U.S. Bank National Association as Trustee. (Incorporated by
reference from Exhibit 4.2 of Registrant's Quarterly Report
on Form 10-Q for the period ended December 31, 2003, filed
on February 27, 2004).
4.20 Form of Senior Collateralized Subordinated Note.
(Incorporated by reference from Exhibit T3E-5 of
Registrant's Application for Qualification of Indenture
under the Trust Indenture Act of 1939 on Form T-3, filed on
December 1, 2003).
4.21 Form of Indenture by and between ABFS and U.S. Bank National
Association. (Incorporated by reference from Exhibit T3C of
Registrant's Application for Qualification of Indenture
under the Trust Indenture Act of 1939 on Form T-3, filed on
May 14, 2004).
4.22 Form of Senior Collateralized Subordinated Note.
(Incorporated by reference from Exhibit T3E-5 of
Registrant's Application for Qualification of Indenture
under the Trust Indenture Act of 1939 on Form T-3, filed on
May 14, 2004).
10.1 Amended and Restated Stock Option Plan (Incorporated by
reference from Exhibit 10.2 of the Registrant's Quarterly
Report on Form 10-QSB from the quarter ended September 30,
1997, filed on November 14, 1997 (the "09/30/97 Form
10-QSB")). **
10.2 Stock Option Award Agreement (Incorporated by reference from
Exhibit 10.1 of the Registrant's 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 Registrant's 1996 Form SB-2 filed on
February 4, 1997 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 Registrant's Annual Report on Form
10-KSB for the period ended June 30, 1996, filed on
September 27, 1996 (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 Registrant's 09/30/97 Form 10-QSB). **
274
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
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 Registrant's Registration Statement
on Form SB-2 filed on 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 the
Registrant's 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 Registrant's 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
Registrant's 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 Registrant's 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
Registrant's 1996 Form SB-2). **
10.12 Amendment One to Anthony J. Santilli's Employment Agreement
(Incorporated by reference from Exhibit 10.3 of the
Registrant's 09/30/97 Form 10-QSB). **
10.13 Amendment One to Beverly Santilli's Employment Agreement
(Incorporated by reference from Exhibit 10.4 of the
Registrant's 09/30/97 Form 10-QSB). **
10.14 Management Incentive Plan (Incorporated by reference from
Exhibit 10.16 of the Registrant's 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 Registrant's
1996 Form SB-2). **
10.16 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 Registrant's 03/31/95 Form 10-QSB).
275
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.17 Form of Indenture related to the Company's loan
securitizations dated 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
Registrant's Registration Statement on Form S-2 filed June
14, 2001, Registration No. 333-63014 (the "2001 Form S-2")).
10.18 Form of Unaffiliated Seller's Agreement related to the
Company's loan securitizations dated 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 Registrant's 2001 Form S-2).
10.19 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 Registrant's 1997 Form SB-2).
10.20 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 Registrant's 1997 Form SB-2).
10.21 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 Registrant's 1997 Form SB-2).
10.22 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 Registrant's
Registration Statement on Form SB-2, filed on January 22,
1998, Registration No. 333-2445).
10.23 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 Registrant's Registration Statement on Form SB-2,
filed on January 22, 1998, Registration No. 333-2445).
10.24 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 on September 21,
1998).
10.25 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 Registrant's 2001 Form S-2).
276
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.26 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).
10.27 Lease Agreement dated August 30, 1999 related to One
Presidential Boulevard, Bala Cynwyd, Pennsylvania
(Incorporated by reference from Exhibit 10.1 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1999, filed on November 15, 1999 (the
"09/30/99 Form 10-Q")).
10.28 Employment Agreement between American Business Financial
Services, Inc. and Albert Mandia (Incorporated by reference
from Exhibit 10.2 of the Registrant's 09/30/99 Form 10-Q).
**
10.29 Change in Control Agreement between American Business
Financial Services, Inc. and Albert Mandia (Incorporated by
reference from Exhibit 10.3 of the Registrant's 09/30/99
Form 10-Q). **
10.30 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). **
10.31 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 Quarterly Report on Form 10-Q for the quarter
ended March 31, 2000, filed on May 12, 2000).
10.32 Warehousing Credit and Security Agreement dated as of May 5,
2000 between New Jersey Mortgage and Investment Corp.,
American Business Credit, Inc., HomeAmerican Credit, Inc.
d/b/a Upland Mortgage and Residential Funding Corporation.
(Incorporated by reference from Exhibit 10.63 of the
Registrant's Registration Statement on Form S-2, No.
333-40248, filed on June 27, 2000).
10.33 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
Registrant's 2000 Form 10-K).
10.34 Employment Agreement by and between American Business
Financial Services, Inc. and Milton Riseman (Incorporated by
reference from Exhibit 10.66 of the Registrant's 2000 Form
10-K). **
277
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.35 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 Registrant's Registration Statement
on Form S-2, No. 333-40248, filed April 5, 2001 (the
"Amendment to the 2001 Form S-2")).
10.36 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 the
Registrant's Amendment to the 2001 Form S-2).
10.37 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 the Registrant's Amendment
to the 2001 Form S-2).
10.38 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
the Registrant's Amendment to the 2001 Form S-2).
278
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.39 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 the
Registrant's Amendment to the 2001 Form S-2).
10.40 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 Registrant's Annual Report on Form 10-K
for the fiscal year ended June 30, 2001, filed on September
28, 2001).
10.41 Letter Agreement dated July 1, 2000 between ABFS and Albert
W. Mandia. (Incorporated by reference from Exhibit 10.61 of
Amendment No. 1 to the Registrant's Registration Statement
on Form S-2 filed on October 5, 2001). **
10.42 American Business Financial Services, Inc. 2001 Stock
Incentive Plan. (Incorporated by reference from Exhibit 10.1
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2001, filed on November 14, 2001
(the "September 2001 Form 10-Q")).**
10.43 American Business Financial Services, Inc. 2001 Stock
Incentive Plan Restricted Stock Agreement. (Incorporated by
reference from Exhibit 10.2 of the Registrant's September
2001 Form 10-Q).**
10.44 American Business Financial Services, Inc. 2001 Executive
Management Incentive Plan. (Incorporated by reference from
Exhibit 10.3 of the Registrant's September 2001 Form
10-Q).**
10.45 Master Repurchase Agreement between Credit Suisse First
Boston Mortgage Capital LLC and ABFS Repo 2001, Inc.
(Incorporated by reference from Exhibit 10.2 of the
Registrant's December 2001 Form 10-Q).
10.46 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 of the Registrant's December 2001 Form 10-Q).
279
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.47 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 of the Registrant's December
2001 Form 10-Q).
10.48 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 of the
Registrant's December 2001 Form 10-Q).
10.49 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 of 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").
10.50 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 of the Registrant's March 2002 Form 10-Q).
10.51 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 of the Registrant's March 2002 Form 10-Q).
10.52 $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 of the Registrant's March 2002 Form 10-Q).
10.53 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).
280
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.54 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 the Registrant's Registration Statement on Form
S-2, No. 33-90366, filed on June 12, 2002 (the "2002 Form
S-2")).
10.55 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 Registrant's 2002 Form
S-2).
10.56 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 Registrant's 2002 Form S-2).
10.57 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
Registrant's 2002 Form S-2).
10.58 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 of the 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")).
10.59 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 of the
Registrant's 2002 Form 10-K).
281
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.60 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 of the Registrant's 2002 Form
10-K).
10.61 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 of
the Registrant's 2002 Form 10-K).
10.62 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 of the
Registrant's 2002 Form 10-K).
10.63 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 of the
Registrant's 2002 Form 10-K).
10.64 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
from Exhibit 10.1 of the Registrant's Current Report on Form
8-K, dated December 9, 2002, filed on December 27, 2002).
10.65 Letter Agreement dated May 20, 2002 between the Registrant
and the Commonwealth of Pennsylvania. (Incorporated by
reference from Exhibit 10.2 of the Registrant's Current
Report on Form 8-K, dated December 9, 2002, filed on
December 27, 2002).
10.66 Letter of Intent with PIDC Local Development Corporation
dated December 3, 2002. (Incorporated by reference from
Exhibit 10.3 of the Registrant's Current Report on Form 8-K,
dated December 9, 2002, filed on December 27, 2002).
10.67 Letter of Credit from JPMorgan Chase Bank for $6,000,000
provided as security for a lease for office space.
(Incorporated by reference from Exhibit 10.4 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended December 31, 2002, filed on February 14, 2003 (the
"12/31/02 Form 10-Q")).
282
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.68 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 from Exhibit
10.5 to the Registrant's 12/31/02 Form 10-Q).
10.69 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 from Exhibit 10.2 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003,
filed on May 15, 2003 (the "03/31/03 Form 10-Q")).
10.70 Amendment No. 3 to Letter of Credit Agreement with JP Morgan
Chase (Incorporated by reference from Exhibit 10.1 to the
Registrant's 03/31/03 Form 10-Q).
10.71 First Amendment to the Roseland Lease (Incorporated by
reference from Exhibit 10.3 of the Registrant's 03/31/03
Form 10-Q).
10.72 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 (the 06/25/03
Form S-2")).
10.73 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 06/25/03 Form S-2).
10.74 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 06/25/03 Form S-2).
283
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.75 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 06/25/03 Form S-2).
10.76 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 06/25/03 Form S-2).
10.77 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 06/25/03 Form S-2).
10.78 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.
(Incorporated by reference from Exhibit 10.99 of the
Registrant's Annual Report on Form 10-K for the year ended
June 30, 2003, filed on September 29, 2003 (the "2003 Form
10-K")).
10.79 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. (Incorporated by reference from Exhibit 10.100
of the Registrant's 2003 Form 10-K).
10.80 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. (Incorporated by reference from Exhibit
10.101 of the Registrant's 2003 Form 10-K).
284
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.81 Amended and Restated Committed Line of Credit Note, dated
June 2, 2003, between American Business Financial Services,
Inc. and Firstrust Savings Bank. (Incorporated by reference
from Exhibit 10.102 of the Registrant's 2003 Form 10-K).
10.82 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. (Incorporated
by reference from Exhibit 10.103 of the Registrant's 2003
Form 10-K).
10.83 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. (Incorporated by reference from Exhibit
10.104 of the Registrant's 2003 Form 10-K).
10.84 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. (Incorporated by reference from Exhibit
10.105 of the Registrant's 2003 Form 10-K).
10.85 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 from 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 Form
8-K")).
10.86 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. (Incorporated by reference from Exhibit
10.107 of the Registrant's 2003 Form 10-K).
10.87 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. (Incorporated by reference from Exhibit
10.108 of the Registrant's 2003 Form 10-K).
285
10.88 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 from Exhibit 10.2 of the
Registrant's 9/25/03 Form 8-K).
10.89 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 from Exhibit
10.3 of the Registrant's 9/25/03 Form 8-K).
10.90 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 from Exhibit 10.4 of the
Registrant's 9/25/03 Form 8-K).
10.91 Trust Agreement, dated as of September 22, 2003, by and
between ABFS BalaPointe, Inc., as Depositor and Wilmington
Trust Company, as Owner Trustee. (Incorporated by reference
from Exhibit 10.5 of the Registrant's 9/25/03 Form 8-K).
10.92 ABFS Mortgage Loan Warehouse Trust 2003-1 Secured Notes
Series 2003-1 Purchase Agreement. (Incorporated by reference
from Exhibit 10.6 of the Registrant's 9/25/03 Form 8-K).
10.93 Commitment letter dated September 22, 2003 addressed to
American Business Financial Services Inc. from Chrysalis
Warehouse Funding, LLC. (Incorporated by reference from
Exhibit 10.7 of the Registrant's 9/25/03 Form 8-K).
10.94 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 from Exhibit 10.8 of the Registrant's 9/25/03 Form
8-K).
10.95 Amendment to Senior Secured 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 from Exhibit 10.9 of the
Registrant's 9/25/03 Form 8-K).
10.96 Waiver dated September 30, 2003 to Indenture, dated
September 22, 2003 between ABFS Mortgage Loan Warehouse
Trust 2003-1 and JP Morgan Chase Bank, as Indenture Trustee.
(Incorporated by reference from Exhibit 10.13 of the
Registrant's Current Report on From 8-K, filed on October
16, 2003 (the "10/16/03 Form 8-K")).
286
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.97 First Amendment to First Amended and Restated Warehousing
Credit and Security Agreement, dated September 30, 2003,
between American Business Credit, Inc., American Business
Mortgage Services, Inc. and HomeAmerican Credit, Inc. and
Residential Funding Corporation. (Incorporated by reference
from Exhibit 10.12 of the Registrant's 10/16/03 Form 8-K).
10.98 Term-to-Term Servicing Agreement, Waiver and Consent dated
as of September 30, 2003 between American Business Credit,
Inc., MBIA Insurance Corporation as Note Insurer and JP
Morgan Chase Bank as Trustee. (Incorporated by reference
from Exhibit 10.14 of the Registrant's 10/16/03 Form 8-K).
10.99 Extension of the Expiration Date dated September 30, 2003
under the Master Repurchase Agreement between Credit Suisse
First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc.
from Credit Suisse First Boston Mortgage Capital LLC to ABFS
Repo 2001, Inc. (Incorporated by reference from Exhibit
10.10 of the Registrant's 10/16/03 Form 8-K).
10.100 Extension of the Expiration Date dated October 10, 2003
under the Master Repurchase Agreement between Credit Suisse
First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc.
from Credit Suisse First Boston Mortgage Capital LLC to ABFS
Repo 2001, Inc. (Incorporated by reference from Exhibit
10.11 of the Registrant's 10/16/03 Form 8-K).
10.101 Waiver dated October 3, 2003 to Indenture dated September
22, 2003 between ABFS Mortgage Loan Warehouse Trust 2003-1
and JP Morgan Chase Bank, as Indenture Trustee.
(Incorporated by reference from Exhibit 10.8 of the
Registrant's 10/16/03 Form 8-K).
10.102 Master Loan and Security Agreement dated as of October 14,
2003 between ABFS Warehouse Trust 2003-2 and Chrysalis
Warehouse Funding, LLC. (Incorporated by reference from
Exhibit 10.1 of the Registrant's 10/16/03 Form 8-K).
10.103 Asset Purchase Agreement dated as of October 14, 2003
between ABFS Warehouse Trust 2003-1 and ABFS Warehouse Trust
2003-2. (Incorporated by reference from Exhibit 10.2 of the
Registrant's 10/16/03 Form 8-K).
10.104 Asset Purchase Agreement dated as of October 14, 2003 among
HomeAmerican Credit, Inc., d/b/a Upland Mortgage, American
Business Mortgage Services, Inc., and American Business
Credit, Inc., as Sellers and ABFS Warehouse Trust 2003-1, as
Purchaser. (Incorporated by reference from Exhibit 10.3 of
the Registrant's 10/16/03 Form 8-K).
287
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.105 Amended and Restated Trust Agreement between HomeAmerican
Credit, Inc., American Business Mortgage Services, Inc., as
Depositors, and American Business Credit, Inc., ABFS
Consolidated Holdings, Inc., as IOS Depositor and Wilmington
Trust Company, as Owner Trustee. (Incorporated by reference
from Exhibit 10.4 of the Registrant's 10/16/03 Form 8-K).
10.106 Trust Agreement between ABFS Warehouse Trust 2003-1 and
Wilmington Trust Company. (Incorporated by reference from
Exhibit 10.5 of the Registrant's 10/16/03 Form 8-K).
10.107 Fee and Right of First Refusal Letter addressed to ABFS
Warehouse Trust 2003-1, ABFS Warehouse Trust 2003-2,
American Business Financial Services, Inc. and its
subsidiaries from Clearwing Capital, LLC. (Incorporated by
reference from Exhibit 10.7 of the Registrant's 10/16/03
Form 8-K).
10.108 Waiver dated as of October 8, 2003 to Indenture dated
September 22, 2003 between ABFS Mortgage Loan Warehouse
Trust 2003-1 and JP Morgan Chase Bank, as Indenture Trustee.
(Incorporated by reference from Exhibit 10.9 of the
Registrant's 10/16/03 Form 8-K).
10.109 Pledge and Security Agreement dated as of October 14, 2003
between ABFS Warehouse Trust 2003-1 and Clearwing Capital,
LLC. (Incorporated by reference from Exhibit 10.6 of the
Registrant's 10/16/03 Form 8-K).
10.110 Servicing Agreement dated October 14, 2003 between ABFS
Warehouse Trust 2003-2, as Owner, Chrysalis Warehouse
Funding, LLC, as Lender, American Business Credit, Inc., as
Servicer, and Countrywide Home Loans Servicing LP, as Backup
Servicer. (Incorporated by reference from Exhibit 10.15 of
the Registrant's 10/16/03 Form 8-K).
10.111 Second Amended and Restated Sale and Servicing Agreement,
dated as of October 16, 2003, by and among ABFS Greenmont,
Inc., as Depositor, HomeAmerican Credit, Inc., d/b/a/ Upland
Mortgage, and American Business Mortgage Services, Inc., as
Originators and Subservicers, ABFS Mortgage Loan Warehouse
Trust 2000-2, as Trust, American Business Credit, Inc., as
Originator and Servicer, American Business Financial
Services, Inc., as Sponsor, and JPMorgan Chase Bank, as
Indenture Trustee and Collateral Agent. (Incorporated by
reference from Exhibit 10.4 of the Registrant's Current
Report on Form 8-K, filed on October 24, 2003 (the "10/24/03
Form 8-K")).
288
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.112 ABFS Mortgage Loan Warehouse Trust 2000-2 Secured Notes
Series 2000-2 Purchase Agreement, dated October, 16, 2003,
by and between ABFS Greenmont, Inc., ABFS Mortgage Loan
Warehouse Trust 2000-2 and JPMorgan Chase Bank.
(Incorporated by reference from Exhibit 10.2 of the
Registrant's 10/24/03 Form 8-K).
10.113 Fee Letter Agreement, dated October 16, 2003, addressed to
American Business Financial Services, Inc. from JPMorgan
Chase Bank. (Incorporated by reference from Exhibit 10.3 of
the Registrant's 10/24/03 Form 8-K).
10.114 Second Amended and Restated Indenture, dated as of October
16, 2003, by and between ABFS Mortgage Loan Warehouse Trust
2000-2, as Issuer, and JPMorgan Chase Bank, as Indenture
Trustee. (Incorporated by reference from Exhibit 10.1 of the
Registrant's 10/24/03 Form 8-K).
10.115 Waiver to Indenture, dated September 22, 2003, between ABFS
Mortgage Loan Warehouse Trust 2003-1 and JPMorgan Chase
Bank, as Indenture Trustee. (Incorporated by reference from
Exhibit 10.15 of the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2003, filed on
November 5, 2003).
10.116 Waiver to the 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 and to the 9/03 Amendment to
the Senior Secured Credit Agreement, among: American
Business Credit, Inc., HomeAmerican Credit, Inc., New Jersey
Mortgage and Investment Corp., American Business Financial
Services, Inc. and The Chase Manhattan Bank, as amended
(Incorporated by reference from Exhibit 10.117 of the
Registrant's Annual Report on Form 10-K/A, Amendment No. 2,
for the year ended June 30, 2003 filed on December 11, 2003
(the "12/11/03 Form 10-K/A")).
10.117 Consulting Agreement by and between ABFS and Milton Riseman,
dated July 3, 2003. (Incorporated by reference from Exhibit
10.118 of the Registrant's 12/11/03 Form 10-K/A). **
10.118 Amendment, dated December 1, 2003, to Consulting Agreement
by and between the Company and Milton Riseman, dated July 3,
2003 (Incorporated by reference from Exhibit 10.119 of the
Registrant's 12/11/03 Form 10-K/A).
10.119 Joint Agreement dated December 22, 2003 (Incorporated by
reference from Exhibit 99.2 of the Registrant's Current
Report on Form 8-K, filed on December 24, 2003).
10.120 Security Agreement dated December 31, 2003 by and among ABFS
Consolidated Holdings, Inc., American Business Mortgage
Services, Inc., HomeAmerican Credit, Inc., American Business
Credit, Inc., and U.S. Bank National Association, as
trustee. (Incorporated by reference from Exhibit 10.1 of the
Registrant's Current Report on Form 8-K filed on January 2,
2004).
289
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.121 Second Waiver Letter, dated as of October 31, 2003, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., d/b/a Upland
Mortgage ("Upland"), American Business Mortgage Services,
Inc. ("ABMS"), American Business Credit, Inc. ("ABC"), ABFS
Mortgage Loan Warehouse Trust 2003-1, as trust ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee ("Indenture Trustee") and
collateral agent, (ii) the Indenture, dated as of September
22, 2003, between the Trust and the Indenture Trustee; and
(iii) the 3/02 Amended and Restated Senior Secured Credit
Agreement, dated March 15, 2002 (as amended and supplemented
by the 10/02 Letter of Credit Supplement, the 12/02
Amendment, the 3/03 Amendment, 3/31/03 Amendment and the
9/03 Amendment), among Upland ABMS, ABC, Tiger Relocation
Company, ABFS Residual 2002, Inc., and JPMorgan Chase Bank.
(Incorporated by reference from Exhibit 10.24 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended December 31, 2003, filed on February 17, 2004 (the
"12/31/03 Form 10-Q")).
10.122 Third Waiver Letter, dated as of December 31, 2003, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., d/b/a Upland
Mortgage ("Upland"), American Business Mortgage Services,
Inc. ("ABMS"), American Business Credit, Inc. ("ABC"), ABFS
Mortgage Loan Warehouse Trust 2003-1, as trust ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee ("Indenture Trustee") and
collateral agent, (ii) the Indenture, dated as of September
22, 2003, between the Trust and the Indenture Trustee; and
(iii) the 3/02 Amended and Restated Senior Secured Credit
Agreement, dated March 15, 2002 (as amended and supplemented
by the 10/02 Letter of Credit Supplement, the 12/02
Amendment, the 3/03 Amendment, 3/31/03 Amendment and the
9/03 Amendment), among Upland, ABMS, ABC, Tiger Relocation
Company, ABFS Residual 2002, Inc., and JPMorgan Chase Bank.
(Incorporated by reference from Exhibit 10.25 of the
Registrant's 12/31/03 Form 10-Q).
10.123 Employment Agreement dated December 24, 2003, by and between
American Business Financial Services, Inc. and Barry
Epstein. (Incorporated by reference from Exhibit 10.26 of
the Registrant's 12/31/03 Form 10-Q). **
10.124 Restricted Stock Agreement dated December 24, 2003, by and
between American Business Financial Services, Inc. and Barry
Epstein. (Incorporated by reference from Exhibit 10.27 of
the Registrant's 12/31/03 Form 10-Q). **
10.125 Change in Control Agreement between the Company and Stephen
M. Giroux. (Incorporated by reference from Exhibit 10.28 of
the Registrant's 12/31/03 Form 10-Q). **
290
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.126 Form of AMENDED AND RESTATED POOLING AND SERVICING
AGREEMENT, dated as of March 5, 2004, by and among
Prudential Securities Secured Financing Corporation, in its
capacity as Depositor of the Trust ("Depositor"), American
Business Credit, Inc., in its capacity as servicer
("Servicer"), Wilshire Credit Corporation, in its capacity
as back-up servicer, and JPMorgan Chase Bank (f/k/a The
Chase Manhattan Bank), in its capacity as trustee
("Trustee"), relating to:
(i) ABFS MORTGAGE LOAN TRUST 1996-2, amending and
restating the Pooling and Servicing Agreement, dated
as of August 31, 1996, by and among the Depositor, the
Servicer and the Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1997-1, amending and
restating the Pooling and Servicing Agreement, dated
as of March 1 1997, by and among the Depositor, the
Servicer and the Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1997-2, amending and
restating the Pooling and Servicing Agreement, dated
as of September 1, 1997, by and among the Depositor,
the Servicer and the Trustee;
(iv) ABFS MORTGAGE LOAN TRUST 1998-1, amending and
restating the Pooling and Servicing Agreement, dated
as of February 1, 1998, by and among the Depositor,
the Servicer and the Trustee;
(v) ABFS MORTGAGE LOAN TRUST 1998-2, amending and
restating the Pooling and Servicing Agreement, dated
as of June 1, 1998, by and among the Depositor, the
Servicer and the Trustee;
(vi) ABFS MORTGAGE LOAN TRUST 1998-3, amending and
restating the Pooling and Servicing Agreement, dated
as of September 1, 1998, by and among the Depositor,
the Servicer and the Trustee.
(Incorporated by reference from Exhibit 10.1 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2004, filed on May 14, 2004 (the "03/31/04
Form 10-Q")).
291
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.127 Form of AMENDED AND RESTATED SALE AND SERVICING AGREEMENT,
dated as of March 5, 2004, by and among Prudential
Securities Secured Financing Corporation, as depositor (the
"Depositor"), American Business Credit, Inc., as servicer
(the "Servicer"), Wilshire Credit Corporation, as Back-up
Servicer, JPMorgan Chase Bank (f/k/a Chase Bank of Texas,
N.A.), as collateral agent (the "Collateral Agent"), The
Bank of New York, as indenture trustee (the "Indenture
Trustee"), and:
(i) ABFS MORTGAGE LOAN TRUST 1998-4, as issuer (the
"1998-4 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of November 1, 1998, by
and among the Depositor, the 1998-4 Trust, the
Servicer, the Collateral Agent and the Indenture
Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-1, as issuer (the
"1999-1 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of March 1, 1999, by and
among the Depositor, the 1999-1 Trust, the Servicer,
the Collateral Agent and the Indenture Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1999-4, as issuer (the
"1999-4 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of December 1, 1999, by
and among the Depositor, the 1999-4 Trust, the
Servicer, the Collateral Agent and the Indenture
Trustee.
(Incorporated by reference from Exhibit 10.2 of the
Registrant's 03/31/04 Form 10-Q).
10.128 Form of SUPPLEMENTAL INDENTURE NO. 1, dated as of
March 5, 2004, between The Bank Of New York, as indenture
trustee (the "Indenture Trustee") and:
(i) ABFS MORTGAGE LOAN TRUST 1998-4, as issuer
(the "1998-4 Trust"), supplementing the Indenture,
dated as of November 1, 1998, between the 1998-4
Trust and the Indenture Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-1, as issuer (the
"1999-1 Trust"), supplementing the Indenture, dated as
of March 1, 1999, between the 1999-1 Trust and the
Indenture Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1999-4, as issuer (the
"1999-4 Trust"), supplementing the Indenture, dated as
of November 1, 1999, between the 1998-4 Trust and the
Indenture Trustee.
(Incorporated by reference from Exhibit 10.3 of the
Registrant's 03/31/04 Form 10-Q).
10.129 Form of amended DEFINED TERMS, constituting Appendix I to
Exhibits 10.127 and 10.128. (Incorporated by reference from
Exhibit 10.4 of the Registrant's 03/31/04 Form 10-Q).
292
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.130 Form of AMENDED AND RESTATED SALE AND SERVICING AGREEMENT,
dated as of March 5, 2004, by and among Prudential
Securities Secured Financing Corporation, as depositor (the
"Depositor"), American Business Credit, Inc., as servicer
(the "Servicer"), Wilshire Credit Corporation, as back-up
servicer, JPMorgan Chase Bank, (f/k/a Chase Bank of Texas,
N.A.), as collateral agent (in such capacity, the
"Collateral Agent"), and JPMorgan Chase Bank (f/k/a The
Chase Manhattan Bank), as indenture trustee (in such
capacity, the "Indenture Trustee"), and:
(i) ABFS MORTGAGE LOAN TRUST 1999-2, as issuer (the
"1999-2 Trust"), amending and restating
Sale and Servicing Agreement, dated as of June 1,
1999, by and among the Depositor, the 1999-2 Trust,
the Servicer, the Collateral Agent and the Indenture
Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-3, as issuer (the
"1999-3 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of September 1, 1999, by
and among the Depositor, the 1999-3 Trust, the
Servicer, the Collateral Agent and the Indenture
Trustee.
(Incorporated by reference from Exhibit 10.5 of the
Registrant's 03/31/04 Form 10-Q).
10.131 Form of SUPPLEMENTAL INDENTURE NO. 1, dated as of March 5,
2004, between JPMorgan Chase Bank (f/k/a The Chase Manhattan
Bank), as indenture trustee (the "Indenture Trustee") and:
(i) ABFS MORTGAGE LOAN TRUST 1999-2, as issuer (the "1999-2
Trust"), supplementing the Indenture, dated as of June 1,
1999, between the 1999-2 Trust and the Indenture Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-3, as issuer (the "1999-3
Trust"), supplementing the Indenture, dated as of September
1, 1999, between the 1999-3 Trust and the Indenture Trustee.
(Incorporated by reference from Exhibit 10.6 of the
Registrant's 03/31/04 Form 10-Q).
10.132 Form of amended DEFINED TERMS, constituting Appendix I to
Exhibits 10.130 and 10.131. (Incorporated by reference from
Exhibit 10.7 of the Registrant's 03/31/04 Form 10-Q).
293
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.133 Amendment No. 1 to the POOLING AND SERVICING AGREEMENT,
SERIES 2003-1, dated as of the October 31, 2003, by and
among Bear Stearns Asset Backed Securities, Inc., as
Depositor (the "Depositor"), American Business Credit, Inc.,
as Servicer ("Servicer"), EMC Mortgage Corporation, as
Back-Up Servicer, JPMorgan Chase Bank, as Trustee and
Collateral Agent, Bear Stearns & Co. Inc., as Class A-1
Certificateholder, and Radian Asset Assurance Inc., as
Certificate Insurer, amending the Pooling And Servicing
Agreement relating to ABFS MORTGAGE LOAN TRUST 2003-1, dated
as of March 1, 2003, by and among the Depositor, the
Servicer, and JPMorgan Chase Bank, in its capacity as
trustee, collateral agent and back-up servicer.
(Incorporated by reference from Exhibit 10.8 of the
Registrant's 03/31/04 Form 10-Q).
10.134 AMENDMENT NO. 1 TO THE POOLING AND SERVICING AGREEMENT,
SERIES 2002-1, dated as of February 20, 2004, by and among
Bear Stearns Asset Backed Securities, Inc., as depositor
(the "Depositor"), American Business Credit, Inc., as
servicer ("ABC"), JPMorgan Chasse Bank, as trustee and
collateral agent (the "Trustee"), Ambac Assurance
Corporation, as Certificate Insurer and party entitled to
exercise the voting rights of the Majority, and ABFS
Warehouse Trust 2003-1, as Class R Certificateholder,
amending the POOLING AND SERVICING AGREEMENT, dated as of
March 1, 2002, by and among the Depositor, ABC and the
Trustee. (Incorporated by reference from Exhibit 10.9 of the
Registrant's 03/31/04 Form 10-Q).
294
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.135 Form of AMENDMENT NO. 1 TO THE SALE AND SERVICING AGREEMENT,
dated as of February 20, 2004, by and among, American
Business Credit, Inc., as Servicer ("ABC"), JPMorgan Chase
Bank (formerly known as The Chase Manhattan Bank), as
indenture trustee and JPMorgan Chase Bank (as successor to
Chase Bank of Texas, N.A.) as collateral agent
(collectively, the "Indenture Trustee"), Ambac Assurance
Corporation, as Note Insurer and as the party entitled to
exercise the voting rights of the Majority Noteholders, ABFS
Warehouse Trust 2003-1, as Holder of a majority of the
Percentage Interest in the Trust Certificates, and:
(i) Prudential Securities Secured Financing Corporation,
as Depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-1, as issuer (the "2000-1 Trust"), amending
the Sale and Servicing Agreement, dated as of March 1,
2000 by and among the Depositor, ABC, the Indenture
Trustee and the 2000-1 Trust;
(ii) Prudential Securities Secured Financing Corporation,
as Depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-2, as issuer (the "2000-2 Trust"), amending
the Sale And Servicing Agreement, dated as of June 1,
2000 by and among the Depositor, ABC, the Indenture
Trustee and the 2000-2 Trust;
(iii) Prudential Securities Secured Financing Corporation,
as Depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-3, as issuer (the "2000-3 Trust"), amending
the Sale And Servicing Agreement, dated as of
September 1, 2000 by and among the Depositor, ABC, the
Indenture Trustee and the 2000-3 Trust;
(iv) Bear Stearns Asset Backed Securities, Inc., as
depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-4, as issuer (the "2000-4 Trust"), amending
the Sale and Servicing Agreement, dated as of December
1, 2000 by and among the Depositor, ABC, the Indenture
Trustee and the 2000-4 Trust.
(Incorporated by reference from Exhibit 10.10 of the
Registrant's 03/31/04 Form 10-Q).
10.136 Waiver dated March 9, 2004 to the Pooling And Servicing
Agreement, dated as of March 1, 2002, as amended February
20, 2004 ("Pooling Agreement"), and the Sale And Servicing
Agreements, dated, respectively, as of March 1, 2000, June
1, 2000, September 1, 2000 and December 1, 2000, each as
amended February 20, 2004 ("Sale Agreements"), issued by
Ambac Assurance Corporation, as Certificate Insurer under
the Pooling Agreement and as Note Insurer under the Sale
Agreements. (Incorporated by reference from Exhibit 10.11 of
the Registrant's 03/31/04 Form 10-Q).
295
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.137 Waiver, dated April 14, 2004, to the Pooling And Servicing
Agreement, dated as of March 1, 2002, as amended February
20, 2004 ("Pooling Agreement"), and the Sale And Servicing
Agreements, dated, respectively, as of March 1, 2000, June
1, 2000, September 1, 2000 and December 1, 2000, each as
amended February 20, 2004 ("Sale Agreements"), issued by
Ambac Assurance Corporation, as Certificate Insurer under
the Pooling Agreement and as Note Insurer under the Sale
Agreements. (Incorporated by reference from Exhibit 10.12 of
the Registrant's 03/31/04 Form 10-Q).
10.138 Amendment No. 2 to the POOLING AND SERVICING AGREEMENT,
SERIES 2003-1, dated as of April 30, 2004, by and among Bear
Stearns Asset Backed Securities, Inc., as Depositor (the
"Depositor"), American Business Credit, Inc., as Servicer
("Servicer"), EMC Mortgage Corporation, as Back-Up Servicer,
JPMorgan Chase Bank, as Trustee and Collateral Agent, Bear
Stearns & Co., Inc., as Class A-1 Certificateholder, and
Radian Asset Assurance, Inc., as Certificate Insurer,
amending the Pooling And Servicing Agreement relating to
ABFS MORTGAGE LOAN TRUST 2003-1, dated as of March 1, 2003,
by and among the Depositor, the Servicer, and JPMorgan Chase
Bank, in its capacity as trustee, collateral agent and
back-up servicer. (Incorporated by reference from Exhibit
10.13 of the Registrant's 03/31/04 Form 10-Q).
10.139 Fourth Waiver Letter, dated as of March 31, 2004, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., American
Business Mortgage Services, Inc., American Business Credit,
Inc., ABFS Mortgage Loan Warehouse Trust 2003-1 ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee and collateral agent
("Indenture Trustee") and JPMorgan Chase Bank, as note
purchaser, and (ii) the Indenture, dated as of September 22,
2003, between the Trust and the Indenture Trustee.
(Incorporated by reference from Exhibit 10.14 of the
Registrant's 03/31/04 Form 10-Q).
10.140 Amendment No. 1 to Sale and Servicing Agreement, dated as of
May 12, 2004, amending the Sale and Servicing Agreement,
dated as of September 22, 2003, among ABFS Balapointe, Inc.,
HomeAmerican Credit, Inc., American Business Mortgage
Services, Inc., American Business Credit, Inc., ABFS
Mortgage Loan Warehouse Trust 2003-1, American Business
Financial Services, Inc., and JPMorgan Chase Bank, as note
purchaser and as indenture trustee and collateral agent.
(Incorporated by reference from Exhibit 10.15 of the
Registrant's 03/31/04 Form 10-Q).
10.141 Employment Agreement dated May 24, 2004 by and between
American Business Financial Services, Inc. and Stephen M.
Giroux.**
296
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.142 Security Agreement dated June 30, 2004 among ABFS
Consolidated Holdings, Inc., American Business Mortgage
Services, Inc., HomeAmerican Credit, Inc., and American
Business Credit, Inc., and U.S. Bank National Association.
(Incorporated by reference from Exhibit 10.1 to the
Registrant's Current Report on Form 8-K dated June 28,
2004).
10.143 Amendment No. 4 dated as of September 16, 2004, to Sale and
Servicing Agreement, among ABFS Balapointe, Inc., as
depositor, HomeAmerican Credit, Inc., d/b/a Upland Mortgage
("Upland"), American Business Mortgage Services, Inc.
("ABMS" together with Upland, the "Originators"), and
American Business Credit, Inc., ABFS Mortgage Loan Warehouse
Trust 2003-1, as trust, American Business Financial
Services, Inc., as sponsor, JP Morgan Chase Bank, as
indenture trustee, JPMorgan Chase Bank, as collateral agent,
and JPMorgan Chase Bank, as note purchaser. (Incorporated by
reference from Exhibit 10.1 of the Registrant's Current
Report on Form 8-K dated September 20, 2004).
10.144 Amendment No. 5 dated as of September 30, 2004, to Sale and
Servicing Agreement, among ABFS Balapointe, Inc., as
depositor, HomeAmerican Credit, Inc., d/b/a Upland Mortgage
("Upland"), American Business Mortgage Services, Inc.
("ABMS" together with Upland, the "Originators"), and
American Business Credit, Inc., as servicer, ABFS Mortgage
Loan Warehouse Trust 2003-1, as trust, American Business
Financial Services, Inc., as sponsor, JP Morgan Chase Bank,
as indenture trustee, JPMorgan Chase Bank, as collateral
agent, and JPMorgan Chase Bank, as note purchaser.
(Incorporated by reference from Exhibit 10.1 of the
Registrant's Current Report on Form 8-K dated September 17,
2004).
10.145 Amendment Number One to Master Loan and Security Agreement,
dated as of September 30, 2004, by and between Chrysalis
Warehouse Funding, LLC, as lender, and ABFS Warehouse Trust
2003-2, as borrower.
10.146 Letter Purchase Agreement dated as of September 27, 2004 by
and among 50 By 50 LLC, as buyer, and American Business
Financial Services, Inc., as seller, and acknowledged and
agreed to by ABFS Consolidated Holdings, Inc. and American
Business Credit, Inc.
10.147 Fifth Waiver Letter, dated as of June 30, 2004, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., American
Business Mortgage Services, Inc., American Business Credit,
Inc., ABFS Mortgage Loan Warehouse Trust 2003-1 ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee and collateral agent
("Indenture Trustee") and JPMorgan Chase Bank, as note
purchaser, and (ii) the Indenture, dated as of September 22,
2003, between the Trust and the Indenture Trustee.
297
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.148 Sixth Waiver Letter, dated as of September 30, 2004, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., American
Business Mortgage Services, Inc., American Business Credit,
Inc., ABFS Mortgage Loan Warehouse Trust 2003-1 ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee and collateral agent
("Indenture Trustee") and JPMorgan Chase Bank, as note
purchaser, and (ii) the Indenture, dated as of September 22,
2003, between the Trust and the Indenture Trustee.
10.149 Form of Waiver, dated May 11, 2004, June 7, 2004, July 2,
2004, August 3, 2004, September 8, 2004 and October 4, 2004,
to the Pooling And Servicing Agreement, dated as of March 1,
2002, as amended February 20, 2004 ("Pooling Agreement"),
and the Sale And Servicing Agreements, dated, respectively,
as of March 1, 2000, June 1, 2000, September 1, 2000 and
December 1, 2000, each as amended February 20, 2004 ("Sale
Agreements"), issued by Ambac Assurance Corporation, as
Certificate Insurer under the Pooling Agreement and as Note
Insurer under the Sale Agreements.
11.1 Statement of Computation of Per Share Earnings (Included in
Note 21 of the Notes to June 30, 2004 Consolidated Financial
Statements).
12.1 Computation of Ratio of Earnings to Fixed Charges.
14.1 Code of Ethics for Senior Financial Officers.
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.
Exhibit numbers correspond to the exhibits required by Item 601 of Regulation
S-K for an Annual Report on Form 10-K.
298
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
AMERICAN BUSINESS FINANCIAL SERVICES, INC.
Date: October 13, 2004 By: /s/ Anthony J. Santilli
------------------------------------
Name: Anthony J. Santilli
Title: Chairman, President, Chief Executive
Officer, Chief Operating Officer and
Director (Duly Authorized Officer)
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Capacity Date
---------- -------- ------
/s/ Anthony J. Santilli
-------------------------- Chairman, President, Chief Executive Officer,
Anthony J. Santilli Chief Operating Officer and Director (Principal October 13, 2004
Executive and Operating Officer)
/s/ Albert W. Mandia
-------------------------- Executive Vice President and Chief Financial October 13, 2004
Albert W. Mandia Officer (Principal Financial and Accounting
Officer)
/s/ Leonard Becker
-------------------------- Director October 13, 2004
Leonard Becker
/s/ Michael R. DeLuca
-------------------------- Director October 13, 2004
Michael R. DeLuca
/s/ Joseph Pignotti
-------------------------- Director October 13, 2004
Joseph Pignotti
/s/ Jerome Miller
-------------------------- Director October 13, 2004
Jerome Miller
/s/ Warren E. Palitz
-------------------------- Director October 13, 2004
Warren E. Palitz
/s/ Harold E. Sussman
-------------------------- Director October 13, 2004
Harold E. Sussman
299
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation.
(Incorporated by reference from Appendix A to the
Registrant's Definitive Proxy Statement for its 2003 Annual
Meeting of Stockholders filed December 11, 2003).
3.2 Certificate of Designation, Preferences and Rights of Series
A Convertible Preferred Stock. (Incorporated by reference
from Appendix B to the Registrant's Definitive Proxy
Statement for its 2003 Annual Meeting of Stockholders filed
December 11, 2003).
3.3 Amended and Restated Bylaws. (Incorporated by reference from
Exhibit 3.1 of the Registrant's Current Report on Form 8-K
dated September 17, 2004).
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).
300
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
4.7 Form of Unsecured Investment Note (Incorporated by reference
from Exhibit 4.5 of the Registration Statement on Form SB-2
filed May 23, 1997, Registration Number 333-24115).
4.8 Form of Indenture by and between ABFS and U.S. Bank Trust,
National Association, a national banking association
(Incorporated by reference from Exhibit 4.8 of 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).
301
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
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).
4.19 Indenture dated December 31, 2003 by and between ABFS and
U.S. Bank National Association as Trustee. (Incorporated by
reference from Exhibit 4.2 of Registrant's Quarterly Report
on Form 10-Q for the period ended December 31, 2003, filed
on February 27, 2004).
4.20 Form of Senior Collateralized Subordinated Note.
(Incorporated by reference from Exhibit T3E-5 of
Registrant's Application for Qualification of Indenture
under the Trust Indenture Act of 1939 on Form T-3, filed on
December 1, 2003).
4.21 Form of Indenture by and between ABFS and U.S. Bank National
Association. (Incorporated by reference from Exhibit T3C of
Registrant's Application for Qualification of Indenture
under the Trust Indenture Act of 1939 on Form T-3, filed on
May 14, 2004).
4.22 Form of Senior Collateralized Subordinated Note.
(Incorporated by reference from Exhibit T3E-5 of
Registrant's Application for Qualification of Indenture
under the Trust Indenture Act of 1939 on Form T-3, filed on
May 14, 2004).
10.1 Amended and Restated Stock Option Plan (Incorporated by
reference from Exhibit 10.2 of the Registrant's Quarterly
Report on Form 10-QSB from the quarter ended September 30,
1997, filed on November 14, 1997 (the "09/30/97 Form
10-QSB")). **
10.2 Stock Option Award Agreement (Incorporated by reference from
Exhibit 10.1 of the Registrant's 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 Registrant's 1996 Form SB-2 filed on
February 4, 1997 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 Registrant's Annual Report on Form
10-KSB for the period ended June 30, 1996, filed on
September 27, 1996 (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 Registrant's 09/30/97 Form 10-QSB). **
302
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
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 Registrant's Registration Statement
on Form SB-2 filed on 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 the
Registrant's 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 Registrant's 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
Registrant's 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 Registrant's 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
Registrant's 1996 Form SB-2). **
10.12 Amendment One to Anthony J. Santilli's Employment Agreement
(Incorporated by reference from Exhibit 10.3 of the
Registrant's 09/30/97 Form 10-QSB). **
10.13 Amendment One to Beverly Santilli's Employment Agreement
(Incorporated by reference from Exhibit 10.4 of the
Registrant's 09/30/97 Form 10-QSB). **
10.14 Management Incentive Plan (Incorporated by reference from
Exhibit 10.16 of the Registrant's 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 Registrant's
1996 Form SB-2). **
10.16 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 Registrant's 03/31/95 Form 10-QSB).
303
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.17 Form of Indenture related to the Company's loan
securitizations dated 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
Registrant's Registration Statement on Form S-2 filed June
14, 2001, Registration No. 333-63014 (the "2001 Form S-2")).
10.18 Form of Unaffiliated Seller's Agreement related to the
Company's loan securitizations dated 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 Registrant's 2001 Form S-2).
10.19 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 Registrant's 1997 Form SB-2).
10.20 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 Registrant's 1997 Form SB-2).
10.21 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 Registrant's 1997 Form SB-2).
10.22 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 Registrant's
Registration Statement on Form SB-2, filed on January 22,
1998, Registration No. 333-2445).
10.23 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 Registrant's Registration Statement on Form SB-2,
filed on January 22, 1998, Registration No. 333-2445).
10.24 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 on September 21,
1998).
10.25 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 Registrant's 2001 Form S-2).
304
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.26 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).
10.27 Lease Agreement dated August 30, 1999 related to One
Presidential Boulevard, Bala Cynwyd, Pennsylvania
(Incorporated by reference from Exhibit 10.1 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1999, filed on November 15, 1999 (the
"09/30/99 Form 10-Q")).
10.28 Employment Agreement between American Business Financial
Services, Inc. and Albert Mandia (Incorporated by reference
from Exhibit 10.2 of the Registrant's 09/30/99 Form 10-Q).
**
10.29 Change in Control Agreement between American Business
Financial Services, Inc. and Albert Mandia (Incorporated by
reference from Exhibit 10.3 of the Registrant's 09/30/99
Form 10-Q). **
10.30 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). **
10.31 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 Quarterly Report on Form 10-Q for the quarter
ended March 31, 2000, filed on May 12, 2000).
10.32 Warehousing Credit and Security Agreement dated as of May 5,
2000 between New Jersey Mortgage and Investment Corp.,
American Business Credit, Inc., HomeAmerican Credit, Inc.
d/b/a Upland Mortgage and Residential Funding Corporation.
(Incorporated by reference from Exhibit 10.63 of the
Registrant's Registration Statement on Form S-2, No.
333-40248, filed on June 27, 2000).
10.33 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
Registrant's 2000 Form 10-K).
10.34 Employment Agreement by and between American Business
Financial Services, Inc. and Milton Riseman (Incorporated by
reference from Exhibit 10.66 of the Registrant's 2000 Form
10-K). **
305
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.35 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 Registrant's Registration Statement
on Form S-2, No. 333-40248, filed April 5, 2001 (the
"Amendment to the 2001 Form S-2")).
10.36 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 the
Registrant's Amendment to the 2001 Form S-2).
10.37 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 the Registrant's Amendment
to the 2001 Form S-2).
10.38 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
the Registrant's Amendment to the 2001 Form S-2).
306
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.39 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 the
Registrant's Amendment to the 2001 Form S-2).
10.40 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 Registrant's Annual Report on Form 10-K
for the fiscal year ended June 30, 2001, filed on September
28, 2001).
10.41 Letter Agreement dated July 1, 2000 between ABFS and Albert
W. Mandia. (Incorporated by reference from Exhibit 10.61 of
Amendment No. 1 to the Registrant's Registration Statement
on Form S-2 filed on October 5, 2001). **
10.42 American Business Financial Services, Inc. 2001 Stock
Incentive Plan. (Incorporated by reference from Exhibit 10.1
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2001, filed on November 14, 2001
(the "September 2001 Form 10-Q")).**
10.43 American Business Financial Services, Inc. 2001 Stock
Incentive Plan Restricted Stock Agreement. (Incorporated by
reference from Exhibit 10.2 of the Registrant's September
2001 Form 10-Q).**
10.44 American Business Financial Services, Inc. 2001 Executive
Management Incentive Plan. (Incorporated by reference from
Exhibit 10.3 of the Registrant's September 2001 Form
10-Q).**
10.45 Master Repurchase Agreement between Credit Suisse First
Boston Mortgage Capital LLC and ABFS Repo 2001, Inc.
(Incorporated by reference from Exhibit 10.2 of the
Registrant's December 2001 Form 10-Q).
10.46 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 of the Registrant's December 2001 Form 10-Q).
307
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.47 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 of the Registrant's December
2001 Form 10-Q).
10.48 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 of the
Registrant's December 2001 Form 10-Q).
10.49 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 of 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").
10.50 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 of the Registrant's March 2002 Form 10-Q).
10.51 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 of the Registrant's March 2002 Form 10-Q).
10.52 $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 of the Registrant's March 2002 Form 10-Q).
10.53 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).
308
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.54 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 the Registrant's Registration Statement on Form
S-2, No. 33-90366, filed on June 12, 2002 (the "2002 Form
S-2")).
10.55 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 Registrant's 2002 Form
S-2).
10.56 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 Registrant's 2002 Form S-2).
10.57 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
Registrant's 2002 Form S-2).
10.58 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 of the 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")).
10.59 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 of the
Registrant's 2002 Form 10-K).
309
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.60 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 of the Registrant's 2002 Form
10-K).
10.61 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 of
the Registrant's 2002 Form 10-K).
10.62 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 of the
Registrant's 2002 Form 10-K).
10.63 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 of the
Registrant's 2002 Form 10-K).
10.64 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
from Exhibit 10.1 of the Registrant's Current Report on Form
8-K, dated December 9, 2002, filed on December 27, 2002).
10.65 Letter Agreement dated May 20, 2002 between the Registrant
and the Commonwealth of Pennsylvania. (Incorporated by
reference from Exhibit 10.2 of the Registrant's Current
Report on Form 8-K, dated December 9, 2002, filed on
December 27, 2002).
10.66 Letter of Intent with PIDC Local Development Corporation
dated December 3, 2002. (Incorporated by reference from
Exhibit 10.3 of the Registrant's Current Report on Form 8-K,
dated December 9, 2002, filed on December 27, 2002).
10.67 Letter of Credit from JPMorgan Chase Bank for $6,000,000
provided as security for a lease for office space.
(Incorporated by reference from Exhibit 10.4 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended December 31, 2002, filed on February 14, 2003 (the
"12/31/02 Form 10-Q")).
310
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.68 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 from Exhibit
10.5 to the Registrant's 12/31/02 Form 10-Q).
10.69 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 from Exhibit 10.2 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003,
filed on May 15, 2003 (the "03/31/03 Form 10-Q")).
10.70 Amendment No. 3 to Letter of Credit Agreement with JP Morgan
Chase (Incorporated by reference from Exhibit 10.1 to the
Registrant's 03/31/03 Form 10-Q).
10.71 First Amendment to the Roseland Lease (Incorporated by
reference from Exhibit 10.3 of the Registrant's 03/31/03
Form 10-Q).
10.72 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 (the 06/25/03
Form S-2")).
10.73 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 06/25/03 Form S-2).
10.74 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 06/25/03 Form S-2).
311
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.75 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 06/25/03 Form S-2).
10.76 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 06/25/03 Form S-2).
10.77 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 06/25/03 Form S-2).
10.78 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.
(Incorporated by reference from Exhibit 10.99 of the
Registrant's Annual Report on Form 10-K for the year ended
June 30, 2003, filed on September 29, 2003 (the "2003 Form
10-K")).
10.79 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. (Incorporated by reference from Exhibit 10.100
of the Registrant's 2003 Form 10-K).
10.80 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. (Incorporated by reference from Exhibit
10.101 of the Registrant's 2003 Form 10-K).
312
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.81 Amended and Restated Committed Line of Credit Note, dated
June 2, 2003, between American Business Financial Services,
Inc. and Firstrust Savings Bank. (Incorporated by reference
from Exhibit 10.102 of the Registrant's 2003 Form 10-K).
10.82 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. (Incorporated
by reference from Exhibit 10.103 of the Registrant's 2003
Form 10-K).
10.83 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. (Incorporated by reference from Exhibit
10.104 of the Registrant's 2003 Form 10-K).
10.84 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. (Incorporated by reference from Exhibit
10.105 of the Registrant's 2003 Form 10-K).
10.85 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 from 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 Form
8-K")).
10.86 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. (Incorporated by reference from Exhibit
10.107 of the Registrant's 2003 Form 10-K).
10.87 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. (Incorporated by reference from Exhibit
10.108 of the Registrant's 2003 Form 10-K).
313
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.88 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 from Exhibit 10.2 of the
Registrant's 9/25/03 Form 8-K).
10.89 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 from Exhibit
10.3 of the Registrant's 9/25/03 Form 8-K).
10.90 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 from Exhibit 10.4 of the
Registrant's 9/25/03 Form 8-K).
10.91 Trust Agreement, dated as of September 22, 2003, by and
between ABFS BalaPointe, Inc., as Depositor and Wilmington
Trust Company, as Owner Trustee. (Incorporated by reference
from Exhibit 10.5 of the Registrant's 9/25/03 Form 8-K).
10.92 ABFS Mortgage Loan Warehouse Trust 2003-1 Secured Notes
Series 2003-1 Purchase Agreement. (Incorporated by reference
from Exhibit 10.6 of the Registrant's 9/25/03 Form 8-K).
10.93 Commitment letter dated September 22, 2003 addressed to
American Business Financial Services Inc. from Chrysalis
Warehouse Funding, LLC. (Incorporated by reference from
Exhibit 10.7 of the Registrant's 9/25/03 Form 8-K).
10.94 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 from Exhibit 10.8 of the Registrant's 9/25/03 Form
8-K).
10.95 Amendment to Senior Secured 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 from Exhibit 10.9 of the
Registrant's 9/25/03 Form 8-K).
10.96 Waiver dated September 30, 2003 to Indenture, dated
September 22, 2003 between ABFS Mortgage Loan Warehouse
Trust 2003-1 and JP Morgan Chase Bank, as Indenture Trustee.
(Incorporated by reference from Exhibit 10.13 of the
Registrant's Current Report on From 8-K, filed on October
16, 2003 (the "10/16/03 Form 8-K")).
314
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.97 First Amendment to First Amended and Restated Warehousing
Credit and Security Agreement, dated September 30, 2003,
between American Business Credit, Inc., American Business
Mortgage Services, Inc. and HomeAmerican Credit, Inc. and
Residential Funding Corporation. (Incorporated by reference
from Exhibit 10.12 of the Registrant's 10/16/03 Form 8-K).
10.98 Term-to-Term Servicing Agreement, Waiver and Consent dated
as of September 30, 2003 between American Business Credit,
Inc., MBIA Insurance Corporation as Note Insurer and JP
Morgan Chase Bank as Trustee. (Incorporated by reference
from Exhibit 10.14 of the Registrant's 10/16/03 Form 8-K).
10.99 Extension of the Expiration Date dated September 30, 2003
under the Master Repurchase Agreement between Credit Suisse
First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc.
from Credit Suisse First Boston Mortgage Capital LLC to ABFS
Repo 2001, Inc. (Incorporated by reference from Exhibit
10.10 of the Registrant's 10/16/03 Form 8-K).
10.100 Extension of the Expiration Date dated October 10, 2003
under the Master Repurchase Agreement between Credit Suisse
First Boston Mortgage Capital LLC and ABFS Repo 2001, Inc.
from Credit Suisse First Boston Mortgage Capital LLC to ABFS
Repo 2001, Inc. (Incorporated by reference from Exhibit
10.11 of the Registrant's 10/16/03 Form 8-K).
10.101 Waiver dated October 3, 2003 to Indenture dated September
22, 2003 between ABFS Mortgage Loan Warehouse Trust 2003-1
and JP Morgan Chase Bank, as Indenture Trustee.
(Incorporated by reference from Exhibit 10.8 of the
Registrant's 10/16/03 Form 8-K).
10.102 Master Loan and Security Agreement dated as of October 14,
2003 between ABFS Warehouse Trust 2003-2 and Chrysalis
Warehouse Funding, LLC. (Incorporated by reference from
Exhibit 10.1 of the Registrant's 10/16/03 Form 8-K).
10.103 Asset Purchase Agreement dated as of October 14, 2003
between ABFS Warehouse Trust 2003-1 and ABFS Warehouse Trust
2003-2. (Incorporated by reference from Exhibit 10.2 of the
Registrant's 10/16/03 Form 8-K).
10.104 Asset Purchase Agreement dated as of October 14, 2003 among
HomeAmerican Credit, Inc., d/b/a Upland Mortgage, American
Business Mortgage Services, Inc., and American Business
Credit, Inc., as Sellers and ABFS Warehouse Trust 2003-1, as
Purchaser. (Incorporated by reference from Exhibit 10.3 of
the Registrant's 10/16/03 Form 8-K).
315
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.105 Amended and Restated Trust Agreement between HomeAmerican
Credit, Inc., American Business Mortgage Services, Inc., as
Depositors, and American Business Credit, Inc., ABFS
Consolidated Holdings, Inc., as IOS Depositor and Wilmington
Trust Company, as Owner Trustee. (Incorporated by reference
from Exhibit 10.4 of the Registrant's 10/16/03 Form 8-K).
10.106 Trust Agreement between ABFS Warehouse Trust 2003-1 and
Wilmington Trust Company. (Incorporated by reference from
Exhibit 10.5 of the Registrant's 10/16/03 Form 8-K).
10.107 Fee and Right of First Refusal Letter addressed to ABFS
Warehouse Trust 2003-1, ABFS Warehouse Trust 2003-2,
American Business Financial Services, Inc. and its
subsidiaries from Clearwing Capital, LLC. (Incorporated by
reference from Exhibit 10.7 of the Registrant's 10/16/03
Form 8-K).
10.108 Waiver dated as of October 8, 2003 to Indenture dated
September 22, 2003 between ABFS Mortgage Loan Warehouse
Trust 2003-1 and JP Morgan Chase Bank, as Indenture Trustee.
(Incorporated by reference from Exhibit 10.9 of the
Registrant's 10/16/03 Form 8-K).
10.109 Pledge and Security Agreement dated as of October 14, 2003
between ABFS Warehouse Trust 2003-1 and Clearwing Capital,
LLC. (Incorporated by reference from Exhibit 10.6 of the
Registrant's 10/16/03 Form 8-K).
10.110 Servicing Agreement dated October 14, 2003 between ABFS
Warehouse Trust 2003-2, as Owner, Chrysalis Warehouse
Funding, LLC, as Lender, American Business Credit, Inc., as
Servicer, and Countrywide Home Loans Servicing LP, as Backup
Servicer. (Incorporated by reference from Exhibit 10.15 of
the Registrant's 10/16/03 Form 8-K).
10.111 Second Amended and Restated Sale and Servicing Agreement,
dated as of October 16, 2003, by and among ABFS Greenmont,
Inc., as Depositor, HomeAmerican Credit, Inc., d/b/a/ Upland
Mortgage, and American Business Mortgage Services, Inc., as
Originators and Subservicers, ABFS Mortgage Loan Warehouse
Trust 2000-2, as Trust, American Business Credit, Inc., as
Originator and Servicer, American Business Financial
Services, Inc., as Sponsor, and JPMorgan Chase Bank, as
Indenture Trustee and Collateral Agent. (Incorporated by
reference from Exhibit 10.4 of the Registrant's Current
Report on Form 8-K, filed on October 24, 2003 (the "10/24/03
Form 8-K")).
316
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.112 ABFS Mortgage Loan Warehouse Trust 2000-2 Secured Notes
Series 2000-2 Purchase Agreement, dated October, 16, 2003,
by and between ABFS Greenmont, Inc., ABFS Mortgage Loan
Warehouse Trust 2000-2 and JPMorgan Chase Bank.
(Incorporated by reference from Exhibit 10.2 of the
Registrant's 10/24/03 Form 8-K).
10.113 Fee Letter Agreement, dated October 16, 2003, addressed to
American Business Financial Services, Inc. from JPMorgan
Chase Bank. (Incorporated by reference from Exhibit 10.3 of
the Registrant's 10/24/03 Form 8-K).
10.114 Second Amended and Restated Indenture, dated as of October
16, 2003, by and between ABFS Mortgage Loan Warehouse Trust
2000-2, as Issuer, and JPMorgan Chase Bank, as Indenture
Trustee. (Incorporated by reference from Exhibit 10.1 of the
Registrant's 10/24/03 Form 8-K).
10.115 Waiver to Indenture, dated September 22, 2003, between ABFS
Mortgage Loan Warehouse Trust 2003-1 and JPMorgan Chase
Bank, as Indenture Trustee. (Incorporated by reference from
Exhibit 10.15 of the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2003, filed on
November 5, 2003).
10.116 Waiver to the 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 and to the 9/03 Amendment to
the Senior Secured Credit Agreement, among: American
Business Credit, Inc., HomeAmerican Credit, Inc., New Jersey
Mortgage and Investment Corp., American Business Financial
Services, Inc. and The Chase Manhattan Bank, as amended
(Incorporated by reference from Exhibit 10.117 of the
Registrant's Annual Report on Form 10-K/A, Amendment No. 2,
for the year ended June 30, 2003 filed on December 11, 2003
(the "12/11/03 Form 10-K/A")).
10.117 Consulting Agreement by and between ABFS and Milton Riseman,
dated July 3, 2003. (Incorporated by reference from Exhibit
10.118 of the Registrant's 12/11/03 Form 10-K/A). **
10.118 Amendment, dated December 1, 2003, to Consulting Agreement
by and between the Company and Milton Riseman, dated July 3,
2003 (Incorporated by reference from Exhibit 10.119 of the
Registrant's 12/11/03 Form 10-K/A).
10.119 Joint Agreement dated December 22, 2003 (Incorporated by
reference from Exhibit 99.2 of the Registrant's Current
Report on Form 8-K, filed on December 24, 2003).
10.120 Security Agreement dated December 31, 2003 by and among ABFS
Consolidated Holdings, Inc., American Business Mortgage
Services, Inc., HomeAmerican Credit, Inc., American Business
Credit, Inc., and U.S. Bank National Association, as
trustee. (Incorporated by reference from Exhibit 10.1 of the
Registrant's Current Report on Form 8-K filed on January 2,
2004).
317
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.121 Second Waiver Letter, dated as of October 31, 2003, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., d/b/a Upland
Mortgage ("Upland"), American Business Mortgage Services,
Inc. ("ABMS"), American Business Credit, Inc. ("ABC"), ABFS
Mortgage Loan Warehouse Trust 2003-1, as trust ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee ("Indenture Trustee") and
collateral agent, (ii) the Indenture, dated as of September
22, 2003, between the Trust and the Indenture Trustee; and
(iii) the 3/02 Amended and Restated Senior Secured Credit
Agreement, dated March 15, 2002 (as amended and supplemented
by the 10/02 Letter of Credit Supplement, the 12/02
Amendment, the 3/03 Amendment, 3/31/03 Amendment and the
9/03 Amendment), among Upland ABMS, ABC, Tiger Relocation
Company, ABFS Residual 2002, Inc., and JPMorgan Chase Bank.
(Incorporated by reference from Exhibit 10.24 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended December 31, 2003, filed on February 17, 2004 (the
"12/31/03 Form 10-Q")).
10.122 Third Waiver Letter, dated as of December 31, 2003, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., d/b/a Upland
Mortgage ("Upland"), American Business Mortgage Services,
Inc. ("ABMS"), American Business Credit, Inc. ("ABC"), ABFS
Mortgage Loan Warehouse Trust 2003-1, as trust ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee ("Indenture Trustee") and
collateral agent, (ii) the Indenture, dated as of September
22, 2003, between the Trust and the Indenture Trustee; and
(iii) the 3/02 Amended and Restated Senior Secured Credit
Agreement, dated March 15, 2002 (as amended and supplemented
by the 10/02 Letter of Credit Supplement, the 12/02
Amendment, the 3/03 Amendment, 3/31/03 Amendment and the
9/03 Amendment), among Upland, ABMS, ABC, Tiger Relocation
Company, ABFS Residual 2002, Inc., and JPMorgan Chase Bank.
(Incorporated by reference from Exhibit 10.25 of the
Registrant's 12/31/03 Form 10-Q).
10.123 Employment Agreement dated December 24, 2003, by and between
American Business Financial Services, Inc. and Barry
Epstein. (Incorporated by reference from Exhibit 10.26 of
the Registrant's 12/31/03 Form 10-Q). **
10.124 Restricted Stock Agreement dated December 24, 2003, by and
between American Business Financial Services, Inc. and Barry
Epstein. (Incorporated by reference from Exhibit 10.27 of
the Registrant's 12/31/03 Form 10-Q). **
10.125 Change in Control Agreement between the Company and Stephen
M. Giroux. (Incorporated by reference from Exhibit 10.28 of
the Registrant's 12/31/03 Form 10-Q). **
318
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.126 Form of AMENDED AND RESTATED POOLING AND SERVICING
AGREEMENT, dated as of March 5, 2004, by and among
Prudential Securities Secured Financing Corporation, in its
capacity as Depositor of the Trust ("Depositor"), American
Business Credit, Inc., in its capacity as servicer
("Servicer"), Wilshire Credit Corporation, in its capacity
as back-up servicer, and JPMorgan Chase Bank (f/k/a The
Chase Manhattan Bank), in its capacity as trustee
("Trustee"), relating to:
(i) ABFS MORTGAGE LOAN TRUST 1996-2, amending and
restating the Pooling and Servicing Agreement, dated
as of August 31, 1996, by and among the Depositor, the
Servicer and the Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1997-1, amending and
restating the Pooling and Servicing Agreement, dated
as of March 1 1997, by and among the Depositor, the
Servicer and the Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1997-2, amending and
restating the Pooling and Servicing Agreement, dated
as of September 1, 1997, by and among the Depositor,
the Servicer and the Trustee;
(iv) ABFS MORTGAGE LOAN TRUST 1998-1, amending and
restating the Pooling and Servicing Agreement, dated
as of February 1, 1998, by and among the Depositor,
the Servicer and the Trustee;
(v) ABFS MORTGAGE LOAN TRUST 1998-2, amending and
restating the Pooling and Servicing Agreement, dated
as of June 1, 1998, by and among the Depositor, the
Servicer and the Trustee;
(vi) ABFS MORTGAGE LOAN TRUST 1998-3, amending and
restating the Pooling and Servicing Agreement, dated
as of September 1, 1998, by and among the Depositor,
the Servicer and the Trustee.
(Incorporated by reference from Exhibit 10.1 of the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2004, filed on May 14, 2004 (the "03/31/04
Form 10-Q")).
319
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.127 Form of AMENDED AND RESTATED SALE AND SERVICING AGREEMENT,
dated as of March 5, 2004, by and among Prudential
Securities Secured Financing Corporation, as depositor (the
"Depositor"), American Business Credit, Inc., as servicer
(the "Servicer"), Wilshire Credit Corporation, as Back-up
Servicer, JPMorgan Chase Bank (f/k/a Chase Bank of Texas,
N.A.), as collateral agent (the "Collateral Agent"), The
Bank of New York, as indenture trustee (the "Indenture
Trustee"), and:
(i) ABFS MORTGAGE LOAN TRUST 1998-4, as issuer (the
"1998-4 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of November 1, 1998, by
and among the Depositor, the 1998-4 Trust, the
Servicer, the Collateral Agent and the Indenture
Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-1, as issuer (the
"1999-1 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of March 1, 1999, by and
among the Depositor, the 1999-1 Trust, the Servicer,
the Collateral Agent and the Indenture Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1999-4, as issuer (the
"1999-4 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of December 1, 1999, by
and among the Depositor, the 1999-4 Trust, the
Servicer, the Collateral Agent and the Indenture
Trustee.
(Incorporated by reference from Exhibit 10.2 of the
Registrant's 03/31/04 Form 10-Q).
10.128 Form of SUPPLEMENTAL INDENTURE NO. 1, dated as of
March 5, 2004, between The Bank Of New York, as indenture
trustee (the "Indenture Trustee") and:
(i) ABFS MORTGAGE LOAN TRUST 1998-4, as issuer
(the "1998-4 Trust"), supplementing the Indenture,
dated as of November 1, 1998, between the 1998-4
Trust and the Indenture Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-1, as issuer (the
"1999-1 Trust"), supplementing the Indenture, dated as
of March 1, 1999, between the 1999-1 Trust and the
Indenture Trustee;
(iii) ABFS MORTGAGE LOAN TRUST 1999-4, as issuer (the
"1999-4 Trust"), supplementing the Indenture, dated as
of November 1, 1999, between the 1998-4 Trust and the
Indenture Trustee.
(Incorporated by reference from Exhibit 10.3 of the
Registrant's 03/31/04 Form 10-Q).
10.129 Form of amended DEFINED TERMS, constituting Appendix I to
Exhibits 10.127 and 10.128. (Incorporated by reference from
Exhibit 10.4 of the Registrant's 03/31/04 Form 10-Q).
320
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.130 Form of AMENDED AND RESTATED SALE AND SERVICING AGREEMENT,
dated as of March 5, 2004, by and among Prudential
Securities Secured Financing Corporation, as depositor (the
"Depositor"), American Business Credit, Inc., as servicer
(the "Servicer"), Wilshire Credit Corporation, as back-up
servicer, JPMorgan Chase Bank, (f/k/a Chase Bank of Texas,
N.A.), as collateral agent (in such capacity, the
"Collateral Agent"), and JPMorgan Chase Bank (f/k/a The
Chase Manhattan Bank), as indenture trustee (in such
capacity, the "Indenture Trustee"), and:
(i) ABFS MORTGAGE LOAN TRUST 1999-2, as issuer (the
"1999-2 Trust"), amending and restating
Sale and Servicing Agreement, dated as of June 1,
1999, by and among the Depositor, the 1999-2 Trust,
the Servicer, the Collateral Agent and the Indenture
Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-3, as issuer (the
"1999-3 Trust"), amending and restating the Sale and
Servicing Agreement, dated as of September 1, 1999, by
and among the Depositor, the 1999-3 Trust, the
Servicer, the Collateral Agent and the Indenture
Trustee.
(Incorporated by reference from Exhibit 10.5 of the
Registrant's 03/31/04 Form 10-Q).
10.131 Form of SUPPLEMENTAL INDENTURE NO. 1, dated as of March 5,
2004, between JPMorgan Chase Bank (f/k/a The Chase Manhattan
Bank), as indenture trustee (the "Indenture Trustee") and:
(i) ABFS MORTGAGE LOAN TRUST 1999-2, as issuer (the "1999-2
Trust"), supplementing the Indenture, dated as of June 1,
1999, between the 1999-2 Trust and the Indenture Trustee;
(ii) ABFS MORTGAGE LOAN TRUST 1999-3, as issuer (the "1999-3
Trust"), supplementing the Indenture, dated as of September
1, 1999, between the 1999-3 Trust and the Indenture Trustee.
(Incorporated by reference from Exhibit 10.6 of the
Registrant's 03/31/04 Form 10-Q).
10.132 Form of amended DEFINED TERMS, constituting Appendix I to
Exhibits 10.130 and 10.131. (Incorporated by reference from
Exhibit 10.7 of the Registrant's 03/31/04 Form 10-Q).
321
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.133 Amendment No. 1 to the POOLING AND SERVICING AGREEMENT,
SERIES 2003-1, dated as of the October 31, 2003, by and
among Bear Stearns Asset Backed Securities, Inc., as
Depositor (the "Depositor"), American Business Credit, Inc.,
as Servicer ("Servicer"), EMC Mortgage Corporation, as
Back-Up Servicer, JPMorgan Chase Bank, as Trustee and
Collateral Agent, Bear Stearns & Co. Inc., as Class A-1
Certificateholder, and Radian Asset Assurance Inc., as
Certificate Insurer, amending the Pooling And Servicing
Agreement relating to ABFS MORTGAGE LOAN TRUST 2003-1, dated
as of March 1, 2003, by and among the Depositor, the
Servicer, and JPMorgan Chase Bank, in its capacity as
trustee, collateral agent and back-up servicer.
(Incorporated by reference from Exhibit 10.8 of the
Registrant's 03/31/04 Form 10-Q).
10.134 AMENDMENT NO. 1 TO THE POOLING AND SERVICING AGREEMENT,
SERIES 2002-1, dated as of February 20, 2004, by and among
Bear Stearns Asset Backed Securities, Inc., as depositor
(the "Depositor"), American Business Credit, Inc., as
servicer ("ABC"), JPMorgan Chasse Bank, as trustee and
collateral agent (the "Trustee"), Ambac Assurance
Corporation, as Certificate Insurer and party entitled to
exercise the voting rights of the Majority, and ABFS
Warehouse Trust 2003-1, as Class R Certificateholder,
amending the POOLING AND SERVICING AGREEMENT, dated as of
March 1, 2002, by and among the Depositor, ABC and the
Trustee. (Incorporated by reference from Exhibit 10.9 of the
Registrant's 03/31/04 Form 10-Q).
322
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.135 Form of AMENDMENT NO. 1 TO THE SALE AND SERVICING AGREEMENT,
dated as of February 20, 2004, by and among, American
Business Credit, Inc., as Servicer ("ABC"), JPMorgan Chase
Bank (formerly known as The Chase Manhattan Bank), as
indenture trustee and JPMorgan Chase Bank (as successor to
Chase Bank of Texas, N.A.) as collateral agent
(collectively, the "Indenture Trustee"), Ambac Assurance
Corporation, as Note Insurer and as the party entitled to
exercise the voting rights of the Majority Noteholders, ABFS
Warehouse Trust 2003-1, as Holder of a majority of the
Percentage Interest in the Trust Certificates, and:
(i) Prudential Securities Secured Financing Corporation,
as Depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-1, as issuer (the "2000-1 Trust"), amending
the Sale and Servicing Agreement, dated as of March 1,
2000 by and among the Depositor, ABC, the Indenture
Trustee and the 2000-1 Trust;
(ii) Prudential Securities Secured Financing Corporation,
as Depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-2, as issuer (the "2000-2 Trust"), amending
the Sale And Servicing Agreement, dated as of June 1,
2000 by and among the Depositor, ABC, the Indenture
Trustee and the 2000-2 Trust;
(iii) Prudential Securities Secured Financing Corporation,
as Depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-3, as issuer (the "2000-3 Trust"), amending
the Sale And Servicing Agreement, dated as of
September 1, 2000 by and among the Depositor, ABC, the
Indenture Trustee and the 2000-3 Trust;
(iv) Bear Stearns Asset Backed Securities, Inc., as
depositor (the "Depositor") and ABFS Mortgage Loan
Trust 2000-4, as issuer (the "2000-4 Trust"), amending
the Sale and Servicing Agreement, dated as of December
1, 2000 by and among the Depositor, ABC, the Indenture
Trustee and the 2000-4 Trust.
(Incorporated by reference from Exhibit 10.10 of the
Registrant's 03/31/04 Form 10-Q).
10.136 Waiver dated March 9, 2004 to the Pooling And Servicing
Agreement, dated as of March 1, 2002, as amended February
20, 2004 ("Pooling Agreement"), and the Sale And Servicing
Agreements, dated, respectively, as of March 1, 2000, June
1, 2000, September 1, 2000 and December 1, 2000, each as
amended February 20, 2004 ("Sale Agreements"), issued by
Ambac Assurance Corporation, as Certificate Insurer under
the Pooling Agreement and as Note Insurer under the Sale
Agreements. (Incorporated by reference from Exhibit 10.11 of
the Registrant's 03/31/04 Form 10-Q).
323
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.137 Waiver, dated April 14, 2004, to the Pooling And Servicing
Agreement, dated as of March 1, 2002, as amended February
20, 2004 ("Pooling Agreement"), and the Sale And Servicing
Agreements, dated, respectively, as of March 1, 2000, June
1, 2000, September 1, 2000 and December 1, 2000, each as
amended February 20, 2004 ("Sale Agreements"), issued by
Ambac Assurance Corporation, as Certificate Insurer under
the Pooling Agreement and as Note Insurer under the Sale
Agreements. (Incorporated by reference from Exhibit 10.12 of
the Registrant's 03/31/04 Form 10-Q).
10.138 Amendment No. 2 to the POOLING AND SERVICING AGREEMENT,
SERIES 2003-1, dated as of April 30, 2004, by and among Bear
Stearns Asset Backed Securities, Inc., as Depositor (the
"Depositor"), American Business Credit, Inc., as Servicer
("Servicer"), EMC Mortgage Corporation, as Back-Up Servicer,
JPMorgan Chase Bank, as Trustee and Collateral Agent, Bear
Stearns & Co., Inc., as Class A-1 Certificateholder, and
Radian Asset Assurance, Inc., as Certificate Insurer,
amending the Pooling And Servicing Agreement relating to
ABFS MORTGAGE LOAN TRUST 2003-1, dated as of March 1, 2003,
by and among the Depositor, the Servicer, and JPMorgan Chase
Bank, in its capacity as trustee, collateral agent and
back-up servicer. (Incorporated by reference from Exhibit
10.13 of the Registrant's 03/31/04 Form 10-Q).
10.139 Fourth Waiver Letter, dated as of March 31, 2004, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., American
Business Mortgage Services, Inc., American Business Credit,
Inc., ABFS Mortgage Loan Warehouse Trust 2003-1 ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee and collateral agent
("Indenture Trustee") and JPMorgan Chase Bank, as note
purchaser, and (ii) the Indenture, dated as of September 22,
2003, between the Trust and the Indenture Trustee.
(Incorporated by reference from Exhibit 10.14 of the
Registrant's 03/31/04 Form 10-Q).
10.140 Amendment No. 1 to Sale and Servicing Agreement, dated as of
May 12, 2004, amending the Sale and Servicing Agreement,
dated as of September 22, 2003, among ABFS Balapointe, Inc.,
HomeAmerican Credit, Inc., American Business Mortgage
Services, Inc., American Business Credit, Inc., ABFS
Mortgage Loan Warehouse Trust 2003-1, American Business
Financial Services, Inc., and JPMorgan Chase Bank, as note
purchaser and as indenture trustee and collateral agent.
(Incorporated by reference from Exhibit 10.15 of the
Registrant's 03/31/04 Form 10-Q).
10.141 Employment Agreement dated May 24, 2004 by and between
American Business Financial Services, Inc. and Stephen M.
Giroux.**
324
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.142 Security Agreement dated June 30, 2004 among ABFS
Consolidated Holdings, Inc., American Business Mortgage
Services, Inc., HomeAmerican Credit, Inc., and American
Business Credit, Inc., and U.S. Bank National Association.
(Incorporated by reference from Exhibit 10.1 to the
Registrant's Current Report on Form 8-K dated June 28,
2004).
10.143 Amendment No. 4 dated as of September 16, 2004, to Sale and
Servicing Agreement, among ABFS Balapointe, Inc., as
depositor, HomeAmerican Credit, Inc., d/b/a Upland Mortgage
("Upland"), American Business Mortgage Services, Inc.
("ABMS" together with Upland, the "Originators"), and
American Business Credit, Inc., ABFS Mortgage Loan Warehouse
Trust 2003-1, as trust, American Business Financial
Services, Inc., as sponsor, JP Morgan Chase Bank, as
indenture trustee, JPMorgan Chase Bank, as collateral agent,
and JPMorgan Chase Bank, as note purchaser. (Incorporated by
reference from Exhibit 10.1 of the Registrant's Current
Report on Form 8-K dated September 20, 2004).
10.144 Amendment No. 5 dated as of September 30, 2004, to Sale and
Servicing Agreement, among ABFS Balapointe, Inc., as
depositor, HomeAmerican Credit, Inc., d/b/a Upland Mortgage
("Upland"), American Business Mortgage Services, Inc.
("ABMS" together with Upland, the "Originators"), and
American Business Credit, Inc., as servicer, ABFS Mortgage
Loan Warehouse Trust 2003-1, as trust, American Business
Financial Services, Inc., as sponsor, JP Morgan Chase Bank,
as indenture trustee, JPMorgan Chase Bank, as collateral
agent, and JPMorgan Chase Bank, as note purchaser.
(Incorporated by reference from Exhibit 10.1 of the
Registrant's Current Report on Form 8-K dated September 17,
2004).
10.145 Amendment Number One to Master Loan and Security Agreement,
dated as of September 30, 2004, by and between Chrysalis
Warehouse Funding, LLC, as lender, and ABFS Warehouse Trust
2003-2, as borrower.
10.146 Letter Purchase Agreement dated as of September 27, 2004 by
and among 50 By 50 LLC, as buyer, and American Business
Financial Services, Inc., as seller, and acknowledged and
agreed to by ABFS Consolidated Holdings, Inc. and American
Business Credit, Inc.
10.147 Fifth Waiver Letter, dated as of June 30, 2004, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., American
Business Mortgage Services, Inc., American Business Credit,
Inc., ABFS Mortgage Loan Warehouse Trust 2003-1 ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee and collateral agent
("Indenture Trustee") and JPMorgan Chase Bank, as note
purchaser, and (ii) the Indenture, dated as of September 22,
2003, between the Trust and the Indenture Trustee.
325
EXHIBIT
NUMBER DESCRIPTION
------- ------------------------------------------------------------
10.148 Sixth Waiver Letter, dated as of September 30, 2004, from
JPMorgan Chase Bank regarding (i) the Sale and Servicing
Agreement, dated as of September 22, 2003, among ABFS
Balapointe, Inc., HomeAmerican Credit, Inc., American
Business Mortgage Services, Inc., American Business Credit,
Inc., ABFS Mortgage Loan Warehouse Trust 2003-1 ("Trust"),
American Business Financial Services, Inc., and JPMorgan
Chase Bank, as indenture trustee and collateral agent
("Indenture Trustee") and JPMorgan Chase Bank, as note
purchaser, and (ii) the Indenture, dated as of September 22,
2003, between the Trust and the Indenture Trustee.
10.149 Form of Waiver, dated May 11, 2004, June 7, 2004, July 2,
2004, August 3, 2004, September 8, 2004 and October 4, 2004,
to the Pooling And Servicing Agreement, dated as of March 1,
2002, as amended February 20, 2004 ("Pooling Agreement"),
and the Sale And Servicing Agreements, dated, respectively,
as of March 1, 2000, June 1, 2000, September 1, 2000 and
December 1, 2000, each as amended February 20, 2004 ("Sale
Agreements"), issued by Ambac Assurance Corporation, as
Certificate Insurer under the Pooling Agreement and as Note
Insurer under the Sale Agreements.
11.1 Statement of Computation of Per Share Earnings (Included in
Note 21 of the Notes to June 30, 2004 Consolidated Financial
Statements).
12.1 Computation of Ratio of Earnings to Fixed Charges.
14.1 Code of Ethics for Senior Financial Officers.
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.
Exhibit numbers correspond to the exhibits required by Item 601 of Regulation
S-K for an Annual Report on Form 10-K.
326